AMETEK, Inc.
Q1 2020 Earnings Call Transcript

Published: 5 May 2020

[Operator:]

Ladies and gentlemen, thank you for standing by. And welcome to the First Quarter 2020 AMETEK, Inc. Earnings Conference Call. Please be advised that today's conference is being recorded. It is now my pleasure to introduce Vice President of Investor Relations, Kevin Coleman.

[Kevin Coleman:]

Thank you, Andrew. Good morning and thank you for joining us for AMETEK's first quarter 2020 earnings conference call. With me today are Dave Zapico, Chairman and Chief Executive Officer; and Bill Burke, Executive Vice President and Chief Financial Officer.

[Dave Zapico:]

Thank you, Kevin and good morning everyone. Despite a challenging and highly uncertain economic environment due to the Covid-19 global pandemic, AMETEK delivered solid first quarter results, highlighted by excellent operating performance with earnings in line with our guidance range. I'll provide more details on the first quarter results shortly, but first I want to extend my thanks to all my AMETEK colleagues and recognize them for their amazing dedication and commitment through this difficult time. A courage and resilience I witnessed has been truly impressive. As AMETEK has been deemed an essential or life sustaining business at our operating facilities, our employees continue to provide critical solutions and services to customers across many industries including healthcare, defense, food and beverage and laboratory research. To help safety and well-being our employee as they support these essential customers is our highest priority. We've implemented numerous safety measures aimed at providing a safe work environment. Our pandemic response plan providing a framework for our businesses to manage our facilities and workforce during this pandemic.

[Bill Burke:]

Thank you, Dave. I would also like to thank our colleagues around the world for their tremendous efforts over the past few months. We have asked a lot of our colleagues as we manage the impact of Covid-19 on our business. And as always, they have risen to the challenge. The actions our businesses took in the first quarter helped us deliver strong operating performance and improved our already strong balance sheet and liquidity position. Let me provide some financial highlights for the quarter. First quarter general and administrative expenses were down $3 million compared to the same period in 2019 due largely to lower compensation costs. General and administrative expenses were 1.3% of sales versus last year's level of 1.4% of sales. The adjusted effective tax rate in the quarter was 19.4% down from last year's first quarter tax rate of 20.5% with this lower rate in the quarter being due to tax planning initiatives. For 2020, we expect our effective tax rate to be between 20% and 21% and as we've stated in the past actual quarterly tax rates can differ dramatically either positively or negatively from this full-year estimated rate. Operating working capital in the quarter was 18.9% versus 18.2% in the first quarter of 2019. Capital expenditures were $17 million for the first quarter. As Dave indicated, we now expect full-year capital expenditures to be approximately $75 million, down from our initial expectations of a $100 million. Depreciation and amortization expense in the quarter was $66 million. For the full year, we continue to expect depreciation and amortization to be approximately $255 million, which includes after-tax acquisition related intangible amortization of approximately $120 million or $0.52 per diluted share. Operating cash flow in the quarter was outstanding at $271 million, up 38% over 2019's first quarter. Free cash flow was $254 million, up 45% over the prior year period and free cash flow conversion adjusted for the Reading gain was excellent at 148%. Total debt at the end of the quarter was $3.25 billion, up from $2.77 billion at the end of 2019. During the first quarter, we drew down $500 million from our revolver to bolster our liquidity position. We also deployed approximately $115 million on the acquisition of IntelliPower during the quarter. Offsetting this debt is cash and cash equivalents of $1.25 billion, which includes the proceeds from the sale of Reading Alloys and the draw down on the revolver. Our gross debt to EBITDA ratio at the end of the first quarter was 2.2x as we were intentionally holding higher than normal cash balances. This ratio was comfortably below our debt covenants of 3.5x. Our net debt to EBITDA ratio was 1.4x at the end of the quarter. AMETEK is extremely well positioned to manage this economic downturn. We have more than $1.8 billion in liquidity to support our operations and growth initiatives, including $550 million in available revolver capacity. We have a robust balance sheet with no material debt maturities due until 2023. To conclude, our businesses delivered a solid quarter despite extraordinary challenges due to Covid-19. Our world-class workforce, the strong cash generation of our niche businesses and our balance sheet strength position us well to manage this downturn and will position us well to invest in our growth strategies over the long term. Kevin?

[Kevin Coleman:]

Thank you, Bill. Andrew could we please open the lines for questions.

[Operator:]

Our first question comes from the line of Joshua Pokrzywinski with Morgan Stanley.

[JoshuaPokrzywinski:]

Hi. Good morning, everyone. Hope you're well. If you wouldn't mind just talking a little bit about April or maybe March exit rates just give us a sense for what you're seeing out there. I appreciate all the color on decrementals and then certainly how margins held up in the first quarter. But maybe give us a sense for demand cadence, I know a few weeks maybe isn't a trend at this point but just to kind of calibrate where we're at on that first.

[DaveZapico:]

Sure. Josh. So there'll be a substantial revenue drop in April. We were down about 25% in April. And as we look ahead to the quarter we can be down about 25% or a bit more or a bit less because we have limited availability. But I pointed to that 25% that we actually were down in April.

[JoshuaPokrzywinski:]

Got it. That's really helpful. I appreciate, Dave. And I guess on the other side of this understanding that some of these countermeasures on the cost side end up being temporary and some are a little bit more permanent in nature. Anything that would prevent kind of a normal incremental margin on the other side i.e. are you pulling on the temporary levers such that you do need to kind of reflect the cost base or compensation metrics et cetera, when we do finally recover it. It doesn't look like the case but you just want to make sure that that's the way you're thinking about it.

[DaveZapico:]

Yes. That's a good question and that's why there's a balance of structural and temporary cost reductions. I mean we, historically, when AMETEK recover out of these downturns we've been had very high contribution margins and I would expect the same thing to occur this time. But we're using our best judgment and our experience with these businesses to balance the structural cost reductions with the temporary. So we have going to have $80 million in cost savings in Q2 about $30 million of that is structural and about $50 million of that's temporary. And then as we go through the course we'll increase or decrease that temporary cost reductions based on demand. And if it looks like demand is not materializing, it doesn't do any good to leave around the excess and unutilized resources. So we have the capability to do more, but we have a good feel for these businesses and we want to get through this thing with our businesses impact intact. At the same time focus on the decrementals as we get through that. And I would expect that we would have very good incrementals as when we ultimately get through the crisis and we recover.

[Operator:]

Our next question comes from the line of Deane Dray with RBC Capital Markets.

[DeaneDray:]

Thank you. Good morning, everyone. Hey, just to clarify the down 25% in April was that an organic revenue growth? And how did orders shake out?

[DaveZapico:]

Orders and sales are about the same. Orders were about that 25 point level; sales were just a bit more and that's really on the total orders and sales.

[DeaneDray:]

Good. And, Dave, can you talk about visibility? I mean part of the AMETEK business model is you've got healthy recurring revenues around 30%. So how do you think those hold up and just kind of connect us what we're seeing in terms of customer behavior, push outs, cancellations and so forth.

[DaveZapico:]

Yes. Sure. That's a good question, Deane. I mean when I think about Q1 or the end of Q1, we left probably $40 million or $50 million, four or five points of organic growth. We could not ship because our customers weren't available to take delivery or we cannot travel to the site to do the installation and commissioning work. So it's -- that was a big deal for us and we have to get to places in China and around the world and in the US especially in our process and power businesses. And do that commissioning and get that recurring revenue. So part of the customer behavior part for your question is that they delayed shipments. And we weren't able to access them and part of the recurring revenue is, it's driven by the ability to service them. So I think the recurring revenues will hold up relatively well, may be except in the aerospace business but we have to be able to travel and get to our customers and had to return some normalcy there for that to happen.

[DeaneDray:]

That's real helpful and appreciates all the color on the decrementals because that's absolutely within the band that we'd expect based upon the cost outs that you've taken. So I kind of feel like we can ask a more forward-looking question regarding when and how can you pivot to playing offense. You've got just an exceptionally strong balance sheet. We know M&A markets need to settle down, but what's expectation in terms of line of sight on potential acquisitions at the stage or is it just too early.

[DaveZapico:]

I think it's a great question, Deane, because we feel we're going to emerge from this crisis with an excellent M&A opportunity. It's going to remain our first priority for capital allocation. Bill already went through the strong balance sheet, the cash flow generating capabilities of companies and we had a very strong pipeline going into this crisis. We closed on an IntelliPower in Q1. We were very close on another deal, a very nice business we had just felt we could not finalize our diligence and integrate it with the restrictions caused by the virus. Certainly, it's a potential to continue with that deal post crisis because we really like it. And we have a good relationship with the sellers. And we're going to keep developing our pipeline. We have multiple tangible opportunities for post crisis. I mean a great pipeline going into this and we're going to use our business development team to maintain those relationships. In terms of the current environment, buyers and sellers are focused differently what challenges they have in their business. New set of buyers. There's a new set of buyer price expectations that need to get aligned with seller expectations. You don't have the ability to perform face-to-face diligence to negotiate to integrate it. So I think it's going to be late 2020 maybe the fourth quarter of 2020 before the market begins returning to normal. But I think we're well positioned to really capitalize on the opportunity there. And that's the way we're thinking about this thing. We're going to preserve our balance sheet now make sure it's strong and we're going to see a bigger opportunity and we get out of this.

[Operator:]

Our next question comes from the line of Ivana Delevska with Gordon Haskett.

[IvanaDelevska:]

Good morning. So just wanted to ask as we emerge from this what percent of your businesses do you think could kind of more quickly come back versus what could take longer time to get back to normal?

[DaveZapico:]

Yes. That's a good question, Ivana. And it's really -- it's both end market and the time of -- and the type of business that we're talking about. As I mentioned earlier, we serve a range of different end markets and some of these markets are seeing solid demand. These include medical wealth care, defense businesses and some markets are very challenged and oil and gas and aerospace. So I think the oil and gas and aerospace businesses are going to be the last to pick up positively; probably oil and gas will pick up well before aerospace, but the aerospace downturn we could have a couple two or three years but the majority of our businesses I think are going to recover quite well from this. And we have higher incremental margins and we're managing the decremental is on the way down. So I'm pretty optimistic that we'll be able to -- we were able to expand the last three years to 2019, we grew organically 5% a year greater than industrial production. And we got great margin expansion and in the environment that we're going to have in the second half of the year and into 2021 you may be an environment we're growing a little bit faster than that. So I expect our businesses to respond and our businesses to have better margins on the way out and with the exception that aerospace and oil and gas could be down for a while.

[IvanaDelevska:]

Okay. And in terms of mix in terms of marginal impacts of those businesses kind of underperforming. Would it be a positive for margins?

[DaveZapico:]

Yes. I think it'll be a positive for margins on the way down our aerospace is a pretty profitable business. It's a couple of points more profitable than the base business and our oil and gas is about at the base business profitability. We had 20% EBITDA in the first quarter so. But I think if you go back and look at the prior downturns and AMETEK recovered from them. We've always had healthy contribution margins on the way out because we're such a profitable business.

[Operator:]

Our next question comes from the line of Scott Graham with Rosenblatt Securities.

[ScottGraham:]

Hey. Good morning Dave, Bill, Kevin. Hey, so I hope you can help me with a couple of questions on the cost save. So we came into the year with about $90 million of them sort of based productivity as I call it. And I think I heard you say that the restructuring charges are going to give us $85 million in savings. Do we add those numbers together?

[DaveZapico:]

No. Well, you are actually doing an annualized basis. The $85 million is on an annualized basis. So when I think about the second half of the year we talked about $30 million maybe $30 million in structural safe savings in Q3 combined with about $50 million of variable when we get to the second half of the year Q3 and Q4 and we have about $75 million of structural savings right across those two quarters. So the structural savings will ramp up and if it plays out like we think the temporary savings will ramp down. And we'll exit 2021 with a pretty healthy level cost reductions on a run rate basis going into 2021.

[ScottGraham:]

And -- right so the 2021 carryover on structural, what would that be?

[DaveZapico:]

It's going to depend on some things, but I think it will be about $40 million.

[ScottGraham:]

Got it. and if you could just maybe help us understand on the cadence of sales in aerospace, commercial aerospace and oil and gas, certainly we understand that they’re worse, perhaps a lot worse than the April sales number, but is there any kind of parameter you can throw around those numbers to help us understand what the real deltas are?

[DaveZapico:]

Yes. I'll give you an idea with aerospace and, again, there’s a caveat that we don’t have good visibility. But our commercial aerospace business is up 10% of the company, that includes our OE and after market that can be down 50%, and the after-market part of it can be down more, the OE part of it down a little less, but that markets going drop, it’s going to be pretty significant and we’re seeing that happen. So, that’s just a fact for a considerable amount of time.

[ScottGraham:]

Yes. And the oil and gas?

[DaveZapico:]

Oil and gas is going to have a tough time, I think the recovery is going to be faster because it’s going to be more based on a commodity price and it’s not going to be as long term, it’s going to be people start driving their cars again. It’s going to be, you know, definitely less than 50% for the year, but I’d put it in the 25% range or something like that, more so in the upstream than the downstream.

[Operator:]

Thank you. And our next question comes from the line of Nigel Coe with Wolfe Research.

[NigelCoe:]

Thanks. Good morning, gents. So just going back to the decremental margins, obviously, very impressive management of those. So before the discretionary cost savings, what kind of gross decremental margin are we looking at here? Is it sort of 45% type numbers? And are you confident that there’s enough discretionary cost you can go after to manage decrementals into those ranges within a reasonable revenue range?

[DaveZapico:]

Yes, it’s an excellent question, Nigel. And if you think about this kind of environment, you’re going to end up with the decremental margins of – if we did nothing, we’d be in that 50%, 55%, some businesses at 60% range. So what we’re doing is we’re mitigating that greater-than-50% decremental margin in this kind of environment, and we have a higher margin business. And the costs that we’re taking out are getting us to the 25% to 30% decrementals for the year.

[NigelCoe:]

Okay. But what you’re saying is there’s enough discretionary cost in the short-term to comfortably manage in that range? There’s no breakpoints that you see right now.

[DaveZapico:]

Yes, I don’t see – it’s going to be difficult, and we didn’t give guidance, but we’re pretty good at managing the decrementals and that’s our focus right now. We’re going month to month, and our operating operations are making adjustments on the level of capacity and the level of customer demands. And I think that we can manage to that 25% to 30% level for the year.

[NigelCoe:]

Great. And then my follow-up question is one of the keys to success for AMETEK in the past has been the right incentives at the divisional level. Some for growth, some for margin, cash flow, et cetera. Given the lack of visibility right now, how have you changed the incentive structure for your divisional managers?

[DaveZapico:]

We haven’t changed them as of yet. They’re still based on the original targets that were set for the year. And we’re – we are managing through this thing. And I personally – everybody is going to feel some pain through this process, and resetting targets to the existing level of our business isn’t fair for everyone, including our shareholders. So it’s going to be a tough year, and there’s going to be less variable compensation. That opportunity is still there, but it’s not going to materialize. And that’s just the way it is. And I’ll talk to my Comp Committee about the appropriate things in these areas. But in general, there’s going to be lower variable payments from our incentive systems this year.

[Operator:]

Thank you. And our next question comes from the line of Brett Linzey with Vertical Research.

[BrettLinzey:]

Hey. Good morning, guys. Hey. Just wanted to come back to the comments on the medical health care and defense bucket at 20%. Were you suggesting in April that was actually a positive in terms of sales and orders? And then how are you thinking about that for the year?

[DaveZapico:]

Yes, I think the defense, the medical, the health care are going to be positive for the year. And in April, they didn’t decline as much. So that’s how we’re thinking about it. That piece of our business at this point seems to feel pretty solid. The thing that we – it was very encouraging in Q1, we bought Gatan. We have a couple of quarter with Gatan; it’s still above its acquisition model. So they’re doing a great job for us. And some of our recent acquisitions like Rauland in the health care space, MOCON in the food space, and Telular in the IoT space, these are three pretty sizable deals we did over the last couple years. All three of those businesses in Q1 had double digit orders growth. So we’re expecting those kinds of businesses to hold up pretty well. We’re not sure if it’s going to be plus or minus, but it’s certainly not going to be the – they did not see that kind of decline in the quarter. We’re not – they’re not going to see that decline in the quarter.

[BrettLinzey:]

Okay. Great. And then just shifting to free cash flow. Very solid start to the year. What is the expectation as we go forward here? I mean, should we assume that the working capital should get a lift as the business cycles down? And maybe just a little bit of a framework on conversion or maybe a range you’re thinking about for the year.

[DaveZapico:]

Yes, I think in the second quarter, you’d expect a working capital lift as you have both impacted the lower sales level. But then some of that will get added back given the sequential increases in sales that we’re expecting. I think overall a good place to be would be north of 120% of free cash flow conversion to net income.

[BrettLinzey:]

Okay. Great.

[DaveZapico:]

For the year. For the year.

[Operator:]

Thank you. And our next question comes from the line of Robert McCarthy with Stephens.

[RobertMcCarthy:]

Good morning, everyone. Thank you for taking my questions. I guess the first question is a little bit to amplify your comments around the realignment charges you took. I guess this is consistent with kind of your practice periodically. I think the last time you did this was kind of in the 2016 time frame with the oil and gas retrenchment. You talked about a payback I think of 2x or something along those lines. But could you talk about that in terms of what you’re expecting for the run rate savings again? And then just in that context, where are you taking out the most capacity? Is it presumably aerospace? Is it presumably these businesses that seem to be a little more longer cycle and structurally challenged and obviously are in the news because you see a lot of capacity being taken out across the complex?

[DaveZapico:]

Right. That’s a great question, Rob. We attempted to balance these permanent cost reductions in area where demand has been more impacted. So, as an example, in the commercial aerospace market, we had about a 20% headcount reduction, and we had a little bit more than our average in the oil and gas business. Then we used a temporary approach in other areas to be positioned to respond quickly when demand recovers. And when we think about the structural savings, that was about $30 million in Q2, and that will increase sequentially as we go through the year. And then we’ll exit the year – it was a question answered earlier – with about a $40 million benefit to 2021. But we’ll see increased structural savings in Q3 and then in Q4. And we’ll take our temporary savings and adjust that based on volume. But we felt it was necessary for the permanent reductions. It’s very a difficult decision, but where demand is most impacted, not short term but more long term, we took those actions.

[RobertMcCarthy:]

Yes, and just for pedagogical purposes, presumably that’s all baked into the decrementals you already highlighted?

[DaveZapico:]

That’s all baked into the decrementals, correct.

[RobertMcCarthy:]

Yes, okay. Of course. All right. And then the second question is, obviously, I think you answered Deane’s question very well about M&A and the opportunity set. But you are sitting on a lot of cash. It is a very difficult environment for potential share repurchase. You have done share repurchase in the past. I think notably in the fourth quarter of 2018 you thought it was particularly prudent, given the intrinsic value of your company. Well, if memory serves. But how do you think about share repurchase in this environment? Or perhaps you don’t have as much visibility. And then, obviously, you have the whole populism problem with share repurchase as a whole in terms of a use of capital allocation. How do you think about it – because you do have a sizable cash balance? And even despite what we’re going to see right now, still a strong prospect for continued cash generation here.

[DaveZapico:]

Yes, the first point is our priority is M&A. So we want to be able to execute on those M&A opportunities as we clear the crisis. And we have been opportunistic with buybacks, and we have the capacity to do buybacks. So that’s something we’ll consider. And our third priority, we’ll maintain the consistent dividend that we pay. But right now with the situation being so uncertain, we have built some extra cash. We have the liquidity, and we’re going to make sure our balance sheet is strong as we get through this crisis. And if there is an opportunity to do buybacks, that’s something we’ll consider. But clearly, capital allocations number one priority is acquisitions. And right now we’re just making sure we get through this thing with a healthy, strong balance sheet and a strong company.

[Operator:]

Thank you. And our next question comes from the line of Richard Eastman with Baird.

[RichardEastman:]

Yes. Good morning. Dave, could you just speak to – I’m curious a little bit here as we move forward into the second quarter and into the back half of the year, when I look at EIG and that segment of the business, it does I think – oil and gas shows up in there. Could you just talk a little bit more about some of the process industries, the process instruments, how they’re holding together? And then also the large commercial business, I think, falls largely in EIG. So does that suggest that EIG is weaker than EMG as we track through the balance of the year?

[DaveZapico:]

No. The way you think about first our aerospace businesses are, Rick, it’s predominantly in EMG. So that’s going to be a headwind to EMG. But on the EMG side, I think our automation business has been through a lot of – it was the first business that went in. And we’re already starting to see some improvements out of China for automation business. So our automation business could be the first part of the business that does well and recovers. It could be. When you think about EIG, your question about process is a good one, because process serves a wide range of end markets, which are experiencing different dynamics, different end market dynamics. On the positive side we’re seeing solid demand in our medical, health care, and high-end research businesses within that segment. And that segment includes Roland and MOCON and Telular and Demand. And I’ve already commented on these businesses and their growth drivers. Conversely, it’s the part of our business that has oil and gas, which counts overall to about 6% of AMETEK sales. And we’re going to be challenged in that part of it until the oil prices recover because there’s supply and demand imbalance .And while we expect process sales to improve sequentially in the second half of the year, we expect the oil and gas component of it to remain challenged because of the sizable cuts to the capital budgets and the supply and demand imbalances.

[RichardEastman:]

Okay. Okay. And then just a quick question. Just a couple thoughts, if you will, about geographies here in the quarter. And maybe do we see the same type of cadence out of Asia, China? Do we see some recovery late in March – modest recovery? Just maybe the cadence around the geographies here as we exited first quarter and into the second.

[DaveZapico:]

Sure, Rick. I mean, the headline on the geography story is those are broad-based weaknesses in our geographies with Europe and Asia most challenged. And when you think about it, Asia was down high teens. And it was China was down first; it was driven by travel restrictions, the inability to install and commission our products. It was China, Japan, Korea. And then we look at China specifically. As you got to the end of the quarter, it started to recover. And it’s recovering and improving, but it’s not completely back. Our facilities over there are operating with pretty much full capacity now, and we’ve got our supply base up and running. But we very recently started traveling to most customer sites. We weren’t allowed to travel and do installation and do service work. I’ll give an example. In the research end markets, there are some universities that still haven’t opened back up yet. And we have some equipment waiting to be installed there. So in China, I would say it’s improving, but it’s definitely not the whole way back. And then when we think about Europe and it was down low double digits and same kind of drivers. The biggest impact was on our Dunkermotoren business and our process businesses in Europe. And then when we got to the U.S., the U.S. in the first quarter was down about 3% due to the same customer delays and delays, inability to commission product. So it feels like we’re kind of coming out of it in the opposite way that it surfaced. So Asia feels like China is recovering a bit. And it seems like the U.S. may be still heading in a bit, and Europe might be at the bottom right now. So it was broad-based weakness. Europe and Asia were most challenged.

[RichardEastman:]

Understood. And just maybe a last question for me, sorry. When you look at the overall business and the type of downturns here that we’re seeing in demand that has historically not had much impact on your pricing. Is that correct?

[DaveZapico:]

Yes, it’s a great question. I mean, this environment is different. So we’re going to have to see. But I expect that we’re going to be able to achieve this same level of price. We did in Q1. Q1 2020 pricing was good. We got 1.5% of price across our entire business. Total inflation and the impact of tariffs was about 1%. So we had a 50-basis point positive spread adding to our margin expansion, and I expect that’s going to continue for the year, but we’re in an environment now where you really don’t know what the fluctuating demand pattern is.

[Operator:]

Thank you. And our next question comes from the line of Andrew Obin with Bank of America.

[AndrewObin:]

Yes. Good morning. Just a couple of questions. Thank you for providing more information and great execution. Just in terms of your supply chain in Asia and just globally, how has it – how is it holding up with all the shutdowns in places like India and Malaysia? I’m not sure what’s happening in Indonesia. And how are you rethinking your supply chain for the post-COVID-19 world?

[DaveZapico:]

Yes, good question. I mean, our philosophy is to always supply in the region where the demand is and we were moving to that even before the tariffs started and even now with COVID, we think that makes sense. We want to build where the demand is. So that will give us regional thought process around there. You mentioned Malaysia. Malaysia was one of the areas where we had some difficulty in the first quarter. I mean, the government came in and told us we couldn’t operate and that was the only place in the world that happened. And we couldn’t operate for a period of time and then we got authorization to operate at 25%, and then authorization to go to 50% and eventually right now we’re at about 100%. So it’s – the different governments around the world responded differently and we have a really good supply chain team, and they’re out battling with all these problems and getting them solved and they did a good job solving that one. So what we see across the world is – I’ll give Mexico as an example. We have suppliers in Mexico. And Mexico is a little bit later to recognize the coronavirus threat, and then the government jumped in and started to do all the same things that were done around the rest of the world. But they seemed to implement it with the local authorities having different levels of judgment in what was essential and what was not essential. So we spent a lot of time and our supply chain team did a great job during the quarter getting suppliers turned on to Mexico when the local authorities had to tell them to shut them down. And that involved us going to the authorities, telling them why they were essential as a supplier, and we got those all working. So it’s been a really, really difficult time for our supply base, and our people have done just a fantastic job in managing it, and we’ll expect there will be continuing problems like that during the second quarter and as we go through this thing and we have localized problems and outbreaks that we have to deal with, and we’ve got good management, and they know how to deal with these things and we’re dealing with them. But at the same time, it creates enough of a visibility issue that that’s why we went through our guidance.

[AndrewObin:]

And just another question on China. You did sort of say that China is getting better. What kind of lessons, because I think people are trying to figure out what lessons this China holds for the shape of recovery in Europe and the U.S.? We’ve heard from some companies; I think Parker or Honeywell sort of seem to have said that March was this big spur of demand coming back. But then April is a little bit slower because the economy is now back to normal, so maybe it’s not all the way straight up. Can you just give more color on what’s happening in China, April versus March relative and absolute terms? And as I said, more importantly, what lessons do you think this recovery holds for Europe and the U.S.? Thank you very much.

[DaveZapico:]

Yes, I think the lessons for Europe and the U.S. is you have to follow the social distancing mandates that the governments are putting through, and you will recover. And when you recover, it’s not going to be across China. It was a choppy recovery with different regions having different requirements on travel. And I think we’re going to have the same things here. So in terms of China specifically, as I said before, it’s recovering, but it’s not completely back. So our plants are now operating near 100% of capacity, but what’s causing us a bit of the difficulty now is being able to travel to the customer sites and do service work and do install work. And just recently that started to open up. Just very recently. I think last week we started traveling in places like Beijing and things to do service work. So I think you learn from that. I mean, we learned from China. It was interesting to watch within the company. Our operating people did a fantastic job in China managing through this, the COVID-19 problem. And we have essential customers in China, and we were probably one of the few plants that were still operating there, serving the medical customers in China. But they kind of set a work plan for us of using temperature monitoring and PPE and thinking about how to relay out production lines and how to relay out factory floors and talking about the flows of people within the buildings and how you quarantine someone within the building. And we learned from that as a company. So we learned from that. We helped in developing in China, and we saw how it worked and what didn’t work. And now that’s informing our decisions in Europe and the U.S. So it’s – and we learn something new every day, and something changes every day. So I don’t know if...

[AndrewObin:]

But just to follow up, is China up sequentially in April versus March? And thank you so much for answering my questions.

[DaveZapico:]

Yes, China is up in April, but in March, it was very diminished. And it just picked up at the end.

[Operator:]

Thank you. And our next question comes from the line of Andrew Buscaglia with Berenberg.

[AndrewBuscaglia:]

Hi, guys. I wanted to dig in to Aerospace just a little bit more. So obviously, the outlook, weak for that area long-term or longer term. But can you talk about that business, how you guys think about it and where there’s exposure? And I’m talking about where are you exposed to production versus miles flown. And what do you need to see come back within your businesses the most for that market to recover?

[DaveZapico:]

Right. That’s an excellent question, Andrew. And as a reminder, AMETEK has a balanced exposure across our Aerospace and Defense markets. So our total exposure is about 15% of sales. 15% of AMETEK is in Aerospace, with roughly 5% to Defense. So we’re seeing that Defense is still strong, and we expect that to continue for the balance of the year. 5% of the 15% is in Commercial and Business Jet OEM, and 5% is in the Aftermarket. So that 5% in Commercial and Business Jet OEM and the 5% in the Aftermarket, that’s a roughly 10% exposure to Commercial OEM and Aftermarket that we think is going to be very challenged. And when I was talking about the potential to be down 50% and the potential that the Aftermarket is down more and the OE is maybe 50% or a little less, that’s really what I was talking about. And in terms of our exposures, we have broad exposures across essentially all key aerospace and defense platforms. And we have a great business. I mean, we have leadership positions in aerospace power generation. We kind of revolutionized the way power is distributed around an aircraft. We’re winning lots of business there. We have an excellent business in advanced sensors, airframes and engines and all parts of aircrafts. And we have an excellent thermal management business that handles heating and cooling of aircraft on very difficult applications. So the fundamental businesses that we have in that space are just great businesses. And they’re going to go through a tough time, and the Aerospace market is going to look different, but we have really good management there. And as I said, we’re adjusting to it now.

[AndrewBuscaglia:]

Yes, I mean, it sounds like you’re generally still positive on that business over the long term and that – my next question was going to be, what’s going on to discourage you from acquiring in that space and building that business more? Or not? It seems like the latter.

[DaveZapico:]

Yes, I think the way that we think about it is we want balanced end-market exposures. And right now we’re dealing with a lot in that business as we decrease. But we really like the business. We have really sustainable businesses there, with wide moats around the business. They’re good businesses. They’re essential. And those businesses are going to be fine. So there’s going to be an adjustment in volume, where you reset the cost structure. But when those businesses start growing, they’re going to grow with healthy incremental margins. So we still feel good about it.

[Operator:]

Thank you. And our next question comes from the line of Joe Giordano with Cowen.

[JoeGiordano:]

Hey, guys. Good morning. Hey. I think you touched most of the operational stuff already. So Dave, I just want like a bigger picture. I mean when you stepped into the role, it was like maybe the worst possible situation in terms of timing. So what can you kind of – what did you learn managing that initially through an energy crisis and how your businesses were impacted? I mean, I know that that’s all smaller as a percentage of sales, and you just sold Reading, so it’s different portfolio, but what were some of the critical lessons you learned then and how you applying that now?

[DaveZapico:]

Yes, it’s a great question. And I just come back to the seasoned management team that we have at AMETEK. I mean all of my executive office, they have been through many downturns, and they know what to do. We know what to do. And a big part of our – because we have such good culture and we have such long-term employees, they realize we’re going to get through this. And the new people in our business are learning from them, and we’re getting through this. And Bill and I, we’ve changed our management cadence. And in March, we had operating meetings with every one of our business units. And we’re going to do that again probably – I think it starts next week when we get through this call. And we’re – it’s changing the cadence, and through those meetings we understand what’s going on with the business. We make sure we’re focused on cash flow. We are making sure of right things for our customer base and we’ll learn from that. So – and we understand what’s going on in the business. But I think the biggest thing when you step back and you think about this thing long-term, we’re very well positioned. We have proven management capability to manage through this downturn. Our businesses are well positioned with leadership positions, high barriers to entry, strong technology positions, the quintessential essential business, and we’re executing very well, generating excellent cash flow as evidenced by the first quarter, as evidenced by the past few years. We got the question earlier, we have a proven capability to get price and offset inflation with price. We have that capital deployment strategy. World-class acquisition products. So there’s no doubt in my mind we’re going to get through this and we’re going to be stronger for it. But it all comes back to the people, and we have the experience to get it done.

[Operator:]

Thank you. And our next question comes from the line of Steve Barger with KeyBanc Capital Markets.

[KenNewman:]

Hey. Good morning, guys. This is Ken Newman on for Steve. Thanks for taking my question. Good morning. Hope you guys are healthy. I just want to circle back to your – thank you very much. Just want to circle back on your comments around aero. Obviously, I know the environment is very challenging right now. But just trying to think about your 2Q trough comments and maybe any color that you’ve been having on the conversations that you’ve been having with your customers there in terms of the cadence for volumes in the back half as some of these facilities, especially for Boeing are starting to start back up. Curious if you would expect to feel the pull from the facilities as soon as they start up? Or do you think they have enough inventories to start initially and then they would come back to you once that normalizes?

[DaveZapico:]

Yes, I think it’s a mix, Ken, because there’s going to be – you think about a production line. There’s going to be some things they need right away and there’s going to be some excess inventory. So it’s a mix of things. And as I said before, what we’re seeing and what we saw in April is that business is challenged, substantially challenged. So that it’s going to take a while for that business to adapt to those customer bases to the new demand. And the fact that we have balance in our aerospace business and we have 5% of it in defense of the 15%, it really helps us because we have some solid demand there so. But we’ll definitely recover as the business recovers but it’s going to take some time. And quite honestly, all those customers haven’t even decided what the new build rates are going to be. So they’re just deciding that now and those conversations are going on.

[KenNewman:]

Got it. No, that’s helpful. And then just one more for me, bigger picture. I’m just curious about your conversations with customers around the automation solutions that you guys provide. Do you think customers may be looking more towards automation after having to deal with first, tariffs and now the pandemic? Just how are you thinking about that market as we kind of progress through this down cycle and maybe looking towards the other side?

[DaveZapico:]

Yes, I mean, the automation business has an excellent opportunity because if you want to eliminate – in the era of social distancing, that’s going to drive demand for automation. So it’s a demand driver on the exit of this that wasn’t there before we went in. And again, in our automation business, that was weaker in 2019. We started to see that business normalize run rate later in the first quarter, particularly in China. So pretty positive on our automation business, and we were always positive on it because there’s long-term demand drivers. And right now, our automation business is spending time along in the medical world providing automation systems for some of these testing devices for coronavirus where they have to test multiple samples. So they’re using more automation equipment to do that. So we’re positive on it, and that business is going to do well going forward.

[KenNewman:]

And just one quick follow-up to that is do those automation markets typically have – are those considered margin accretive to the base business?

[DaveZapico:]

Yes, I think it’s margin accretive to EMG, for sure.

[Operator:]

Thank you. And I’m showing no further questions at this time. So with that, I’ll turn the call back over to Vice President of Investor Relations Kevin Coleman for closing remarks.

[Kevin Coleman:]

Great. Thank you, Andrew, and thank you, everyone, for joining our call today. And as a reminder, a replay of the webcast can be accessed on our website in the Investor section. Have a great day.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may all disconnect.