Colfax's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb. 6.14 | About: Colfax Corporation (CFX)

Colfax Corporation (NYSE:CFX)

Q4 2013 Earnings Conference Call

February 6, 2014; 08:00 a.m. ET


Steve Simms - President & Chief Executive Officer

Scott Brannan - Chief Financial Officer

Farand Pawlak - Director of Investor Relations


John Inch - Deutsche Bank

Nathan Jones - Stifel Nicolaus

Kevin Maczka - BB&T Capital Markets

Liam Burke - Janney Capital Markets


Good day ladies and gentlemen and thank you for standing by, and welcome to the Colfax Corporations fourth quarter 2013 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 be given at that time. (Operator Instructions) As a reminder, today’s conference call maybe recorded.

Now it’s my pleasure to turn the floor over to Farand Pawlak. Sir, the floor is yours.

Farand Pawlak

Thanks Steven. Good morning everyone and thanks for joining us. My name is Farand Pawlak and I'm Colfax's Director of Investor Relations. With me on the call today is Steve Simms, President and CEO; and Scott Brannan, our Chief Financial Officer.

Earnings release was issued this morning and is available in the Investors section of our website at We'll also be using a slide presentation to supplement today's call, which can also be found on the Investors section of the Colfax website. Both the audio of this call and a slide presentation will be archived on the website later today and will be available until the next quarterly call.

During this call we'll be making some forward-looking statements about our beliefs and estimates regarding future events and results. These forward statements are subject to risks and uncertainties, including those set forth in our SEC filings. Actual results might differ materially from any forward-looking statement that we may make today. The forward-looking statements speak only as of today. We do not assume any obligation or intend to update them, except as required by law.

With respect to any non-GAAP financial measures during the call today, the accompanying information required by SEC Regulation G related to those measures can be found on our investor press release and supplemental slide presentation under the Investors section of the Colfax website.

Now, I'd like to turn it over to Steve.

Steven Simms

Good morning and thank you all for joining us today. This morning we reported net sales of $1.171 billion for the fourth quarter, an increase of 14% over the same period last year. This consists of 10% organic growth, 7% growth from acquisitions and a negative 3% impact from foreign exchange.

Top line growth exceeded expectations in both, gas and fluid-handling, as well as our fabrication technology business. Its important to note this was the first quarter in 2013 that fabrication technology saw year-over-year organic growth. In addition to increasing sales year-over-year, we experienced a record backlog of $1.6 billion in our gas and fluid-handling business, which was driven largely by recent acquisitions.

Fourth quarter operating performance was in-line with expectations. Fabrication technology delivered higher profitability on a year-on-year basis with relatively slow growth on the top-line. Given the impact of holidays and the significant reduction in their inventory, we were particularly pleased with this teams performance during the period.

From a total company perspective, margins increased to 10.6% in the fourth quarter, as compared to 8.7% in the prior year, a 190 basis point increase. In addition to the strong margin growth, both segments did an outstanding job of driving working capital and operating cash flow in the fourth quarter. These improvements are directly linked to the continued adoption and deployment of CBS across the organization.

As our associates become more proficient in the use of CBS, we are seeing an acceleration and improvement for our customers and reductions in working capital similar to those realized in the fourth quarter.

Adjusted EPS for the 2013 fourth quarter was $0.61 per share, which exceeded our expectations, primarily due to a lower tax rate. Full year adjusted EPS was $2.04 as it compared to $1.34 per share in 2012. We had two large non-cash accounting items that excluded from our adjusted results this quarter, which Scott will discuss in more detail.

Now let's take a look at our business segments. For gas and fluid-handling, net sales for the fourth quarter were $650.8 million, an organic increase of 18% compared to $514.4 million in last year's fourth quarter. Organic revenue growth was as expected strong across all end markets, except marine. The organic increase significantly exceeded expectations largely due to work progressing further than anticipated on several large projects.

Acquisitions also contributed more revenue than anticipated as the fluid handling purchase of Sicelub was completed subsequent to that guidance. As anticipated entities added it the fourth quarter had no significant impact in operating profits after consideration of transaction costs and fair value accounting items.

Orders for the fourth quarter were $548 million, up 5% due to acquisitions. As in previous periods we saw significant variation across sectors, due in large part to two key factors: First, the timing of large project orders, which can distort comparisons of specific quarters; and second, certain trends specific to our individual sectors, which I will discuss in detail momentarily.

Overall we saw continued strength in power generation orders, as well as growth in marine driven by the recently introduced CM-1000. This was offset in other sectors as particular mining – in particular mining resulting in an organic decline of about 3%. As we expected, for 2013 bookings finished the year above 2012 levels, providing us with the necessary backlog to achieve our stated revenue guidance for 2014.

Now let’s focus on our largest gas and fluid-handling end market, power generation. For the 2013 fourth quarter, revenues increased 32% organically. Sales continue to benefit from the healthy backlog, which was driven by further environmental upgrade projects in China and to strengthen maintenance work in South Africa.

Orders remain strong with year-on-year organic growth of 11% and the outlook continues to be positive. Additionally we are seeing increased quotations and order activity in Saudi Arabia, where oil is used for power generation. Our newly patented three-screw pump is ideally suited to this application and is helping to win orders. We expect power generation to grow in both sales and orders throughout 2014.

Next is our second largest market for gas and fluid-handling, oil, gas and petrochemicals. Sales were up 20% organically as expected, while orders decreased 5% organically in the fourth quarter. This decrease was largely related to several project awards that were delayed into 2014.

Looking forward we are most optimist about our midstream business. We are seeing strong quotation activity, particularly in the Middle East and Southeast Asia, where we’ve invested in local selling and technical resources.

Additionally on our last call we highlighted our continued investment in The Voice of the Customer new products. This quarter we began shipping an important new product, the largest three-screw pumping system in the world, targeted at oil pipelines in Latin American and North America.

This system is capable of handling up to 85,000 barrels a day at pressures to 2,000 psi, which enables our customers to move product more efficiently and reliably than competitive alternatives. So in short, while oil and gas and petrochemical orders fell short of expectations in the quarter, we expect modest revenue and order growth in this end market during 2014.

Turning now to marine, which is primarily served by fluid-handling. While revenue this quarter was relatively flat year-on-year, marine delivered orders and an organic growth rate of 38%. We continue to see strength in vessels serving the offshore oil and gas industry and roughly $4 million of CM-1000 orders in the fourth quarter.

We talked about the CM-1000 on the last earnings call and the orders we are now seeing really started to move the needle in the fourth quarter, but we are also finding that the CM-1000 is an excellent door opener at new customers.

Many accounts that we struggled to penetrate in the past are now interested in the value our CM-1000 solutions provides. As a result, we are now being exposed to major opportunities for the CM-1000, along with other core fluid-handling products and services. Our view of this end market remains unchanged. We expect to see solid growth in revenue and bookings through 2014.

Now lets look at the mining market, which has been subdued all year. Orders for the fourth quarter posted an organic decline of 60% due to a very weak capital equipment spending market. We continue to work our way through our remaining backlog and due to some deliveries in the fourth quarter we saw an organic sales increase of 10%.

As discussed at our Investor Day, we’ve seen a bright spot such as a sizeable order for copper projects in Chili. However, given the overall state of the mining sector, we expect to see organic declines in sales and a challenging environment for orders in 2014. The Alphair acquisition, which broadens our product portfolio and strengthens our channel in North America will help moderate this decline.

Finally, the general industrial end market. For the fourth quarter of 2013, sales increased 7% organically and orders decreased 7% organically. As mentioned, while quarter-to-quarter comparisons can be quite volatile due to the timing of large orders, this end market has been relatively flat over the past year. We’ve mentioned environmental investments in China as an opportunity for this end market.

New policy released -- the government indicates that energy consumption will be a key performance indicator for local provincial governments. This is good news for our Howden retrofit business that we highlighted at our Investor Day, especially in the cement industry where the energy efficiency of most original fans installed is 8% to 15% lower than what can be achieved with the Howden fan. The combination of this policy and the addition of TLT-Babcock, and the additions of Flakt Woods GII will significantly boost our sales and orders in this market in 2014.

Moving now to profitability, adjusted operating margins for the gas and fluid-handling segment remain relatively flat year-on-year. 12% in the fourth quarter of 2013 compared to 12.1% in the same period last year. It is worth noting however that overall margins were diluted by acquired entities, which had minimal profit contributions on $57 million in sales due to the factors previously discussed.

Excluding acquisitions, operating margins improved by 80 basis points in the quarter. While the acquisitions were dilutive to market this quarter, they are being quickly integrated into our culture of continues improvement. In fact, in several of the transactions we began to apply CBS even before closing.

I want to highlight our sourcing tools this quarter, but more specifically how rapidly we integrated our sourcing tools into the acquisition of Flakt Woods. During the first quarter of 2013, our newly created strategic sourcing team was able to implement a world class Spend Analytic system, which now provides visibility into 100% of our spend in each of our businesses. This includes all of our supply chain and SG&A as well.

With this new system we are now able to classify and analyze our spend data across 150 different sites, in over 50 countries, with over 30 languages and currencies with each of our vendors. This has been an enabler in our ability to apply our CBS strategic sourcing Kaizen methodology to optimize our global spend in areas like motors, castings, steal, travel and energy.

As previously announced, the Flakt Woods acquisition was completed on November 29, 2013. Immediately after that acquisition our sourcing and IT organizations were able to apply the tools contained in our CBS acquisitions integration module, to extract the spend data from Flakt Woods Systems.

This data was in our system, classified and ready for use within three weeks of close. We were then able to leverage the existing Colfax agreements in travel, as well as maintenance and all MRO items through our strategic sourcing Kaizen process, to achieve synergistic savings in these areas, resulting in better service at a lower overall cost.

As a result of the rapid system integration this week, members from Flakt Woods have now joined the Global Colfax team with representatives from all three of our businesses to conduct a CBS strategic sourcing in Kaizen. The objective of this Kaizen is to consolidate our freight providers in North and South America by 70% and to produce a cost reduction of over $3 million, while shortening lead times to the customer by 5%.

While we won’t know the impact of this Kaizen for several days, this provides you with a solid example of how we are leveraging the tools of CBS to rapidly on-board new acquisitions to insure we deliver targeted improvements to product quality, delivering in cost.

Now lets turn to the results for fabrication technology. When we acquired Charter, we saw a need to have a strong brand and an attractive market with mediocre operating performance, but many opportunities for improvement. I am pleased to report that our team continued to deliver these opportunities in the fourth quarter. Sales for fabrication technology were $520.6 million, up 2.5% organically versus the fourth quarter of 2012.

This was better than our expectations and this marks the first quarter in 2013 that fabrication technology saw in year-on-year organic growth. Regionally Russia and the Middle East performed best with most other regions reporting relatively flat sales. We believe growth was enhanced by continued improvements in equipment delivery, the result of our CBS efforts around build-to-order and direct shipment. As encouraging as the organic growth is in the quarter, it’s worth pointing out that Europe remained flat on a year-on-year basis and we continue to face a relatively sluggish global economy.

Fabrication technology also continued to deliver on its operational turnaround, achieving operating margins of 11.2% for the quarter. As expected, margins were slightly lower than the 11.4% in the third quarter, which is a seasonal high of this business and the industry. However the business experienced a 460 base improvement versus last year’s fourth quarter. What makes this even more noteworthy is that this was done in a slow growth environment, with holiday related plant shutdowns and a substantial decrease in inventory balances.

Working capital performance was also strong. As I mentioned on previous calls and Clay highlighted at our Investor Day, since the Charter acquisition two years ago the new management team has been relentless in its deployment of the CBS tools across that organization. This quarter we really see the impact of the teams focus on demand pull, build-to-order, direct shipments and improved supplier terms.

Over the last several quarters we’ve discussed the increased focus we’re putting on organic growth. While we continue to emphasize operational improvement, targeted investments and new product development, introduction of CBS tools to improve the commercial processes and the realignment and top grading of our global sales and marketing organization are just a few of the steps the team is taking.

While we maintain a cautious outlook, I am pleased that our investments appear to be bearing fruit. We believe fabrication technology exits the year well positioned to continue delivering operational improvements throughout 2014, as well as realizing the improved organic growth.

While we have a long way to go before reaching the low teens operating income we’ve committed to for ESAB, the team continues to deliver on its restructuring plan as 20 distribution centers were exited from the business in 2013, in addition to the seven plant closures in 2012.

The benefits from these actions have helped to improve operating margins, fuel the growth programs noted above and support the critical resources which has been added throughout the year.

And now, I’ll turn it over to Scott to provide more detail on the financials.

Scott Brannan

Thanks Steve. As Steve mentioned earlier, sales for the fourth quarter of $1.17 billion, were up 10% organically compared to the 2012 fourth quarter. Our 2013 acquisitions, nearly all of which occurred in the fourth quarter contributed $57 million in additional revenue.

Foreign currency declines; primarily those in emerging markets were a drag on reported revenue performance. Adjusted operating income was $124 million for the quarter, representing an adjusted operating margin of 10.6%. Fabrication technology's adjusted operating margins were 11.2%. Gas and fluid-handling's adjusted operating margins were 12%.

As Steve just discussed, restructuring savings in our ESAB business met our 2013 goals. While the 2013 acquisitions didn’t increase sales for the quarter, their contribution to operating profit was minimal after the fair value accounting adjustment and transaction cost and this was in line with our guidance and with management’s expectations.

Corporate and other costs were slightly lower than typical, as transaction costs reported at corporate in earlier quarters were allocated to the gas and fluid-handling segment as the deals closed in the fourth quarter. Excluded from adjusted results are restructuring cost of $18 million incurred in connection with the cost reduction programs discussed earlier, roughly $500,000 of costs associated with our asbestos insurance coverage litigation and two large non-cash items that Steve mentioned in his earlier comment.

First in connection with the third amendment to our primary credit agreement in November, the company incurred a non-cash charge of approximately $27 million. This non-cash charge is primarily due to the write-off of the original issued discount and the differed cost associated with the complete repayment of our Term Loan B facility.

This non-cash charge has been excluded from adjusted net income and adjusted earnings per share. At current debt levels the refinancing is expected to save annually approximately $10 million in cash interest and approximately $5 million in non-cash interest due to the write-off. I would note that we filed a Form 8-K in November, which provides additional detail on this transaction.

Also in the fourth quarter the company acquired the remaining 56% of its investment in Sicelub, which is part of our fluid handling business. In accordance with the required accounting rules, the original 44% investment has been marked to fair value at the transaction data, which resulted in a non-cash gain of approximately $14 million. This non-cash gain has also been excluded from adjusted net income and adjusted earnings per share.

Interest expense excluding the $27 million write-down that I just discussed was $17.9 million for the quarter. Interest expense includes approximately $3 million on non-cash amortization of the debt discount and differed issuance cost that includes $700,000 of cash cost associated with the refinancing, as well as the typical facility fees and the cost of banks guarantees and letters of credit.

Our effective tax rate for adjusted net income and adjusted net income per share of 27.6% was lower than expectations, primary as a result of the reduction in an accrual previously provided for an uncertain tax position. This resulted in a decrease in our effective tax rate of 2.3 percentage points and increased our adjusted EPS by $0.02 for the quarter.

Operating cash flow of $175 million in the fourth quarter was our best quarter ever. As Steve mentioned, we had very strong performance in working capital across the company, particularly in fabrication technology. Continued focus on CBS and reducing customer lead times helped drive inventory down $80 million this year.

Accounts receivable and payables resulted in an additional $30 million of working capital reduction for the year. These numbers are adjusted for the working capital added by the entities acquired in the fourth quarter. In total, we were able to reduce working capital $155 million in the fourth quarter.

Finally, backlog in our gas and fluid-handling segment as Steve mentioned was a record $1.6 billion at quarter end. Our book-to-bill ratio for the quarter was a weak 0.84 to 1. While the fourth quarter tends to be stronger for sales and orders, the significant drop in the book-to-bill ratio reflects the significant progress made on large projects in the quarter. Orders were in line with expectation.

The fourth quarter performance on the whole was in line with expectations as the adjusted operating profits lined with lower than expected taxes as just discussed. Given that the lower tax rate resulted from discreet items related solely to the fourth quarter, we are reaffirming our previously stated 2014 guidance provided on December 17 at our Investor Day. I would refer you to the slides from our Investor Day for more details on the financial guidance which is available on our website.

And now, I’ll turn it back to Steve.

Steven Simms

Thanks Scott. Overall we’re pleased by the quarter. We grew organically, improved margins, reduced working capital, closed five acquisitions and continued to see our culture of continues improvement, gain traction in both existing, as well as our newly acquired companies. While its unlikely future quarters will have as much M&A activity as this one, acquisitions remain an integral part of our growth strategy and our funnel of potential deals has never been stronger.

As I have shared before, our talent pool is essential for successfully executing our strategy of integrating smart bolt-on acquisitions, while driving strong sustained growth on our core business. In line with this, we’ve made good progress in strengthening our bench in 2013.

As I mentioned at our Investor Day, we hired and promoted a total of 56 individuals into our senior leadership positions during 2013. We continue to add talent to the organization with a number of senior associates joining us in early 2014. Many of these senior leaders are from Fortune 500 companies and other top tier industrial manufacturers. These leaders share our passion for continuous improvement and have quickly added value in areas such as procurement, acquisition integration and driving organic growth.

Additionally we sharpened our focus on early talent recruitment from a number of graduate and under graduate schools across the globe and introduced Colfax Pathways. Colfax Pathways is a program focused on developing early talent, which we believe has general management potential.

We are recruiting students from top tier schools such as the Kellogg School of Management in Northwestern, MIT, The London School of Business and NCEES. We’re pleased to have our second wave of Colfax Pathways Associates starting this summer and expect this to be a great source of future leaders to continue to grow our business.

With that, I’d like to open up the session for Q&A.

Question-and-Answer Session


(Operator Instructions). All right, and it looks like our first question in the phone queue will come from the line of John Inch with Deutsche Bank. Please go ahead, your line is open.

John Inch - Deutsche Bank

Thank you. Good morning everyone.

Steve Simms

Good morning John.

John Inch - Deutsche Bank

Good morning guys. Talking about gas and fluid-handling margins Steve, I realized that there was dilution associated with recent acquisitions, but we’re still a little weaker than we thought. Were there project mix issues in the quarter and how do you see the margins? Is there any guidance you can give us with respect to segment margins for the year in terms of your thoughts or range?

Scott Brannan

Sure John, that’s a good question. Overall there were two factors impacting margin as we outlined. One was acquisition and as you correctly pointed out, we had experienced a negative mix here in the gas and fluid-handling inside of the quarter. However, you know this is one of the businesses where we have great visibility to the year, because of the strong backlog and what I would say is that based on the quality of the backlog and the mix of that backlog, we feel that we’ll be very much on target with the operating commitment that we’ve made for the entire portfolio or the platform I should say.

John Inch - Deutsche Bank

So, give a range or thought process of a range Steve in terms of how much margins could be up this year based on backlog.

Scott Brannan

I think we gave a reasonable indication of that in the guidance material that was provided in December, but we give -- expected contribution margins from the increase in sales in that business and if you add that to where we finished this year, you’ll be able to calculate the precise margins that we expect for next year, but I would note they are clearly better next year as we continue our stair-step progression in gas and fluid-handling toward our mid-teens operating margin target.

John Inch - Deutsche Bank

Yes Scott, I was just trying to understand if the fourth quarter results somehow modified. I recognize your conversion and I’m just wondering if it modifies kind of your outlook. It sounds like it did a little bit, just because of the contribution that you are facing, you know like off of this year right, but probably not materially.

How did Warrior do? You launched Warrior in Europe. Do you have any – are there any quantitative statistics you can share with us in terms of the progression of the launch or maybe how it affected ESAB’s results?

Scott Brannan

Overall the new products for ESAB have continued to perform well relative to expectation. Your talking about the Warrior, the 450 volt industrial welding machine that we added in the fourth quarter and the receptivity has been quite strong, not only in Europe, but also in the Middle East and South America. In fact it was South America and U.S. where we launched it first, so we have more data. It continues to sell quite well and it’s taken off very nicely in Europe as well. So we feel very comfortable with the performance of Warrior.

We’re also quite comfortable with our performance from a manufacturing standpoint in our responsiveness. This comes out John, on one of plants where demand pull has been most effective and so our shipping times and ultimately our deliveries here will be – we think will be quite improved and we think that’s also behind and improvement in our operating performance is what’s behind the growth for fabrication technology in the fourth quarter. So new product, the Warrior line in Europe has done well, but most importantly continues to do well in Latin America and North America where it was launched first.

John Inch - Deutsche Bank

Yes. Steve and Scott, you guys are the most international of the companies we cover. Could you share with us maybe your obviously emerging markets are hot button right now. What are you seeing specifically in Latin America? Is there any real change to the cadence of business that’s kind of on a core basis or any of the other emerging markets and maybe just give us a sense of your updated sort of thoughts towards Forex or currency as 2004 is expecting to play out.

Steve Simms

I’ll talk a little bit about what we’re seeing in terms of the order and the trends in some of these emerging markets and Scott, maybe you’ll talk a bit about the FX side of it.

Scott Brannan

It’s a key question John you know. We’ve gone through and what we’ve actually seen is that while the macro level issues that you pointed to are certainly in place, as we look at our business, we feel that we continue to see very positive trends. We saw that in the fourth quarter and we don’t look at – we don’t review a lot of data on a month-by-month basis, but I’d say that on a quarter-to-date basis we continue to feel quite positive about the trends that we’re seeing in each of our business in general and specifically in Latin America.

So overall we think what we’re really seeing inside of our business is the fact that one, we are really focused on core end markets that remain a top priority in virtually all of these key geographies. And when we talk about power, energy or environmentally driven activity, these businesses that we have and the focus that we’ve provided, those are the key end markets that we’re driving.

So we believe that’s why, despite all the slowness that we’ve heard about around the world, our business continues to perform well in the fourth quarter and the outlook remains positive here for quarter one and the full year.

So overall we’ve seen that in general, we see that in Latin America. More recently just this week, we actually asked all of our leaders to go back and take a look at the forecast for the first quarter and as best we can, the outlook for the full year, in light of the tapering and all the issues that we’ve heard and our team remains positive and bullish on our ability to deliver and we just haven’t see it impact what we’re doing as a business.

Again, I think that’s the function of the end markets that we’re focused on and when you think about power, energy, the environmentally driven activity that we’ve talked about in China and also in the U.S., we’ve taken a look at our order rates over the last six years in fact and in a business like Howden, we find that they virtually are rarely if ever cancelled.

So we may see a delay by one month to another month, but generally we feel quite positive about the quality of our backlog in those businesses where we can see and have that kind of depth, but also in the shorter cycle businesses like ESAB, we continue to see very solid trends. So we remain optimistic about the quarter and the year.

John Inch - Deutsche Bank

So just in other words Argentina and Venezuela are not sufficiently disruptive is kind of what your saying.

Steve Simms

They aren’t John and at the end of the day, keep in mind that we have such a broad geographic footprint, that we’re able to balance our way through many of these issues over time and frankly when we talk about Venezuela, Argentina, Greece, Thailand, they are relatively small in the scheme of things and that plus the end markets, I think gives us the ability or balance to make our way through these tough economies.

Scott Brannan

Yes, I mean just to add to that, Argentina and Venezuela are less than 1% of net assets and less than 2% of revenues. So we aren’t talking extremely material items and as Steve said, on a local currency basis we haven’t really seen much deterioration in those markets anyway.

On the other part of your question John, the FX relative to our guidance, some of the emerging FX rates have come down, but the European rates are actually stronger than what was in our original guidance, the euro, the sterling and the Northern European rates. So on balance we’re comfortable with our guidance. There really hasn’t been a material change in the aggregate in our FX assumption.

John Inch - Deutsche Bank

Perfect. Thanks very much.


Thank you. And it looks like our next question will come from Nathan Jones with Stifel. Please go ahead, your line is open.

Nathan Jones - Stifel Nicolaus

Good morning Steve, Scott, Farand.

Steve Simms

Good morning Nathan.

Nathan Jones - Stifel Nicolaus

Just on the gas and fluid progress you made on large projects, was that more a result of good execution on your behalf or pull forward from your customer?

Steve Simms

Good execution.

Nathan Jones - Stifel Nicolaus

Simple answer. Does that change the outlook at all for 2014 seeing – you know it sounds like you pulled forward revenues from ’14 into the fourth quarter of ’13 or is there sufficient orders to backfill that?

Steve Simms

Again, we’ve just gone through the process there Nathan and if you look at it, we feel we’re spot on relative to where we thought we would be when we created the budget and then the follow on guidance, so we feel quite confident.

Nathan Jones - Stifel Nicolaus

Okay. Obviously significant working capital reductions in 2013; do you have a target you can share with us for 2014 and maybe a percent of sales, longer time that your targeting?

Scott Brannan

Our target is 1% of sales, which is roughly $45 million of working capital contribution to cash flow. So even with increasing sales, we expect working capital to come down by 1% of sales to positively contribute to cash flow and we believe we can sustain that for a period of years, because I don’t want to give an exact number of years, but into the foreseeable future, that’s our target for each of the years.

Steve Simms

And Nathan I would just add to John, as Scott explained, everybody in our organization is tied into working capital improvement, not only in terms of dropping that dollar level and improving free cash flow, but importantly shortening the lead time it takes to get our products to our customer and the exceptional delivery level.

So we’re using CBS to generate more flexibility in our manufacturing process, so that we can provide outstanding service and drive this working capital and the waste that we have tied up in inventory out of the business and we’re making progress and we feel quite positive about it, but at the end of the day we are all tied to that. Its tracked on a weekly, monthly basis and ultimately a lot of what we realized at the end of the year is driven by our performance on working capital and free cash flow.

Nathan Jones - Stifel Nicolaus

And just one more for me on that power generation side of the business. Can you give us a little bit more color on how that’s breaking down geographically, maybe where we are in the environmental upgrade cycle in China, what your seeing in that same cycle coming in the U.S.?

Steve Simms

I think as we’ve mentioned on previous calls and maybe at the Investor Day, we really have peaked in China. Those orders will start to moderate here over the next year and at this point we’re working through that backlog.

As China is coming down and it’s been an outstanding period for us, that is partially being offset by some of the opportunities I noted around our industrial business. The Chinese government has increased its focus on power consumption and is now monitoring that on a monthly basis at the local provincial level and that’s great news for us, because the Howden product, which by the way is manufactured there in China and so it both has great margins that we allow, that we can compete pretty attractively.

We now see other environmentally driven opportunities beginning to pop up on the horizon that hopefully will help to balance that environmental activity that’s starting to come down in terms of overall growth. However with significant addition on the other side of course as we’ve talked before is here in the U.S.

We have the same environmentally driven requirement here in North America. That part of the business is continuing to come in and we’re doing very well in competing for that business and we’re seeing a very nice increase in our order rate as a result of the U.S. coming online with this compliance. So hopefully that gives you a sense to where we are with that portion.

Nathan Jones - Stifel Nicolaus

Yes, very helpful. Thank you.

Steve Simms

Thank you.


Thank you. And it looks like our next question will come from Kevin Maczka with BB&T. Please go ahead, your line is now open.

Kevin Maczka - BB&T Capital Markets

A couple of questions on ESAB. I guess first is, with the organic growth turning positive 2.5% in Q4, I know your not changing your guidance there and then we don’t have great visibility and its short cycle, I realize. But as we look forward to 2014, especially with the easier comps that we have in Q1, shouldn’t we take away that that, at leas the low end of that is starting to look pretty conservative here.

Steve Simms

I think I would take away what we shared at the Investor Day and that we continue to feel that the gain for us at ESAB is outstanding execution, and whether we get top line growth or not, we have to get to the 13% level of operating income that we committed to in the past, an increase and Clay and the guys are creating a vision of maybe going beyond that, so that’s our priority one. But as you’ve observed here and stated Kevin, we are and have been making, even though we’ve been focused on execution, we have been making smart rifle shot investments in those areas that are designed to drive organic growth over the long term.

We’re optimistic, but we’re probably a little more cautious than you are. We just don’t see any significant change in the market conditions around the world, so we see it as a sluggish environment. We think we’ve stopped the market share declines that we saw under – when ESAB was owned by Charter, and the first few months of our ownership we think we have certainly stopped those share declines, but we don’t see a significant change in the economy or our end markets beyond what we had included in our guidance for 2014.

If we do see stronger organic growth, then we would expect to see it flow through at the stated BCMs that we talked about in the past, but make no mistake about it. We are making those investments and as the economy starts to improve we hope that the organic growth will deal with this over the long term.

Kevin Maczka - BB&T Capital Markets

Got it and Steve can you comment on the price component that you experienced in Q4. That was positive this time after being negative the prior couple of quarters. Can you just comment on the price dynamic that you’re seeing?

Scott Brannan

Yes, this is Scott, Kevin I’ll take that one. Most of that is actually mixed in this quarter. There weren’t any significant pricing actions in the fourth quarter. We don’t have the ability to differentiate price from mix, so I would attribute most of that by increase to mix rather than pricing actions.

Kevin Maczka - BB&T Capital Markets

Okay, and then just finally on ESAB, can you just give us a reminder, where did 2013 shake out in terms of the geographic mix and if you can comment, I know you touched on the emerging markets for the business generally, but Scott or Steve, I think you said Europe was flat; if you can maybe comment on Asia and North America there.

Steve Simms

Yes, sure. If you think about the fourth quarter, we had three pockets of solid growth; Russia, the Middle East and also Asia. Europe was essentially flat in the fourth quarter and North America was down slightly and so overall I think that sort of trend has sort of been what we’ve observed before. I think if there was a change quarter-to-quarter, probably increasingly momentum in Russia would have been a change there, but overall that would be the split.

Scott Brannan

And South America has been, generally it’s marginally up for the year and as Steve mentioned earlier, there’s been no noticeable change in that trend.

Kevin Maczka - BB&T Capital Markets

Okay great, thank you.


Thank you. Next question will come from Liam Burke with Janney. Please go ahead, your line is open.

Liam Burke - Janney Capital Markets

Thank you. Good morning Steve.

Steve Simms

Good morning.

Liam Burke - Janney Capital Markets

On air and fluid handling, how much has the growth in after market sales contributed to the margin improvement. I know you had some offsets this quarter with the acquisitions, but how has the aftermarket trended?

Steve Simms

Aftermarket, the trend, the business is up, but I think the overall mix relative to the total was about the same.

Liam Burke - Janney Capital Markets

I’m sorry, it was running at a low double digit rate in the past. Is that trend continuing?

Steve Simms


Liam Burke - Janney Capital Markets

Okay. And on the margin side you saw – your anticipating on the ESAB side. How much has the currency fluctuations in Latin America affected your reported operating margins and how do you look at that in anticipation for 2014?

Scott Brannan

Well, I think most of that 3% currency decline that we show in the reported change in revenue does relate to the emerging markets and the largest of which for the welding business is Latin America. It basically has that proportional effect that we do hedge all of our transactional FX, but the translation effects sort of goes through the financial statement with that effect. So it would have a 3% effect on overall ESAB results for the quarter.

So far in the first quarter we’ve seen a probably something along the similar level as we mentioned earlier, a little – a much stronger devaluation in Argentina, but not as significant a change in India and Brazil, which were obviously much larger markets for us. So something along those lines is sort of the early indication.

As Steve said, we did go through a full review to look at order rates and other things and the European exchange rates are actually higher. So after all that we are very comfortable with the revenue and profit guidance we’ve given for 2014.

Liam Burke - Janney Capital Markets

Great. Thank you Steve, thank you Scott.

Steve Simms

Thank you.


Thank you sir. And presenters, I am at this time showing no additional questions in the queue. I’d like to turn the program back over to management for any additional or closing remarks.

Steve Simms

Right. Well, we have no additional questions. Just want to thank you all again for joining us today and we’ll speak with you next time and look forward to updating you then. Thank you.


Thank you gentlemen and thank you ladies and gentlemen. Again, this does conclude today’s call. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.

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