Global X U.S. Cash Flow Kings 100 ETF
Q3 2017 Earnings Call Transcript

Published: 1 Nov 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 SPX FLOW Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference, Mr. Ryan Taylor. Sir, you may begin.

[Ryan Taylor:]

Thanks, Carolyn, and good morning, everyone. Thank you for joining us today. With me on the call this morning are Marc Michael, our President and CEO; and Jeremy Smeltser, our Chief Financial Officer. Our Q3 2017 earnings release and 10-Q was issued early this morning and can be found on our website at spxflow.com. This webcast is also being, or this call is also being webcast with the presentation located in the Investor Relations section of our website. I encourage you to follow along with the presentation during our prepared remarks. And later today, there will a replay of the webcast available on our website. Portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. And please also note the risk factors in our most recent SEC filings. In the appendix of today’s presentation, we have also provided reconciliations for all the non-GAAP and adjusted financial measures presented today. With that, I’ll turn the call over to Marc.

[Marc Michael:]

Thanks, Ryan. Good morning, everyone. Thanks for joining us on the call. The end of Q3 2017 marked our two-year anniversary as a standalone company following our spinoff from SPX Corporation. Over the past two years, we successfully transitioned SPX FLOW to an operating company with an improved cost position and a streamlined organization. We’re nearly finished executing our realignment program, expect to fully realize an annualized $140 million of savings in 2018. Through this transition, we also established a strong foundation for customer engagement, growth and margin expansion. Our financial results through the first nine months of this year underscore our progress. We’ve seen organic order growth for three consecutive quarters leading to 6% order growth over the first nine months of the year. This has led to significant growth in our backlog, which has increased 23%, or $177 million from the end of 2016. We generated $160 million of cash through three quarters, including $131 million of adjusted free cash flow and $37 million from asset sales. This enabled us to pay down $105 million of debt reducing net debt by 19%. Importantly, net leverage was down to 3.4 times at the end of the third quarter. We continue to focus on strengthening our financial position. Consistent with this emphasis, yesterday, we made a voluntary prepayment of $80 million on our term loan. As it relates to our realignment program, we realized an incremental $42 million of cost savings through nine months of this year, including $14 million during the third quarter. I’m pleased with the collective efforts of our team members across the world who have supported our transformation and contributed to the positive results we’ve achieved on several fronts this year. We have positioned ourselves well for the future success, as we continue our journey to transform SPX FLOW into a high-performing enterprise. Before we move on to our Q3 results, I want to first take a moment to publicly thank all our team members in Texas, Florida and Mexico for their perseverance in the aftermath of the recent natural disasters in their respective regions. I’m happy to report that all our employees made it safely through these challenging and tragic events. In Texas and Florida, our teams were well prepared for the hurricanes and fortunately, we did not experience any major damage to our facilities. That said, we did experience work stoppages due to flooding and power outages. After our facilities were declared safe for employees to return to work, our teams in Texas and Florida did a remarkable job to support our customers and deliver products in a timely manner, despite the challenges imposed by the hurricanes. Overall, the net impact of the hurricanes to our Q3 results was $5 million of revenue, $3 million of segment income and $0.05 of EPS. Even with the challenges caused by the hurricanes, our Q3 financial results were in line with our guidance and improved over the prior year. Revenue increased 5% year-over-year to $491 million with 3.4% organic growth driven by our Power and Energy and Industrial segments. Segment income was $55 million, up 14% year-over-year, and segment margins expanded 80 points to a 11.1%. Adjusted EBITDA was $55 million and adjusted EPS was $0.42, and adjusted free cash flow was $52 million, a solid performance driven by cash collections in our project-based business. Taking a closer look at orders, Q3 orders were $512 million, up $56 million, or 12% year-over-year. Organic growth was 10% and was broad-based across our product lines. OE orders increased 15% over the prior year, highlighted by $28 million award for dairy processing system. After market orders grew 7% year-over-year, underscoring our emphasis on expanding our aftermarket presence. On a sequential basis, orders were up modestly due to currency. Looking at our Food and Beverage segment, Q3 orders were $189 million, up 16% year-over-year. Organic growth was 14% highlighted by double-digit growth in our component orders. Dwight Gibson and his team are emphasizing growth in our high-value component in aftermarket business. As part of this effort, we are investing in new product development. In Q2 this year, we launched a new Twin Screw pump, which has been well received by our distributors, and we have other new products launches planned for early 2018. In the aftermarket, we’re seeing good traction on our initiatives, as we continue to expand our capabilities to help our customers maximize the efficiency of the process systems. In our systems business, Q3 orders grew double digits year-over-year. This growth was highlighted by $28 million win in Europe, where we install a dairy system that will produce way, whole and skim milk powders. This award marks the first large food and beverage contract we booked since Q1 2016. On a sequential basis, orders increased 14%, driven by the large systems award, which was offset by a lower level of small to medium-sized system orders in a modest decline in component aftermarket orders. This sequential trend is consistent with historical seasonality and is reflective of the spending patterns of our customers, particularly in Europe. Moving on to Power and Energy, Q3 orders were $140 million, up 18% year-over-year. Currency was a modest benefit. The organic growth was led by orders for pipeline valves supporting our customers in North America. Aftermarket orders were up low single digits versus the prior year. We’re encouraged by the recovery in power and energy orders through the first nine months of this year. Jose Larios and his team have done a nice job capitalizing on markets, where we’ve seen growth opportunities, including midstream oil applications, nuclear power in the broader power and energy aftermarket. In the upstream, we have not seen any meaningful recovery in demand for our OE pump technologies and are planning for this market to remain depressed. In the near-term, our growth initiatives are focused on expanding our presence in the aftermarket at legacy locations in the new service centers we opened earlier this year. In our Industrial segment, Q3 orders grew 5% year-over-year to $184 million. Orders in our dehydration and mixer product lines were up high single digits versus the prior year, and orders in our hydraulic tools and heat exchanger products were up mid single digits. We continue to be encouraged with the macro trends in industrial manufacturing and PMI indices. We believe the elevated level of quarterly orders this year reflects the positive macro trends. Sequentially, we saw a lower level of capital projects and we anticipate small to medium-sized capital orders to remain choppy quarter-to-quarter in the near-term. The sustained momentum in the broader industrial markets is very encouraging and a good leading indicator for growth in this segment. Our Industrial products have strong brand names and are generally well positioned within their historical region and end markets. Given the strength of our brands, the high-quality of these products in the critical applications they serve for our customers, we see good potential for growth in this segment. We are investing for growth in our higher value industrial products and we see good opportunities to leverage our manufacturing footprint and localize production in regions where we are currently underpenetrated. Moving onto our realignment program, we’re on track to realize $50 million of savings this year and we expect $20 million of incremental savings in 2018. The majority of our realignment actions have been structural in nature and designed to improve our cost structure, enhance our ability to serve customers. Optimizing our global footprint has been a key focus within the program. Over the past two years we consolidated five manufacturing facilities with two additional consolidations in process. By the end of this year we will have 31 key manufacturing facilities down from 38 at the start of 2016. And overall, we reduced headcount by approximately 20%. The actions required to achieve the total savings are essentially complete and on a positive note the cost to achieve these savings was lower than our original estimates. As a result, we lowered our target for special charges to approximately $22 million this year. With our operating structure now in place, the next phase in our journey will be focus on driving growth in our higher value product lines and aftermarket, as well as expanding margins through continuous improvement efforts across the enterprise. That concludes my opening remarks and at this time I’ll turn the call over to Jeremy.

[Jeremy Smeltser:]

Thanks Marc, good morning everyone. I’ll begin with earnings-per-share. On a GAAP basis we reported $0.30 of earnings per share in Q3. Special charges were $0.04 and discrete and other tax items were $0.08 in the period. Excluding these items adjusted EPS was $0.42 per share. This includes the $0.05 hurricane impact that Marc mentioned. The tax rate on adjusted EPS was just under 29% in the quarter. Looking now at our consolidated results, revenue was $491 million, up 5% or $24 million year-over-year. Organic growth was a 3% and currency was a 2% benefit. Segment income was $55 million, up 14% year-over-year and segment margins expanded 80 points to 11.1%. The improved profitability was driven by the organic growth and realignment savings. These benefits more than offset a 200 basis point headwind from variable compensation expense year-over-year. Moving on to the segment results, starting with Food and Beverage, revenue was $176 million, up 2% versus the prior year due to currency. On an organic basis component sales were up high single digits year-over-year, offset by a low single digit decline in system revenue, and aftermarket sales were flat. Segment income was $20 million or 11.3% of revenue. Profitability was stable year-over-year as savings from the realignment program and improved efficiencies on our Poland facility offset an increase in variable incentive compensation. Moving now to Q3 results in our Power and Energy segment, revenue was $141 million, up 11% year-over-year including a modest currency tailwind. Organic revenue grew 9% driven by double-digit growth in aftermarket sales. In our OE product lines organic growth from a higher volume of valves and pumps in the midstream oil applications was partially offset by a lower level of revenue from our pipeline closure and filtration products. Segment income more than doubled year-over-year increasing the $13 million and margins improved 680 points to 9.1%. The increase in profitability was driven primarily by leverage on the organic revenue growth, particularly from the higher-margin aftermarket sales. And in our Industrial segment revenue was $174 million, up 4% versus the prior year. Currency was a 2% benefit. Organic growth of 2% was driven by increased sales of heat exchangers and hydraulic tools. Segment income was $22 million and margins were 12.7%. The decrease in segment income and margin was due primarily to an increase in variables incentive compensation versus last year. Looking now at our financial position, in Q3, we generated $52 million of adjusted free cash flow and $7 million from the sale of the European manufacturing facility after we completed the transfer of manufacturing activities to Poland. Through nine months, adjusted free cash flow was $131 million and proceeds from the sale of assets were $37 million. As of September 30, cash on hand had increased to $281 million. Net debt was $723 million, a 19% reduction from the start of the year, and net leverage was at 3.4 times, down over half a turn as compared to December 2016. Through Q3, we allocated $105 million to debt reduction. As Marc mentioned, yesterday, we made a voluntary prepayment of $80 million, reducing the outstanding principal balance on our term loan to $295 million. This payment was partially funded with $20 million of borrowings on our AR securitization facility. At current interest rates, the $80 million prepayment reduces our annual net interest expense and cash payments by approximately $2 million, or $0.04 per share. Later this quarter, we will make our required quarterly principal payment of $5 million, which will bring our gross debt reduction for the year to $190 million. We expect to end the year with total debt of approximately $925 million, down from $1.1 billion at the end of 2016. Our capital structure provides us very good flexibility. And as you can see on a maturity schedule, we don’t have any material required payments until 2020. In addition to the term loan, our capital structure includes two $300 million tranches of senior notes maturing in 2024 and 2026. These notes are fixed at rates of 5.58% and 5.78%, respectively. Our financial position has improved significantly this year, and we are in a very stable situation with sufficient liquidity to fund organic initiatives and continue to reduce our debt and leverage. Moving on now to backlog, our Q3 ending backlog was $961 million, up 23%, or $177 million from the end of last year, with backlog building across all three segments. About 40% of the backlog is expected to convert to revenue in Q4, and approximately 50% is expected to convert to revenue next year. We expect to enter 2018 with a higher opening backlog position than we did this year, supporting the mid single-digit revenue growth assumed in our 2018 financial framework. Looking at our fourth quarter targets on a consolidated basis, revenue is expected to be about $500 million to $520 million. We’re targeting segment income to be between $56 million and $63 million, with margins in the 11% to 12% range. Similar to Q3, the improvement in our underlying margin performance is expected to be partially offset by about a 140 basis point headwind from variable incentive compensation. Special charges are expected to be between $2 million and $5 million. Excluding special charges, our adjusted EPS guidance range is $0.40 to $0.52 and adjusted EBITDA is expected to be between $55 million and $62 million. For the full year, we’ve updated our guidance to reflect our Q3 results and outlook for Q4. Starting with cash flow, we increased our adjusted free cash flow guidance to a range of $150 million to $160 million, an increase of a 11% at the midpoint, reflecting our strong cash flow performance year-to-date and a reduced expectation of CapEx in the year. This implies adjusted free cash flow per share of approximately $3.70. Our target range for revenue came down by 1%, or $20 million at the midpoint, primarily due to timing delays on certain projects and backlog. On this level of revenue, we expect segment income and adjusted EBITDA to be between $193 million and $200 million. We lowered our expectation for special charges to approximately $22 million. And for earnings per share, excluding special charges and discrete tax items, we are now expecting adjusted EPS of $1.20 per share at the midpoint of our guidance range. Our 2018 financial framework is unchanged. As compared to our 2017 guidance, the 2018 framework implies revenue growth of 4% to 6% to just over $2 billion, EBITDA growth of 20% to 30% to approximately $250 million, and free cash flow of approximately $150 million, or $3.50 per share. We plan to provide detailed guidance for 2018 when we report our Q4 2017 earnings in February. With that, I’ll turn the call back over to Marc.

[Marc Michael:]

Thanks, Jeremy. In closing, we’ve made significant progress over the past two years, underscored by our financial results so far this year. We’re moving in a positive direction and building momentum as we move into 2018 with a higher backlog and stronger financial position. I’m pleased with the effort by our team on executing the realignment program. We’ve also done a good job this year controlling costs and improving our execution. That said, I believe there’s a lot of runway ahead of us for continuous improvement and value creation. As we plan for 2018 and beyond, we’re prioritizing investment in our highest-value product lines in emphasizing continuous improvement actions across the enterprise to drive margin expansion. And we will continue to focus on cap – working capital performance and free cash flow generation. On the front-end of our business, we’re emphasizing strong product management and disciplined pricing. We’re investing for profitable growth with an emphasis on aftermarket penetration, localization and channel management. At our manufacturing facilities, we’re focused on delivering high-quality products on cost and on-time to our customers. In our project-based businesses, we’re using root-cause analytics to drive a higher level of value to our customers on large project execution and delivery. And across all our functions, we’re tracking key performance indicators to drive an overall higher level of performance and accountability throughout the enterprise. We’ve made good progress over the past two years and I’m proud of our teams across the world for their collective efforts. Going forward, we’re committed to creating value for all our stakeholders, as we continue our journey to transform SPX FLOW into a high-performing operating enterprise. Thanks to everyone who’s joined us on the call this morning. That concludes our prepared remarks. At this time, we’ll be happy to take your questions.

[Operator:]

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

[Mike Halloran:]

Hey, good morning, guys.

[Jeremy Smeltser:]

Good morning, Mike.

[Marc Michael:]

Good morning, Mike.

[Mike Halloran:]

Hey. So, the guidance on the fourth quarter, I’m having some trouble bridging 3Q to 4Q, obviously, you guys called out some timing in the backlog here. But hoping you can give us some more context on what is a below normal sequential trend relative to what is pretty healthy order patterns, and what should be a bigger FX tail, as you get to the fourth quarter? So could you walk through some of those puts and takes?

[Jeremy Smeltser:]

Yes, from an FX perspective, it’s actually pretty consistent with our expectations when we gave Q3 guidance. I believe, there’s about $6 million or $7 million for the whole second-half of the year the FX benefit from that period of time to now. I think, you point on our typical seasonality in Q4 is valid. I would say, at a couple of short cycle areas in Q3, we saw a bit of a pausing, Marc mentioned in his prepared remarks, particularly in Europe on spending, which does impact our expectations for Q4, because a lot of that short cycle business turns in 12 to 14 weeks or so. And then additionally, it’s really just the timing of backlog. Right now, a lot of our project-based business is actually timed for Q1 and Q2. When – if you go back 90 days, even we expected more of it to be here in Q3 and Q4. So there’s nothing really underlying the concerns just a matter of what we see in timing of backlog, which is the delays we talked about in the earlier remarks really primarily customer-driven and they’re on a handful of projects, no particular single large project.

[Mike Halloran:]

So putting them into context of the – how the 2018 framework, which you guys still seem to have a lot of confidence in. When you think about the order progression from here, how does it compare to a normal year as you start filling out 2018? Are you ahead of what’s normal kind of consistent with what’s normal, maybe provide some context on how that build is shipping up versus a typical year, which I know we haven’t seen in a couple of years?

[Jeremy Smeltser:]

Yes, I mean, it is a little bit difficult to compare to the last couple of years. Obviously, we’ve been deflationary top line for a while until this quarter really in orders all year long. I would say, about consistent with our expectation, I think, on the order line, Q2 to Q3 what you see is a step down, which is a bit of seasonality we talked about. If you exclude the $28 million order in food and beverage, typically for us, we would see that short cycle orders increase from Q3 to Q4, that’s kind of a broad-based statement across our end markets, because a lot of our customers do try to exhaust their maintenance budgets for the year and so that is typically short cycle business that we can look in turn in the quarter, but I mean I haven’t seen anything really different than our expectations if you go back 90 days and even six months.

[Marc Michael:]

Yes, I would just add to that again that the seasonality we see in Europe, especially in Food and Beverage on a sequential basis there is a bit of a step down, but on a year-over-year basis like we mentioned, really pleased with the progress in F&B components, we’re up there just kind of mid-teens area on a year-over-year basis. The F&B systems was up based on the large order, we see good orders in pipeline valves on a year-over-year basis, mixers, dehy, hydraulics, HEX all in the Industrial segment on a year-over-year basis are up between mid and high single digits. So, now the orders are moving forward as we expected and progressing as we expected in the shorter cycle parts of the business. It’s really associated in the second half with these ETO projects that were primarily associated with customer timing to change in Q4. So overall the progression in short cycle is where we would anticipate it being and even now there are some move out of the longer ETO cycle projects, that does set up for a bit better backlog position from where we were last year at this time. We’ve got about taking 25% in backlog for next year, we’re ahead of where we were last year at this time by roughly $140 million, so what we’re planning for is, setting up in the right way for 2018 and yes that’s what we really remained focused on and ensuring we achieve our 2018 financial framework.

[Mike Halloran:]

And then last on the incentive comp. Jeremy, could you could help with what you think the overall dollar number impact is this year or at least frame it in some way relative to a normal year and what I’m looking for really is how that incentive comp should normalize this year versus next year if you’re towards that framework that you laid out?

[Jeremy Smeltser:]

Sure. What I would say Mike is, I would not expect it to be headwind in 2018. So, in the quarter, we referenced 200 basis points on margins, so you can do the math that’s about 10 million bucks, for the year it’s about $30 million, from 2016 to 2017 which represents a payout for the entire organization of a third over target. So by about 133% payout which maxes at 200%, but our expectation is that we will set targets for 2018 around the 2018 financial framework that we have been talking about over the last year.

[Mike Halloran:]

And so if you hit that framework then you would be paying a comparable amount or would you be paying less, call it a 100%, yes?

[Jeremy Smeltser:]

We’re actually comparable Mike, I don’t want to get ahead of the comp committee which will decide those final targets in December, but I think it’s safe to assume directionally we’d pay around a comparable amount.

[Mike Halloran:]

Great, I appreciate it.

[Marc Michael:]

I’d just add one thing Mike. We feel these are the right metrics and we’ve seen really great performance this year in orders and cash and in two really key areas that we wanted to improve upon as we move through this year. And that’s obviously helped in the cash piece and reducing our debt and leverage and the order is improving again so we’re discussing helps positions with the stronger backlog. So to Jeremy’s point, as we evaluate the program each year, we still believe these are the right metrics, but we’ll make sure we’re aligning the incentive plans to create – to be aligned with shareholder value. So, we’ll take a look at that as we move through the end of the year and position to plan properly for next year to drive the metrics that we want to achieve.

[Mike Halloran:]

Great, thanks for the time.

[Operator:]

Our next question comes from Nathan Jones with Stifel, your line is now open.

[Nathan Jones:]

Could we start here on cash flow, good cash flow in the quarter and increased for the year, but it’s primarily on lower CapEx and the CapEx for the year is now going to come in fairly considerably below the level of depreciation. Can you talk about why the lower CapEx and what we should expect from CapEx going forward?

[Jeremy Smeltser:]

Sure, yes. So, I think about half the increase to the high-end of our new range came from lower CapEx and what we’ve seen is just a lower need than we originally expected in the year in the factories, so our IT spending is relatively consistent with our early expectations. But in the areas where we’ve seen the largest level of order increase, think midstream pipeline value is a great example. We have invested quite a bit in our Houston plant over the last few years as that market was strong and so we just haven’t needed – we haven’t needed as much spend this year as we originally expected. I still model $30 million to $35 million in the long-term I think is the right range Nathan and I would expect if orders continue at the level that we’re seeing now, the environment remains positive like this that we’ll move back into that $30 million, $35 million range next year. But as we look around the plants, we’ve made significant investment in Poland, a lot of new equipment, as I think you saw a lot of new machinery there and that’s a big chunk of our production as is our plant in Wisconsin which you’ve seen and so those are all well-capitalized. There are few areas where we’re looking at new machines for next year, but I think they fit nicely into that $30 million range and I wouldn’t model anything different from that.

[Nathan Jones:]

That is a question I’d love to talk a little bit more about. We did see a lot of that new machinery in Poland and you guys have clearly invested in upgrading the asset base here over the last year or two. Where do you think the quality of the asset base is now relative to where it was a couple years ago relative to the competition, is there more investment that needs to be made to ensure that you are delivering quality products on time to the customers to be more competitive?

[Jeremy Smeltser:]

I mean from my perspective, Nathan, what I’d say is, I think the plants are well-capitalized around the world for what we have. I would say that the one big opportunity – I wouldn’t call it is a GAAP per se, I’ll call it an opportunity to continue to localize to manufacture in every region of the world where we sell. And so we have to continue to invest in India, in Korea, in China for example where a lot of our product still comes out of the U.S. are out of Europe to feed those regions and the lead times in some cases aren’t competitive. That being said, those are – from where we are today, I don’t think those are massive capital investments like we saw in Poland. I think they’re incremental and I think they still fit largely within that $30 million to $35 million range I referenced.

[Marc Michael:]

And what I would add to that Nathan is, as Jeremy indicated, our investments are more towards the areas of opportunity. And if you look at our emphasis, what it’s been for the last two years and what it will continue to be going forward is investing in our high-value product lines. So, as we’ve consolidated into these larger multipurpose facilities, we’ll continue to invest to a greater degree there to make sure those factories remained well-capitalized and competitive and we drive into grow them at a faster rate than the market average. So that’s an important point, as we move through not only 2018, but as we look to the future. And then we do continue to make investments in our aftermarket capabilities. So, we’re going to be well positioned to invest capital where we see the best opportunities to get a return in growth and that’s going to be the emphasis in these high-value product lines are what are in our focus.

[Nathan Jones:]

Okay and then just – I had another question around this – around the 2018 framework. You’ve got around a 5% growth at the midpoint, I think you are going to have 1 point or 2 point of FX tailwind next year. You got some very easy comps in the first half, you’ve got backlog up 23%, firming markets, improving orders. To what level do you feel like that framework is conservative in the face of what are pretty dramatically improving metrics leading into 2018?

[Jeremy Smeltser:]

Yes, I think a lot of things have gone well for us this year as we march here toward the end of the year. I think certainly the $20 million of project slip out from the second half of this year to next helps next year by 1 percentage point. That said, there’s always timing changes in the project ETO business, we’ll see where Q4 orders go. I think we feel comfortable with it, but I think the 2018 framework just as a reminder to everyone was meant to be a specific set of guidance. It was meant to be a framework we thought was achievable under a certain set of assumptions and so we’ll get much more detailed on our expectations for 2018 as we typically do in February of next year. So, I think we feel good. We think it’s a prudent framework to maintain here as we go through Q4 and we’ll be happy to update everybody with more details in a few months.

[Nathan Jones:]

Okay, thanks for the help.

[Operator:]

Our next question comes from John Walsh with Vertical Research. Your line is now open.

[John Walsh:]

Hi, good morning.

[Jeremy Smeltser:]

Good morning, John.

[Marc Michael:]

Good morning, John.

[John Walsh:]

So, why don’t you just get a little bit of commentary around what you’re seeing on the pricing front? Maybe you can talk a little bit about some of the larger projects? And then we’ve been hearing from competitors, they’ve been able to kind of see opportunistic price, particularly on kind of industrial valve products, wanted to see what you were hearing in the market?

[Marc Michael:]

Yes. Sure, John. So maybe just to break it down into a couple of different areas, in our ETO business where we’re engineering and more of a view of a cost build up, it comes from third-party suppliers on a case by case basis, as well as our internal cost, that passes through fairly quickly to the market. Our CTO businesses will be more quick cycle and we’ve had a lot of good sourcing initiatives from Barry McGinley and Dave Kowalski’s his team has done a nice job and looking to do good sourcing initiatives over the last couple of years. And so we’ve been in a good spot with our costing. And we have been in several years of minimal inflation in which you could describe, I guess, is almost a deflationary environment. So is that we see that change. The good thing that we’ve done over the last two years is, we really strengthened our product management organization. So they don’t only look at new products and the markets and the channels. They really task with ensuring the health of our margins of which looking at cost to market pricing and what we need to do to be competitive, as well as stay ahead of any inflationary trends. So this team is constantly monitoring the markets and the pricing. So as we see changes, we’ll be in a position where we will be able to adjust pricing accordingly. And I would expect, we’ll look to be doing some of that as we move forward.

[John Walsh:]

Gotcha. And then as we think about the balance sheet and the ability to kind of deploy some potential deployment as you continue to grow EBITDA and bring that leverage ratio down for next year. Do you have kind of a – have you been maintaining an active pipeline of opportunities? And could we actually start to see you look to do bolt-ons in 2018? Thank you.

[Marc Michael:]

Yes. So, John, I’ll just reiterate the five areas we’re focused on really completing our realignment program. And our plan for achieving our cost savings objective is top of list and emphasis on growth and our high-value CTO product lines and our aftermarket. We remain in a very disciplined in our ETO systems and products on proving the execution to help with margins, and continuous improvement in our factories is a focus, improving our cash flows, the reduction in working capital and paying down our debt, reducing our leverage, all this is leading to a stronger balance sheet. Really we want to culminate in focus of achieving our 2018 financial framework. And as we move through 2018, we’re going to have a significant flexibility starting to be created to invest further for growth. And we’ve got great plans. Our product managers are looking at the best areas to invest. And if you look at the high-value product lines, those are the ones that we’re emphasizing organic as a forerunner. But as we move through time, we’re looking at those high-value product lines and where we have gaps and where opportunities may start to be created.

[John Walsh:]

All right. Thank you.

[Marc Michael:]

You bet.

[Operator:]

Our next question comes from Nigel Coe with Morgan Stanley. Your line is now open.

[Nigel Coe:]

Yes. Good morning, guys.

[Marc Michael:]

Good morning, Nigel.

[Jeremy Smeltser:]

Good morning, Nigel.

[Nigel Coe:]

Just want to – yes, hey, guys. I just want to go back to the pricing question. And I believe that you’re predominantly FIFO accounting for inventory, I think, may have had some of your inventories on FIFO. Should we expect maybe 4Q to show a bit more pressure from raw material inflation than 3Q, or do you think that you’ve got enough pricing out there to cover that?

[Marc Michael:]

So we’re primarily FIFO with a couple of exceptions. But I don’t see much of an impact from the accounting methodology. I think, we’re pretty well locked in for Q4 consistent with Q3 from what we saw in most of our inputs. And as a reminder more generally speaking, majority of our markets, we’re able to pass through materials inflation in raw materials and inputs. So not a big concern for us. I mean, certainly, we have to have the right plans in place for 2018, as we continue to see PMI indices where they are in growth like we’re seeing, we would expect additional inflation. I think, Marc talked earlier about beginning plans for 2018 pricing on our side as well.

[Marc Michael:]

Nigel our product management teams are, this is a monthly review with – for them with our operations to ensure that we’re staying ahead of that curve. So, they do a nice job in making sure pricing is staying consistent with what’s needed in the market, as well as ensuring that they’re maintaining the health of our margin profiles.

[Nigel Coe:]

Okay, that’s great. Thanks, guys. And then, obviously, the older trends are encouraging on a sequential basis. Can you just give us some color on the front log activity you are seeing helped by segments. And would you expect the trend of acceleration to continue, maybe you gave us some color in terms of the P&E orders outlook from 1Q to 2Q, you said some of the trend. Would you encourage us to shuffle this trend from 3Q based on the front log activity you see?

[Marc Michael:]

Yes, I think, so far from what the feedback we’re getting, we’re not seeing deceleration in front log activity. So it’s either consistent, or could be described as even moderately better.

[Nigel Coe:]

Okay, that’s helpful. And then just finally, $10 million in incentive comp that you called out, Jeremy, was that fairly evenly spread across the three segments? And maybe just touch on the margin contraction in industrial? I’m sorry, if I missed the reason for that, but maybe just touch on that as well?

[Jeremy Smeltser:]

Yes, it’s directionally consistent across the segments and some in corporate as well, Nigel. I think, in industrial, not a great mixed quarter for us as it relates to margin. Certainly, we’ve seen margins get into the mid-teens on higher volume historically, albeit. So, while we’ve seen some recovery, the revenues still kind of need to get into that 200-plus level to get margins like we’ve seen them in the past, we’re around 175 right now. So, we think there’s room for improvement there just through mix. But certainly, as volumes continue to increase, then we see the growth that we expect in our 2018 financial framework, I think, we’ll see that drop through to the bottom line better than we’ve seen this year due to those comp headwinds.

[Marc Michael:]

Yes, I mean, utilization will improve in the factories as a result of volume pickup, too. So that’s all positive, if you look forward versus where we are today.

[Nigel Coe:]

Okay, that’s great. Thanks.

[Jeremy Smeltser:]

Thanks, Nigel.

[Operator:]

Our next question comes from Robert Barry with Susquehanna. Your line is now open.

[Robert Barry:]

Hey, guys, good morning.

[Marc Michael:]

Good morning, Robert.

[Jeremy Smeltser:]

Good morning.

[Robert Barry:]

Congratulations on the return to positive organic growth, good to see.

[Marc Michael:]

Yes, thank you, sounds good.

[Robert Barry:]

Yes, maybe I wanted to maybe put a finer point on an earlier question. What I’m trying to understand is that, since the original guide for 2017, I think, your revenue midpoint is up about $70 million, while the FX impact has become about $75 million more favorable, which I think implies the FX – ex-FX revenue guide that actually a little lower. Displayed in every quarter, the run rate order is tracking well above the second-half 2016 run rate, which I think is what the outlook was set on. So like I understand that maybe there are some longer cycle or short cycle. But I mean, is that really all that’s going on, or doesn’t seem to square?

[Jeremy Smeltser:]

Yes, it really is just timing of when those projects are expected and requested to ship by our customers. So it’s – a we’re not seeing any cancellations. We don’t expect any cancellations. There’s no real execution issues on the projects that moved out of the year. It’s simply timing of the order book that’s flowed in and where it’s expected to be delivered.

[Robert Barry:]

I mean, it doesn’t even look like we’re seeing the benefit of the above run rate short cycle orders from the first quarter?

[Jeremy Smeltser:]

Well, remember, we saw the biggest driver of the Q1 orders was in the midstream oil and we have delivered the vast majority of those large orders, I’d say, probably 80% of them here over the last six months.

[Robert Barry:]

Okay.

[Jeremy Smeltser:]

But they were…

[Robert Barry:]

I mean, yes.

[Jeremy Smeltser:]

We had plan for those large orders in Q1 when we gave guidance, because we knew that they were imminent when we saw some of those pipeline increases early in Q1. And we were already staged actually to deliver them very quickly. And I think, we even talked about in the Q1 call that we expected to deliver those in Q2 and Q3. So, that specific question around going back to Q1, that was contemplated in our guidance.

[Robert Barry:]

Gotcha. Maybe just also a follow-up on the the weaker sequential order trends. I mean, there seems to be very clear evidence we are moving off of these trough levels in energy and industrial, so very good year-over-year orders. But maybe quickly finding a new kind of modestly higher plateau in activity just meaning there doesn’t seem to be clear evidence that there’s a lot of momentum beyond these initial moves off the trough. I mean, is – would you say that’s consistent with what you’re seeing, or how you’d interpret these sequential declines?

[Jeremy Smeltser:]

Yes, I mean, I think, Marc mentioned earlier, I think, we see it primarily as seasonality, particularly in Europe. We follow global manufacturing PMI indices pretty closely and they’re stronger, right? I mean, Germany, it’s over 60 is good, U.S. in that range as well. I would say that, North America, while it’s better, we do still see some level of hesitancy in stocking orders and capital projects, as we continue to have uncertainty in the political and tax reform environment. So I think, perhaps we’re seeing some underspending in the market as compared to some of the positive data that we’re seeing. So there’s potential for it to move north of the volume level that we saw in Q3. But there’s certainly nothing I see kind of byproduct line when I look at a sequential organic change Q2 to Q3 in orders. There’s nothing that I really see there that concerns me.

[Marc Michael:]

Yes, I would echo that. And again, as we move through Q4, we’ll see how that develops in all the product lines. The one other thing, I would mention overall too in the sequential change, we did have a larger nuclear order in Q2, which was about, I think, $12 million. So, that does have an impact on the sequential part of the Q2 to Q3.

[Robert Barry:]

Got it. Maybe just one last quick one on just curious the logic of using the revolver to help pay down the term loan?

[Jeremy Smeltser:]

Actually that was our AR securitization facility that we used.

[Robert Barry:]

I’m sorry, yes, the securitization facility, you’re right. Correct.

[Jeremy Smeltser:]

One point I want to clarify.

[Robert Barry:]

Yes.

[Jeremy Smeltser:]

So couple of things. I mean, one, we still have couple months of cash flow to come in the quarter. And so our expectation is, we’ll pay the majority, if not all of that off by the end of the year. On the term loan just from a technical perspective, you really only get the option to pay at the end of each month. And so, we would add another 30 days to wait. So it’s really based on our expectations for cash flows in the quarter, and from a rate perspective as well, it’s about 150 points lower than where the term loans at today.

[Robert Barry:]

Got it. Thank you.

[Jeremy Smeltser:]

Thanks, Robert.

[Marc Michael:]

You’re welcome.

[Operator:]

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

[Walter Liptak:]

Good morning, guys. Thank for taking my questions.

[Marc Michael:]

Good morning.

[Walter Liptak:]

I don’t – good morning. I don’t think anyone has asked yet about the large dairy order, and you’ve kind of alluded to maybe, this is the first one in a while that’s of any size. We finally bottoming out in the dairy sector, do you see more orders coming out of Europe or North America that could – maybe this could be a sign that things are beginning to turn up?

[Marc Michael:]

Yes, if you reflect back, first, in Q2, we’d mention that we would anticipate that there could be some pickup in the market based on what we’re seeing in the recovery in dairy pricing. Dairy pricing came down significantly through 2014, kind of bottom late 2015, started recovering late last year. And I would say, it’s been pretty stable as we’ve moved through most of 2017 since Q1 anyway. And it’s really nice to see big pickup, too, when imports into China, which is a big driver of what happens in the countries that are producing a lot of dairy. So China has really picked their imports on a year-over-year basis in infant milk formulas, whole milk powders, skim milk powders. So that’s all encouraging. So it looks like its bottom is stabilizing and the front log remains active. This project that we’re – that we secured in the quarter, I think, is reflective of that. And I would expect, they’ll be projects that present themselves. We’re being disciplined in our selection of projects based on first looking at what it delivers in terms of potential content for us, or positions us with key customers and key accounts to support them. But I would anticipate, there’s a pickup to the kind of 2013, 2014 levels in the near-term. But we could see additional projects to start to hit the backlog as we go through the next 18 months or so here.

[Walter Liptak:]

Okay, g. And then I want to – it’s good that you’re being disciplined on the orders that you’re willing to take. I wonder if you could talk to us about the competitiveness of the markets and what kind of margins where you’re looking at with it the large carry order and the forward orders as well?

[Marc Michael:]

Yes. The market is a bit more competitive. It was at its peak, and we’re seeing that even going back to – going through 2015, and as we move through 2016, the projects that were out there. But I wouldn’t describe this project is different from what our expectations would have been over the last couple of years in terms of the margin profile, and I would expect the same going forward.

[Walter Liptak:]

Okay, great. Thank you.

[Jeremy Smeltser:]

Thank you.

[Marc Michael:]

Thank you.

[Operator:]

Our next question comes from Damian Karas with UBS. Your line is now open.

[Damian Karas:]

Hi, good morning, everyone.

[Marc Michael:]

Hi, Damian.

[Jeremy Smeltser:]

Hi, Damian.

[Damian Karas:]

Marc, in power and energy, you noted still not seeing recovery yet in demand for early pumps. Could you maybe refresh our memory here on what your oil and gas exposure is between the up, mid, and downstream and maybe onshore versus offshore? And it does kind of feel like we are starting to see increased bullish sentiment out there on oil prices. What do you think it’s going to take here to get to see this pumps business to come back?

[Marc Michael:]

Yes. So our exposure for ClydeUnion specifically is more in the upstream offshore business is, that’s what we were seeing at the peaks. To a lesser extent, we’ve been historically exposed to the midstream. And what our teams have done over the last couple of years is a – in our project – our product management has been a really nice transition to reposition some of the products for the midstream. So some of the orders that we have seen in ClydeUnion for oil and gas has been in the midstream. But our – the greater – the bigger majority of our products for ClydeUniontend to be upstream offshore, which is still slow. The North Sea is starting to come back a bit, but it’s still slow. And so that’s why we’re not really counting on anything associated with the OE part of the business. That’s consistent with where we were in 2016, what we’ve done through 2017, and now we’re even thinking about 2018. So we’ve sized the business now to really be able to be successful on the slower run rate, and really the emphasis being on securing aftermarket business in our ClydeUnion area especially. Our other exposure of significance in oil and gas is in the midstream valve business, and again, that’s come back nicely on a year-over-year basis. And it was – it really popped up nice in Q1 and has remained above the 2016 trends through Q2 and Q3. And as we look forward, we expect that to continue in the near-term for what we can see with what’s in the front log. So for the upstream offshore to come back, it’s still – we feel it’s going to be a bit of time before that happens for the larger pumps. But again, we positioned and planned for that throughout 2016 and 2017, and we’ll be able to be successful in 2018, even without that part of the business being out there for us and available.

[Damian Karas:]

Okay, that’s helpful. And just a follow-up on food and beverage, so it is nice to see that European dairy systems award, I’m assuming that that’s one of the potentially large projects that you guys alluded to earlier in the year. And just in terms of how the environment is progressing in Asia, could you maybe give us an update on what you’re seeing, whether that’s been really – that’s related to regulatory developments, market trend, or just overall sentiment towards dairy investment?

[Marc Michael:]

Yes. The projects of this size that we’re tracking and working on, usually, we have good visibility to the one we booked in Q3. We’ve been working on that for several months even going back into the latter part of last year. So we have good visibility of those projects as we work on them with customers. And that’s where we feel that the front log has remained active and we have visibility to other projects out there and we’ll monitor and watch them closely. Again I think there’ll selectively be some ones that could develop over the next 18 months or so. If we look at China and Asia, China specifically, which is a really big driver, overall the environment there, again on the import side has been improving. We’ve seen, as I mentioned, upticks in what’s happening with infant formulas which do come out of Europe, in many cases there is a lot of imports. There is an uptick pretty significantly in whole milk powders and skimmed milk powders, whey powders have increased, so it’s good to see these dairy products increasing going into China on a year-over-year basis. The program or projects themselves have been a little bit slower in China this year versus the prior couple of years, but that’s been throughout the course of 2017, so nothing new in developments there with what we had traditionally been focused on more in the fresh dairy space of yogurt facilities for example where those products need to be produced within the country. From a regulatory perspective, I mean not a lot has changed over the last couple of years. So we’re consistently finding ourselves in a good spot when there are especially fresh dairy opportunities in China and India and across the region. So I think we’ll continue to see opportunities there as we go through the next several years, albeit a bit off the peak that we saw through 2014 and 2015.

[Damian Karas:]

Okay, great thanks.

[Operator:]

Our next question comes from Julian Mitchell with Credit Suisse. Your line is now open.

[Ronnie Weiss:]

Hi, it’s Ronnie Weiss on for Julian, good morning. One the Food and Beverage margins, can you talk about the mix differential here with the components revenue being up high single digits I think you said and system being down, I would think there would be some mix benefit, maybe I’m just wrong on the margin differential there, so just talk about the flat margins?

[Jeremy Smeltser:]

Yes, no, I think your thesis is correct. I think one thing that might help would be to look sequentially from Q2 to Q3 revenue exactly flat and margins up 150 basis points with higher compensation expense in there. So, we’re making progress as the year progresses. The overall mix is a little bit different from a year ago, but I think we expect to see the progression that we saw from Q2 to Q3 continue in Q4 as we continue to see improved efficiency in the Poland plant. I think overall I would remind everybody that while we are producing well in Poland, we’re pleased with the progress. The ramp up to the expected margins eventually it would still take time right and these are complex products and we’re getting them out the door, but we’re doing it with more people than we would have right now in the past facilities and so we expect through the rest of this year and through next year to continue to ramp up efficiencies and margins in that particular plant.

[Marc Michael:]

I would – and just to echo Jeremy’s point, holistically if you look Q2, Q3, Q4 on what we could describe a similar revenue levels we’re seeing progression in our segment income and our margins again based on all the improvements we’re making and the cost initiatives the re-realignment starting to take hold. So it’s a good trend and that’s again what we’re expecting to obviously continue as we move into the 2018.

[Ronnie Weiss:]

Got it. And then I’m sure you’ll dive a little bit more into this in February, but on the free cash for 2018, even with the CapEx stepping back up here, only embeds a slight increase from the 2017 guidance. Just wondering if there is any other big cash headwinds I should be thinking about from 2017 to 2018 perspective?

[Jeremy Smeltser:]

No headwinds Ronnie, just we’re little more conservative on the expected working capital benefit in 2018 versus what we’re currently seeing for 2017. I think we’ve assumed a $5 million working capital, a benefit for next year and we’ve done better than that this year, particularly in the project-based businesses.

[Ronnie Weiss:]

Got it. And then just real quickly last, there is no other hurricane impact embedded into the Q4 guidance right?

[Marc Michael:]

That’s correct, we would expect to catch up on the new shipments. There is a little bit of lost cost in the $3 million that we called out which is ramp-up. We paid our employees when we were shutdown, we kept wages going to benefit their families in the difficult time they were going through. We had some ramp-up and – ramp-down and ramp-up costs et cetera that are lost, which is probably little less than $1 million on the year, but the rest of it comes back in Q4.

[Ronnie Weiss:]

Got it. Thank you.

[Marc Michael:]

Thanks, Ronnie.

[Jeremy Smeltser:]

Thanks.

[Operator:]

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

[Andrew Krill:]

Good morning. Thank you. This is Andrew Krill on for Deane. So incrementals in power and energy this quarter were very strong over 50% and we’ve seen this happened to a lot of oil and gas levered businesses that are reflecting. So I want to gauge, how sustainable you think this could be? And if you can give any sense on drop through for 2018 for power and energy? Thanks.

[Jeremy Smeltser:]

Yes. So we did call out an increase in aftermarket sales shipments in Q3 sequentially, which would certainly helped both sequentially and year-over-year. We think this levels that we achieved in Q3 is about right and is sustainable. We would expect a relatively similar margin profile in Q4. For the year, the big hit to margin was really the extremely low level of volume we saw in Q1, which was really challenging given our fixed cost base in that business. So, with the backlog where it is, we don’t expect that that super low level of volume in Q1 2018. And so I think, our 2018 profile will look much better than what we saw in 2017 for P&E overall.

[Andrew Krill:]

Okay, got it. And then just, is there any chance, I guess, you might have to add back some costs into the business if the growth kind of continues at this pace. I know most of the restructuring has been structural rather than variable. But just any additional color there would be helpful? Thank you.

[Jeremy Smeltser:]

Sure. Yes, again, we’re managing costs very closely. It’s again still something that we have a regular cadence around that we look at monthly and then do an overall quarterly review of our progress against the realignment program and assessing how volumes are progressing in the facilities, looking at all our overheads, expenses and direct labor. And so I would expect that if volumes increase, the real impact will be around direct labor, if we need just additional people to produce the products and keep our on time delivery in line. But the overheads, we’re going to look to continue to leverage that even more strongly as we move through 2018 and beyond through a lot of the continuous improvement efforts that we have going on.

[Andrew Krill:]

Okay, great. Thank you.

[Jeremy Smeltser:]

Thank you.

[Marc Michael:]

Thank you.

[Operator:]

Our next question comes from Brett Kearney with Gabelli & Company. Your line is now open.

[Brett Kearney:]

Hi, guys, thanks for taking my question.

[Marc Michael:]

Sure, Brett.

[Jeremy Smeltser:]

Hi, Brett.

[Brett Kearney:]

So you guys touched on it already. But I just want to ask with the Poland facility ramping up nicely here, just want to see if you guys could provide a sense for kind of where that facility is at in terms of the utilization today? And kind of in what time period, do you expect that to reach for steady state production levels?

[Marc Michael:]

Sure. Yes, I mean, we’re certainly far from fully utilized, that was by design. We still have to move our 100,000 square foot, at least, operation across the street into the new facility that we own. That’s a project that will – is in the planning phases and we’ll execute in the first-half of next year. And so that is another driver of my comments earlier on where we’re at with margins now versus where we expect to be. So I would expect, in 2018, one, we’ll do that specific move. But I would expect, each quarter margins will likely improve sequentially in Poland throughout next year.

[Brett Kearney:]

Okay, great. Thank you.

[Marc Michael:]

You’re welcome. Thank you.

[Jeremy Smeltser:]

Thanks, Brett.

[Ryan Taylor:]

Thanks, Brett. This is Ryan Taylor. That concludes our call for today. We appreciate everybody joining us. Per the usual, Stewart and I’ll be available throughout the day to answer any follow-up questions. So thanks for joining us, and we’ll talk to you next quarter.

[Operator:]

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