SPX Technologies, Inc.
Q1 2015 Earnings Call Transcript

Published: 3 May 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the First Quarter SPX Corporation Earnings Conference Call. My name is Matthew and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions]. As a reminder, this call is being recorded for replay purposes. And now I would like to turn the call over to Mr. Ryan Taylor, Director of Investor Relations. Please proceed, sir.

[Ryan Taylor:]

Thank you, Matthew, and good morning, everyone. Thank you for joining us. With me on the call this morning are Chris Kearney, Chairman, President and CEO of SPX; and Jeremy Smeltser, our Chief Financial Officer. Our Q1 earnings press release was issued this morning and can be found on our website at spx.com. This call is being webcast with a slide presentation located in the Investor Relations section of our website. I encourage you to follow along with the details on the slides during the webcast. A replay of this webcast will be available on our website until May 6. As a reminder, portions of our presentation and comments are forward-looking statements and subject to Safe Harbor provisions. Please also note the risk factors in our most recent SEC filings. The financial information presented today is on a continuing-operations basis. And in the appendix of today’s presentation we have provided reconciliations for the non-GAAP and pro forma measures presented today. As a reminder for 2015, we have provided financial modeling targets for revenue, segment income, EBITDA and other reasonably predictable items for SPX as currently reported and also for the two future companies. We do not believe it is useful to provide 2015 EPS guidance given our plan to complete the spin-off of our Flow business in the third quarter of this year as well as the uncertain timing of the related financial impacts. And with that, I’ll turn the call over to Chris.

[Chris Kearney:]

Thanks, Ryan, and good morning, everyone. As expected, our Q1 financial results reflect the strengthening of the U.S. dollar, the impact of lower oil prices and the ongoing weakness in power generation markets. Broadly speaking, these factors have caused many of our customers to reevaluate their capital spending budgets leading to delayed order placement and project timing. As a result, Q1 orders across our Power & Energy businesses were down double-digits over the prior year and significantly lower than anticipated. These declines overshadowed a strong bookings quarter in our Food & Beverage business which also reported solid organic revenue growth and margin improvement in the quarter. Given the slower start to the year and the uncertain timing of capital investments in oil and oil related markets, we have implemented additional cost production initiatives and increased our plan restructuring actions for the year. Our revised full-year targets reflect these changes as well as the strengthening of the U.S. dollar. For 2015, we now expect organic revenue to be flat to down 4% with total revenue down 6% to 10% including a 6% currency headwind. Before reviewing the first quarter results, I’ll provide a brief update on the spin-off of our Flow business. We continue to identify candidates to serve on our board for both future companies. We recently appointed IBM executive Anne Altman, to our Board of Directors. Anne is a valuable addition to our board, and I’m confident we can leverage her experience and expertise to help advance our overall business strategy. From an organizational perspective, we’ve determined the tier 1 reporting structure for both companies including the direct reports for both Gene Lowe and myself, and we’re now the process of finalizing the broader corporate teams. We expect them to be fully established by the end of Q2. On the Form 10, we’re in the latter stages of preparing the document and expect the initial filing with the SEC to occur in Q2. The timing of our Form 10 filing and subsequent review process with the SEC is one of the primary factors in determining the effective date of the spin. Based on our progress to date, we remain on track to complete the Spin transaction in the third quarter and we believe the effective date will most likely be towards the end of Q3. From a cost perspective, in the first quarter we recorded $9 million of after tax cost related to the spin. In total we recorded $26 million to date and our estimate of total cost for completion remains at between $60 million and $80 million. I also want to mention that as we prepare for this separation, there is a tremendous amount of work going on behind the scenes by our corporate employees and external partners. I want to take this moment to personally thank all of those involved for their hard work and dedication. We believe this is a unique opportunity to create value for shareholders of both future companies. Moving on now to the consolidated results for Q1. Revenue in the quarter was $947 million down 12% year-over-year. Currently was 6% or $69 million headwind to revenue, slightly more than expected due to continuing strengthening of the dollar. Organic revenue was down 6% primarily due to lower Power & Energy revenue in our Flow and Thermal segments, reflecting the impact of lower oil prices on our customers’ capital spending and ongoing weakness in power generation markets. In total, revenue was lower versus our expectations due largely to project timing, delays that were customer driven as well as lower than anticipated book in turn sales and Flow’s Power & Energy business. Segment income was $76 million or 8% of sales consistent with our target range. The year-over-year decline in segment income was due primarily to lower profitability in the Power & Energy businesses, within Thermal and Flow and to a lesser extent, currency headwinds. Partially offsetting these declines was the strong performance by Flow’s Food & Beverage business, which reported mid-single-digit organic growth and 360 points of improvement in operating margins. Our Food & Beverage business also had a strong bookings quarter with orders up about 15% year-over-year excluding currency, driven by several attractive new system orders. The growth in system orders was more than offset, excuse me, more than offset, a slow-down in component bookings in North America, which remained at a high level but declined versus the prior year. We believe the slowdown was due in large part to distributors adjusting inventory levels at the start of the year. In Q2, we’ve already seen a pick-in in weekly component orders an encouraging sign. Taking a broader look at the global dairy market, despite recent declines in dairy prices, many of our customers are taking a long-term investment approach given trends in consumer demand. In particular, Chinese customers have a growing appetite for importing products, including powered milk and baby formula. And in Western markets, rising demand for protein enhanced dairy products are high growth opportunities for our customers. We’re benefiting from these shifts and consumer demand as our dairy process technologies and global capabilities have us well positioned to support our customers as they expand production. Growing our installed base of dairy systems is a key to our strategy as it drives near-term volume in our component manufacturing plants and puts us in a leading position to capture the aftermarket annuity stream over the life of the system. The aftermarket tends to be very steady as these process plants are typically run 24 hours a day, 7 days a week to maximize production. During 2014 Marc Michael and his team did an excellent job implementing new processes to drive strategic order selection and improved project execution with a longer term focus on growing the aftermarket business. These changes are reflected in their improved Q1 financial results and are helping to offset the challenging market headwinds we face in Flow’s Power & Energy business. Flow’s Power & Energy orders were down more than 20% year-over-year in Q1 with the decline concentrated in upstream and midstream orders. We experienced a sharp decline in upstream orders which were at very low levels. And in the midstream orders for pipeline valves also declined versus the prior year and our expectations. These declines were partially offset by an increase in downstream orders highlighted by large order to supply pumps for an L&G facility in the U.S. On a positive note, aftermarket demand was steady with Q1 aftermarket orders up modestly versus the fourth quarter. Order activity for Flow’s power generation products was generally stable with a solid level of nuclear orders and continued low levels of activity in conventional power plants. Overall, Power & Energy orders throughout the industry were much slower to start the year than many anticipated. Although we’re still tracking a healthy level of front-log opportunities, timing of order placement in the near-term is difficult to predict particularly for large orders. Additionally, we’re also seeing pricing pressure from customers and certain competitors. The work accomplished by Tony Renzi and his team over the past two years to reduce our cost structure, improve productivity and execute a more disciplined commercial strategy has put us in a position to remain competitive in the current environment. That said, Tony has implemented further actions to reduce cost including additional restructuring actions focused primarily in Europe. Given all these factors we’ve reduced our 2015 expectations for Flow’s Power & Energy business. We now expect organic revenues to decline in the mid-teens with margins down about 250 points over the prior year. Flow’s industrial business experienced steadier overall demand versus the prior year, although the underlying trends were mixed. We experienced some timing delays for order placement on small to medium sized capital projects. This was most notable when chemical processing applications where we continue to see positive quoting activity but customer investing timing has been pushed out. At the outset of the year, we also saw areas of soft demand for our dehydration products. Exiting the quarter, order activity and compressed air, and compressed air markets has begun to improve. Mining continues to be weak however we are seeing some discreet opportunities developing. Moving on now to our thermal segment, the North American HVAC market was a bright spot during the quarter. The expanded winner benefited our comfort heating businesses which saw strong Q1 demand consistent with last year. In our package cooling business, demand in North America was stable year-over-year and we expect favorable trends in commercial construction to benefit our package cooling business over the balance of the year. Gene Lowe and his team continue to focus on initiatives to expand their business in adjacent non-power markets. New product development is a key part of this strategy. During Q2, our Marley brand is poised to launch a new evaporative condenser in the U.S. refrigeration market. This is an extension of Marley’s current product offering and a great example of leveraging existing technology to serve an adjacent growth market. In power generation, we’re experiencing ongoing weakness, some of which may be attributable to lower oil prices. During the quarter, we saw several customers defer projects from 2015 into 2016. Demand for new capacity remained sluggish and quoting activity for large projects has slowed considerably, particularly for the refurbishment of aged cooling towers in the U.S. In addition, project timing on a few large orders and backlog was pushed out due to customer specific reasons. These projects are concentrated in EMEA region and specifically in oil producing countries. Given this weakness, Gene and Scott Sproule are focused on broad-based cost reduction initiatives including additional restructuring actions in Europe and in North America to reduce Thermal’s global cost structure and appropriate reflect market conditions. Looking, now at the ending backlog, Q1 backlog, on a sequential basis, our total backlog was down 2% due to currency, which reduced the backlog by 4% or $87 million. Excluding currency, the backlog grew $52 million driven by solid backlog growth across all three Flow businesses and a modest increase in the industrial segment backlog. So, given the challenging environment and Power & Energy markets, we’ve increased our planned restructuring actions for the year. We now expect restructuring expense of $25 million to $30 million in 2015. In Q1 we executed $7 million of actions focused primarily in the Flow and Thermal segments. Over the balance of the year, we expect the restructuring actions to also be concentrated within Flow and Thermal and specifically at the Power & Energy businesses in those segments. We expect this year’s actions to drive $10 million to $15 of cost savings in the second half and approximately $30 million of annualized savings. Beyond the $25 million to $30 of planned actions, we’re also evaluating additional opportunities to further simplify our global footprint. So, at this time, I’ll turn the call over to Jeremy to provide a detailed analysis of our Q1 results and revise full-year targets.

[Jeremy Smeltser:]

Thanks, Chris, good morning everyone. I’ll begin with a brief look at earnings per share. For the fourth quarter, we reported a diluted loss per share from continuing operations of $0.78. As Ryan mentioned, this included some notable items not in our Q4 guidance, which I’ll discuss in more detail. For Q1, we reported a loss per share from continuing operations of $0.17, which included $0.22 of cost associated with the spin-off of our Flow business. The cost associated with the spin included $5 million of professional fees recorded in corporate expense and $5 million of tax expense related to legal entity reorganization. Excluding the spin related costs, EPS from continuing operations was $0.05 in the quarter. Moving to the segment results beginning with Flow, revenue declined 14% to $531 million. Currency was an 8% or $51 million impact to the year-over-year revenue decline. Organic revenues were down 6% due to a double-digit decline in Power & Energy sales, reflecting the impact of lower oil prices on our customers’ capital spending decisions. This decline was partially offset by a mid-single-digit increase in sales of Food & Beverage components and systems. Segment income was down $7 million versus the prior year, with currency translation driving $5 million of the decline. Excluding currency, lower income due to the organic revenue decline in Power & Energy was largely offset by improved profitability in our Food & Beverage business, as well as cost savings from last year’s restructuring actions. Flow’s margins increased 50 points to 11.2%, a good result given the macro-environment and top line challenges. The margin improvement was driven by our Food & Beverage business, where operating margins were up 360 points year-over-year reflecting the disciplined order selectivity and improved project execution that Marc and his team have been working on. Flow’s backlog was up 1% sequentially. Organic backlog growth of $68 million was largely offset by a $55 million impact from currency. Book-to-bill for the segment was 1.1 in the quarter, driven by strong orders in our Food & Beverage business. As evidenced in our Q1 margin performance, we continue to build a healthy backlog and remain focused on driving margin improvement. Looking now at Thermal’s Q1 results, using the same format as last quarter, we’re isolating the financial results of the large power projects in South Africa to provide you greater transparency into the core business. Beginning with the reported results on the left side, total revenue declined 12% to $247 million. Currency was a 5% headwind. Organic revenue declined 7% or $19 million. Revenue related to the South Africa projects declined $15 million year-over-year and accounted for the majority of the organic revenue decline for the segment. Thermal reported an operating loss of $3 million in Q1 including a loss of $8 million on the South Africa projects. The Q1 loss in South Africa relates primarily to increased cost estimates resulting from extended project timelines as well as additional work we are providing for one of our customers related to the modification of certain boiler components. We’ve agreed to perform this work in the interest of avoiding further delays and to keep these projects moving forward. That said, we believe we’re entitled to reimbursement of a portion of the additional cost we’ve recorded over the last two quarters. That reimbursement is ultimately subject to the resolution of certain disputes among the various parties involved. In our most recent communications, we believe there is positive momentum towards resolving these claims in the near future and a common interest in moving forward on these projects. Looking at the core Thermal business, on the right hand side, revenue in the quarter was $233 million. As compared to the prior year, currency was a 4% headwind and organic revenue declined 3%. The organic decline was due to lower sales of heat exchangers in Asia Pacific and a reduction of cooling tower reconstruction activity in the U.S. which has declined to historically low levels. On a positive note, packaged cooling towers grew by high-single digits year-over-year driven by growth in Asia and steady demand in North America. Also due to the extended winter, our heating businesses had a very nice quarter with strong volume consistent with last year and solid year-over-year margin improvement. As a reminder, Q1 is Thermal’s weakest revenue and earnings quarter due in part to the timing per service and rebuild work which our customers generally schedule to coincide with the timing of power plant maintenance. Large maintenance projects require a scheduled shutdown of power plant, which we typically see customers scheduled during the spring and fall. Thermal’s core backlog declined 8% or $52 million sequentially. Currency accounted for $32 million of the decline. Excluding currency, the core backlog declined 3% from year-end reflecting the challenging market trends Chris described. Also, the timing on a few large projects and backlog has been delayed by our customers for various reasons that we believe may be influenced by the impact of lower oil prices. These are dry-cooling projects in the EMEA region specifically in oil producing countries. This has impacted our revenue expectations for 2015. In terms of backlog ageing, we now expect about $310 million or 55% to be recognized as revenue this year with about 45% or $250 million expected as revenue in 2016 and beyond. In South Africa, the ending backlog was $82 million. Given the extended project timelines and additional work that we have taken on over the last two quarters, we are working with our customers to negotiate the amount of future revenue associated with contract extensions and scope changes, not currently reflected in backlog. At this time, we expect at least $100 million of additional revenue from future contract adjustments. While the overall environment remains challenging on these projects, progress continues and we’re working closely with our customers towards resolution of claims and ultimately completion of these projects. Finishing up with industrial, revenue for the period was $169 million down 7% from last year. Organic revenue declined 4% and currency was a 2% headwind. The organic revenue decline was due to lower sales of fair boxes, power transformers and communication technologies. These deployments were partially offset by organic growth in sales of table and pipe locators at our radio detection business. Segment income was $19 million and margins were 11.2%. The year-over-year decline in segment income and margins was due to the decrease in sales of our Genfare collection systems and TCI Communication Technologies. At our Genfare business, with the current federal highway and transportation funding set to expire on May 31, and no clear path to a long-term funding program, we continue to see slow quoting activity across the U.S. transportation industry. Given the near-term uncertainty, we’ve reduced our 2015 full-year revenue and operating profit expectations for Genfare. We’ll be watching closely over the next few weeks for any developments on highway and transportation funding. Moving on to the backlog, the ending backlog for industrial was up 1% sequentially. Our power transformer business continues to see strong quoting activity tied to replacement demand as utilities focus on addressing aged install base. Pricing remained stable and average industry lead-times are slowly expanding with higher voltage medium power units being quoted at lead times ranging up to 10 months, an encouraging trend. We are quoting 8 to 10 months lead times for medium power units. We remain selective as we fill out our remaining production slots for the fourth quarter and begin to take orders for delivery in 2016. Internally, we remain focused on improving productivity in our Waukesha facility and reducing design cost and total operating cost of our power transformers. Looking now at our second quarter modeling targets, consistent with the first quarter, we expect revenue to be down about 12%. Currency is expected to be at 7% or $85 million headwind to revenue and a $7 million headwind to segment income. We expect organic revenue to decline 4% to 6% due primarily to lower Power & Energy sales in our Flow and Thermal segments. Segment income is expected to be between $86 million and $96 million with margins at approximately 8.7%. We expect lower profitability versus the prior year as a result of the revenue decline in Flow’s Power & Energy business as well as lower sales of fair collection and communication technologies in the industrial segment. And we have $5 million to $8 million of restructuring actions planned in the second quarter concentrated in our Flow and Thermal segments. We’ve revised our full-year targets to reflect the slower than expected start to the year and the strengthening of the U.S. dollar. As compared to our previous mid-point model, currency has reduced our targets for revenue and EBITDA by about $70 million and $10 million respectively. From an organic perspective, we’ve lowered our expectations across each segment with the largest declines coming from our Power & Energy businesses within Flow and Thermal. In the industrial segment, we reduced our expectations for fair collection revenue and profit this year given slow Q1 orders and uncertainty around federal funding. On a consolidated basis, we are now expecting revenue to decline 6% to 10% year-over-year to about $4.36 billion at the mid-point. This includes a 6% headwind from currency translation. At current exchange rates, currency translation is expected to be a $275 million year-over-year headwind to revenue, a $28 million headwind to segment income and about $0.50 headwind to earnings per share. On an organic basis, we expect revenue to be flat to down 4% with segment income margins modestly better than the prior year at approximately 11.2%. From a quarterly perspective, our financial performance is generally stronger in the second half of the year, reflecting the overall seasonality of our businesses. For this year, we are targeting a modestly higher percentage of segment income in the second half as compared to prior years. For 2015, we expect to generate two thirds of our full-year segment income in the second half. This is partly due to normal seasonality particularly in our comfort heating and aftermarket businesses. In the second half of the year, we also expect to begin recognizing revenue on several of the recent large Food & Beverage Awards. There are also a few specific projects in our industrial segment that we expect to ship in the second half which should benefit margins. Lastly, we expect the restructuring actions to result in $10 million to $15 million of cost savings in the second half. Looking at our revised targets on a pro forma basis for both future companies, for the Flow Company which will include the Hydraulic Technologies business, we are targeting revenue of about $2.5 billion, down approximately 10% year-over-year including an 8% currency headwind. And pro forma EBITDA is expected to be about $360 million. This is calculated consistent with our credit facility definition for EBITDA which adjusts for restructuring expense and non-cash compensation expense. For the new SPX Corporation, we’re targeting revenue of about $1.9 billion down 4% year-over-year including a 3% currency headwind. Pro forma EBITDA is expected to be about $160 million. Our financial targets for both future companies have been impacted by currency headwinds and the impact of lower oil prices on our customers’ capital spending decisions. Despite these near term challenges, we believe both future companies are well positioned as leading suppliers and attractive long-term growth markets. Now, I’ll provide a brief update on our free cash flow performance and financial position. Given the seasonality in many of our businesses, Q1 is historically our weakest free cash flow quarter. This year, net cash usage in the period was $123 million as compared to $70 million last year. The year-over-year variance was due primarily to working capital performance, lower operating profit and currency headwinds. Over the balance of the year, we expect a much stronger working capital performance, particularly through reductions and accounts receivable and inventory. For the full year, we expect free cash flow conversion of approximately 100% of net income. This includes costs and cash flows related to the spin. We ended the quarter with $363 million of cash on hand and $1.5 billion of total debt. Our gross leverage ratio was 2.7 times and our net leverage was 2.1 times. We remain in a solid financial position and expect to have both future companies in a similar condition, with ample liquidity and flexibility to execute their future strategies. With that, I’ll turn the call back over to Chris for closing remarks.

[Chris Kearney:]

Thanks Jeremy. So, in summary, given the slower than expected start to the year and the impact of lower oil prices on our customers’ capital investments, we provide for full year targets to reflect the challenging environment in our energy, power and industrial markets. Given these challenges, we’re focused on items that are within our control including restructuring actions, cost reduction initiatives and working capital performance. We also continue to make progress towards the spin-off of our Flow business and expect to complete that transaction around the end of Q3. We believe the spin will provide both future companies greater flexibility to focus on and pursue the respective growth strategies enabling them to create significant value per shareholders, customers and employees. We also believe the execution of this plan will allow investors to distinctly value the unique attributes of each company. So that concludes our prepared remarks. And at this time, we’ll open the call for questions.

[Operator:]

[Operator Instructions]. And the first question comes from the line of Shannon O’Callaghan. Please go ahead.

[Shannon O’Callaghan:]

Hi, Chris, maybe on South Africa to start, just can you provide some more detail on how the losses play out there and also the dynamics of what’s really taking place, how and when this all gets resolved? You mentioned the potential of reimbursement maybe just a little bit more color what we can expect as this goes forward?

[Chris Kearney:]

Yes, sure, happy to Shannon. As you know, and as many know who have followed this, and followed the company for a while, this is - these are two very large and very complex projects in South Africa that have now been going on for some time. And there is a common imperative among all parties starting with Eskom and that is to get it done right. And Eskom particularly is highly motivated to get these power plants up and running as soon as possible, just given the rolling blackouts in South Africa and the severe need for additional power generation in that country. So, with that, I mean, Medupi has successfully achieved the oil fire on its first unit that’s unit 6, which is a significant milestone I believe we talked about that on the last call. I mean, it’s important to understand that in order to achieve first fire, the boiler and all the related systems, we’re in fact available and fully commissioned. So that is a very important milestone. That said, there remain challenges for everyone involved again just given the size, the complexity and working conditions in South Africa. So it’s created a complex set of contractual relationships. We have taken an aggressive position to keep this project moving forward as Jeremy mentioned in his remarks. And so, with the cost, we’ve recognized in this quarter and in the previous quarter those are obviously intended for us to take greater control and to keep the project moving forward. The amounts that are invested, some of those obviously will be the subject and are the subject of dispute which again as Jeremy mentioned in his remarks will be resolved at a later date. And our position is that we have claims relating to, much of the charge that we have taken. But it is again important to understand that the imperative here is just to keep the projects moving forward and to get them done. What I will tell you is that, in recent weeks and months we have seen a concerted effort among all the contracting parties on these projects to try and find resolution with again that common goal to getting the projects done. And those discussions have been facilitated as you expect by Eskom because again Eskom has a great imperative to get this thing done. So, with that all said, I mean, if you look at the project there certainly is potential for future risk and volatility. With the actions that we’ve taken and the cost that we’ve recognized, with respect to our portion of these projects, we feel like we’re in a position of better control and focused on getting these done and getting this behind us.

[Shannon O’Callaghan:]

Okay, great. That’s very helpful. And then on the second half ramp, right, I mean, you guys always have it, but this year it’s a little more than normal. I mean, on the one hand, you’ve got some of these strong Food & Beverage orders that you’ve received that look like they’ll kick in, in the second half. On the other hand, you’ve pushed something out of the second half, yet still have a pretty big ramp. So, what’s the visibility into the stuff that you’ve assumed in ‘15 not pushing out to ‘16, or potentially even vice versa with some of this Genfare stuff or otherwise, things you’ve assumed to push to ‘16 come back in maybe just so more clarity on how much visibility you have into that?

[Jeremy Smeltser:]

Sure Shannon. One thing I do want to point out on that slide, the kind of skews, the comparison to last year in particular that the $25 million charge in Q4 for Thermals included in that 29% figure in the middle of that section. So it isn’t actually quite as big from last year than it appears on the slide. But what I would say is, a lot of what we have and forecast isn’t the backlog, particularly Food & Beverage, and Power & Energy and Thermal and Waukesha, which is a good thing. We have visibility to the projects that we have left in the outlook as well as some of the shorter cycle businesses, but they’re not yet in backlog and so there certainly is some level of risk but we think we’ve been appropriately cautious for everything that we know now. And the restructuring action that should drive the savings that help us as well, those are underway some have already been executed additional ones in process for Q2 and early Q3. So, certainly always some risk of customers pushing projects out further into 2016 and such an uncertain macro time. But encouraged by certain other things, such as the aftermarket orders holding up and Flow Power & Energy, that’s a positive for us, actually increasing sequentially which is a big driver of underlying profit expectations in the second half for that business.

[Shannon O’Callaghan:]

Okay, great. Thanks, guys.

[Chris Kearney:]

Thanks Shannon.

[Operator:]

Thank you for your question. Your next question comes from the line of Mike Halloran. Please go ahead.

[Mike Halloran:]

Good morning, guys.

[Chris Kearney:]

Good morning Mike.

[Jeremy Smeltser:]

Good morning Mike.

[Mike Halloran:]

Just sticking with that question, I’m just wondering. I doesn’t sound, I just want to make sure here that there’s any core fundamental underlying improvement embedded in the second half of the ramp with the exception of maybe on-boarding a little bit more of these shorter cycle type product categories. Is that a fair statement?

[Chris Kearney:]

It is fair. We certainly, given where we’re at four months into the year, have to assume the conditions continue as they are right now.

[Mike Halloran:]

Fair. And then, switching over to the Flow side, with the margin degradation you guys are expecting there, could you just try to bucket in wide buckets what those pressure points are in delineating between volumes, price cost side, mix, things like that? And related to that maybe just talk about how that price cost dynamic is working out? Obviously, some price pressure on the environment here, how that’s flowing through on a net basis.

[Jeremy Smeltser:]

Yes, I’m not going to get into specific numbers but I’ll describe kind of for each end market. I’ll start with Flow industry which I think is the simplest story, we’re pretty steady both on the revenue and margin front and our expectations. And I would tell you that orders in the first four months of the year, support that position so, we’re confident there. On Food & Beverage, we expected as we started the year, as we communicated externally that Food & Beverage would have a big margin improvement year, and we’re certainly off to a great start with that with 360-point margin improvement in the first quarter. And then it really comes down to Power & Energy which is offsetting the Food & Beverage margin improvement to get us to where we are which is basically flat in total for the year. And in P&E, I would tell you that the vast majority of it is volume. Although we are seeing some pricing pressure and we’re negotiating the marketplace actively on timing of delivery versus price, etcetera. And it’s not pervasive but it’s certainly is a challenge for us but it doesn’t represent more than 20% of our margin degradation in that business.

[Mike Halloran:]

Great. I appreciate the color, guys.

[Chris Kearney:]

Thanks Mike.

[Jeremy Smeltser:]

Thanks Mike.

[Operator:]

Thank you for your question. Your next question comes from the line of Nigel Cole. Please proceed.

[Nigel Coe:]

I just want to pick up on the last question, the offsets to the turn-up points of P&E margin pressure. And just really given the ramp up in the system’s backlog within Food & Beverage, how confident are you that that improvement in Food & Beverage margins can continue into the back half of the year?

[Jeremy Smeltser:]

Yes, I mean I would say, we have a lot of confidence in it, particularly with the good start that we had in the first quarter. The execution has been solid across the system business. As we mentioned, the short-cycle orders particularly in North America, on the Food & Beverage pump side, we’re a little lighter than we expected. And we were still able to deliver that level of margin improvement in Q1. And given that that we’ve seen a pick-up there more recently I would say, it gives us increased confidence in delivering that second half.

[Chris Kearney:]

Yes, and I would tell you Nigel that the significant improvement we’re seeing in the Food & Beverage businesses, real credit to Marc and his team. And really the manifestation of a couple of years’ worth of really good work in terms of much better project selection, much better project execution, he’s put a really terrific team together and a pretty cohesive unit around the world. So, we have seen very steady improvement in that business particularly over the course of the second half of last year. And to Jeremy’s point, the start we’ve seen in Q1 does give us a lot of confidence in their ability to continue down that path. So, I can’t say enough good things about Marc and his team and what they’ve done and how pleased we are, starting with the book of business that we have in that group, but secondly with just the execution on the projects.

[Nigel Coe:]

Okay. That’s good to hear. Obviously, good news on the aftermarket orders, but on the OE side, you saw a big step down in OE orders during 3Q, and that continued into 4Q, albeit, it was a bit lumpy. Has the rate of decline, sequential decline and the OE orders start to stabilized, or are we still seeing pretty big step-downs on the OE side?

[Jeremy Smeltser:]

I think it stabilized as the quarter progressed particularly challenging in January and February, March as better. And I think March is continued into April from an activity perspective. So it seems to have stabilized sequentially as it relates to the year-over-year decline in orders.

[Nigel Coe:]

And is there a good reason why you would’ve seen that decline earlier than some of your peers?

[Jeremy Smeltser:]

Good question, hard for us to answer that at this point in time. I mean, we haven’t really seen a significant change in competitive behavior in the marketplace as of yet, perhaps with a couple of exceptions as it relates to price as we mentioned in the prepared remarks.

[Nigel Coe:]

Okay, thanks Jeremy.

[Operator:]

Thank you. Your next question comes from the line of Jeff Sprague. Please proceed.

[Jeff Sprague:]

Thank you. Good morning. Just back to South Africa for a moment, are you in fact getting paid, or have line of sight of getting paid on this additional scope that you’re taking on, in the name of getting this stuff done, or are you jamming through and finishing this stuff and kind of then stake your claim after the fact?

[Jeremy Smeltser:]

We’re getting paid for a portion of it. But the things that we’re taking to charge for what we’re doing is, assuming that we have to bear those costs and we’re not recording receivable, that’s why there is in that charge. That said, there are active settlement conversations ongoing as Chris mentioned which lead us to believe that as we said earlier, there will be some level of recovery of those costs.

[Jeff Sprague:]

Right, because you’ve got max leverage before this thing is done, right not after it’s done. I just wanted to shift gears then to the delays that you’re seeing in power. You mentioned EMEA and oil producing countries, and that makes sense. Would you draw the same conclusion on the U.S. delays that you’re seeing, that it’s someway second derivative related to energy pressures, or you would not conclude that?

[Chris Kearney:]

I think that’s fundamentally fair Jeff in terms of projects that are directly or indirectly energy related. The distinction however I would make with respect to differences in the U.S. market is the, is frankly the dearth of reconstruction opportunities which were mostly U.S. based in the past. And in the past, had supported margin improvement, because as you know those tend to be higher margin and quicker term projects. But with the lack of investment in the existing power infrastructure in the United States, particularly in the older facilities, we’ve seen those projects in the U.S. slow down pretty dramatically.

[Jeff Sprague:]

And if I can just slip one more, and I’ll move on, Food & Beverage orders into the balance of the year, do you think there’s enough there in the pipeline to support a view into 2016, or have we just kind of seen a nice surge in orders that we’re now going to burn off over the next 12 months or so?

[Chris Kearney:]

No, the project planning activity that’s going on out there around the world, that we participate in and are getting our share of wins with respect to those projects continues. And so, I think the front-log activity is healthy. And going back to my comments at the beginning of the call it’s being driven by the predictable markets, right. So, activity in China around powered milk, infant baby formula and other dairy products like yogurt and protein drinks and things like that, that activity remains strong in the age-specific world. But in Europe as well, and so, we’re certainly in a comfortable position with respect to how we have targeted the rest of the year for that business. But with respect to additional activity, it’s fairly active.

[Jeff Sprague:]

Thank you very much.

[Operator:]

Thank you. Your next question comes from the line of Robert Barry. Please proceed.

[Robert Barry:]

Hi, guys. Good morning.

[Jeremy Smeltser:]

Good morning, Robert.

[Robert Barry:]

I’m sorry if I missed it, but did you update us on what the expectation is for oil and gas, the estimate that had been down 5% to 10%?

[Jeremy Smeltser:]

We did all and its mid-teens.

[Robert Barry:]

Okay. Concentrated, I guess, on the upstream?

[Jeremy Smeltser:]

That’s on an organic basis too.

[Chris Kearney:]

Correct, yes.

[Robert Barry:]

Right, okay. And could you just maybe give us a little bit more color on how things progressed through the quarter because I had the impression that maybe after a very bad January, things got a little better in February, and then maybe did it deteriorate again?

[Chris Kearney:]

No, I think what Jeremy was describing was the order process in terms of starting out pretty rough in January, improving as the quarter went on. And what we would describe Robert is stabilizing in March. And so, I think there is a fair amount of activity still going on out there in terms of quoting activity and projects that are out there. But I think the view that we’ve taken with respect to reduced expectations for the balance of the year is prudent and one that has to be taken just given how Q1 started.

[Robert Barry:]

Got you. And then just finally on Industrial, it sounds like the main change in the view there is Genfare because I guess maybe transformers sounding even a little better?

[Chris Kearney:]

Yes, transformers is performing in a steady fashion. And we’ve seen performance stabilized, what we’re seeing in transformers is, we continue to see a robust order process as we’ve seen over the last two plus years. But what we’re experiencing right now in Waukesha, much like we’ve seen improvement in some of our other businesses is a more disciplined approach around order intake. But in terms of how we see improved performance in the transformer business, it really relates to operating efficiencies and transformer design improvements that we’ve made that we’ve really benefited from. Because the pricing environment while stable is still no-where near where it was at the last peak in the market. And we don’t expect that to change. With respect to Genfare, it’s really all about project timing right. And so, and that relates fundamentally to government funding, which relates back to the status of the Highway Transportation Bill as Jeremy mentioned in his remarks which is still unresolved. And so, one way or the other, we expect resolution although it could be just an extension of existing programs rather than a new funding proposal being adopted. But that is at the core of where the customer buying decisions are. And so, as we see those delayed, or as we see that process delayed, as we have in past years, it tends to delay decision-making projects, decision-making on these projects in cities across the country. And the nature of the Genfare business is that while that decision making process can be slow and can be pegged to funding challenges when the decisions are made, the projects actually turn pretty quickly. So, but we have just given the slow development again, I think we’ve taken a prudent approach to that business in terms of the targets that we’ve set now for the balance of the year. We have seen sort of a pent-up potential program backlog in that business because we saw this pattern really in last year and it has been completed resolved in 2015.

[Robert Barry:]

Okay, great. Thank you.

[Chris Kearney:]

Sure.

[Operator:]

Thank you. Your next question comes from the line of Julian Mitchell. Please go ahead.

[Julian Mitchell:]

Hi. Thank you.

[Chris Kearney:]

Hi Julian.

[Julian Mitchell:]

Hi, I just wanted to follow-up on transformers, not so much on the margins but specifically on the top line. Because I think in Q4 and now into Q1 the commentary on the backlog is pretty good, but the revenues for transformers, I think, were down year-on-year in Q4, down also in Q1. So, is there something going on in terms of the conversion of backlog into sales, or it’s just timing of a few specific units that moves around?

[Chris Kearney:]

It’s really timing Julian, more than anything. And it’s those cold winter quarters, Q4 and Q1. So, in Q1 we saw revenues decline $4 million, about $3 million of that related to a couple of very large units that were completed and shipped but could not be accepted because they were in very cold weather states. And pursuant to the terms of those contracts they have to be accepted, put on the pad and then you recognize the revenue it’s just as simple as that. So, that accounted for most of the revenue mix in Q1 and some OP that goes with it.

[Julian Mitchell:]

Thanks. And then within Flow, the Food & Beverage piece, the dairy outlook on the demand side I guess, looks very good. I just wondered how you felt about the balance of supply relative to that because you had a lot of supply added in markets like New Zealand for exporting into China. China’s also been building out a lot of its own domestic dairy processing capacity more recently. So, I guess, is there a risk that the demand stays good, but there’s so much supply coming on that that may damage or limit the orders going forwards?

[Chris Kearney:]

Yes, I don’t really think so Julian because the demand particularly in China is just so great. And so, while we have seen new capacity contracted for in places like New Zealand, Australia, Europe for export into China and then obviously directly in China, the quoting activity for additional projects continues. And so, I don’t think by any stretch that there has been saturation on the supply side. I think the demand side is still quite significant. And there is additional need and we have the benefit of seeing that in terms of the front-log activity and the quoting opportunities that are out there.

[Jeremy Smeltser:]

And Julian, I think if you go back to some of the work that Ryan’s done and I think probably the slides from the September Day, you’ll see there are some studies that show that the CAGR over the next decade expected on Chinese consumers demand increases is double digits over the decade. So, I think some of the macro data kind of supports what we hear from our customers in the front-log.

[Julian Mitchell:]

Great. Thank you.

[Jeremy Smeltser:]

Sure.

[Operator:]

Thank you for your question. Your next question comes from the line of Nathan Jones. Please proceed.

[Nathan Jones:]

Good morning, everyone.

[Jeremy Smeltser:]

Good morning, Nathan.

[Chris Kearney:]

Nathan, how you’re doing?

[Nathan Jones:]

Good thanks. I’ll just follow up on Julian’s question there. If you have a double-digit CAGR of demand in China, how long do you think it takes the market to catch up with that demand, so that you do see supply and demand in balance?

[Jeremy Smeltser:]

Difficult to say and I think also the product diversification makes it even more difficult to analyze. So back to Chris’ remarks, I mean, it’s one thing to just assess the baby formula market demand. But when you start looking at the innovation into drinkable yogurts, we’re seeing orders around coconut milk, almond milk, soy milk, lot of protein drinks. I mean, just a variety of things that our customers are adding. Because in that business for them it’s all about innovation and new products and that’s really where the second part of their growth comes from on a global basis. So, difficult to say but everything that we’re hearing from our customers and even new customers that are developing who are really farms and co-ops who are starting to think about going straight to the market themselves, supports what we see and what we’ve read from a macro perspective.

[Chris Kearney:]

And it’s also important to remember Nathan that, part of this business model of ours and one of the more attractive aspects of it is, as this installed base increases, the need for aftermarket service and repair, and then improvement in those existing facilities in terms of efficiency gains that we can provide to our engineered changes will continue. And frankly that’s the more attractive part of the model.

[Nathan Jones:]

It sounds like it would be fair to say many years then.

[Chris Kearney:]

I think that’s the short answer.

[Nathan Jones:]

If I can just go back to the overall guidance, specifically on the top line, you have about 6% organic decline in revenue in the first quarter. The midpoint of guidance is at 5% organic decline for the second quarter. To get to minus 2% for the full year would imply that you need to do 1% or 2% organic growth in the back half. To get to flat for the year, you’d have to do mid-single digit organic growth in the second half. The comps actually get tougher as the year go on. I’m just wondering given the current climate with project deferrals and deferred capital spending, how you get comfortable with forecasting organic revenue growth in the second half of the year?

[Jeremy Smeltser:]

Yes, I mean for us that’s all backlog driven Nathan. So, the comps do get tougher from a dollar perspective but that’s really driven by our historical seasonality to the second half. So what I’d tell you is we have not made any assumptions on run rate or short-cycle order increases to support the second half forecast that we’ve put out, it’s all about what’s in the backlog and the timing of when that backlog is currently scheduled to be delivered.

[Nathan Jones:]

So, you haven’t made any assumptions of the run rate business getting any tougher, just continuing the way it is at the moment?

[Jeremy Smeltser:]

Continuing with the current environment that we’re seeing yes.

[Nathan Jones:]

Okay. Thanks a lot.

[Chris Kearney:]

Thanks Nathan.

[Jeremy Smeltser:]

Thanks Nathan.

[Ryan Taylor:]

Thanks Nathan, this is Ryan Taylor. We’re at our hour time for the call. So we’re going to conclude it here. We still have some analysts in the queue. Per the normal, I’ll be around throughout the day to answer all questions. Please feel free to reach out to me directly. Thank you for joining us today. And we’ll see you next time.

[Operator:]

Thank you for joining in today’s conference ladies and gentlemen. This concludes the presentation. You may now disconnect. Good day.