Global X U.S. Cash Flow Kings 100 ETF
Q4 2018 Earnings Call Transcript

Published: 5 Feb 2019

[Operator:]

Good morning, ladies and gentlemen, and welcome to the SPX FLOW Fourth Quarter 2018 Earnings and 2019 Guidance Call. At this time, all participants are in listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call will be recorded. I would now like to introduce your host for today's conference, Mr. Ryan Taylor, Chief Strategy Officer, you may begin.

[Ryan Taylor:]

Thank you, Catherine, and good morning, everyone. Welcome to our fourth quarter 2018 and 2019 guidance call. We appreciate you joining us. With me here today are Marc Michael, President and CEO; and I am pleased to introduce our recently appointed Chief Financial Officer Mr. Jaime Easley. Our Q4 2018 earnings release was issued this morning and can be found on our website, spxflow.com. We also provided our 2019 guidance this morning and we will discuss it in greater detail during the call today. This call is also being webcast with a presentation located in the Investors section of our website and a replay of the webcast will be available later today. Note that elements of this presentation contains forward-looking statements that are based on our current view of our businesses and their markets. Those elements are subject to change and we ask that you view them in that light. Principal risk factors that may impact our performance are identified in our most recent SEC filings. In the Appendix of today's presentation, we have provided reconciliations for all non-GAAP measures presented. And before we begin the call, I just want to provide some color on the adjusted measures presented today for the fourth quarter 2018 and for the 2019 guidance. For the fourth quarter, our adjusted results exclude $0.88 of tax losses related primarily to the U.S. Tax Reform and $0.42 per share or $80 million combined of impairment charges and specific restructuring expenses related to strategic actions that we are taking to reduce our exposure to large dry dairy projects. Note the effective tax rate on our adjusted Q4 EPS is 29.6%, and that is consistent with our guidance assumption. For 2019, we are planning a total of $15 million to $20 million of restructuring actions. This is comprised of approximately $5 million of runrate restructuring consistent with our annual budget expectations and our communications to investors in the past. It also includes $10 million to $15 million of discrete strategic actions that we plan to take this year. In our adjusted 2019 earnings guidance and EBITDA guidance, we have excluded the $10 million to $15 million that relates to discrete strategic actions, but we have included the $5 million of runrate restructuring. With that, I'll turn the call over to Marc.

[Marc Michael:]

Thanks, Ryan, and good morning, everyone. Thanks for joining us on the call. 2018 marked our third year as an independent standalone company. We’ve been on a journey to transform SPX FLOW into a high-performing operating enterprise. Over the past three years, we’ve successfully realigned [Technical difficulty] continued focus on debt reduction and an infusion of talent at the factory, commercial, and leadership levels. This progress was underscored by 5% organic revenue growth, 200 points of operating margin expansion, and 19% growth in adjusted EBITDA. I want to thank all of our global team members for their hard work, contributions to our 2018 accomplishments, and ongoing dedication to serving customers. The journey to high-performance continues in 2019 as our global team is aligned on the key initiatives we are emphasizing to drive sustainable, profitable growth, and outsize margin expansion over time. Specifically, our top priorities are to drive higher capital efficiency, increased productivity, and accelerated working capital turns to unlock value and increase our capacity to grow our high value product lines. These priorities are aligned with our goals to achieve 12% operating margins and generate free cash flow at 120% of net income on a consistent basis. Given our progress over the past three years, I am confident in our future and believe 2019 has great potential to represent an important turning point on our journey. I’ll begin this morning with a brief recap of our Q4 performance. We ended the year on a positive note delivering 5% organic revenue growth and 70 points of margin expansion at the segment level with margins up in all three segments. Our Industrial segment delivered a strong quarter with 13% organic revenue growth, 110 points of margin expansion, and 6% order growth versus the prior year. On a consolidated basis, orders were stable sequentially at just over $500 million. As compared to the prior year, orders declined $48 million on an organic basis as two large dry dairy orders totaling $72 million did not repeat. The underlying order development was healthy as we continued to drive a high quality of bookings focused on growth in our higher margin products and aftermarket value streams, while remaining highly selective on large projects. Taking a look at the full year results, we delivered 5% organic revenue growth, 19% EBITDA growth and operating margins expanded 180 points to 8.9%. Importantly, the mix of orders was consistent with our product line strategy securing mid-single-digit organic order growth in our highest value product lines. Orders in the product lines where we are focused on enhancing performance declined by double-digits on an organic basis due primarily to increased selectivity on Food and Beverage system orders. We expect this strategy will continue to result in a higher margin profile across the enterprise in a more consistent level of operating performance. Capital allocation in 2018 remained focused on organic investment and debt reduction. Gross debt was reduced 14% year-over-year driven by $110 million of voluntary prepayments on our term loan during the year. Gross leverage ended the year at 2.8 times, down more than a full turn from a year ago and net leverage was 2.2 times. We are pleased with this balance sheet improvement, and we will continue to focus on debt reduction in 2019. As I mentioned, our order development is consistent with the strategy we’ve described at our Investor Presentation early last year. Our product line strategy is to shift our business mix to a higher margin profile with a simpler operating environment. Our Aggressively Invest product lines serve high specification customer applications with faster cycle times across common operational platforms. Over time, we believe the shift toward higher value, higher margin products will feature more prominently in our revenue and margin profile, and we continue to be encouraged with our order development on this front. During 2018, on an organic basis versus the prior year, orders in our Aggressively Invest category grew mid-single digits with growth across all six product lines. Orders in the opportunistic invest category were up low-single digits with growth spread throughout the product lines. And in product lines where we are enhancing performance, orders declined double digits, primarily due to selectivity and discipline in Food and Beverage systems orders. In this category, we continue to see improvement in the quality of new orders. Execution of our product line growth strategy has possibly shifted the mix of our backlog compared to the prior year, a trend we expect to continue. In line with that strategy, 2018 ending backlog was $952 million, down 1% organically year-over-year. Backlog for Aggressively Invest growth product lines was up 13% and Opportunistically Invest product lines were up 5%, and backlog for product lines where we are enhancing performance saw a 13% reduction year-over-year, again consistent with our strategy. We are focused on growing our highest margin product lines and exercising discipline in project-related businesses where our emphasis is enhancing performance. As a result, we expect to see favorable shift in margin performance as we move into the second half of 2019 and into 2020. In contrast, we are planning for a lower level of project-related revenue specifically, in our Food and Beverage systems business where our selective approach contributed to a 32% or $114 million reduction in orders last year. This reduction was specifically concentrated in large dry dairy process applications, a portion of the market where we have methodically decreased the company’s exposure and plan to adjust our cost structures accordingly in 2019. Going forward, we will maintain our capability in technology and dry processing and remain committed to delivering on our commitments to customers. Taking a brief look at our 2019 full year guidance, on the order front, our guidance assumes modest organic growth versus the prior year and we have not assumed any new large project orders. For revenue, and on a consolidated basis, we are targeting organic revenue to be flat and are expecting a 2% headwind from currency. We expect the decline in 2018 orders for Dry Dairy, Food and Beverage systems will drive a $40 million or 2% reduction in total revenue. Excluding Food and Beverage systems, we expect organic growth of 1% to 3% across the rest of the business. In the segments we expect margins to expand about 100 points at the midpoint to 12.5% driven by an improved mix of higher margin products and savings from restructuring actions. We expect to be net neutral from a price cost perspective. At the midpoint, adjusted EBITDA is expected to grow 7% to between $245 million and $265 million and adjusted EPS is expected to be between $2.40 and $2.75 per share, up 11%. Our free cash flow target is $105 million to $125 million and includes $30 million of CapEx and $15 million to $20 million in restructuring payments. We intend to remain focused on debt reduction and plan to pay down an additional $50 million to $75 million on our term loan in 2019. After considering the needs for the next phase of the journey, I made several changes to my management structure in 2018. In Q2, I brought on Ty Jeffers from GE to lead our Global Manufacturing team and he is spearheading the pathway to excellence efforts for sustainable operational improvements; promoted Ryan Taylor to the newly created position of Chief Strategy Officer in order to provide additional talent and focus to our strategy and future capital allocation opportunities. And I appointed Jaime Easley as our Chief Financial Officer which will continue our tradition of functional excellence and bring new energy and perspective our leadership team. Jaime has a strong background in finance, accounting, capital markets and leadership. He joined SPX Corporation in 2011 and served in Senior Audit and segment CFO roles. Prior to this appointment, Jaime served as Corporate Controller and Chief Accounting Officer. Jaime is a Clemson Tiger and also earned his Master’s from the University of Texas, McCombs School of Business. Jaime is ready for this leadership position role and I am excited to have him on my team. And with that, I will turn the call over to Jaime.

[Jaime Easley:]

Thank you, Marc, and good morning everyone. I am excited to be here today and I look forward to meeting many of you in person at upcoming investor conferences, employee meetings and community events. I’ll begin this morning with earnings per share. For the fourth quarter, we reported a loss of $0.64 per share on a GAAP basis. This included $0.88 of tax losses primarily for U.S. Tax Reform remeasurement period adjustments, non-cash impairment charges of $0.34 per share related to intangible and fixed assets in our Food and Beverage segment and $0.08 or $3.5 million of restructuring expense related to certain actions we were taking to adjust the cost structure of our dry processing business. The impairment charges and restructuring expense, both reflect the strategy Marc discussed, relative to the large dry process applications. Excluding these items, adjusted EPS was $0.66 per share, $0.04 above midpoint of our guidance range. As compared to our expectations, segment income was $0.03 higher driven by solid execution by our power and energy team. We also benefited from a favorable pension adjustment and other income. The effective tax rate on our adjusted EPS was 29.6% in line with our guidance assumptions. Looking at the segment results, starting with Food and Beverage. The team here delivered 6% organic revenue growth on strong project execution and increased aftermarket sales. This growth was offset by a 4% negative impact from the adoption of ASC 606 and a 3% currency headwind. The net result was a 1% year-over-year decline in revenue to $195 million. Segment income was $22 million or 11.5% of revenue. On the order front, the Dwight and his team continued to deliver growth in component and aftermarket orders which grew mid-single-digits year-over-year in Q4. This growth was more than offset by lower level of systems orders previously mentioned. Overall, the market trends for Food and Beverage remained healthy and we continue to emphasize growth in our higher value process components and aftermarket solutions. Moving on to power and energy, revenue for the period was $147 million down 3% to the prior year. ASC 606 was a 6% benefit to revenue and currency was a 3% headwind. Organic revenue declined 6% on a lower level of OE pump and valve shipments. On a positive note, José and his team delivered double-digit organic growth in aftermarket sales which is reflected in the year-over-year margin performance. Segment margins improved 70 points to 10.1% marking the highest margin level since Q3 2015. Orders in the quarter were $42 million, down from $150 million in the prior year on a lower level of pipeline value orders from our North American distributors and the end-users. The Midstream market in North America remains healthy and we anticipate modest growth in pipeline valve orders in 2019. Also of note, during the quarter, we were awarded a $16 million order for safety pumps, a solid win with healthy margins consistent with our selective approach on large OE orders. José and his team have done a nice job improving the quality of the backlog and focusing on high-quality orders that leverage our strong brands and engineering talent. Rounding out the segment results with Industrial, a pretty solid quarter all around with 13% organic revenue growth, 110 points of margin expansion and 6% organic order growth. The organic revenue growth was broad based with growth across each product line led by double-digit growth in mixer shipments. Our liming mixers are produced in Rochester, New York and boast the high-quality reputation. We have seen strong order growth in mixer orders over the past year and it was encouraging to see strong shipments in Q4 from the team in our Rochester facility. We are telling on them to drive greater capital efficiency and throughput as we look to drive continued growth in that product line. Segment income grew 19% to $26 million with margins of 13.4% reflecting solid leverage on the organic growth. Orders were $185 million in the quarter, a healthy level and up 6% on an organic basis versus the prior year. Our growth was broad based and led by double-digit growth for hydraulic tools. Looking now at our segment targets for 2019. Note that we expected 2% currency headwind to revenue across each segment, that’s about a $40 million headwind in total to consolidated revenue. In Food and Beverage, we are targeting margin expansion for the third consecutive year despite an expected organic revenue decline in the low-single-digits. The margin improvement is expected to come from a more profitable revenue mix as we anticipate mid-single-digit organic growth for component and aftermarket sales to mitigate a decline in system revenue of approximately $40 million. In power and energy, we are targeting modest organic growth and a similar margin profile in 2018. We expect demand for pipeline valves in North America to remain at a healthy level and we expect aftermarket sales to be steady in 2019. And for Industrial, we are targeting low-single-digit organic growth and a 100 points of margin expansion on a more profitable revenue mix and cost savings. On a consolidated basis, we are targeting essentially flat organic revenue, with a 100% margin – points of margin expansion. As Marc mentioned, our guidance assumes we are neutral on price cost for the year and our margin targets includes continued investments in R&D and new talent to support future growth and improvement. This reflects the efforts to drive growth where we believe we can achieve strong returns on invested capital and to reduce our exposure to project-related revenue. This next chart provides a great detail to the assumptions in our full year midpoint guidance. Corporate expense is expected to be $45 million, down 6% from 2018. As previously mentioned, we have approximately $18 million of restructuring actions planned for 2019. Our adjusted earnings and EBITDA guidance includes the $5 million of pure runrate restructuring that Ryan mentioned. Excluded from our adjusted guidance are the discrete strategic actions we are taking to focus on targeted areas of our value creation strategy. Interest expense is expected to decline $5 million or $0.08 per share to $42 million. This reflects the debt reduction we are planning. We are assuming an effective tax rate of approximately 29% and 43 million shares outstanding. Based on these assumptions, our 2019 earnings per share guidance range is $2.40 to $2.75 per share on an adjusted basis and adjusted EBITDA is expected to grow about 7% at the midpoint to $255 million. We expect to generate between $105 million and $125 million of free cash flow net of $30 million of CapEx and $15 million of restructuring cash payments. Note that we are not adjusting restructuring cash payments out of our free cash flow guidance. Looking at Q1, we are targeting revenue to be between $475 million and $495 million. About 80% of the revenue target was in backlog at the end of the year. Currency is expected to be a 5% headwind year-over-year to the top-line. Organic growth is expected to be in the mid-single-digits and concentrated in our Industrial and Food and Beverage segments. We are targeting $45 million to $52 million of segment income. Our adjusted EPS guidance range is $0.31 to $0.43 per share, which assumes a 28% to 30% tax rate and we expect adjusted EBITDA to be about $47 million. Taking a look at our financial position. In Q4, we generated $49 million of free cash flow bringing the full year free cash flow to $80 million. We invested $26 million in CapEx and $13 million in restructuring payments. During 2018, we made $110 million of voluntary prepayments on our term loan reducing its outstanding balance to $140 million. We ended the quarter with $213 million of cash on hand and $769 million of total debt, down 14% from 2017. Net leverage was 2.2 times at the end of the year, down more than three quarters of a turn from the beginning of the year. We have significantly improved our financial position over the last two years and we intend to continue to emphasize debt reduction as a priority for capital allocation this year with $50 million to $75 million earmarked for debt. Our guidance implies gross leverage of approximately 2.3 times at the end of the year with net leverage declining to approximately 1.7 times. One of my key goals as CFO is to improve our capital efficiency, drive our teams to ramp up growth investments and drive attractive returns above our weighted average cost of capital and create long-term value. Our overall debt maturity schedule remains staggered. We exited the year with undrawn balances on our revolver and securitization lines and the term loan is now at $140 million and matures in Q3 of 2020. During 2019, we intend ot monitor the refinancing markets and we’ll opportunistically look to refinance our credit facility. Our senior notes mature in 2024 and 2026 making remaining debt maturities out over five years. That concludes my prepared remarks. At this time, I’ll turn the call back over to Marc.

[Marc Michael:]

Thanks, Jaime. In closing, we are committed to creating value through our journey to high-performance. During the last three years, we have laid the foundation for the future by realigning the overhead cost structure, consolidating our manufacturing footprint, implementing a high-value product line strategy and strengthening the balance sheet. The next phase of our journey centers on operational excellence driven through our pathway to excellence. With solid execution, we will create new capital allocation opportunities for our shareholders. Our value creation model highlights the focused action plans that will generate great customer and shareholder outcomes. Our drive to 12% operating margin is supported by, continuous growth in our aggressive invest to grow product lines, selectivity in large projects in Food and Beverage systems and OE power and energy… [Technical Difficulty]

[Operator:]

Ladies and gentlemen, please standby. [Operator Instructions]

[Ryan Taylor:]

We are going to pick up where Marc left off in the webcast on Slide 20 I believe.

[Marc Michael:]

Yes, so, in my summary, it’s we are all pick back up after Jaime’s closing comments. So, in closing, we are committed to creating value through our journey to high-performance. During the last three years, we have laid the foundation for the future by realigning the overhead cost structure, consolidating our manufacturing footprint, implementing a high-value product line strategy and strengthening the balance sheet. The next phase of our journey centers on operational excellence driven through our pathway to excellence. With solid execution, we will create new capital allocation opportunities for our shareholders. Our value creation model highlights the focused action plans that will generate great customer and shareholder outcomes. Our drive to 12% operating margins is supported by, continuous growth… [Technical Difficulty]

[Operator:]

[Operator Instructions]

[Marc Michael:]

Hey, again, sorry about the technical difficulties we’ve had here with the phone lines. I am going to pick this up one more time from my closing and then we will jump right into Q&A. If for some reason I don’t like to do the drop the closing it drops again. We are going to try an alternative way to call back in and we will skip the closing. In closing, we are committed to creating value through our journey to high-performance. During the last three years, we have laid the foundation for the future by realigning our overhead cost structure, consolidating our manufacturing footprint, implementing a high-value product line strategy and strengthening the balance sheet. The next phase of our journey centers on operational excellence driven through our pathway to excellence. With solid execution, we will create new capital allocation opportunities for our shareholders. Our value creation model highlights the focused action plans that will generate great customer and shareholder outcomes. Our drive to 12% operating margins is supported by, continuous growth in our aggressive invest to grow product lines, selectivity in large projects in Food and Beverage systems and OE power and energy orders, global process excellence and a consistent one-world, one fingerprint lifecycle service to our customers. We expect our value creation journey to create positive financial outcomes including 120% annual free cash flow conversion, double-digit returns on invested capital, and growth in the right mix of business and product lines. I am confident in our ability to transform SPX FLOW into a high-performing operating enterprise and that concludes my prepared remarks and at this time, we will take your questions.

[Operator:]

[Operator Instructions] And our first question comes from Mike Halloran with Baird. Your line is open.

[Michael Halloran:]

Hey, morning everyone.

[Marc Michael:]

Morning, Mike.

[Jaime Easley:]

Morning.

[Michael Halloran:]

So, can you just help get us comfortable with that cadence as you work through the year, obviously back half loaded? So, maybe a little bit more color on how these projects time out? Anything else on the internal side that ramps through the year. Just give some – a little bit more clarity in detail on how you expect to achieve that ramp through the year?

[Jaime Easley:]

Mike, this is Jaime. So, as we talked about the strategy and the mix, we’ve seen the lower margins on our systems projects which will trade out in the first half of the year. So that will help improve margins as we move throughout the year, and we mentioned the restructurings actions that we will do, we have done some of that here in the reported results for Q4. And the additional actions as we get through 2019, and those will continue to have increasing levels of savings as we work throughout the year as well. And then, kind of one more point, I’ll mention is, at the end of Q3 last year, we talked about some of the execution issues we had, had around pricing, still have a bit of that in the backlog that will also trade out early in the first half and really give us some tailwinds towards the second half of 2019.

[Michael Halloran:]

So, if I take the project rolling off, is that predominantly first quarter or pretty even between first and second quarter? And then, the same question on the pricing side? Is that mostly going to hit the first quarter than a little bit in the second quarter or pretty balanced?

[Jaime Easley:]

I think it’s a bit more heavily weighted towards the first quarter, but there’s certainly some trailing pieces that will trade in the second quarter.

[Michael Halloran:]

Okay, it makes sense. And then maybe just a little thought on what the underlying assumption is in guidance on the core run rate aftermarket recurring-type business or at least the book and ship type business. Does it assume relative stability from fourth quarter levels as you look through the year? Any thoughts on the trajectory underneath in 2019 and what’s assumed?

[Jaime Easley:]

Yes, I think that’s fair. We are not expecting there to be a dramatic change in what we’ve seen in our recent run rate. If you look to the category, the product categories that we’ve laid out, we are expecting about 1.5 of growth in our Aggressively Invest product category, the same for – Opportunistically Invest and then what we are seeing is an offset of that coming through in our enhanced performance product line. So, naturally, the higher margin, faster turning product lines are going to be the pieces that we expect to grow in the 1.5% range in 2019.

[Marc Michael:]

Hey, Mike, it’s Marc. And just to step back from that, I’ll begin big picture-wise. We’ve got about for the year, coming into the year, $40 million of FX headwind, $40 million of lower systems business, and then the underlying business is growing 1% to 3%, and to Jaime’s point, that’s going to be supported by this faster cycle business that we’ve been focused on and emphasizing that we’ve grown kind of in – at the higher end of mid-single digits throughout 2018. So, we’ve been a little more conservative coming into 2019 based on the macro environment, and should the macro environment pick up and we see momentum, that’s going to help provide some catalyst as we move through the year. But again, we think we’ve been prudent in our approach in how we’ve structured the outlook based on the order profiles we are expecting in the margins and what’s in backlog.

[Michael Halloran:]

That makes a lot of sense, Marc, and just to follow-on to that, maybe some thoughts on the psyche of your customer base right now, and what you guys are seeing from a trajectory exiting 4Q into January? Are there signs of slowing in the core businesses that are better leading indicators for you or is it pretty stable and you are just trying to make sure you get ahead of any potential slowing as you look forward?

[Marc Michael:]

Yes, we saw steady – we saw the business steady in Q4. So sequentially, we are thinking more sequentially now versus year-over-year. So sequentially, Q3 to Q4, the business was steady. I will say the run rate business was still fairly good. There were some pockets where project-related business, these kind of mid-size projects as well as components to go into some of our Food and Beverage projects were a little slower. We don’t get an indication from customers that the projects have gone away. They just maybe took a pause in Q4 as this thing’s got kind of crazy in Q4. So, front logs are still good and which is encouraging, but again we haven’t assumed that that’s going to recover significantly as we go into the first half of this year. So, just in January, we haven’t seen any red flags, I would say at this point that says that we would expect anything different at this stage.

[Michael Halloran:]

Makes sense, Appreciate it.

[Operator:]

Thank you. Our next question comes from Nathan Jones with Stifel. Your line is open.

[Nathan Jones:]

Good morning everyone.

[Jaime Easley:]

Morning, Nathan.

[Marc Michael:]

Good morning, Nathan.

[Nathan Jones:]

I just like to maybe ask a few questions. On 2019 guidance, as it relates to the 2020 targets that you guys laid out last year, you . You had targeted 4% to 5% organic growth 2018 through 2020 with flat in 2019 and 5% in 2018. You are going to be at 2.5% through the first two years. Maybe any discussion you could have on if you think you can make that 4% to 5% or if not, where you think it might come out at? And it looks like the consolidated and margins here for 2019 are going to be about 10% and your target for 2020 was 12%. Do you think you can still make those? How much impact does the restructuring savings have? Any color you can give us on what you are thinking about those 2020 targets now?

[Marc Michael:]

Yes, our strategy, Nathan is consistent with what we communicated back at the beginning of last year. Trajectory can sometimes have a bit of a saw toothed based on what’s happening in the markets and as our strategy progresses, so what we saw that’s I would say is different from where we were in March of 2018 is our systems business and the selectivity we’ve taken there especially around the dry dairy projects. So, about $100 million reduction in systems business in 2018 versus 2017. So, that was a bit more significant than we had originally projected. It’s been the right thing to do though. Again, we are focused on the higher value liquid processing that keeps our factories full with the components and develops the aftermarket stream. So we are going to be working off a lower base in systems as we roll through 2019 and 2020 than we had originally planned. And then the caveat I would say, on the other product categories is, again, we have been prudent in our approach coming into 2019, as Jaime mentioned, this kind of 0.5% growth profile in orders is lower in our higher value product lines and simply based on again, looking at the macro environments and it being a bit lower growth environment than what we entered 2018. Again, if that picks up that will create some opportunity. And then the other piece, that’s important as we gained traction on our process excellence initiatives and our pathway to excellence. So, we’ve got a lot of work going on across the enterprise. And especially in our factories which what Ty is doing to improve performance and create more throughput which is going to help in a lot of areas including cost, the customer experience with the lead times, and inventory terms to reduce working capital. So the strategy is intact. Fundamentally, the two things that I would say that are a bit different from where we were in March 2018 are the systems order intakes in that level and again, a bit lower expectations or a little bit lower outlook for 2019 and what we considered in the higher value fast turn cycle business. And not to say that that won’t pickup as the year progresses. We will watch that closely. But again, we’ve been prudent and as we go into 2020, that business sits in these higher value product lines is what’s going to be our catalyst. So, timing may shift a bit. But we are still committed to the 12% and again, shifting just based on the macro environments for the high value products and a bit lower systems level as we go through 2019.

[Nathan Jones:]

Okay. I mean, I think what I am hearing there is, the 4% to 5% organic growth target over that period is out and that's primarily related to taking a more conservative outlook on the dry dairy systems orders, which I think it's fine. I mean, that derisks the backlog and those kinds of things. So I think that probably gives you a more predictable kind of profile there, but I would think that would also be margin-accretive if you had some lower business particularly out of that. So, maybe your mix should be a little bit richer. Are you guys still targeting doing 12% operating margins in 2020, because the first things I heard you say there, Marc, were not things that I think should be margin negative, relative to what you targeted for 2020. So, do you think that you can still make 12% in 2020?

[Marc Michael:]

Yes, they are not - you are correct. So they are not margin negative. The mix profile is going to improve. What it will hinge on is what the macro does to support our higher value or higher margin product lines and again, we’ve been a bit more conservative on that and it will also hinge on the progress Ty makes in the operations throughout 2019. So, when we get to 2020, it’s still our goal to achieve 12%. Think it will, again, it will depend on how the orders shape up in these higher value product lines. So, we are making good progress towards the 12% and we are seeing improvement in 2019 and as we get to 2020, we will assess where we are at that point. But we are on the right trajectory in the things we are working on. The strategy is solid. We are executing it and we do expect the margin profiles to continue to improve as we get to the second half of the year and into 2018.

[Nathan Jones:]

So, little bit hinges here on whether or not you are going to that leverage on volume out of the higher value product lines and what the organic growth underlying that is, is going to determine how close you get to that 12%?

[Marc Michael:]

Yes, that would be right.

[Nathan Jones:]

Okay, thanks very much. I’ll pass it on.

[Marc Michael:]

Yes, thanks, Nate.

[Operator:]

Thank you. Our next question comes from Robert Barry with Buckingham. Your line is open.

[Robert Barry:]

Hey guys. Good morning.

[Marc Michael:]

Good morning.

[Jaime Easley:]

Good morning.

[Robert Barry:]

Curious how you guys are modeling the organic revenue growth cadence. It looks like maybe 3 to 4 in the first quarter. But is it kind of up in the first half and down in the back half, in particular maybe in Food and Bev?

[Marc Michael:]

No, I don’t think that we’ve modeled that down in the first half. I think we are largely going to be at about our runrate that we experienced as we exited 2018 and then we are expecting it to pickup and ramp through the course of 2019.

[Robert Barry:]

So, you would expect the organic growth rate to improve through the course of 2019?

[Ryan Taylor:]

I think, Jaime was referring to the underlying growth that 1% to 3%. But as you look at the total business, we are looking at the 3% to 4% that you mentioned Robert, in Q1 is spot on. We are looking at very modest organic growth for the business and puts out in Q2. And then Q3 and Q4, this is what we’ve modeled and expect to see some pressure in the revenue line for Food and Beverage. And a little bit in the back half of the year in our Industrial segment as well where we mentioned in the prepared remarks, but this is similar to Food and Beverage systems in the highest performance category for Industrial. We’ve got a heat exchanger business that has very good value to certain customers in our sanitary and HVAC applications. And as we’ve gone through the strategy with that product line, Robert, we’ve been narrowing our focus to those particular markets and not participating it much in some broader Industrial spaces where the value for our customer and the value for our margin performance is not as good. So, in that business, we expect to see some pressure as we get to the back half of the year. So, kind of sum it up, we’ve got, we are going to call low-single-digit organic growth models in the first half of the year. And modest organic shrink in the second half and what’s happening in the second half of the year is, some of the lower margin backlog is declining in the revenue stream in our modeling and we are assuming that the growth rate, as Jaime mentioned in our higher value products and aftermarket remains steady to slightly up as the year progresses.

[Marc Michael:]

Yes, and I just got to dig into, Robert, just to – this is Marc, just to reaffirm with everyone the total year guidance assumes a $40 million drop in our systems business. So the underlying 1% to 3% growth in our runrate business is higher value products will start to kick in and replace that as we move through the second half of the year. So, it does taper off in the second half in terms of the organic growth. But underlying growth of 1% to 3% in these key product lines is something that will be important.

[Robert Barry:]

Got it. Great, great. Now that was super helpful. On this slide, thank you by the way, slide 6 this profile of the backlog composition, how much of the 100 basis points of margin expansion that you are targeting is coming just from this, just from the fact that the opening backlog has a much more favorable mix?

[Marc Michael:]

Well, so coming into the year, we have 40% of our total revenue in backlog and we are seeing that backlog margins are up about 0.5 to a bit more than that.

[Robert Barry:]

Okay. I am trying – I think I have had to read that into the goal. Does that mean, the risk to getting only a 100 basis points is just been what’s happening with the runrate?

[Marc Michael:]

Yes, the first half of the year, again, the lower margin business and the systems business is putting a bit of a headwind for us. And then, we see that pickup as we – the margins pickup as we get into the second half of the year. So, again, couple things driving that begin to positive mix shift change in the second half of the year. And we do see the restructuring start to kick in, in the second half of the year. So, overall, the margin profile starts to pickup better in the second half as we exit these larger systems projects.

[Robert Barry:]

Got it. So, would it be fair to say it, if outside of kind of unforeseen mix headwinds at this point, it sounds like your 100 BPS of segment margin expansion is already kind of achieved by the opening backlog mix and the planned restructuring?

[Marc Michael:]

Sorry, say that again.

[Robert Barry:]

Yes, I was just trying to get a sense of how much – how far along you are on your way to the 100 basis points of segment margin expansion? Just based on things in your control, and things that you’ve already bucked essentially?

[Marc Michael:]

Yes, so the margin profile in the backlog as Jaime mentioned is about or – again, call it, 100 to 200 basis points is starting to develop and that backlog entering the year, as Jaime mentioned is about at 40% shippable backlog to our revenues. So it’s developing nicely to support the margin performance based on how we’ve guided again being prudent with the order development no more – no large project business and consistent runrate business. So we feel the trajectory is achievable given where we are entering with the backlog and how we profile the order intake for the year.

[Robert Barry:]

Great, great. Just lastly, what’s the working capital assumption in the cash flow range that $105 million to $125 million? Are you assuming any material kind of headwinds or tailwinds from working capital there?

[Jaime Easley:]

We’ve assumed a modest improvement in working capital of $5 million to $10 million.

[Robert Barry:]

Got it. So, a small benefit from working capital?

[Jaime Easley:]

That’s correct.

[Robert Barry:]

Got it. Thanks a lot guys.

[Marc Michael:]

Thank you.

[Ryan Taylor:]

Thanks, Robert.

[Operator:]

Thank you. Our next question comes from Walter Liptak with Seaport Global. Your line is open.

[Walter Liptak:]

Hi, thanks. Good morning.

[Ryan Taylor:]

Hi, Walter.

[Walter Liptak:]

I wanted to ask an Industrial question. The organic orders decelerated a little bit, like the plus 6%. And I wonder if you can just give us some color on some of the things that are moving around changing – it sounds like the hydraulics business has picked up nicely that I wonder about their businesses that have been growing faster like the mixers, and kind of where you are with the heat exchangers at this point?

[Ryan Taylor:]

Yes, sure, Walter. So, what we saw in the quarter and I am going to look more at a sequential basis than a year-over-year basis, I think it becomes more relevant at this stage. Industrial, on a sequential basis was down about 5% and it’s primarily due to these more project-related orders that are smaller in nature that are still in the frontlog but didn’t come through as prevalently in Q4. And what we are hearing from customers is that, they are still planning to do the projects, but as we look across the globe there was some hesitancy that pulled the trigger in Q4 and that was off slightly in our dryer business and some of our Industrial pump project business and specifically our heat exchanger business in China. The runrate business, I would say was still pretty healthy. We saw mixer is up, hydraulic is up, some of our discrete Industrial pumps were up, our F&B pumps were up in the quarter on a sequential basis. So, overall, it was still a pretty good order intake for Industrial. If we look regionally, North America was up low-single-digits. We saw good progress in Europe, high-double-digits. And I would again say, the headwinds, I would call out globally in Industrial did start to develop a little in China and across Asia-Pac as we saw a bit of a pullback there. But overall, we still feel good about what’s happening in our Industrial product lines. And some of these projects start to break loose as we go through Q1, Q2, we expect the order trends to again remain consistent and that’s how we’ve looked at it as we’ve modeled the first half of the year on a runrate basis similar to the second half of 2018.

[Walter Liptak:]

Okay, okay. That sounds great. The comments about Europe, at a high-single-digit rate, was it an acceleration and I wonder which products through Europe are picking up?

[Ryan Taylor:]

Yes, it was actually around high double-digit in Europe and that was primarily – we did have some nice kind of runrate dryer business in Europe. Our pump business, our discrete pump business in Industrial was pretty healthy and our hydraulics business is pretty healthy in Europe.

[Walter Liptak:]

Okay. Okay, I wanted to ask a cash flow question too. As you are looking into your – into 2019, you used as a free cash flow, where do you stand out by that versus looking for M&A opportunities?

[Ryan Taylor:]

Yes, so, I think in 2019, we are focused primarily on reducing our term loan A. We are expecting as you seen to have about $110 million of free cash flow, we also expect to continue to focus on high growth and high return on investment opportunities in the business. I think the teams are and have been building pipelines of organic opportunities and you are seeing a bit of that come through in the increase in CapEx year-over-year and we are really looking to revitalize the team around coming forth of those opportunities to grow at the product line level at amounts that are above our weighted average cost of capital. So, I think the way to think about capital allocation for the year is first and foremost going to be debt reduction and then, we will kind of exit the year and see where we stand going into 2020.

[Marc Michael:]

Yes, I would add to that, Walter, well, putting Ryan in the position he is in, and we brought on [Indiscernible] who works with Ryan on our strategy development and looking at the acquisition pipeline. It’s something that we are going to be assessing closely. We’ll obviously be in a much more comfortable and comfortable position as we get through this year in terms of where our leverage is. So we are going to have flexibility, but we are going to be again prudent and disciplined in our approach that we deployed our capital.

[Walter Liptak:]

Okay. And maybe just one last one. On the restructuring actions toward 2019, are these benefits that will come through primarily in 2020 or do you start seeing some of them in 2019 and one, and then, other is a more restructuring that you can do beyond that to help get you through the 2020 margin targets.

[Marc Michael:]

Yes, so we’ll certainly see benefits from the restructuring actions in 2019. They are a bit more heavily weighted toward the second half, but we will see some meaningful amounts in the first half. So, I think the way to think about it is about half of the restructuring savings will come through in 2019 and another half in 2020.

[Walter Liptak:]

Okay. Okay, thank you.

[Ryan Taylor:]

Thanks, Walter.

[Operator:]

Thank you. Our next question comes from Julian Mitchell with Barclays. Your line is open.

[Unidentified Analyst:]

Hi, guys. This is Jason on for Julian. Just a quick one on the price cost dynamics. I know you said it’s neutral for the year. But is there any sort of step change in how that dynamic evolves throughout the years? I.e. is it a headwind in the first half and you sort work through in the back half or is it just neutral throughout?

[Ryan Taylor:]

Yes, so, as we put those actions in place in Q4, as we talked on the Q3 earnings call and put the actions in place to increase price and put additional controls in place across the business on managing our pricing into the market, we saw good progress as we moved through the quarter and the first half of the year, in these more project-related parts of the business, in P&E and certain areas in some of the Industrial products. But more prominently in P&E, and there is still is some headwinds in the backlog as we move through the first half of the year on cost price. But we do expect that to start to get better as we move into the second half of the year and as we mentioned full year backlog margins are improving above where we were at this time last year by 100 to 200 basis points. So a combination of the mix, combination of offsetting the headwinds we had from price in 2018 especially in the second half, is what we expect to happen.

[Unidentified Analyst:]

Understood. And then, going back to that order detail that you gave on Industrial for the China headwind that you cited in APAC, was that sort of – in terms of how that sequentially evolve throughout the quarter? Was that sort of stronger towards the end or was it steady state a headwind throughout all three months?

[Ryan Taylor:]

I don’t have that detail in front of me. I can tell you it was primarily based in our heat exchanger business and mixers actually were a little more positive. So, the big headwind was in our heat exchanger business.

[Unidentified Analyst:]

Great. Understood. Thank you.

[Operator:]

Thank you. Our next question comes from Deane Dray with RBC Capital Markets. Your line is open.

[Andrew Krill:]

Hi, thanks. Good morning. This is Andrew Krill on for Dean. I wanted to ask, same realm of price cost, just on tariffs, something that’s been touched on. Has the impact changed assuming for 2019 I believe in the last quarter you sized of a $10 million or so growth headwind? And then, can you just remind us which list this includes, please?

[Marc Michael:]

Yes, so, we’ve tried to source most of our materials in regions. So, while we don’t have a very large direct impact for materials, of course, the tariffs overall are pushing prices up through the supply chain. So, I’d say, we believe that the increases that we are seeing inflation that we are noting are going to be offset by price are broad based. But the tariffs themselves are not individually meaningful. And then, back to the assumption around price overcoming, inflation throughout the course of the year, we had – what I was very proud of in the fourth quarter were a number of pricing actions that were able to be taken and put into place. A lot of process improvements and then as we look at what we are doing here in the first quarter, we’ve got price increases in nearly all of our product lines of 2% to 5%. So we are comfortable with these are going to play certainly in the year and have the ability to offset inflation as we see it work through the inventory levels and then purchasing through 2019.

[Andrew Krill:]

Okay, got it. Thank you. And then, a quick follow-up, I was just wondering if I guess any additional like color can be shared on the circumstances surrounding the CFO transition at the end of last year? Thank you.

[Marc Michael:]

Yes, so, what I would say is really pleased to have Jaime on board. Jeremy left on really good terms. We wish him the best and really pleased to have Jaime in the chair and looking forward to working with him in 2019 and beyond.

[Andrew Krill:]

Thank you.

[Marc Michael:]

You bet.

[Operator:]

Thank you. Our next question comes from Nathan Jones with Stifel. Your line is open.

[Nathan Jones:]

Hey guys.

[Marc Michael:]

Hey, Nate.

[Ryan Taylor:]

Hey, Nathan.

[Nathan Jones:]

I just wanted to ask a question about the tax charge in 4Q. Can you talk about how much of that is actually related to discrete events in 4Q or how much of it's a true up of things throughout the first three quarters? I am just thinking if we exclude the whole thing from 4Q and some of that should have actually been realized as a higher tax rate in the first three quarters of the year, then your 2018 earnings would actually have been a little bit lower than they were. So I am just trying to level set what the growth is from 2018 to 2019 on earnings if you had normalized for tax?

[Jaime Easley:]

Yes, Nathan, as you know, at the end of the last year, that being 2017 or at the end of 2017, the tax law was published. Our teams made the best effort to estimate not only the impacts on our balance sheet at that point in time, but also the impacts of the transition tax which, as a reminder we will pay over eight years. And so, as we work throughout the course of the year, we found that the treasury and various other bodies wrote more legislation than our teams have really ever seen come out and so throughout the course of the year, we were trying to estimate and anticipate what those changes meant to us. So, we did have, as we’ve noted a lumpy year in tax, we do think, at the end of the year, as we exit 2018, we have accounted for all of the potential impacts of tax reform and kind of reminder on that where the ball lands as we expected to be about $35 million to $40 million of transition tax must be payable over a period of eight years as I mentioned. So, there is a true up in Q4 which relates to some of the various attempts we made during the year to estimate the tax and so, again, I think you’ll look at the full year in total and that is looking forward at 28% to 30% tax rate. We think there is some opportunity to get that tax rate down a bit by these restructuring actions that we are taking here. We took in Q4 and then we will continue to take over the course of 2019 and many of those are targeted to jurisdictions where we’ve had some sustained losses over time and haven’t been able to recognize tax benefits. So, we are looking forward to that potentially being a benefit on future rates.

[Nathan Jones:]

So, the 28% to 30% guidance that you've got there, is obviously a fair bit above the statutory rate and it's fairly significantly above what most companies are looking to get. It sounds like there is some losses that you can't take deductions on in certain places. Maybe you can give us any more – any color around why it is so high at the moment and what actions you can take to maybe get that down?

[Jaime Easley:]

Yes, and that’s the reference I was making to a number of these countries where we had staying losses over time and so I would tell you, that’s about a 4% drag on the rate and those – many of the actions that was got planned for 2019 is targeting those territories. So, that’s what we are looking at as our upside potential on the tax line out of the future years.

[Nathan Jones:]

I wonder if then maybe you could give us the an idea of what you think the long-term tax rate for the business is after you've gone through these restructuring actions?

[Jaime Easley:]

Yes, I think we have to study how the impacts of the restructuring actions roll through the various tax returns in all the countries thereafter we get through this year. So, I’d be better prepared to answer that towards the back half of this year and see how those play out on the tax team’s study – the statutory of tax.

[Nathan Jones:]

Okay, fair enough. Thank you.

[Marc Michael:]

Thanks, Nate.

[Ryan Taylor:]

Okay, thanks Nathan. This is Ryan Taylor. Just coming back to conclude the call. I would appreciate everybody joining us today and we look forward to a happy and successful 2019. Thanks again and we will talk to you next time.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone, have a great day.