Colfax's (CFX) CEO Steve Simms on Q2 2014 Results - Earnings Call Transcript

| About: Colfax Corporation (CFX)

Colfax Corporation (NYSE:CFX)

Q2 2014 Earnings Conference Call

July 17, 2014 9:00 AM ET

Executives

Farand Pawlak – Director-Investor Relations

Steven E. Simms – President and Chief Executive Officer

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

Analysts

Walter Scott Liptak – Global Hunter Securities, LLC

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

D. Mark Douglass – Longbow Research LLC

Jeffrey D. Hammond – KeyBanc Capital Markets, Inc.

Brian Konigsberg – Vertical Research Partners Inc.

Joseph A. Ritchie – Goldman Sachs & Co.

Andrew Obin – Bank of America Merrill Lynch

Jamie Sullivan – RBC Capital Markets

John G. Inch – Deutsche Bank Securities, Inc.

Operator

Good day, ladies and gentlemen and welcome to the Colfax Corporation Second 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 follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now turn the call over to your host, Farand Pawlak. Please go ahead.

Farand Pawlak

Thanks, Stephanie. Good morning, everyone. Thanks for joining us. My name is Farand Pawlak, and I am 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 was issued this morning and is available in the Investors section of our website colfaxcorp.com. 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 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 Investors section of the Colfax website.

In the interest of getting to everyone during Q&A, we’d ask that you limit yourself to one question and then one follow-up before reentering the queue.

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

Steven E. Simms

Good morning and thank you all for joining us today. We’re disappointed in our second quarter results, while most parts of Colfax performed well; earnings were below expectations due to soft demand in welding and pumping markets, as well as certain issues in fluid handling. On today’s call, Scott and I will take you through our customary review of the business and its operating environment, and will also address what we’re doing to improve the performance.

As stated in our release this morning, we reported net sales of $1.2 billion for the quarter in the first – second quarter of 2014, an increase of 12% over the same period last year. This was driven by 18% growth from acquisitions, partially offset by a 5% organic decline and a 1% negative impact from foreign currency. Revenues for our Houttuin business were in line with expectations. However, we continue to see sluggish demand in our welding and pumping markets, which resulted in revenues below our expectations for the quarter.

Adjusted operating margins decreased to 9.1% in the second quarter, or a 180 basis point decrease over the prior year, due to poor margin performance in our fluid handling business. Houttuin performed in line with expectations and a bright spot in the quarter was continued margin improvement at ESAB, both sequential and year-on-year despite lower revenue. We will discuss the issues at fluid handling in more detail later in the call.

Finally, our various acquisitions continue to perform in line with expectation. Last year’s gas and fluid handling acquisitions are achieving their targets and integration proceeding well. Victor, which we closed on April 14, is off to a strong start. Revenues and margins for the quarter were in line with the expectations in numerous integration activities are underway.

Now let’s turn to our business segment. Sales for fabrication technologies were $630.4 million, down 3.1% organically versus last year, while we saw a good growth in the Asia and Russia. This was more than offset by lower than expected sales in Latin America or sales declined due to continued weakness in mining, as well as soft demand in the automotive and the offshore marine sectors.

As I mentioned before, Victor got off to a good start contributing 19.4% growth in the quarter in line with our expectation, while we are disappointed in ESAB’s organic growth, we are pleased with the continued improvements in profitability the team has achieved, particularly in light of the weak top line.

Excluding Victor, adjusted operating margins for the second quarter were 12.6%, as compared to 10.7% in the prior year, an increase of 190 basis points. This performance reflects the continued delivery of the $35 million cost savings we’ve committed to for 2014 and given current market conditions will accelerate the SG&A reduction plans we have in place.

As expected, Victor was dilutive to fabrication technology margins in this quarter, but we expected to be accretive in future periods. While we expect fabrication technology sales to remain sluggish for the balance of the year, we will deliver our operating margin goals.

In addition to the $35 million cost savings we’ve committed to for 2014, we will further leverage the tools of CBS to free up additional dollars to ensure we meet our bottom line targets, while continuing to invest in programs to drive long-term growth. An example of how the ESAB team is leveraging CBS to improve customer delivery, while driving manufacturing, productivity and cash flow involved our Vamberk site in Czech Republic.

By implementing the Value Stream Mapping, KanBan and Standard Work tools, this plant is now operating on a delta order basis with two of our largest automotive customers. Historically, orders were generated by the customers, MRP and forecasting systems, which created a lot of fluctuations in material and production requirement. As a result, both our customers and ESAB carried excessive levels of buffer inventory.

Now, after 14 different Kaizen events, we’ve established an electronic pool system, which [Audio Dip] on a daily basis and delivers direct to the customer, bypassing any warehouse or distribution centers. Service levels are now at 100% an inventory of both the customers and ESAB has been reduced by 30%, due to our improved manufacturing flexibility. Our goal is to expand to the remainder of our customer base, which will eliminate many of our distribution centers and drive top line growth by delivering world class fill rates and lead times.

Now, let’s move onto the results for gas and fluid handling. Net sales for the second quarter were $568.9 million, an organic decrease of 7% compared to $516.8 million in the same period last year. This was primarily driven by an expected decline at how related to the percentage of completion accounting on certain large projects for which revenue was recognized in the first quarter.

On a year-to-date basis, top remains up 8% organically inline with our full year expectation. However, unexpected weakness of fluid handling resulted in larger than anticipated organic revenue decline. This was primarily caused by continued softness in our oil, gas, and petrochemicals and power generation business this as well as the lubrication services group. Revenue from our acquired business at both Howden and fluid handling remains largely inline with expectations for the quarter.

Orders for the second quarter were $593.8 million, up 24% compared to the prior year with 19% coming from acquisitions and 5% from organic growth; backlog remained strong at $1.580 billion for the quarter-end.

All end markets experienced year-on-year organic growth in the quarter with the exception of oil, gas and petrochemicals due to continued project deferrals and power generation the reasons I will discuss shortly. We continue to be encouraged by increasing strength in marine and general industrial.

As I always note, the timing of orders makes comparisons across sectors and periods a little difficult, this quarter is no exception. Let’s take a closer look at gas and fluid handling end markets starting with our largest one power generation. As you know, Power Gen has been very strong for us over the past several years, while performance this quarter was less robust. We continue to expect power generation sales to grow throughout 2014.

During the second quarter, revenue decreased by 15% organically, sales weakened due to new-build revenue in China, mainly related to project timing as well as slow aftermarket sales in the U.S. Orders were also weak during the quarter with year-on-year organic declines over 11%.

Fluid handling business was impacted by a downturn in demand for combined cycle power stations, for which we provide fuel transfer and lubrication pumps. Howden saw declines in its China SCR related bookings, partially offset by increases in new-build components, particularly air heaters.

Additionally, the proposed CO2 regulations in the U.S. caused utilities to hold orders while they digest the likely impacts.

In spite the weak orders this quarter; we remained positive about the outlook for power generation, while fluid handling will continue to experience headwinds from the sharp declining combined-cycle plant demand. Power plants investment rate is strong in Southeast Asia and Howden’s strength in that region positions us well to benefit.

In addition, around the world, end user interest in retrofits that have improved energy efficiency remains strong. With respect to the U.S., we believe the higher efficiency requirements resulting from the proposed CO2 regulations could ultimately drive additional demand for high end fans and heat exchangers. However, until the rules are enacted, we expect the U.S. market to remain sluggish.

Next is our second largest gas and fluid handling market; oil, gas and petrochemicals. Oil, gas and petrochemicals performed below our expectations for the quarter. We continue to see deferrals of major projects across core geographies, particularly Asia and Latin America with orders decreased in 26% organically. This decrease occurred in both our midstream business, which is primarily served by fluid handling and our downstream business, which is primarily addressed by Howden.

Revenues were down 17% due to the continuing softness in our order book. However, we began to see some of our growth investments beginning to pay off this quarter, with our bookings weaknesses partially offset by strong orders for our recently released dry-seal screw compressor, as well as our recent CKD acquisition. We believe dry-seal screw compressor provide an outstanding growth opportunity and we continue to make selective investments in these sources as differentiated product. Given this quarter’s performance in oil, gas and petrochem, we now expect modest growth in orders and flat revenues for the full year of 2014.

Turning now to marine, which as you know is primarily served by fluid handling. Marine which includes both our commercial marine and defense business, continues to perform in line with our revenue expectation, growing sales at 2% organic.

Market conditions remained relatively unchanged, strong demand from vessels serving the offshore oil and gas industry, with continued pricing pressure in commercial marine, particularly from Japanese competitors. We had an excellent quarter for bookings, with organic growth of 85% led by defense along with strength in offshore service vessels and continued success with our CM-1000.

Our defense business received a $30 million order for valves, which are expected to ship in later – at the end of 2014. Last quarter, I announced our first CM-1000 retrofit order. In this quarter, I’m pleased to announce retrofit orders for another nine vessels with competitive pumps. The Active Valve Control feature, which is in the unique to Colfax Fluid Handling, was a key to closing the order. We reaffirm our 2014 outlook for the marine segment and expect to see solid growth in the revenue and bookings for the year.

Switching to mining, this end market has faced subdued spending for the past year and a half, partially offset by our 2013 Alphair acquisition. Revenue grew 12% organically in the quarter, albeit off of a very low base, and orders grew 4%. Although mining remains a depressed market, we’ve seen bright spots over the past several quarters, this quarter a large Australian order for a tin and zinc mine as well as some additional copper projects in Chile. Given the state of the mining sector, we now expect to see revenue and orders decline over the balance of the year, with order declines being partially offset by Alphair’s contribution.

Lastly, the general industrial end market. General industrial had another good quarter with revenue growth of 8% organically and orders growth of 21% organically. While quarter-to-quarter comparisons can be volatile due to the timing of large orders, we were encouraged by the continued booking strength. We saw significant activity in steel and cement where SO2, NOX and particular standards are the same as the power sector with steel plant desulfurization being the most active area.

Revenue and bookings growth on the Howden side were driven by fan orders to Asian steel facilities, lowers for wastewater applications and fans for locomotives. Fluid handling benefited from strength in diesel engines, non-residential construction, primarily low-rise elevator pumps. While quarterly trends are volatile, we expect growth in the segment over the balance of the year in both sales and bookings, but at a lesser rate than what we’ve seen in the second quarter.

Looking at probability, adjusted operating margins for gas and fluid handling were 8% in the second quarter of 2014, down 550 basis points from the prior year. As mentioned, adjusted operating margins fell short of expectations for the quarter due to fluid handling performance. Even excluding the one-time items that Scott will discuss in more detail, the margins were below our expectation.

There were several clear causes. First, while our higher margin services business improved its performance versus the first quarter, it’s also still below our expectation. Second, we had several operational issues, in particular poor performance in our European project business as well as production inefficiencies on several large diameter pump shops. In light of this poor performance, we’ve announced across the board reduction in SG&A in all fluid handling businesses and regions and also reducing overhead within our manufacturing operations.

In addition, during this quarter we exited underperforming operation in our marine sector and are phasing out certain activities related to an acquisition completed in 2010. These actions resulted in a charge during the quarter that Scott will address in his remarks. It’s worth noting that these reductions are in addition to our ongoing restructuring in the Netherlands.

Beyond the cost actions we’re taking, the business will benefit from certain other margin improvements and fluid handling in the balance of the year. First, the majority of our Latin American service business is completed in the second half, resulting in much stronger margins compared to the first half of the year. In addition, after a weak quarter four and quarter one, the order rate of our high margin lubrication service business improved significantly during the quarter. We believe it will result in higher sales and profits in the second half.

Finally, the poor performance of our project business that I previously mentioned resulted from several large orders with extremely low margins. Since these orders were taken last year, we’ve improved our project estimation and quoting process to prevent reoccurrence. In addition to the steps we’ve taken to improve fluid handling margins, in early July we conducted a detailed strategic review of the business across all served segments to understand whether if these performance-related issues relate to any market shifts or strategic changes.

In short, aside from the near-term market trends I’ve already mentioned and the operations we’ve exited, we do not believe there’s been any deterioration in the strategic position overall potential of our fluid handling. While fluid handling had a challenging quarter, Howden continued to perform in line with our expectations. The team there continues to work with last year’s acquisitions to drive CBS and reduce purchasing spend.

We held a third of our President’s Kaizen week this year at Howden’s CKD site in Prague during the month of May. The future vision session for this Kaizen was discussed in last quarter’s call and today we’ll discuss the results from the Kaizen this past week. The Howden President’s Kaizen was hosted by Howden’s CEO, Ian Brander, and the executive team during the week of May 19. Four teams worked on the CBS lane conversion of the Prague site, and utilized the CBS tools and production process planning, lean line design, project management and [demand poll] (ph) to prepare the site for transfer of manufacturing from Western European sites to Prague in the upcoming months.

The four focus areas of the teams were impellers, shafts and rotary machines, as well as engineering design and project management. The team was successfully able to create single piece cellular manufacturing for impellers, shafts and rotors, along with implementing the CBS project management process.

Results from the week were as follows, the Kaizen event freed up 28,000 square meters of core space, which will now enable us to transfer manufacturing from other higher cost western European sites. Secondly, the team eliminated $1.1 million of cost through labor efficiency and productivity associated with the new sell layouts, and in addition, in lower working capital by $3.3 million, or also reducing customer lead times with 50 days – with 15 days once the full transfer is complete, an excellent example of leadership and action, leveraging the tools of CBS to drive significant benefits for the customer and for Colfax.

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

C. Scott Brannan

Thanks, Steve. Recapping the numbers for the quarter, sales for the second quarter were $1.2 billion, down 5% organically, compared to the 2013 quarter. Adjusted operating income was $109 million, representing an operating margin of 9.1%. Fabrication technology’s adjusted margins were 12.2% in line with expectation. Corporate and other costs were also in line with expectations at $13.6 million.

Excluded from our adjusted operating income, our restructuring cost of $13.5 million incurred in connection with the cost reduction programs, as well as a large one-time non-cash tax benefit associated with the reversal, previously established valuation allowances against deferred tax assets and others related to fair value asset estimates made at the time of the Charter acquisition.

As I introduced during the last quarter’s call, there are some one-off items, which are reflected within our adjusted operating income. Starting with fabrication technology, transaction costs and the reversal of fair value increases to acquired inventory at Victor technologies reduce the fabrication technology adjusted operating profit by $9 million.

We also determined that the use of the CCAD2 exchange rates that translate our Venezuelan net assets into U.S. dollars was the most appropriate. While we have nearly no fab tech operations in Venezuela, the write-down of our net monetary assets in Venezuela resulted in a charge in this segment of approximately $5 million. These two one-off items reduced adjusted operating income by $14 million in the second quarter. Excluding these items, our adjusted margin in fabrication technology would have exceeded 14%.

In the gas and fluid handling segment, one-off items included the following: we exited a small business line in fluid handling in April, which generated a pretax non-cash loss on dispositions of approximately $4 million. The use of the CCAD2 exchange rates resulted in a loss of approximately $1 million, related to a small Venezuelan operation in fluid handling, and we took a $12.1 million impairment charge against the intangible assets of our Baric operation, which will be undergoing a substantial restructuring. Excluding these items, adjusted operating margin in gas and fluid handling for the quarter would have been 11%, which was still below expectations for the reason Steve discussed earlier.

Interest expense for the second quarter was $13.6 million, which includes approximately $2 million of non-cash amortization, as well as the facility fees and cost of bank guarantees and letters of credit. Interest expense was favorably impacted by approximately $1 million as we were temporarily in the lowest borrowing margin tier, saving 25 basis points on our entire credit facility borrowings. We will return to our typical tier in the third quarter, as our leverage increased when the Victor acquisition was funded in April.

As we discussed on the last quarter’s call, we recognized a significant tax benefit in the second quarter as some of our net offering losses, which were not previously reflected as assets in our accounts are now on the balance sheet with a corresponding tax benefit recorded in the second quarter.

As explained previously, this is largely due to the significant additional U.S. based income from the Victor business. We have excluded this non-cash gain, as well as an additional approximately $22 million of other non-cash tax benefits associated with accruals related to few fair value estimates. The impact of Victor’s operations on our adjusted results is to slightly raise our effective tax rate going forward, as U.S. earnings now carry a full tax charge, which is at a substantially higher rate than the average of our other territories.

However, this increase will not – substantial in cash payments, as we do have our operating losses to shelter our U.S. tax cash requirements. Our effective tax rate for adjusted earnings this quarter was 30.7%. We anticipate an adjusted effective tax rate of approximately 29% to 30% for the balance of the year. Backlog in the gas and fluid handling segment was $1.58 billion at quarter-end. Our book-to-bill ratio for the second quarter was 1.04:1, which is typical for this quarter.

Turning now to guidance for the balance of the year. we have reduced our 2014 guidance from the ranges provided on last quarter’s call for the following reasons: sales in our fabrication technology segment remained below our initially expected range and there is no indication of any near-term inflection point; secondly, the fluid-handling business has also failed to achieve sales within the initially expected range and as Steve mentioned has fallen below our anticipated margin targets; and finally, foreign exchange rate changes from the initial estimates will also slightly reduce the expected sales for the year.

It is important to note that there is no change in expectations for the Howden business. For Victor Technologies or for the margin percentages in fabrication technology, despite the lower sales. There are also no significant change to guidance on items below adjusted operating profit.

As such, we’ve made the following revision. The range of expected revenue is now $4.7 billion to $4.8 billion, the range of expected adjusted operating profit from $485 million to $510 million and the range for adjusted earnings per share of $2.20 to $2.35 per share. While we do not normally give quarterly guidance, we expect the pattern of revenues and profits in the second half of 2014 to be somewhat different than previous years.

In particular, the Howden backlog we expect to ship as percentage of completion revenue recognition that results in a larger than typical fourth quarter. In addition, completion of the service contracts at the Sicelub acquisition, that we closed late last year is similarly skewed towards the fourth quarter. As a result, the fourth quarter adjusted earnings per share is expected to be approximately 25% higher than third quarter adjusted earnings per share.

Please refer through the slide deck for additional details on the guidance. With that I’ll turn it back to Steve.

Steven E. Simms

Thanks, Scott. As we’ve noted throughout this morning’s overview, we are excited about the ongoing improvements occurring at both Howden and ESAB. These businesses continue to drive significant margin gains, while also making the right investments in people, products and services, which will clearly drive long-term sustained organic growth.

In addition, they are an aggression of recently completed acquisition is on track versus expectation, while this was a disappointing quarter for fluid handling. Believe the issues experienced in this quarter are manageable and that the counter measures noted involve will improve our cost structure and ongoing margin performance.

In addition to these actions we made two key additions for our fluid handling leadership team. First, on Tuesday, we announced that Darryl Mayhorn will be joining the company as the new President and CEO of our fluid handling business and Senior Vice President of Colfax. Darryl comes to us from Rexnord, where he was the President of the Rexnord Aerospace Group and the Chief Human Resource Officer of Rexnord Corporation. Prior to joining Rexnord, he was the Group President of the Aerospace and Defense Group at Danaher Corporation. Before that, he held several leadership positions within Eaton Corporation.

We are pleased to have an individual with such a deep industrial background leading the teams coupled with his demonstrated ability to drive continues improvement and developed talents. Darryl will be an invaluable to the fluid handling business since we address their current performance.

In addition, Ken Fairleigh joined our lubrication services business as Vice President of Sales and Marketing. Ken is a proven business leader with a strong track record for delivering growth and commercial process excellence in industrial markets. Most recently Ken was President and CEO of Paragon Technology, a provider of capillary to the power industry. Prior to that, Ken honed his sales and marketing skills at top industrial companies such as Danaher, GE, Square D and Rexnord.

In summary, while we are not happy with the quarter, we remained very positive about the long-term outlook for Colfax. Howden continues to meet its targets. ESAB continues to improve margins and strengthen the business and the structural and leadership team changes we are making in fluid handling position it well for success.

In addition, we continue to focus on recruiting and developing talents, giving priority to key roles to drive performance. Likewise, we remain active on the M&A front and have a strong pipeline though our top priority remains as always, delivering strong performance from our core business.

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Walter Liptak with GHS. Your line is open.

Walter Scott Liptak – Global Hunter Securities, LLC

Hi, thanks for that, good morning everyone.

Steven E. Simms

Good morning.

Walter Scott Liptak – Global Hunter Securities, LLC

I wanted to ask about FABTECH and just I understand the outlook as if, you are not expecting any inflection? What’s happened and do you think with the overall market for to be so weak, some of the macro numbers are getting better, may be the industrial economies better in the second half?

Steven E. Simms

From our perspective we do believe that we’re seeing improvement in the overall fabrication technology industry. It’s been slow relative to the overall economic growth, because we believe that some of the pockets that are most important to our performance and well, they have been slower to rebound.

So if we look at the different regions around the world we see very different trends. For us, in North America, we experienced steadily improving order rates really since the February timeframe, but we have yet to see positive growth resulting from the improvements. The most significant weakness that we’ve seen here has really been around in marine and offshore, railcar and off-road production has improved, pressure vessels were up slightly, but generally not enough to really reverse the declining trends we’ve seen in the past, improving but not a positive trend yet. In South America, we were down during the period and there we think that automotive has been weak as well as large component manufacturing which ties to the welding industry or the mining industry. So we believe that in South America those two verticals are what’s driving the sort of slower growth or no growth.

In the European market, our business is down slightly from an organic standpoint. Then, again, most of the key end markets have shown slight improvements, but we’re not seeing growth at this point in time. For us in Russia, Eastern Europe, the trends have been very, very positive. In fact, Russia has continued to build the momentum and I think that’s tied to the investments in oil and gas that we’re seeing across that region. In the Middle East, we’ve also seen an improvement here. Again, we think oil and gas for our part of the business has helped to improve in these key regions.

I guess the last one for us would be India. We’re starting to see some signs of growth here. There has been a renewed commitment to strength the infrastructure. So we think that industry in India will begin to improve with some of the renewed commitments to the market. Does that help to give you a sense of both the industry and where ESAB has fared on a region by region base?

Walter Scott Liptak – Global Hunter Securities, LLC

Yes. Yes, thanks for the color. And given the outlook for no inflection, I think that in July you’re sort of seeing the same trends that you saw during the quarter.

Steven E. Simms

Generally speaking, yes.

Walter Scott Liptak – Global Hunter Securities, LLC

Okay. If I can ask just a quick second one, in your Power Gen business, the order is down. It sounds like it’s largely U.S. I wonder if you could break out what the U.S. orders? How much they were down and what do you think the timing is of that opportunity you alluded to?

Steven E. Simms

The orders down are – the U.S. is certainly one of the contributors, but I think as Steve said in his remarks, that China is also an area where we saw areas in order decline. We’ve got to break the quarter’s information out by territory.

Walter Scott Liptak – Global Hunter Securities, LLC

Okay. All right, I got that. What’s the timing of the churn in the U.S. or China?

C. Scott Brannan

Well, we’ve talked at length in prior calls about China. The SCR order pattern is running its course over the balance of the year. Steve talked a little today and we talked previously about the projects that we think will increase demand in other areas to makeup to that. I think U.S. is much harder. I mean people are still digesting the call for regulations that haven’t even been published yet. So at this point it would be difficult to provide a precise answer when the segment will turn in the U.S.

Steven E. Simms

What we’ve been thinking about it, Walter is that, as we’ve said on prior calls, if you look at China and SCR and new build activity for Howden, that’s coming to an end as Scott mentioned. We had anticipated that North America would over time continue to offset that. So we see a moderation of the decline in China by growth in the U.S. and that has happened exactly as hoped. In fact our share of that has probably greater than what we anticipate in terms of winning the opportunity. Now this new discussion around the CO2 emissions, which cause for a 30% reduction in the emissions below the 2005 levels, clearly that’s going to slow our stock investments in some of these smaller plants that are complying with SCR.

However, in anticipation of that as you know from prior calls, we’re aggressively focusing on Southeast Asia where new power and new power generation construction is very high. And we’ve been also essentially focused on expanding our presence in the aftermarket. And so those two areas in particular are two examples of how we’re offsetting the anticipated slowdown in China and the slowdown here in North America.

Walter Scott Liptak – Global Hunter Securities, LLC

Okay, got it. Thanks very much.

Operator

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

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

Good morning, Steve, Scott, Farand.

Steven E. Simms

Good morning.

C. Scott Brannan

Good morning.

Farand Pawlak

Good morning.

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

If you could just go to fluid handling for a minute, obviously lower margins and lower organic revenue growth outlook. Can you talk about what changed from last quarter to this quarter in terms of your organic growth outlook? And then if you could elaborate just a bit more on the execution issues that you encountered during the quarter and what countermeasures you’re taking.

C. Scott Brannan

I’ll take the organic growth outlook and I’ll let Steve comment on the execution issue with that. We continue to see a weakness in power generation. As we’ve discussed today and on some earlier calls, that the combined cycle power generation market is not strong and that’s affecting our pump orders and revenue. Secondly, as we’ve stated probably over the last – at least the last year, the oil and gas market, while there’s a lot of activity in terms of floating, a lot of activity continues to be deferred. So those are the two reasons we’re taking down the revenue outlook, given where we are in the year, assessing the backlog we have in hand, and we felt it was appropriate to revise our outlook on organic growth.

Steven E. Simms

From an executional standpoint, Nathan the two key projects that were mentioned in the script were also tied to the executional issues from a manufacturing standpoint. This is a part of the business that we entered several years ago, and these were two early orders that were finally locked in 2013, early part of 2013 that really go all the way back to 2012. And these particular project orders were new to the company both in terms of complexity, size, and technical content. And as we went through the final assembly and production of the product, we really had a significant issue on a couple of our European operations relative to the costs.

And so we think we’ve addressed that for the future part of the business and we believe that we’ve addressed both manufacturing and refocused those key areas of the project segment that we want to compete in based on our capability, and also based on the margin potential. So we’ve begun, sort of taken on a process that refocusing the resource that we put into the space, trying to concentrate on those projects where we have the greatest value, both in terms of technology and material content.

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

So are they any similar projects, what that might be new to the company where you might have an execution issue here in the future, or is this a one-off kind of thing?

Steven E. Simms

We’ve got a couple more of the projects but those projects have been incorporated into the forecast going forward.

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

Okay and – sorry go ahead.

Steven E. Simms

We think we’ve addressed the project management system around as well as the quotation process as well.

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

Okay. So there may be execution issues but you’ve already reflected that in your guidance.

Steven E. Simms

Yes we have, correct.

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

Okay. You didn’t say that you’re still expecting oil and gas order growth for 2014, given this soft first half and the fact that you are talking about these things continuing to be pushed to the right. Can you kind of give a little bit more color about how you get comfortable that you can still actually grow oil and gas orders overall for 2014?

Steven E. Simms

Yes, I think there’s two reasons; one, the comparisons getting much easier, which makes it easier to accomplish given that does the market has this deferral situation is not recent. And then secondly, we’ve actually experienced some recent including early in July a couple of very large orders have been booked here between quarter end and the call here this morning, and a couple of others that we believe are close to execution.

So we actually see a few bright spots, we try to be cover that in the comments that few of these bright spots will hopefully bring this up to a net positive, not a huge improvement, but at least it will hopefully reserve the trends we’ve seen over the last three or four quarters.

Nathan H. Jones – Stifel, Nicolaus & Co., Inc.

Okay. Thanks very much guys.

Operator

Our next question comes from Mark Douglass with Longbow Research. Your line is open.

D. Mark Douglass – Longbow Research LLC

Hi good morning gentlemen.

Steven E. Simms

Good morning.

D. Mark Douglass – Longbow Research LLC

Scott, can you address fab tech operating margins, you said extra one-offs, so are you going to see that to some initial charges on inventory, right on Victor? But you be over 14% without those is that what you said?

C. Scott Brannan

That’s correct.

D. Mark Douglass – Longbow Research LLC

So what are you thinking in the back half, I mean just assuming fab tech kind of models along here similar type of run rate on quarterly sales. What are you thinking as far as margins, can we push it to over 14%, or do you see it following in the kind of 13% range?

C. Scott Brannan

I think well as you know following the welding industry market the second quarter is typically the strongest quarter for welding. So, I think this may be the apex of the margins, but we certainly would expect to be able to be close to this for the balance of the year.

D. Mark Douglass – Longbow Research LLC

Okay, great, that’s helpful. And then looking at the – I guess the sales and order volatility in the gas and fluid handling. Are you finding ways to improve your ability to forecast? I mean obviously, some of these big projects get pushed into other quarters. But is that part of your – how you’re addressing certainly some of the problems in fluid handling?

Steven E. Simms

I think that clearly, we’re trying to dig into improvements in forecasting process, which we have done. the biggest challenge we had is really around oil and gas, where we’ve seen significant orders push out and they tend to be order – decisions reached fairly late in the process obviously, related to expectations. To give you an example, in Latin America, we start to push out from PDVSA, we’ve seen a shift from Hess in the Southeast Asia and Lukoil in Russia.

So it’s been fairly broad based, what we’ve tried to do in managing our week-to-week opportunity funnels as a sales organization is to really dig into far greater detail by customer in terms of where we are in the decision-making process, but – and we think that we’ve reflected a more conservative, faster in the balance of the year in the forecast than we’ll see as we go forward. but we’ve driven and retrained all of our sales people across the company and with value selling concepts and also in managing simply around the oil and gas funnel.

I would just add that the funnel continues to grow in overall size. The opportunities that are being awarded, Mark, we look at that and believe that we’re maintaining share of those orders that are being led, and we’re acted upon. So we don’t think if the case where we are losing share, we do know and recognize that we’ve got to get a lot better, a lot of closer and being able to forecast these push outs.

D. Mark Douglass – Longbow Research LLC

Okay, thank you.

Steven E. Simms

Thank you.

Operator

Our next question comes from Jeff Hammond with KeyBanc Capital Markets. Your line is open.

Jeffrey D. Hammond – KeyBanc Capital Markets, Inc.

Hey, good morning guys.

Steven E. Simms

Good morning.

Jeffrey D. Hammond – KeyBanc Capital Markets, Inc.

Just to come back to the organic growth rates, I think coming into the year, you’re thinking 2% to 4% for fluid handling and down 1% to plus 2% for fab tech. Can you kind of give a sense on how you’re thinking about those now just to understand the order of magnitude?

Steven E. Simms

Sure. For Howden, which was 4% to 6% that we have no gains, so as I said in the prepared remarks, Howden is performing. as expected, we have a very solid look at the balance of the year through the backlog and expect no change for the Howden business. The range we’ve put around both fluid handling and fabrication technology correlates to how they performed through the six months of the year and welding is down 3% and fluid handling is down something very, very close to that. So that’s sort of where we’ve put the range around for those two businesses. As I mentioned, FX is the small contributor to this decrease from the initial guidance that you’re trying to reconcile on the total number.

Jeffrey D. Hammond – KeyBanc Capital Markets, Inc.

Okay. And then you talked about some potential headwinds, and Howden around just the CO2 and uncertainty, and I guess some of the China new-build. how should we think about that in terms of the out year or the longer-term growth rate as some of those plays grew, and just visibility into next year?

C. Scott Brannan

I think as Steve said, we feel very confident. we have a whole list of other areas that will make up for the expected roll off the SCR projects. Some of that U.S. business will undoubtedly get canceled, but a good portion of it will go ahead, it will probably just be deferred. but we think we have enough things in the pipeline to feel confidence where the wrong growth rate for Howden, and in 18 months, we don’t have visibility much beyond that, but we haven’t been able to change our – their view there.

Jeffrey D. Hammond – KeyBanc Capital Markets, Inc.

Okay. and then just last thing on similarly, I think, you said X items, your margin run rate in gas and fluid was 11%. So how should we think about building out the second half of the year relative to kind of that first half run rate?

C. Scott Brannan

Well, that’s actually the non-cash items, some of the other items that Steve talked about the large diameter pump projects, as well as the systems businesses in Europe, including the one we took the impairment on those depressed margins in the second quarter. So we expect significantly better margins in that for the second half of the year.

Jeffrey D. Hammond – KeyBanc Capital Markets, Inc.

Okay. thanks, guys.

Operator

Our next question comes from Brian Konigsberg with Vertical Research Partners. Your line is open.

Brian Konigsberg – Vertical Research Partners Inc.

Yes. hi, good morning.

Steven E. Simms

Good morning.

C. Scott Brannan

Good morning.

Brian Konigsberg – Vertical Research Partners Inc.

Actually, just following more on power with Howden, so I mean you’re talking about the CO2 regulations in the U.S., which I can understand is giving some people pause. but at the same time, actually the cross-state rules, the CSAPR rules are reinstated by the Supreme Court. I believe it was in early May. I believe that’s going back to the ETA for kind of a reshuffling of the regulations, if you anticipate that actually spread demand for SCR as well, or might that have been kind of absorbed by the match rules that have gone to effect already, and maybe there’s – maybe not much incremental required?

C. Scott Brannan

I guess the best way to answer that would be that the CO2 rules may cause people to close class that there were other lot of planning, but SCR applications in. So as we’ve tried to say both in the remarks at and response to earlier questions, we believe a good portion of this U.S. market for the reason, you stated will still come to fruition, but people are being cautious of studying the CO2 issue, determining whether some of these smaller plants might need to be closed. and as Steve said, we expect that to have an impact on our shorter-term order rate in the business.

Brian Konigsberg – Vertical Research Partners Inc.

Okay, I got you.

Steven E. Simms

One of the things that we’ve talked about before is that with the – and I think that’s your point is that with the new legislation that’s pending, once that becomes law, we believe it will be a significant pump for our business at Howden. It’s been a question of whether or not that hits in 2015 or 2016. In the meantime, our challenge is to leverage the tremendous investment going into Southeast Asia, and new power facilities and also in the aftermarket, which is what we’ve been pretty successful and being able to do.

Brian Konigsberg – Vertical Research Partners Inc.

Understood, thanks. And separately, can you maybe just talk about pricing, especially maybe within the oil and gas on fluid handling side. so you are seeing push outs. but generally, it seems some projects are starting to come to market, and you could see some more activity, but you also have a lot of competitors that are looking to, I guess absorb excess capacity. Maybe just talk about what trends you’re seeing and is that a concern and anything based on your guidance?

Steven E. Simms

What I would say to you, looking at our margins in oil and gas without going into the detail of it, I can tell you that thinking up on your specific question, our margins in oil and gas have actually improved in the quarter, they’re up relative to the first quarter and up relative to the prior year. So we continue to benefit from some of the activities and manufacturing in a better process around oil and gas, or our margins have been hanging in there in fact that improve.

Brian Konigsberg – Vertical Research Partners Inc.

Okay. thank you very much.

Operator

Our next question comes from Joe Ritchie with Goldman Sachs. Your line is open.

Joseph A. Ritchie – Goldman Sachs & Co.

Hi, good morning, everyone.

Steven E. Simms

Good morning.

C. Scott Brannan

Good morning, Joe.

Joseph A. Ritchie – Goldman Sachs & Co.

On the gas and fluids handling side, let me ask a question about margins, it was helpful to get the explanation that ask one off was roughly 11% for the quarter. But then Steve, you discussed clearly some other issues that occurred this quarter that impacted the margins, I mean, on a year-over-year basis that was still down 250 basis points. What I’m trying understand a little bit better is the quantification of some of those items and so perhaps, if there is any way to quantify how much the European project business execution issues impacted the quarter and also that the manufacturing inefficiencies that would be helpful?

Steven E. Simms

I think that’s probably a level of detail that beyond, that we would discuss for competitive reasons competitive reasons. So I think we’ll leave it at those are far significant issues that are issues of the several million dollars each type of variety that I don’t believe we try to quantify them.

Joseph A. Ritchie – Goldman Sachs & Co.

I guess maybe said in other way more broadly, would margins have been closed to flat, or potentially up this quarter, absent [those issues] (ph) or would margins still have been down on a year-over-year basis?

Steven E. Simms

I think margins would have still been down on a year-over-year basis. We made some other comments about the pricing pressure in the marine business, as well as our services business well better than the first quarter was not strong as we hope. So margins would have still been down, but not significantly if you adjust it for the large project jobs and the European system business.

Joseph A. Ritchie – Goldman Sachs & Co.

Okay and then I guess one follow-up question. On the commentary that you made earlier regarding embedding potential, additional issues from other projects into your guidance for the remainder of the year, is it possible that some of these other projects will then spill into 2015, or is this an issue that you feel like you’ve got pretty well mitigated for the 2014 timeframe?

Steven E. Simms

I think it’s all contained within 2014.

Joseph A. Ritchie – Goldman Sachs & Co.

Okay, great. Thanks for answering my questions.

Steven E. Simms

You welcome.

Operator

Our next question comes from Andrew Obin with Bank of America. Your line is open.

Andrew Obin – Bank of America Merrill Lynch

The first question, if I look at your end markets, Brazil seems to be a problem, Russia did really well, what I can do is a real question mark, as to what’s going to happen in the second half. We’re having some sort of execution issues that we need to fix going into the second half. So what does it mean in terms of your bandwidth to continue to do M&A over next six to twelve months?

Steven E. Simms

Again, when we try to explain to you is that, if we look at our ESAB business, we think the business is performing very, very well. We believe that the order rates although not showing positive growth year-on-year, we’re seeing signs of improvement in virtually every region around the world for the business. The integration of Victor, fairly large deal just completed is on track and certainly in line with what we had hope, leveraging that a business exactly on the path that we had communicated. So from an ESAB standpoint we believe that we are doing very well in fact, we’re very much on tract with the targeted long-term operating income goal of 13%. In fact, we feel very comfortable about delivering that on time or even a little early.

So we believe the business is in very good shape. We also believe that with the new product commitment that we’ve made and what will begin to hit the market in the fourth quarter, early first quarter of 2015, hopefully, we’ll begin to see organic growth in the space. I’d also say that it’s difficult that it is, we can also look at our market share and we know that if we look at the history of ESAB we’ve gone from losing market share when we acquired the business, stabilizing, to now regaining loss market share particularly in the European arena.

So we feel very good about the business, the team leading the business and just to comment on, as we look at the trends in Russia and Eastern Europe, we’re actually pleased with the way the business has performed and our ability to compete there, both as margin and top line growth, and being a key player and manufacturer there probably helps significantly, as well.

So we are very excited about the opportunities that ESAB and Howden, it goes without saying. Howden continues to grow on the core business. The core margin in the business performed very nicely this quarter, acquisitions were in line with what we expected and we believe that marketplace for acquisition on both of those businesses remain just attractive today as it did a quarter ago, a year ago or in line with our expectations when we began the mission here.

I would say in broader terms, we believe that acquisitions will continue to be a very important part of our strategy. Dan Pryor has added a couple of new leaders to the business. So we’re focused even more intensely on driving acquisitions. At the end of the day, I’ve worked with Dan and we push aggressively to look at deals across all three businesses and we’re constantly thinking through together with our Board where we want to make those resource allocations over time and what are the deals that are going to give us the greatest return for our shareholder and where do we feel we have the greatest chance of being successful and that would be irrelevant for all three business.

In fluid handling, we’ve got a new leader coming in. I’m sure he’ll get a seat on the ground very quickly. The plants that we put in place, we think improve those margins in a six to 12-month timeframe. So we see fluid handling as a business that will be back on track within a reasonable timeframe. So we look at acquisitions and the possibility of acquisition on Alphair. We do have to make sure above all that that we’re running our core business well and we’ll make sure that we strike that balance as we consider where we allocate our resources.

Andrew Obin – Bank of America Merrill Lynch

Now that makes sense and Darryl seems like a great hire. Just a follow-up question, oil and gas, if I look at Emerson’s process orders, they have actually been quite good. Dover printed numbers today sort of not really indicating any particular weakness. Now they’re pretty big on downstream. How much of it do you think is Colfax specific on oil and gas? How much do you think you really are seeing as this air pocket in terms of oil and gas CapEx for now? I guess you guys are in Brazil. So I guess that impacts disproportionately.

Steven E. Simms

Sure. As I said in the comments, for us we track in this vertical market very carefully and closely all the orders that are irrelevant in the space that we’re competing in. And as I’ve said before, our funnels have generally been on the increase in terms of size, but the speed with which those opportunities are moving through the funnel have slowed significantly. And the awards, when they are made, we look at it on a project by project basis on every monthly operating review. Our batting average is very consistent with what we’ve seen in the past. So we don’t believe we’re losing share. We do believe that in our space within oil and gas we’ve seen very important orders shifting out.

C. Scott Brannan

I think on the compressor side you would not get the kind of feedback from our peers there that you quoted for the flow side. There is continued deferral on the compressor side and that’s pretty consistent across the whole market.

Andrew Obin – Bank of America Merrill Lynch

I appreciate it. Thank you very much.

Operator

Our next question comes from Jamie Sullivan with RBC Capital Markets. Your line is open.

Jamie Sullivan – RBC Capital Markets

Hi, good morning.

Steven E. Simms

Good morning.

Jamie Sullivan – RBC Capital Markets

A follow-up on the fluid handling business. The progress that you mentioned that are impacting the margins where you’ve had some challenges, are those complete or when do those get completed?

Steven E. Simms

The projects that we recognize today were completed and shipped in the quarter.

Jamie Sullivan – RBC Capital Markets

Okay.

Steven E. Simms

As Scott mentioned, we have one or two others that have been included in the guidance then they should run their course by the end of this calendar year.

Jamie Sullivan – RBC Capital Markets

Okay, thanks. And then, for the 4Q waiting you mentioned Houttuin and [Tushaco] (ph), the visibility there, what kind of confidence do you have that you’ll see that ramp going into the fourth quarter?

Steven E. Simms

I think we have as high confidence as we possibly can, because we have new orders in hand in those businesses. So we have high confidence.

Jamie Sullivan – RBC Capital Markets

Okay, great. That’s all I had. Thanks very much.

Operator

Our next question comes from John Inch with Deutsche Bank. Your line is open.

John G. Inch – Deutsche Bank Securities, Inc.

Good morning, everyone. When did you see in Western Europe as a whole – could you give us a little bit of color perhaps in terms of how the quarter played out and what you’re seeing today?

Steven E. Simms

Largely from the standpoint ESAB, our fabrication technology group?

John G. Inch – Deutsche Bank Securities, Inc.

Yes, that’s fine. Yes.

Steven E. Simms

Within ESAB, as we think about Europe and if would have focused specifically on Western Europe, we’ve seen the business – again, the level of decline is certainly moderated and overall it’s improved. And what we can see in Europe, as you know, we do have a chance to look at market share in that arena, at least a fairly good surrogate and we’ve seen market share gains that occurred in the fourth quarter and we are confident that that happened again at the end of the first quarter. So we believe that that’s improving. We think we’re gaining traction and we believe we’re in a position where hopefully in 2015 we’ll start to see that market rebound for ESAB and we’ll see growth. But you’re right.

If you look at Western Europe where we’ve got the significant share, the trends are very different. That’s been down sort of in the low single-digits. We’ve seen that trend improved just slightly quarter-to- quarter, very different as you point out than what we see in Russia and the former Soviet Union, where to be honest, our growth there were up in the very high single-digits. In fact, John, it’s picked up momentum since the first quarter.

John G. Inch – Deutsche Bank Securities, Inc.

It’s impressive. Did the market, Steve, for welding in Western Europe, do you think the market – you get pretty good share of data. Did it deteriorate in Europe throughout the quarter?

Steven E. Simms

We don’t think the rate of decline deteriorated any further than we had seen in the recent past.

John G. Inch – Deutsche Bank Securities, Inc.

All right, okay. So that’s sort of encouraging. I want to ask you just go back to – I think Andrew asked the question just about the cadence of M&A. I don’t know that I really understood the answer. My question is if you had a couple of operational issues, why wouldn’t it make more sense to simply focus internally off a little while and take a pause in M&A and then come back to M&A later just to get some of these internal things kind of cleaned up or fixed, or do you feel like you’ve got the bandwidth to do both simultaneously?

Steven E. Simms

Sorry about the confusion to response, my apologies there. At the end of the day, we’ve got three very attractive areas for investment from an M&A standpoint and what I was trying to get across to, I believe was Andrew.

John G. Inch – Deutsche Bank Securities, Inc.

Yes.

Steven E. Simms

We’re in an outstanding position to continue acquisitions in Howden, as well as ESAB and we are focused on correcting some of the operational issues at fluid handling. But keep in mind, as I said, those issues from our perspective were fixed within a six to 12-month timeframe. So it’s not a moratorium on acquisitions for fluid handling, but they understand they need to get the core business under control that would really be an aggressive push here.

John G. Inch – Deutsche Bank Securities, Inc.

That makes sense. And then Steve, just lastly or Scott, how exactly are you making up the fab tech process with the worse top line. you mentioned CBS, but a little nebulous I mean is it – was it, are you driving from just what would have been conservative guidance cushion or there’s some obvious area where you’re driving this?

Steven E. Simms

So I think that it really, that we really do deleverage the tools of CBS as shared in the example there. The other thing is that Clay Kiefaber and his team that leads the business have been unbelievably aggressive about cutting cost and overhead, where it did make sense and redeploying a portion of those savings into investing to the long-term growth, but also improving profitability. the guys are tracking in line, or as you can see ahead of schedule in terms of cost improvement. it’s not just SG&A. you’ll look at what we’ve been able to do on the procurement side, which we’ll share with you in September at the ESAB Day.

I think you’d see that they’re making wonderful strives on many different front, freeing up waste, and being able to improve margins that way, and also putting it into top line growth, which you’ll see in the new product activity from Clay and Ken.

John G. Inch – Deutsche Bank Securities, Inc.

That makes total sense. Thank you very much.

Steven E. Simms

Thank you.

Operator

I am showing no further questions. I would now turn the call back over to Farand Pawlak for closing remarks.

Farand Pawlak

Great, thanks again, for joining us. and we look forward to updating you on the next call.

Operator

Ladies and gentlemen, that does conclude today’s conference. You may all disconnect, and everyone, have a great day.

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