Colfax's CEO Discusses Q1 2014 Earnings Results - Earnings Call Transcript

Apr.24.14 | About: Colfax Corporation (CFX)

Colfax Corporation (NYSE:CFX)

Q1 2014 Results Earnings Conference Call

April 25, 2014 8:00 am ET

Executives

Farand Pawlak – Director of Investor Relations

Steven E. Simms – President, Chief Executive Officer, Director

C. Scott Brannan – Chief Financial Officer, Senior Vice President Finance & Treasurer

Analyst

Jeff Hammond – Keybanc Capital Markets

Nathan Jones – Stifel Nicolaus

Mark Douglass – Longbow Research

Andrew Obin – Bank of America Merrill Lynch

Operator

Welcome to the Colfax Corporation first quarter earnings conference call. At this time all participants are in a listen only mode. Later, we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this call may be recorded. I’d now like to introduce your host for today’s conference Farand Pawlak, Director of Investor Relations.

Farand Pawlak

My name is Farand Pawlak and I’m Colfax’s Director of Investor Relations. With me on the call today are Steve Simms, President and CEO and Scott Brannan, our Chief Financial Officer. Our earnings release that was issued this morning and is available in the investor’s section of our website www.ColfaxCorp.com. We also will be using a slide presentation to supplement today’s call which can also be found on the investor’s section of the Colfax website.

Both the audio of this call and the slide presentation will be archived on the website later today and will be available until the next quarterly call. During this call we’ll be making some forward-looking statements about our beliefs and estimates regarding future events and results. These forward-looking statements are subject to risks and uncertainties including those set forth in our SEC filings.

Actual results may differ materially from any forward-looking statements that we might make today. The forward-looking statements speak only as of today and we do not assume any obligation or intend to update them except as required by law. With respect to any non-GAAP financial measures during the call today, the accompanying information required by SEC Regulation G related to those measures can be found in the earnings press release and supplemental Slide presentation under the investor’s section of the Colfax website.

In the interest of getting to everyone during the Q&A session, we’d ask that you limit yourself to one question and then one follow up before reentering the queue. Now, with that, I’d like to turn it over to Steve.

Steven E. Simms

Earlier this morning we reported net sales of $1,054,000 for the first quarter of 2014, an increase of 11% over the previous year. This consists of 6% organic growth, 9% growth from acquisitions offset by 4% negative impact from foreign exchange. Gas and fluid handling continued to deliver strong organic growth while fabrication technology sales were down slightly for reasons I’ll discuss later. The acquisitions made in 2013 on the gas and fluid handling side of the business performed in line with expectations and as you know, we closed the Victor Technologies acquisition early last week.

With respect to profitability, overall margins increased to 8.9% in the first quarter as compared to 8.3% in the prior year, a 60 basis point increase. Fabrication technology performance continued to improve with margins up 270 basis points versus previous year. However, gas and fluid handling margins fell below expectations. While our housing business continued to show margin gains and acquisition performance was in line with guidance, our pump business failed to meet growth and margin targets.

More specifically, revenue growth was predominately in four market products for both housing and fluid handling which are lower than our aftermarket products. Similarly, our very short cycle lubrication service business which has the segments highest gross margins experienced a decline in sales for the quarter. While the acquired businesses in gas and fluid handling will continue to dilute operating margins in the second quarter, bookings have improved in lubrication services since February and steps have been taken to reduce costs in those areas not meeting growth expectations.

Given the mix of projects forecast in the second half of 2014 we expect to return to a more normalized balance between our core market and highly profitable aftermarket businesses. Adjusted EPS was a first quarter record of $0.43 per share as compared to $0.26 last year. This includes $0.01 of dilution from the equity offering completed in February which Scott will discuss in more detail later.

Now, turning to our business segments. Gas and fluid handling net sales for the first quarter were $573.9 million, an organic increase of 16% compared to $425.1 million in last year’s first quarter. Revenue from our acquired businesses was in line with expectations for the quarter with housing achieving significant organic growth and fluid handling experiencing a modest decline. As expected revenue was up organically across all end markets except mining.

Orders for the first quarter were $583 million, up 16% compared to the prior year with 14% coming from acquisitions and 2% from organic growth. This resulted in a record $1.6 billion in backlog at the end of the quarter. Year-on-year we experienced organic growth in all end markets with the exception of oil, gas, and petrochemicals and we’re particularly pleased to see strength in end markets that were down last year. However, as always, I’ll note that the timing of large orders makes comparisons across sectors and periods a little difficult.

Now, let’s focus on our largest gas and fluid handling end market, power generation. For the 2014 first quarter revenues increased 32% organically. Sales continue to benefit from a healthy backlog particularly related to environmental upgrade projects in China and maintenance work in South Africa. Order intake also remained strong with year-on-year organic growth of 14% and the outlook continues to be positive with numerous opportunities in Asia, the Middle East, Turkey, and North Africa.

On the last call, we mentioned increased quotation and order activity in Saudi Arabia where oil is used for power generation. This quarter we were pleased to book a significant order totaling roughly $30 million involving both our Houttuin and fluid handling businesses. Fluid handling will provide a recently patented three screw pump that is ideally suited for these applications as well as two screw progressive cavity and gear pumps. Houttuin will supply forced draft and induced draft fans for four super critical boilers. Overall, we continue to expect power generation and orders to grow throughout 2014.

Next is our second largest market for gas and fluid handling, oil gas and petrochemicals. Sales were up 10% organically as expected while orders decreased 42% organically in the first quarter. This decline is largely related to continuing delays in project awards principally for compressors. However, quoting activity is strong in our midstream and downstream business led by the Middle East, Southeast Asia and Southeast Asia where we have invested in local selling and technical resources.

Additionally, in fluid handling we’re seeing an increasing interest across various regions in our upstream capabilities which are primarily served by multiphase systems. Despite seeing year-on-year declines in oil, gas, and petrochem orders for the quarter, we expect modest order growth for 2014 as delay projects are released as well as moderate revenue growth as we work through our existing backlog.

Turning now to marine which, as you know, is primarily served by fluid handling. Marine performance is in line with expectations with orders and revenues 6% and 3% organically as we continue to build on the success of the CM1000. Market conditions remain relatively unchanged. We continue to see strength in vessels serving offshore oil and gas industry with continued pricing pressure in general ship building. We’ve addressed this pricing environment by focusing on new value added products to deliver demonstrated efficiency and returns to the customer, most notably the CM1000.

During the quarter we received our first retrofit CM1000 order in which our controls will be installed on an existing vessel with competitive pumps. This greatly expands the potential market for the CM1000 and reaffirms our outlook for the marine segment. We expect to see solid growth in revenue and bookings continue through 2014.

Switching to mining, an end market which faced subdued spending all last year. Revenue was down 20% for the quarter with a 42% organic decline which was partially offset by the [inaudible] acquisition we closed last November. During the period orders increased 59% organically versus a low base in the first quarter 2013. Although mining remains a depressed market we’ve seen some bright spots the last several quarters. For example, a significant $5 million coal mine order in Australia and various orders related to copper and gold mine projects in South America. However, given the overall state of the mining sector, we expect to see organic declines in sales and a challenging environment for orders throughout 2014 partially moderated by the [inaudible] acquisition.

Finally, the general industrial end market. For the first quarter 2014 sales increased 17% organically and orders increased 25% organically, though as I mentioned before quarter-to-quarter comparisons can be quite difficult due to the timing of large orders. As you may remember on the last call we discussed the fan retro fit opportunity in the Chinese cement sector and we secured a number of those orders in this quarter.

In addition, we received a large steel order for Houttuin which is part of a continuing trend of plant upgrades and replacement. These opportunities in our base business as well as the addition of TLT-Babcock and Flakt Woods will continue boosting our sales and orders in the general industrial market during 2014.

Moving to profitability. As discussed earlier, adjusted operating margins for the gas and fluid handling segment were 9.8% in the first quarter of 2014 down 60 basis points from the 10.4% level achieved the same period last year. We expect this business to recover in the balance of the year due to the cost reductions we’ve implemented as well as the improvement in service bookings that began in March and has now continued into the second quarter.

We continue to [inaudible] apply [CDS] across all our businesses with the objective of improving quality, delivery, cost, and driving growth. As an example, earlier this month we assembled a cross platform team of 40 of our most experienced leaders in [Mediseal] Germany, our largest fluid handling production site. The objective of that team was two-fold. First, these leaders were given the goal of creating a new manufacturing strategy designed to deliver a 50% reduction in lead times on our highest velocity products while also improving inventory turns by 50% and reducing site costs by 20%.

Second, the team was given the task of implementing the first step towards achieving this vision by running a week long [inaudible] event. During this first week the team successfully implemented two single piece flow manufacturing cells, changed the plant scheduling process and significantly streamlined our front end processes from receipt of order to manufacturing build. As a result of these changes, lead times were reduced from several days to a few hours. 1,500 parts were eliminated resulting in a $150,000 inventory reduction and the number of operators in each cell will be reduced by 43%. We’re optimistic and confident of hitting our overall objectives this year and since these are the first of 10 single pieces flow cells to be created, each producing similar results for our customer base.

Now, let’s turn to the results of fabrication technology. ESAB continues to perform well operationally despite a continued end market choppiness. Sales for fabrication technologies were $480.4 million, down 2.5% organically versus the prior year. This decline was mostly driven by North America and the Middle East with a large proportion of the North American declines tied to weather related delays in January and February. Europe and Asia were both relatively flat year-on-year while both Russia and China experienced solid single digit growth.

From an operating income perspective ESAB continued its dramatic profit turnaround as margins ended the quarter at 11.2%, an increase of 270 basis points versus the first quarter of 2013. These significant improvements were driven by the continued execution of our cost reduction programs and focus on more profitable consumables. The lab remains a key strategic priority and the acquisition of Victor supports it well. Not only does Victor complement ESAB’s existing regional presence, but it also adds various attractive high margin product categories to our range. In addition, it brings a talented group of associates with a demonstrated track record of success and we’re delighted to welcome the team to Colfax.

With that said, we believe there’s still an opportunity for improvement in every one of our businesses including Victor. Similar to previous acquisitions, we’ve quickly started to work with Victor associates in the deployment of CBS. Clay Kiefaber, the CEO of ESAB recently led a president’s [inaudible] week in Belo Horizonte, Brazil. The week included the most senior leaders within ESAB along with several key leaders from Victor. The executives from both ESAB and Victor worked hands on with our manufacturing associates to implement the basic CBS principles of lean manufacturing.

The rapid deployment of CBS into each of our acquisitions affords us the opportunity to reinforce our culture of continuous improvement with all of our new associates while also accelerating the speed and effectiveness of integrating these new organizations.

Now, I’ll turn it over to Scott to provide more details on the financials.

C. Scott Brannan

As Steve mentioned earlier, sales for the first quarter were $1,054,000 up 6% organically compared to 2013 first quarter sales. Sales were up 11% in total reflecting the impact of the acquisitions for gas and fluid handling closed in the fourth quarter of 2013. Adjusted operating income was $94.1 million representing an adjusted operating margin of 9.8%. Fabrication technologies’ adjusted operating margins were 11.2%. Gas and fluid handling’s adjusted margins were 9.8%.

Corporate and other costs were above expectations at $15.8 million for the quarter. Most of the higher spending is attributable to cost associated with the legal and diligence activities surrounding the Victor acquisition. Excluded from adjusted operating income are our restructuring costs of $6.3 million incurred in connection with the cost reduction projects discussed on previous calls.

Interest expense was $12.3 million for the quarter which includes approximately $2 million of non-cash amortization of debt discounts and deferred issuance costs as well as facility fees and the cost of bank guarantees and letters of credit. While we paid our revolving credit facilities down to zero with the proceeds of the equity offering, we drew approximately $800 million on April 14th to fund the Victor acquisition. We anticipated revolving credit borrowings near this level for most of the second quarter.

Our effective tax rate for adjusted net income and adjusted net income per share for the first quarter was lower than expectations. This was a result of the mix of expected income by territory being more favorable than our original guidance estimate. I will discuss the expectations for the balance of 2014 when discussing the revised guidance incorporating Victor’s operations.

Operating cash outflow for the first quarter was $67 million. Although we do seasonally build working capital in the first quarter, we had a higher than expected working capital build in this first quarter. This was largely caused by a reduction in payables from high levels at year end and most significantly a larger than expected increase in costs over billings on long term contracts. This is a temporary increase which will largely be mitigated by the end of the second quarter. Reversing this trend is a top priority for the balance of the year with our overall goal of achieving a $50 million reduction in working capital for the full year. We are very confident we will be able to achieve that target.

The backlog in our gas and fluid handling segment was $1.6 billion at quarter end. Our book-to-build ratio for the first quarter was 1.02 to one which is slightly weaker than a typical first quarter reflecting subdued bookings in the oil and gas end market. As Steve mentioned, we issued 9.2 million shares on February 20th. The proceeds from these shares provided a significant portion of the funding for the Victor acquisition. The net impact of this was, for adjusted EPS purposes, to raise the fully diluted share count to 120 million shares for the first quarter. We expect to have 124 million fully diluted shares for 2014 full year and approximately 125 million fully diluted shares for each of the second, third, and fourth quarters.

In addition to the additional equity raise and the revolving credit borrowings discussed previously, BDT Capital’s preferred shares were converted to common stock in February. These if converted shares were already reflected in the share count provided in our 2014 guidance. At the time of the conversion we paid BDT the dividends accrued through the conversion date plus an inducement payment of $19.6 million in exchange for conversion of these shares before the time the company could force conversion. This inducement payment, which does have a significant impact on GAAP earnings per share, has been excluded from our adjusted earnings per share.

Turning now to guidance for the balance of the year. First, we are making no changes to the guidance issued in December other than the direct impact of the Victor acquisition. Please refer to our slide deck for precise numbers. As you know, the Victor transaction closed on April 14th and their operations will be included in our results from that day on. Specific changes to the guidance include revenue was increased by a range of $350 million to $365 million reflecting Victor’s expected sales for the period April 14th to December 31, 2014. Operating profit before amortization was increased for the same period by $64 million to $68 million. Amortization and transaction costs for the Victor acquisition are expected to be $25 million in 2014. $12 million of that amount will not repeat in future periods. Interest expense will be approximately $5 million higher for the balance of the year as we financed approximately $350 million of the Victor transaction price under our revolving credit facility. The request of the acquisition was financed through the equity offering discussed earlier.

Our effective tax rate will be slightly higher due to Victor’s earnings being largely in the USA and Australia where the statutory rates are higher. However, the increase in cash payments for taxes will be significantly less than the increase in the [inaudible] tax expense due to the large net operating loss carry forward we have available to reduce cash tax payments in the USA. Importantly, we expect to recognize a significant tax benefit in the second quarter as some of our net operating losses which are not currently reflected as assets in our account will be added to our balance sheet and a corresponding tax benefit will be recorded. This is largely due to the significantly additional US based income from the Victor business. We have not completed our analysis of this gain yet but we expect that it will be significant. We will however exclude this gain from adjusted profit and adjusted earnings per share.

Finally, expected restructuring costs have been increased by $10 million to $60 million for 2014 which reflects the estimated cost of severance agreements inherited at the Victor acquisition date and other 2014 restructuring actions anticipated in connection with the Victor acquisition. The net result of adding Victor’s operations beginning April 14th and the additional debt and interest cost and additional shares from the equity offering is to increase both the high and the low end of our adjusted EPS range by $0.05 per share for 2014.

While we do not provide specifically quarterly guidance, there are certain items that would impact expected seasonality. Specifically, revenue and profits before the non-recurring items that I will discuss in a minute are expected to increase sequentially each quarter based on the rollout of our existing backlog. The second quarter will be adversely impacted by the following. After transaction costs and the reversal of some of the fair value step up of the acquired inventory, Victor’s operations will be dilutive to adjusted EPS by approximately $0.02 for the quarter. Victor will be accretive for the third and fourth quarter and for the full year. The specifics are in the slide deck.

Secondly, we exited a small business line in our fluid handling operations in April which generated a pre-tax $3.8 million non-cash loss on disposition further reducing expected second quarter earnings per share by approximately $0.02 additional. With that, I’ll turn it back to Steve.

Steven E. Simms

With the close of the first quarter we’re now entering our third year following the acquisition of Charter. Having reached this bip point I believe it’s useful to place the team’s performance in context versus our long term objectives. First, from a sales and profitability standpoint we’ve dramatically improved operating margins despite a sluggish economic environment and remain confident in achieving both our 2014 targets and our longer term operating profit goals of 13% for ESAB, 17% for fluid handling, and 15% for Howden business including the acquired entities.

As we’ve highlighted in the past, we’re excited about the strength of our brands in the industries in which we compete. In line with this, we remain confident of delivering more solid organic growth over the longer term while continuing to aggressively pursue smart bolt on acquisitions. Over the last 27 months we’ve completed 11 deals representing over $1 billion in annualized revenues and feel that we’re just scratching the surface of the opportunities we see.

Most importantly, we continue to build a culture of continuous improvement while dramatically adding talent from both in and outside the corporation. In just the last quarter we’ve made two more additions to our leadership group. Andrew [Banim] has joined ESAB as senior vice president of the Americas. Andrew will have responsibility for the ESAB and Victor sales organizations in North and South America. Andrew has a wonderful background in industrial products from General Electric, Allied Signal, and most recently WR Grace where he was vice president and president of their construction products division.

Also joining our team as president and CEO of our fluid handling business and senior vice president of Colfax Corporation is Chris Metz. Chris most recently was a managing partner with Sun Capital where he led a $5 billion portfolio of consumer durables and industrial products. Prior to Sun, Chris was president of Black & Decker’s home hardware group.

The focus on recruiting and developing talent positions us well to both continue our acquisition strategy and drive further internal improvements. Last week we spent two days in Prague conducting a 100 day strategic plan review of the acquisition Howden consummated late last year. Not only are performance and integration in line with expectations, but the review also reinforced to me the opportunities that remain in our core business for dramatic top and bottom line growth. Our possible pipeline of potential acquisitions remains healthy and I anticipate additional announcements in the balance of 2014.

In closing, I continue to feel confident in our team and our ability to deliver upon the longer term commitments established with the acquisition of Charter. With that, I’d like to open it up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeff Hammond – Keybanc Capital Markets.

Jeff Hammond – Keybanc Capital Markets

Just on the guidance, can you maybe talk about how you’re thinking about the segment organic growth rates the same or differently? It looks like fab tech may be a little bit more of a drag and Howden a little bit stronger, just how are you thinking about those?

C. Scott Brannan

I think we’re clearly affirming our guidance. We don’t see any real change for the full year. The welding group is expected to be in the down one to positive two for the year. We didn’t see anything in the first quarter that would cause us to change that. The Victor revenue is projected in accordance with that same growth expectation. The expectation for gas and fluid handling continues to be two to four for fluid handling and four to six for the air and gas handling segment. The increase in the first quarter was mainly due to the timing of the rollout of the backlog which caused the Howden group to be a little bit higher than the full year guidance. But despite that, we don’t have any expected change in our full year revenue guidance.

Jeff Hammond – Keybanc Capital Markets

Is there a way to quantify the weather impact that hit fab tech in the first quarter and what do you see from a catch up standpoint along those lines?

Steven E. Simms

It really would be difficult to quantify the impact of weather. What we can say is that January and February started out very slow, March was much better and we’ve seen that trend continue into the April time frame. We believe that the overall performance, and that would include both Howden as well as fluid handling and fab tech, we believe that that performance will certainly deliver what we need on a full year top line.

Operator

Your next question comes from Nathan Jones – Stifel Nicolaus.

Nathan Jones – Stifel Nicolaus

If I could start with the oil and gas end market, significant decline in orders but you’re still talking about expecting orders to be up at least a little bit this year. Can you talk about what gives you the confidence? I mean, you’re going to need to do I guess 15% growth nearly in the remaining three quarters of the year to make that number.

Steven E. Simms

I think that we first look at what were the causes of the delay and again, we would stress that in this area in particular, large orders can significantly distort performance quarter-to-quarter. I’d remind you, and you probably remember this, that in the first quarter last year, for example, we had a very large $10 million order from Brightoil as I recall, and so that certainly set up a very large comparison. But overall, the root cause issues that we’ve really seen can really be grouped in the two areas of either cost over runs on existing projects or resources to execute the project at the customer level.

A third component that we’ve seen, which is unique to fluid handling, is that we can identify four or five different orders that shifted from quarter one to the later part of quarter two early quarter three that were tied to changes in specification from the customer. In other words, they were driving the design to provide greater capacity than originally identified. So those are the three variables that we identified as root cause issues. When we look at the size and quality of the opportunity funnel, it continues to grow and the opportunity funnel captures every competitive situation that we’re involved in.

As we progress that funnel we can identify or associate a level of probability of winning each one of those targeted opportunities and what we’ve seen is the size of the funnel has increased the number of opportunities and the dollar volume that are moving through the funnel which are associated with a higher probability continue to grow and in no case have we lost an order to a competitive company. In every situation we’ve been able to hold onto the business and as we’ve seen in fluid handling we’ve actually seen an increase in the original order size and so because of that we continue to feel optimistic about delivering the oil and gas growth on a full year basis.

Nathan Jones – Stifel Nicolaus

You mentioned in your prepared remarks about receiving some orders from the cement industry in China. I think that’s fairly new and is just beginning for you, is there a way to size the potential of that market and possibly the duration of that cycle?

Steven E. Simms

I would answer that question this way, what we’ve talked about in China, to step back, is that we’ve certainly benefitted from the compliance driven activity in that region and we are still certainly working through a very healthy backlog created 18 to 24 months ago. We see that part of our business and that order rate starting to moderate but we see opportunities like the cement industry and also the retrofit opportunities that were identified as growing in overall [inaudible].

Another component that we are starting to take advantage of us with the new systems that have been installed to comply with the environmental regulations, they’ve now uncovered other issues further downstream in the process which opens the door to our aftermarket business in China. So the combination of retrofit cement opportunities and expanded service capabilities in China are indicative of what we hope will be a strategy to not only offset what we’ve seen in China but allow us to continue to grow as that part of the business tapers down.

What I’d also add to that point that is important to keep in mind is that the US has been behind China in the enforcement of the EPA driven regulation and what we’ve seen is a continuation of the building that we talked about in prior calls here in the US. So, we hope and believe that the combination of the US, the cement opportunity, the retrofit opportunities that exist in China and now the expanded service opportunities, will help to offset a significant drop off as that environmental compliance gets behind us.

Nathan Jones – Stifel Nicolaus

Is it fair to say that you see the opportunity in China, in those kinds of markets, as being bigger now than you did say a year ago?

C. Scott Brannan

Yes, I think that’s an accurate statement. Because of the pollution situation there we are seeing the remediation extended to additional industries so I would say – it’s hard to quantify it to a precise amount but because of the situation in China and from a pollution standpoint we are seeing this opportunity expand.

Steven E. Simms

I’d just add to Scott’s point, what’s really interesting, Scott and I were working in our team in Howden in an operating review and the team has started to identify major major opportunities in other areas of the compliance that we hadn’t originally anticipated, to your point. We’re finding equipment that is out of spec, out of standard and so it gives us an opportunity to bring in the Howden line or to bring in our services to get the performance of the equipment up to an acceptable standard. We hadn’t anticipated that at all and it’s a very attractive part of the business with high margin and significant volume potential.

Operator

Your next question comes from Mark Douglass – Longbow Research.

Mark Douglass – Longbow Research

It’s interesting you said that China grew for you single digits in welding, do you think that’s share gains, particular end markets, or new products? Can you discuss that a little bit?

Steven E. Simms

Of course, it’s a little difficult to say for sure and again, you have to remember that we have a relatively small base and our strategy initially in China was to stabilize the business, to fine tune, really drive and create a much stronger strategic plan and to change the leadership organization in place in China. That’s a strategy that Clay Kiefaber and also Ken Konopa have been driving aggressively.

So, there really have been three or four things that have helped to improve the trends there. One, we have a revised strategic plan that really is segmenting the market far more effectively than we have in the past and so we think we’re competing in a sector which is both stronger margin potential and growth that we can capture and as a result probably take some market share. Secondly, as we mentioned, we’ve been very successful in adding a new leader in China. Stanley has been with us now just over a year. He’s done a wonderful job of coaching, mentoring, and upgrading the caliper of our team in China. So, it’s both people, end market focus to the higher end of the business.

Then, as you probably remember, Clay and his team executed a major restructuring effort not only in SG&A but also in manufacturing. They consolidated out of way high into a second facilities and so we’re leveraging more volume through an existing facility hopefully improving our overall cost base. We know that our margins have improved dramatically. There again, it’s a small business in relative terms but it’s improved dramatically. We seem to be taking share at the high end and importantly we have the right team in place, we think the right strategy, a better manufacturing cost base, and are now starting to achieve the kind of margins that you would expect for us to post.

Mark Douglass – Longbow Research

This is mostly consumables in China?

Steven E. Simms

It’s really a combination of consumables and our efforts in automation as well.

Mark Douglass – Longbow Research

Speaking of margin, very strong in metal fabrication under organic decline, does 12% seem pretty reasonable? Would it be pretty feasible if there’s some persistent weakness in welding?

C. Scott Brannan

I think if you look at our full year guidance and factor in the cost savings that we specifically identified for the fabrication technology, you would arrive at those margin levels.

Operator

Our next question comes from Andrew Obin – Bank of America Merrill Lynch.

Andrew Obin – Bank of America Merrill Lynch

Just a question on fabrication, you commented on Brazil and Russia and the question in Brazil is do you have any concerns about Brazilian industrial production and the question on Russia, any impact from Ukraine?

Steven E. Simms

Two very good questions. In Brazil we think we’re probably continuing to take share in that marketplace. We believe the market is flat to slightly down and that market reflects a shift in the mining market. Because the markets have slowed we’ve seen a slowdown in a number of areas, heaving moving equipment, as a result it’s impacting in our hard facing business and our work around both the buckets and shuttle cars that are key in serving the mining market. We believe that’s what happened in South America. Our business in terms of market share is holding in, maybe expanding, but the market has been sluggish.

In Russia, as we talked about, fabrication technologies you probably know, Clay and his team manufacture virtually all of their product locally. That business has been very, very strong throughout the entire first quarter, continues that way into the second quarter. The Ukraine has been a pocket of weakness for us but it’s a very small part of the total. So, if we were to talk about Russia perhaps in a broader context of Russia and the former Soviet Union, our business has been quite healthy in terms of overall order rate even though it’s been down in the Ukraine.

From a margin standpoint business has performed very very well under Constantine’s leadership. Our manufacturing strategies have been very effective. You’ll hear more about that in calls to come but, our business has performed well and we continue to believe that Russia is a key market for us over the long term. The strength that we’ve seen in the marketplace has really been through pipeline construction and planet production in that region and based on our order book and the outlook on the horizon, we feel pretty comfortable with where we sit for the balance of the year.

Andrew Obin – Bank of America Merrill Lynch

So, no near term impact from Russia that you can tell?

C. Scott Brannan

No, actually our fabrication business is up in Russia for the quarter so clearly no near term impact.

Andrew Obin – Bank of America Merrill Lynch

The second question, just the treatment of preferred, has that changed? Have we changed how we include it in the guidance because it’s not in your explicit guidance and before you had preferreds in the guidance and now you have it in reconciliation from GAAP to non-GAAP how should I think about that?

C. Scott Brannan

The preferred has been converted which is the reason for the difference presentation. The comments I made in the prepared remarks give you the expected share count after the equity offering. The conversion doesn’t really effect it because the adjusted EPS was calculated on an if converted method anyway.

Operator

I am not showing any further questions in queue. I would like to turn the call back over to Farand Pawlak for any closing remarks.

Farand Pawlak

If there’s no further questions then we’d like to thank everyone for joining us today and we look forward to updating you next quarter.

Operator

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

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