Colfax Corporation
Q4 2017 Earnings Call Transcript

Published: 7 Feb 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Colfax Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, this conference may be recorded. I would like to introduce your host for today's conference, Kevin Johnson. You may begin.

[Kevin Johnson:]

Thank you, Glenda. Good morning, everyone, and thank you for joining us. My name is Kevin Johnson, and I am Vice President of Finance at Colfax. With me on the call today are Matt Trerotola, President and CEO; and Chris Hix, Senior Vice President and CFO. Our earnings release was issued this morning and is available in the Investors section of our website, colfaxcorp.com. We will also be using a slide presentation to walk you through today's call, which can also be found on our website. Both the audio of this call and the slide presentation will be archived on the website later today and will be available until the next quarterly call. During this call, we'll be making some forward-looking statements about our beliefs and estimates regarding future events and results. These forward-looking statements are subject to risks and uncertainties, including those set forth in our SEC filings. Actual results might differ materially from any forward-looking statements that we might make today. The forward-looking statements speak only as of today and we do not assume any obligation or intend to update them, except as required by law. With respect to any non-GAAP financial measures during the call today, the accompanying reconciliation information relating to those measures can be found in our earnings press release and today's slide presentation. Now, I'd like to turn it over to Matt, who will start on slide 3.

[Matthew L. Trerotola:]

Thanks, Kevin. Good morning and thank you for joining us today. I want to highlight the progress we made in 2017 as we further strengthened our foundation and improved our business for the future. We believe the best team wins, period. And we continued to strengthen our team at all levels in 2017. This is the most evident in ESAB, where we've made significant talent improvements over the past few years. In Howden, we redeployed a lot of great engineering and commercial talent from Power and developed markets to industrial applications and higher-growth markets. In 2017, we delivered our committed restructuring savings through initiatives that are better positioning our company for the future and we used CBS to drive significant improvements in safety, quality and delivery. I'm very happy to see our ESAB business has returned to healthy organic growth. We exited the year with a strong quarter and growth in all regions across the world. Despite, some significant challenges in the Power and Oil & Gas markets during the year, I'm pleased with the significant growth made in Howden's industrial applications. Our continued investment in this healthy growing segment positions us to turn over to a more sustainable order growth in the second half of 2018. During the year, we had many new product launches, with ESAB customers in multiple regions coming to me on how much we've strengthened and deepened our range. We made another significant step forward in both segments, on digital growth or what we call data-driven advantage solutions for our customers through a combination of organic efforts and technology acquisitions. The investments that we've made in growth regions position us well as many of the emerging economies seem poised for a healthy run of industrial growth. We were very active in M&A during the year, completing six complementary acquisitions that add important technologies and accelerate growth initiatives. And finally, we completed the sale of our Fluid Handling business at an attractive price, a move that gives us more flexibility as we work to find the right next platform for our company's future. Please turn to slide 4. The team at ESAB has now returned to growth in all regions and has demonstrated the ability to expand margins through a variety of market conditions. Our strategy in Fabrication Technology has been consistent. With less energy now focused on restructuring, we're making healthy progress driving CBS in our supply chain and advancing a range of growth initiatives. The result has been accelerating growth and strong year-on-year margin improvement. Although we felt some pressure in Q4 from continued steel escalation, the team has been proactively addressing this through price and productivity. The business should have solid growth this year and another step forward on our path to mid-teen segment margins. I got to spend some time last month with our Indian team that's been one of the strong growers for us in ESAB; and the new team from EWAC. We've got a great leadership position in that market, and the outlook for industrial growth in 2018 is very healthy. I came away reminded of the strength of our positions and talent in high growth markets, and the passion that talent has for applying CBS to drive profitable growth. On slide 5, we summarize the acquisition of the Sandvik Welding consumables business, which we completed in January. Sandvik is a leading provider of stainless steel and nickel alloy filler metal and extends ESAB's portfolio in the faster-growing specialty filler metal segment. They're well-respected around the world for their technology and quality. I want to welcome the talented team from Sandvik to Colfax. This acquisition strengthens our position in these segments and presents a significant opportunity for margin improvement as we take advantage of synergies with our existing business and use our Business System to drive improvements. On slide 6, I would like to provide an update on our Air & Gas Handling segment. 2017 was a challenging year for Howden. After returning the four quarters of organic growth, they hit a difficult patch in Q3 when Power dropped sharply again and the Oil & Gas recovery temporarily stalled as projects shifted to the right. In addition, the business had margin pressure as we began to deliver on the large projects from a very competitive stretch in 2015 and 2016. Significant restructuring efforts enabled us to limit the impact on our operating profit. I'll share a bit more about the path to sustained revenue growth at Howden. We've talked many times about our strategy to expand our addressable market by targeting General Industrial applications. Howden's made strong progress in this critical area in 2017, as we delivered strong organic growth performance that outpaced the industrial market. Our mining funnel is also very strong and supports a healthy return to growth in the coming years. Oil & Gas was down on the prior year, but we saw project activity moving some again in the fourth quarter. And we still view Oil & Gas, which for us is heavily weighted to refining and petrochemical, as fundamentally improving. Our sales funnels continue to increase, oil prices have moved in the right direction, and customer sentiment remains generally favorable. We continue to expect Oil & Gas to return to sustained growth in the second half of this year. On our Q3 earnings call, we communicated the sharper-than-expected pause in the China Power's investment. During Q4, we saw no further change in this picture. And the new reality has been built into our estimate and view for 2018. While the next few quarters will still be difficult for Howden, we see a clear path to order growth in the second half and are taking further cost actions to make sure we improve margins and strengthen the business for the future. Although delayed, our medium-term growth expectations for this segment remain unchanged. Please turn to slide 7. Colfax is well-positioned for a year of 15% or higher earnings growth. We expect to deliver overall organic growth supported by our faster-growing Fabrication Technology business. ESAB will continue to use CBS to drive productivity and improve customer service, and we have some exciting new products in the pipeline. We expect Air & Gas Handling market conditions to improve later in the year, and are implementing restructuring actions in that segment that should deliver the majority of our $25 million savings in 2018. Recently completed acquisitions further strengthened our business and will contribute additional profit. The sales of the Fluid Handling business and strong cash flow generated in the fourth quarter increases our financial capability and we've ramped up efforts on new platforms with a goal to add a great new business by the end of 2018. In summary, we'll continue to strengthen our operating capabilities in 2018 and execute our strategic growth program. And now, I'll turn it over to Chris to discuss the financial results.

[Christopher M. Hix:]

Thank you, Matt. Before we dive into the business results, let's walk through the other items that affected our continuing operations, GAAP results on slide 8. Continued market pressures on our Air & Gas Handling business, mostly from Power, but also due to cyclically lower performance in Oil & Gas, resulted in a $153 million non-cash charge to write down the book value of the businesses, goodwill, and intangibles. Moving forward, the business is positioned to benefit from its improving cost structure and strategic pivot to industrial applications and higher growth regions. As part of our plans for further restructuring of the Air & Gas Handling business, we'll be closing a manufacturing plant and have included a write-down of $27 million in fourth quarter restructuring expense. Also in the quarter, we entered into a buyout arrangement for one of our largest pensions and recorded a $47 million non-cash charge. This action removes our $300 million of pension liabilities from our balance sheet and is consistent with other de-risking efforts taken over the past two years, such as issuing our fixed-rate Eurobonds. Lastly, we have completed our initial assessment of U.S. tax reform and recorded a small P&L benefit in the quarter. Included in this net benefit, is our transition tax estimate for foreign earnings of $50 million, which will be paid over eight years. We have excluded these items from our continuing operations-adjusted results on slide 9. These adjusted results exclude discontinued operations, so you don't see the Fluid Handling business results or the $308 million pre-tax gain on the divestiture. Total cash taxes on the business sale are expected to be less than $40 million. Total company sales grew nearly 8% to $874 million in the quarter with some FX benefit and contributions from acquisitions. Organic growth was up 3% with our FabTech business posting its highest quarterly growth rate since we acquired the business in 2012. Air & Gas Handling declined 15%. Gross margins were down 20 basis points in the quarter, as restructuring benefits offset most of the impact from lower sales in the Air & Gas Handling business and raw materials cost inflation in the FabTech business. Operating profit declined $11 million on lower Air & Gas Handling sales and $6 million of STE acquisition-related costs. Below the line, there was an increase in interest expense due to U.S. Fed rate hikes, and also because we changed part of our debt to fixed rates with the April 2017 Eurobond offering. We also posted a lower tax rate due largely to favorably resolving some older tax issues and excluding Fluid Handling's higher taxed U.S. earnings from continuing operations. Adjusted EPS of $0.45 excludes discontinued ops, the non-GAAP items we reviewed earlier, and amortization and other non-cash acquisition-related charges. Slide 10 provides a quick snapshot of the growing financial capacity to support our strategic growth program. We generated over $200 million of operating cash flow in 2017. Higher growth rates in our FabTech business created working capital pressure that should moderate in the first half of 2018 and customer funding on projects should improve as Air & Gas Handling order levels recover. Our year-end balance sheet reflects the initial proceeds received from the Fluid Handling sale and there is over $200 million of additional liquidity yet to be realized from the transaction. This will put our pro forma net leverage at about 1.5x, down from 2.6x a year ago. We're well capitalized and positioned with growth with over $1 billion of capacity from our existing bank group. Turning to the businesses, slide 11 includes the Q4 results for the Fabrication Technology business. Segment sales of $500 million were up 7% organically in the quarter. We saw excellent progress in every region, especially North America. Acquisitions added another 4% to top-line growth. The latest acquisition, EWAC, is off to a solid start in an Indian industrial market with accelerating growth. This business has built real muscle into its price management disciplines, creating standard work that helped us to create 2% price realization in the quarter and should allow us to catch up with raw material inflation in the first half of 2018. Adjusted operating profit grew to $52 million in the quarter, but margins declined 50 basis points to 10.3% due to inflation, additional growth investments and some one-time costs in the quarter that are not expected to recur. Although steel will continue to create some year-over-year pressure, we expect margins to sequentially recover in Q1. The Air & Gas Handling segment, as shown on slide 12, was nearly flat in sales quarter-over-quarter, including contributions from the STE acquisition. The business also had an FX tailwind but organically sales were down 15% due to Oil & Gas project timing and lower demand for Power applications. Lower organic sales resulted in operating profit being up $19 million compared with the prior year. Benefits from restructuring actions largely offset margin pressures from larger projects. We expect these lower-margin projects to clear backlog in the first half of the year, enabling a step up in margins in the second half. STE operating profit was completely offset in the quarter by $6 million of deal costs, inventory step-up charges and other amortization, and we expect the business to contribute to Q1 performance. Slide 13 includes our orders and backlog comparison. Total orders increased 12%, primarily due to the STE acquisition. Orders were down only 2% organically as we saw a significant sequential improvement from our third quarter. Broad-based improvement in General Industrial orders continued. We also booked higher orders in Oil & Gas in the quarter, and Power declined in line with expectations. Backlog levels support the expected sequential improvement in Air & Gas Handling after we exit Q1 of 2018, and we continue to forecast this business' revenues to be flat to down 2% organically for the full year. Wrapping up on slide 14, we expect to deliver the strong earnings growth we outlined in our December call. Year-over-year organic revenues are forecasted to be flat to up 2%, but the Air & Gas Handling business entered 2018 with a little less momentum than we expected. As a result, our teams are developing cost actions to de-risk for market recovery timing and to continue to better position the business for long-term success. Amortization costs are higher than originally expected due to acquiring Sandvik and finalizing valuations for other recent acquisitions. Below the line, we expect higher interest costs from recent acquisitions and from a rising rate environment in the U.S. We expect the Sandvik acquisition to become accretive in 2019. Following the completion of the Fluid Handling divestiture and recent U.S. tax reform, we believe that our tax rate for 2018 will be about 24%. In summary, we continue to expect $2 to $2.15 of adjusted net income per share in 2018, which represents growth of 15% or higher. That concludes our prepared remarks. Glenda, would you please open up the call for questions?

[Operator:]

Certainly. And our first question comes from the line of Mike Halloran from Baird. Your line is now open.

[Mike P. Halloran:]

Hey. Morning, guys.

[Matthew L. Trerotola:]

Good morning.

[Christopher M. Hix:]

Good morning, Mike.

[Mike P. Halloran:]

Could you just help bridge guidance from mid-December to today? Obviously, the tax rates come down, feels like the growth rates on the revenue side are comparable, but as you said in the deck a lower base, so a little pressure there. Maybe just talk about the profitability swings then and how you're looking at the two segments today versus mid-December, and then just pinpoint what some of those pressures are more concretely, please.

[Christopher M. Hix:]

Mike, if we're to bridge from December expectations to today's conversation, we would highlight the following items. We'd say, number one, we finished with a little less wind in our sales in 2017, principally in the Air & Gas Handling business. We saw lower revenues in some of the Power sectors than what we'd expected and that created a lower base, of which we expect to grow in 2018. The second thing I'd highlight is the change in the tax rate, which puts a more favorable tax rate for the company going forward. And then, the third item I'd mention, and it's really related to the power and power gen downturn. And in addition some of the cost comments we've made, there's a little bit of cost pressure in the quarter as well that impacted margins. So I'd say, those are the three items that bridge from the December guidance to today.

[Mike P. Halloran:]

So when I think then about the cadence as you work through the year here, obviously, the thought process in mid-December was maybe a little bit more of a ramp through the year as you work through some of the Air & Gas Handling air pockets and as that gives you a little more time to get some of the restructuring going through. That certainly seems to be the case. Does that even get magnified here with some of the price/cost comments as well as some of the incremental pressures you guys are seeing on some of the project margins?

[Christopher M. Hix:]

Yeah. I'd say that the trajectory looks roughly the same. As you described the air pocket may be a slightly different than what we'd expected in December. But we still expect to clear those larger projects out of backlog to get some of the additional restructuring benefits. And all of that positions us, we think, for the improvement in the second half. So, that's unchanged. We just start up with a slightly lower jump off point from 2017.

[Mike P. Halloran:]

And then, FabTech margins, maybe just go through the cadence in 2018 there. And I know the comments in the prepared remarks were certainly highlighting the comfort in gaining price with all the work you guys have done over time. But how does that cadence through as you work through the year, catching up on the price/cost side?

[Matthew L. Trerotola:]

Yes. Matt here. Let me comment on that. I think that business did a lot of really good work in 2017 continuing to drive price and productivity as steel continue to escalate really throughout the year. Q4 was a bit of a pinch point on that front and we do expect things to improve here in Q1. But at the same time, there has still been some additional cost escalation in Q1 and so we're definitely expecting to see some improvement in margins as we move into Q1 in that business. And then as we make our way into Q2 and beyond, it should get stronger in terms of the year-over-year margin performance, based on continue to drive aggressively on price. The current view is that things are starting to stabilize a little bit here in Q1. Some regions went up, but China which can be a bit of a bellwether was in some places down a little bit. And so, we are expecting that at some point in 2018 the steel price escalation will plateau and then that will put us on the right side of it.

[Mike P. Halloran:]

Great. That makes a lot of sense. I appreciate it.

[Operator:]

Thank you. And our next question comes from the line of Jeffrey Hammond from KeyBanc. Your line is now open.

[Jeffrey Hammond:]

Hey, good morning, guys.

[Matthew L. Trerotola:]

Good morning, Jeff.

[Christopher M. Hix:]

Good morning.

[Jeffrey Hammond:]

So just back on Air & Gas, so is it that China Power is worse or is it that Oil & Gas orders are not coming through? I just want to understand the kind of less momentum or lower jumping off point versus a month-and-a-half ago?

[Christopher M. Hix:]

Okay. Yeah, Jeff, what we saw was not so much related specifically to China. It was really more in the aftermarket, in more the developed regions of the world, so Power in the developed markets for aftermarket, that was really the key change that we saw.

[Jeffrey Hammond:]

Okay. And what's driving that change?

[Christopher M. Hix:]

Well, I think that we've discussed in this business that we expect to see the developing regions of the world continue to expand their use of coal-fired power. Even though that rate has changed, we do expect to see continued growth in the installed base, and that'll lead over time to higher after-market levels. In the developed markets, we haven't seen that same rate of investment, as you know that's under a little bit more pressure and that's been a declining base. We just saw a sharper decline in demand late in the fourth quarter than what we typically would have expected to see. Now, some of that could be related to timing for specific projects and some of it could just be the continued pressure on that sector of the power generation in developed markets.

[Jeffrey Hammond:]

Okay. And in Oil & Gas, I mean, with oil kind of north of $60, maybe just a little more granularity on what you're hearing about projects and customer movement there?

[Matthew L. Trerotola:]

Yeah, the funnels are actually quite healthy in Oil & Gas that were building through the last year. Things really got quite slow in Q3, but then in Q4 a number of projects did cut loose. And so, we are expecting those funnels to move over time. If we look at some of the data in terms of capital investment in 2018 versus 2017 that's expected in the oil and gas space, including in the areas where we participate, the forecasts are all to have some healthy increases in that capital investment. And so, everything we're seeing would suggest that oil and gas is headed towards a good steady recovery. But history has shown over the past year or so that it can be a little choppy and things can start moving and then stop again. So, we're really not anticipating any big recovery here in oil and gas in the first half of the year, but do see some things that ought to get us moving in a positive direction in the second half.

[Jeffrey Hammond:]

Okay. Thanks, guys.

[Matthew L. Trerotola:]

Thanks, Jeff.

[Operator:]

Thank you. And our next question comes from the line of Andrew Obin from Bank of America. Your line is now open.

[Andrew Burris Obin:]

Good morning, guys.

[Matthew L. Trerotola:]

Good morning, Andrew.

[Christopher M. Hix:]

Hey, Andrew.

[Andrew Burris Obin:]

Yeah. Just inflation in the quarter on FabTech, could you guys, by any chance, quantify the breakout of inflation, investments, and other just maybe percentage point drag on margin in the quarter, if you could?

[Christopher M. Hix:]

Yeah. If I were to group that, I'd say that it's roughly a third of each of those categories is what affected the particular quarter. So, we would have expected normally to see the margins either flat or slightly up in the quarter and that drag is roughly equally proportional to those three elements.

[Andrew Burris Obin:]

And can I just – sort of moving to cash number methodology, based on my numbers, I guess, your conversion ratio for cash is going to be below 100% for 2018. And just philosophically; a, am I correct in my math that the conversion rate is going to be below 100%? And second, can you just talk why move to the sort of adjusted earnings methodology before a deal? So – because usually companies do it to highlight cash that's higher than 100%, but I think for you that's going to be lower, 100%, if my calculation is correct.

[Christopher M. Hix:]

Yeah. The move to an adjusted EPS that reflects the amortization and other non-cash add-backs that came after a long couple of year dialog with investors. And I think what they all realized is that the entire portfolio we have has been constructed over the last six, seven years. And that's a little bit unique in the space. And because of that, we had an unusually high amount of amortization in the results. And so everybody, I think, realized that. We got a lot of encouragement to consider that and to make sure that we're on a level playing field when considering us relative to other industrial companies. And so, that was really the logic behind that to better reveal the earnings performance of the company relative to other companies. I'd say that with respect to the cash generation, I think we've got a good line of sight for good cash flow generation here. The key question is always is on working capital. And the question that we had, for example, in 2017 was the level of growth that we had that really helped offset some of the gains that we're making in some other areas. The other element that we had was on – with declining orders in our Air & Gas Handling business, we end up with a lower cash flow, lower deposits from customers. So, those are the principal factors that we had in 2017. As I mentioned in my comments, as we go into 2018, and we levelize for that growth, the higher growth rates in the Fabrication Technology business, that gives us a chance to reduce the impact from growth on working capital. And as order levels recover in our Air & Gas Handling business, we think that should contribute to higher cash flow with respect to the deposits from customers. So I hope that helps you, Andrew, think about the cash flow for 2018.

[Andrew Burris Obin:]

But from that perspective, it is going to be a tad below – until we sort of get the next platform, it is going to be tad below adjusted earnings at least for now, is that fair?

[Christopher M. Hix:]

The key driver in that is probably the level of restructuring expense that we have, so depending on the amount of restructuring that we need to spend in the year, it could potentially be below 1 for 1 (29

[Andrew Burris Obin:]

Terrific. This is very useful. Thank you very much.

[Operator:]

Thank you. And our next question comes from the line of Andrew Kaplowitz from Citigroup. Your line is now open.

[Andrew Kaplowitz:]

Hey. Good morning, everyone.

[Matthew L. Trerotola:]

Good morning, Andrew.

[Andrew Kaplowitz:]

So, can you give us more color? I mean, you took the impairment in Air & Gas Handling and Power. How should we think about earnings capability in Power going forward? Do you see stabilization in that business at some point in 2018? And then can you talk about how much of a drag Power puts on your ability to achieve higher margin in Air & Gas in 2018 or mid-teens margin over time in the business?

[Matthew L. Trerotola:]

Yeah. Let me comment on that. I think what we shared in late – after Q3 that I think remains the view that we have for Power is that there has been a step down in that business as China really turned the spigot off there and that's taken the business to a historic low level. The last two quarters of last year was a historic low level for Power investments. And we're not predicting a significant rebound from there. I think the funnel for this year would suggest a little bit of rebound over that second half rate, but not to recover to the full year rate from last year. And so when we look at the overall Power business, we've got a piece of our Power business, less than 10% now of the Howden business that is in the foremarket area in the orders in Q4. And then we've got a piece that is in developed markets aftermarket area and then a piece that's in high-growth markets aftermarket area. And that collectively makes up about 25% to 30% of the Howden business down the back half of last year. The foremarket part of that, the new investments we expect to be flat to up over time, not up a lot, but flat to up over time from this low base. And that's a very small amount of incremental coal Power going into the world that creates that. The developed markets part of this, Chris commented, a little bit of pressure on it. It's something that is flat to down a bit and we've been working hard through things like retrofit projects to be able to offset some of the downward pressure as capacity gets retired. And then the third part of that, the high-growth markets aftermarket has seen healthy growth and is expected to see healthy growth as quite a bit of capacity went in there over the past 5 to 10 years and continues to go in. And so, that creates an aftermarket growth trajectory and we've been repositioning resources to get more than our fair share of that aftermarket growth trajectory. So when you roll those together, the flat to down a little view of Power that we've given in the past few years still holds. And if you put that together with the other pieces of Howden, it's still a business that can have a good solid GDP plus growth over time once we get through this difficult patch.

[Andrew Kaplowitz:]

And Matt, do you think you could still grow margin though even with Power being a little weak in 2018 in Air & Gas itself?

[Matthew L. Trerotola:]

Yes. Yeah. We've taken restructuring actions last year and then more this year to ensure that we can get margins moving back in a positive direction in the Air & Gas Handling part of the business. And then as revenue comes back in the subsequent years that will give an opportunity for some sharper margin improvement that still gives us a path to that mid-teens target that we put out there. We talked about three to four years to mid-teens back in our Investor Day. And clearly, in the Air & Gas Handling part of our portfolio, the outer end of that timeframe is more realistic than the inner end. But the FabTech piece is on a healthier path and we're going to be driving hard to see if we can get it there sooner.

[Andrew Kaplowitz:]

Okay. And you sound pretty bullish on Mining. You mentioned the Mining funnel continues to improve. If I just look at the orders, year-over-year, they're down quite a bit. But it's a small business for you guys. Is it just because you won a couple of chunky projects last year, I guess, in 2016 and so you had tough compares in orders and would you expect Mining to be up at least in orders pretty nicely in 2018 over 2017?

[Matthew L. Trerotola:]

Yeah, you hit it right on the head. It is a little bit smaller segment and it tends to be a bit chunkier and we had an enormous project in last year's orders that is terrific, but distorted the picture a little bit in terms of just one year of growth. And when we look at the funnels in terms of what can play out over the next couple of years, we expect a period of healthy growth. Certainly, in any given quarter, there is going to be the effect of that, that chunkiness of that business. But the funnels are extremely strong there and the activity is healthy. These are conservative customers that take their time making decisions. We've got a tremendous funnel of some smart opportunities and expect to see some exciting growth from that business, but we're certainly learning that these customers take their time, they check the math number of times and then they have to work through their capital cycles and things and that's going to be a dynamic in that industry. But we do expect that here in 2017 and beyond there is a – or 2018 and beyond, there is a good healthy growth path in Mining.

[Andrew Kaplowitz:]

Appreciate it, Matt.

[Operator:]

Thank you. And our next question comes from the line of John Inch from Deutsche Bank. Your line is now open.

[John G. Inch:]

Thanks. Good morning, everyone.

[Christopher M. Hix:]

Good morning, John.

[Matthew L. Trerotola:]

Hey, John.

[John G. Inch:]

Hey, guys. Could we – just remind me, can we size the aftermarket for Air & Gas? I think I'm just looking at my notes. I think you said before, new power build is less than 7% of total company and then Power is 38% of sales. I'm just trying to make sure I'm scoping this correctly, just because obviously the Air & Gas results, core were lower than expected this quarter.

[Christopher M. Hix:]

Yeah. We just want to give you the right view of this. Yeah, we've said that the aftermarket part of the Air & Gas Handling business is about 43% of the business. And I think we've represented as well that Power for all of 2017 was roughly 35% to 38% of the business. And so, that probably gives you a bit of a sense of the magnitude of this.

[John G. Inch:]

And the split, Chris, between, say, developed versus developing, what would that be on the aftermarket side?

[Matthew L. Trerotola:]

Let me comment there, because I think you're trying to kind of get at the Power question more than anything. So, let me just kind of come back to my comments specific to that. First of all, yeah, our total Power was 35% to 38% for the full year, but down, the back half of the year was in the 25% to 30% range, and that's the jumping off point that I was talking about when I make the Power comments. And then within Power, obviously, with the dynamic in that business, the aftermarket is a more significant piece, it's about two-thirds of the overall Power business, especially down in the back half of the last year. And then that aftermarket – we don't want to cut it to short straws, but there's a reasonable distribution between different places in the world, in developed and emerging parts of the world in that aftermarket business as well. And that's why the full profile of it says that really the forward view would be that there's a meaningful chunk of high-growth markets, aftermarket that will have healthy growth. There is a chunk of newbuild that will be flattish from the base that we've now established but down a little in 2018. And then, there's a developed aftermarket that could be flat, could be down some, depending on how those markets play out and how our growth initiatives play out in terms of retrofits and other things that we're driving there.

[John G. Inch:]

Yeah. On the FabTech side, I think you obviously did 7% core. Did you attain the 3% to 5% guide for the year that's sort of implied? I'm just wondering why doesn't FabTech – why don't you think it does a little bit better just based on the momentum that you have?

[Matthew L. Trerotola:]

Yeah. That 7% core in Q4 is something we're real happy about it, but certainly we had a little bit easier comp in that quarter. And when we look at the components of that, we see that rolling over into the first quarter, more in the mid-single digits kind of range as we think about the jumping off point for the year. And so we stick with our guidance there. Obviously, it'll be – the comps will get tougher as you work through the year. And so, we think that there is sort of a mid-single digits first half opportunity in that market. And whether the second half can hold the mid singles or not depends a little bit on how things play out through the year.

[John G. Inch:]

And then, did you guys pull forward some restructuring? It looks like you did. I'm just wondering why are the savings still $25 million for 2018.

[Matthew L. Trerotola:]

Well, I think, we've said we're going to have at least $25 million of savings for 2018. We can continue to push to have as much savings as we need to in Air & Gas Handling, in particular, in order to make sure we protect the profitability of that business. I think, Chris is going to add a comment there as well.

[Christopher M. Hix:]

Yeah. Just the other thing to note is that the restructuring expense was particularly high, because we did have the write-off of a facility and that's going to be included in the restructuring. That'll take a little bit longer to fully take shape and the benefits of that we'll see a little bit of that more in the back half of 2018 and then heading more into 2019.

[John G. Inch:]

That makes sense. And then just one more for me, because of U.S. tax reform, I don't think you guys historically have paid much of any U.S. tax. I understand you're big international company, but I guess my question is, now that the U.S. is actually a low-tax country, does that cause you to operationally or financially seek to potentially make some changes where you could kind of debase maybe other higher tax jurisdictions in the world versus the United States?

[Christopher M. Hix:]

It certainly changes the playing field as we think about the structure that we have globally and ways to drive that structure to get to a systemically lower rate regime. And so, we'll have to continue to look at that. It's a new playing field for the company. What is attractive to us is being able to quickly depreciate items in the U.S., which gives us a better tax cash position. We like the ability to have more room to maneuver as we think about acquisitions and investments globally and in the United States. So, it definitely helps us to be a little bit more nimble and agile.

[John G. Inch:]

Yeah. Got it. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Josh Pokrzywinski from Wolfe Research. Your line is now open.

[Josh Pokrzywinski:]

Hi. Good morning, guys.

[Matthew L. Trerotola:]

Hey, Josh.

[Kevin Johnson:]

Good morning.

[Josh Pokrzywinski:]

Jumping around on a few calls this morning, so I apologize if you've already mentioned this, but if I look at kind of ending organic backlog in Air & Gas Handling and think about this kind of flat to down 2% that you guys has spelled out for 2018, how should we think about the bridge between the two and how should I think about what aftermarket needs to grow inside of that?

[Christopher M. Hix:]

I guess, so the way we look at this is we've got – if you strip out STE and you look at the backlog, we feel like we've got the backlog that they gets us off to a reasonable first half start in 2018. All the vectors we have in Air & Gas and Mining and some of the – or in Oil & Gas and Mining and General Industrial, we see those paths to improvement. The Oil & Gas improvement, we think, largely bakes in, in the second half of the year. And so as we look at the second half versus the first half, we expect to see growth improvement in Air & Gas Handling. And it's that improvement in that second half that enables the business to achieve its forecast. The other thing I'd remind everybody is that we do have a shift to shorter-cycle businesses in there with the acquisition of STE and Roots previously and another businesses. The amount of backlog we have at the beginning of the year is becoming less of a determinant and for the full year performance.

[Josh Pokrzywinski:]

So, is the call, I guess, that is it short-cycle OE build momentum or aftermarket, or maybe just the fact that the whole thing is a little shorter cycle than maybe it was kind of in the (43

[Christopher M. Hix:]

I'd say it's both. Yeah, I'd say it's the shorter – it's a reflection of the shorter-cycle businesses, it's a reflection of the faster growth in industrial applications, and it's a reflection of what we believe is this recovery in Oil & Gas that's coming, and then, to a lesser degree, what we feel is a strong funnel for the Mining business.

[Josh Pokrzywinski:]

Got you. And then, on the restructuring side, with the higher spend in the fourth quarter, is this kind of a clearing of the decks on the Power side to really say we've kind of distanced ourselves from this in terms of not being very helpful for a recovery there and don't need to take any more action? Or is this still something where you guys kind of have a bit of hope out there on the horizon and don't want to cut to the bone too soon?

[Matthew L. Trerotola:]

Yeah. So setting aside Chris' comment about the facility write-down, the restructuring that we've talked about and that we're executing is really a few more waves of proactive strategic realignment of the Air & Gas Handling business for the future. So, some of that is about how the businesses are structured and where our commercial engineering resources are in the world. And that's both about facing the right geographic market and facing the segment markets they're going to have the best growth. But then it's also about realignment of our supply chains in order to be more competitive and more powerful in the future in our product lines. And so, we've made multiple waves of progress there in Howden. And I think each time we see another step down, it forces us to take a harder look at what's possible in order to keep realigning that business for the future.

[Josh Pokrzywinski:]

Does that mean that we're kind of more in a pay-as-you-go-type environment? I don't mean that you won't be excluding it, just more of a smaller increments on restructuring.

[Matthew L. Trerotola:]

Yeah. In our company, on the whole, I think we've stated a number of times that we're headed to a likely a period of lower restructuring versus the period that we went through over the past couple of years, and I don't think that has changed. I think certainly within the Air & Gas Handling business we're going to stay in a little elevated place through 2018 based on this additional step down in Power. But we certainly don't see that as a permanent reality that we'll have high restructuring levels in Air & Gas Handling versus that at some point these market – the oil and gas and mining markets start growing back half of this year, industrial keep growing, Power stabilize and now we're in a more normal environment.

[Josh Pokrzywinski:]

Perfect. Thanks for the color.

[Operator:]

Thank you. And our next question comes from the line of Joe Ritchie from Goldman Sachs. Your line is now open.

[Joe Ritchie:]

Thank you. Good morning, everyone.

[Christopher M. Hix:]

Good morning, Joe.

[Joe Ritchie:]

So maybe just starting with Air & Gas Handling and you guys mentioned the margin pressure in the first half from large projects still coming through. Can you just comment on the pricing in the backlog on recent orders? And then also specifically the backlog that came in from the Siemens Turbo business, have you gotten a chance to scrub that backlog and how do you feel about the margin profile there as well?

[Matthew L. Trerotola:]

Yes. This is certainly something that we've had a lot of focus on, And the order that we took in the back half of the year support an improving margin profile for that business through the back half of this year. We've been in a competitive market. We've been fighting hard to make sure we get the best prices that we can. We've also been working hard on the supply side of the business and on the productivity or project management to make sure that we can both, win and have better margin profiles for the orders. And what we've seen down the back half of the last year and even into January supports a margin recovery in the back half of this year. And to your question about the STE backlog, certainly, it's come in the range that we had expected in terms of the size of it and the margin profile of it. And so, we expect to be able to perform in that business. We've been doing a little bit of cost realignment from what type of backlog came in, in the back half of last year, but we expect that business to be able to perform in line with our expectations in 2018.

[Joe Ritchie:]

Okay. All right, that's helpful, Matt. Maybe following on and just sticking with this whole price cost dynamic and moving over to FabTech. Can you guys just tell us a little bit more about what the expectation is for 2018 for price/cost across the portfolio? And then also, just commenting specifically around the most recent quarter, it looks like you got about 190 basis points of pricing. Is there a time lag in between, like when you expect to get additional pricing and for pricing to exceed cost? So any more color around that would be helpful.

[Matthew L. Trerotola:]

Yeah, sure. So, the price cost dynamic in FabTech, I think, was a battle throughout all last year. And really, the main reason for that is that steel kept escalating and it's a business where I think, historically, steel increases have been passed through, but they don't automatically pass through on most of the business. And so, in every region in the world, with the different channels and things, there's a need to put through the prices and get them through the channel and get them into the marketplace. And that does take a little bit of time, and in environment where you might have a price increase and then stabilization, you get it through and you get to the other side of it. But in an environment like last year, it was an ongoing fight through the year. Each of the last – this is something we've put a lot of standard work in, we got very sharp visibility within the team. Through the last few quarters, each quarter, we were able to get to – we're in the third month of the quarter, we got back in the right range, but at the same time in that third month in the quarter, we were seeing the steel price escalation in the next quarter and then having to put through more price increases for the next quarter. And so last two quarters, as we exited, we were back in the right balance place. And so, that's our comment that as we roll over into Q1 and then Q2, yeah, we still feel a little bit of pressure because steel keeps going up, but we've continued to execute aggressively to get to the right side of it. And as soon as steel flattens and potentially then it even moves down, then we'll get to a better place here. Now, you might ask, well, why don't you put through twice as much? The reality is that these price increases need to be justified. Our customers can do the math and they need to be justified based on the actual transparent data what's going on in the marketplace. And so, you try to execute as much as you can in light of the environment, but if it keeps escalating, you do have to then go back and keep getting more is the dynamic of this industry. So as a little bit more color on that, but again, as I said earlier, as we look at what we're expecting steel to do in the coming quarters from the signals that we have and the plans that we have for price in the coming quarters, we expect to sequentially improve our operating margins at FabTech in Q1. And then, continue to improve from there and have strong operating margin growth in FabTech for 2018 again.

[Joe Ritchie:]

That's helpful. If I can just maybe follow on, one quick clarification. So, is there an expectation then as soon as 1Q that FabTech margins you'll see a positive price/cost spread on either a dollar basis or on a margin basis?

[Matthew L. Trerotola:]

What I would say is that 1Q has – in terms of the price/cost spread, it has the potential to look a little bit better than Q3 and Q4, but still have a little bit of a gap on that price/cost spread. But there's also some healthy growth in 1Q as well that will create some productivity progress and opportunities there as well. I think, as we work through the year, we expect to get fully on the other side of that price/cost spread likely in Q2.

[Joe Ritchie:]

Great. Thanks, Matt.

[Operator:]

Thank you. And our next question comes from the line of Seth Weber from RBC Capital Markets. Your line is now open.

[Seth Weber:]

Hey, good morning.

[Christopher M. Hix:]

Good morning, Seth.

[Seth Weber:]

I appreciate the color on the FabTech pricing. That was actually a good part of my question. So just given your answer, I'm just trying to think through, do you think this is still a 30%-type incremental margin business? Is that how you guys are still thinking about FabTech going forward? I know you mentioned that there was some one-time costs here in the fourth quarter. So I'm just trying to square kind of on a normalized basis on your path to sort of low-teen margins, should we think about this as a 30% incremental margin, I guess, is my first question.

[Christopher M. Hix:]

Seth, we continue to think about it as a 30% incremental margin business, and the math lays out, as you know, a little bit higher on a gross basis and then we're always trying to find ways to reinvest a little bit of that back into the business to drive some of our growth initiatives. But 30% is a good net incremental number to think about.

[Seth Weber:]

Okay. And can you just – I think in the prepared remarks you talked about some one-time costs here in the fourth quarter in FabTech that you absorbed. And I guess, can you just quantify that and will that repeat going forward?

[Christopher M. Hix:]

Yeah. We don't expect those to recur, as I said, in my comments. And those are largely either year-end true-up adjustments or other cleanup activities that occurred. So, I think we've cleared the deck on that as we go into 2018.

[Seth Weber:]

Okay. So, is it not a material number, though?

[Christopher M. Hix:]

No, I think as I mentioned before, as we think about the ESAB margins, we had about a third of the impact in the quarter was that and a third was the inflation, a third in the other elements that we discussed earlier.

[Seth Weber:]

Okay. Thanks. And then, just maybe – I apologize if you've talked to this before, but on the Oil & Gas business, is it possible to just help us understand how far off that business is relative to recent peaks? I mean, do you talk to it that way?

[Matthew L. Trerotola:]

Yeah. Well, it's off a lot relative to recent peaks, I think, would be – it would be my comment. And I think what I'll say is that my view is that the oil and gas environment had a kind of a permanent shift. And what drove the last peak that also drove a nasty backside of that peak, I think, is a dynamic that is not really likely to recreate in the oil and gas industry with the shape of the supply curve. And the forward view that we have for Oil & Gas is more of a long steady growth recovery as the fracking piece of the supply curve can come and go in terms of the role that it plays in that industry and the rest of the supply curve can have maybe a normal steady growth investment path versus the sharp cycle up and sharp cycle down that happened in the last cycle.

[Seth Weber:]

Okay. I appreciate it. Thank you, guys.

[Matthew L. Trerotola:]

Thanks. And I would say, I think the exposure – our business' a exposure within that industry – we've got a fair amount of downstream exposure, which I think is going to have a – probably more of economic driver in terms of the build-out that happens there. And then our exposure to the other parts is more balanced than not, say, concentrating on fracking where there could be a sharp up and a sharp down, but more balance, and I think positions us for kind of long and steady growth in Oil & Gas, up against I think the likely new reality in terms of how the investment cycle plays out in that industry.

[Seth Weber:]

Got it. Okay. Thank you, guys.

[Operator:]

Thank you. And our next question comes from the line of Nathan Jones from Stifel. Your line is now open.

[Nathan Hardie Jones:]

Good morning, everyone.

[Matthew L. Trerotola:]

Good morning, Nathan.

[Christopher M. Hix:]

Good morning.

[Nathan Hardie Jones:]

Just back to Air & Gas orders once more, I think the organic order number came in maybe $10 million, $15 million lower than kind of was implied on some of your comments on the 3Q call. I know you talked about timing of some Oil & Gas orders and you did say that some of those shook loose in the fourth quarter. Did all the ones that shook loose in the fourth quarter or all the ones you expected to shake loose come in, and then you had some delayed ones in 3Q? Can you just talk about the outlook for those in the first half of the year? What customers are telling you about plans on those ones that you're looking at?

[Matthew L. Trerotola:]

Yeah. First, I think what I'd say, we talked at the end of Q3 about Q4 likely being flattish in terms of core order growth, and we're down a couple. And so, I think our order performance in Q4 was about in line with what we'd expected. And if anything on the project business was a little bit healthier. As Chris talked about, we had some delays and deferrals in the aftermarket business. So, Q4 was about where we expected. As we look into the first half of the year, we still see a flattish view of the first half of the year. As you know, Power pulls us down and Industrial and Mining contribute some growth and Oil & Gas bounces around a little bit, we could certainly see some projects in that first half that will be a little bit difference makers in terms of when and where the growth comes. If we look at the project flow and the comps, I think we'd say that more likely we'll be down a little in the first quarter and up in the second, and flattish for the first half of the year. And then that will be some momentum into the back half of the year to have healthy order growth down the stretch.

[Nathan Hardie Jones:]

And then one for Chris. You mentioned higher interest expense with the Fed raising rates. The market is obviously having a bit of a freak out about potential inflation and faster interest rate increases from the Fed. Can you talk about how you're thinking about potentially getting rid of the floating-rate debt and looking in some fixed-rate debt in the U.S.?

[Christopher M. Hix:]

Yeah. We took a nice step forward as you know in 2017 by issuing the Eurobonds, and that took a big slug of our debt from floating rate to fixed at a really nice coupon of 3.25%. And it's clear that there will be additional opportunities for us here, especially in conjunction with the portfolio moves that we make. I suspect that in 2018, we'll either take another step forward on fixing some of the rates and/or look at other improvements that we can make in our borrowing capacity.

[Nathan Hardie Jones:]

All right. Thanks very much.

[Operator:]

Thank you. And our next question comes from the line of Chris Dankert from Longbow Research. Your line is now open.

[Chris Dankert:]

Hey. Morning, guys. Thanks for squeezing me in here.

[Matthew L. Trerotola:]

No problem, (1

[Chris Dankert:]

I guess just given the tax form in the U.S., I guess does that change some of these prospects for M&A in developed markets versus emerging or bring some new guys into play? I guess, just any comments on it from the platform-level M&A you've been targeting here?

[Matthew L. Trerotola:]

Yeah. Chris, I'd say, our primary consideration for the platform-level M&A is strategic. We're looking for attractive industries with good healthy secular long-term drivers, areas where technology and brand matters, areas where we can see the right entry point where we can get a strong position we can build on and we can see how our Business System can add value. And so, that's really the primary driver. Certainly, value considerations come into play and tax is one of the value considerations. And so, certainly, what you brought up would be a factor, but it would certainly not be the primary factor in terms of our next new platform.

[Chris Dankert:]

Yeah, understood. I think just not to harp on the restructuring too much, but just as I kind of think about the buckets that these savings fall into, with that plant closure, how are you thinking about payback? Is it typically a two-year timeframe or just kind of how does that roll 2018 versus 2019 and beyond?

[Christopher M. Hix:]

Yeah. Most of our restructuring, if I were to generalize, has had a payback typically of one to two years. And everything that we are looking at today, I think, largely falls in that payback.

[Chris Dankert:]

Got it. Thanks so much, guys.

[Matthew L. Trerotola:]

Okay. Thank you.

[Operator:]

Thank you. And that concludes our question-and-answer session for today. I would like to turn the call back over to Kevin Johnson for closing remarks.

[Kevin Johnson:]

Thank you again for joining us today. We look forward to updating you on our next call.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. And you may now disconnect. Everyone, have a great day.