塞拉尼斯 (CE) 2016 Q3 法說會逐字稿

Good morning and welcome to the Celanese third-quarter 2016 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Chuck Kyrish. Please go ahead.

Thank you, Gary. Welcome to the Celanese Corporation third-quarter 2016 earnings conference call. My name is Chuck Kyrish, Vice President Investor Relations. With me today are Mark Rohr, Chairman and Chief Executive Officer; Chris Jensen, Senior Vice President and Chief Financial Officer; and Scott Sutton, Executive Vice President and President of Material Solutions.

Celanese Corporation's third-quarter 2016 earnings release was distributed via business wire yesterday after market close. The slides for the call and our prepared comments for the quarter were also posted on our website, www.celanese.com in the investor relations section.

As a reminder, some of the matters discussed today and included in our presentations may include forward-looking statements concerning, for example, Celanese Corporation's future objectives and results. Please note the cautionary language contained in the posted slides.

Also, some of the matters discussed and presented include references to non-GAAP financial measures. Explanations of these measures and reconciliations to the comparable GAAP measures are included with the press release and on our website in the investor relations section under financial information.

The earnings release and non-GAAP reconciliations have been submitted to the SEC on a form 8-K. The slides and prepared comments have also been submitted to the SEC on a form 8-K.

This morning we'll begin with introductory comments from Mark Rohr and then we'll field your questions. I'd now like to turn the call over to Mark.

Thank you, Chuck, and good morning, everyone. Our prepared remarks were released with earnings last night, so I will keep these opening comments brief and open the line up for your questions.

Before I discuss our quarterly results, I'd like to talk about an exciting announcement last night, an agreement to purchase to SO.F.TER Group based in Forli, Italy, one of the world's largest independent thermoplastic compounders with operations in Italy, Mexico, Brazil, and the United States.

SO.F.TER. and Celanese are a great fit given our similar design capabilities, excellent technology, and a shared focus on developing customer-oriented solutions. This combination will nearly double the number of engineered material platforms available to Celanese, and will open new markets to expand upon.

The deal will be immediately accretive, adding roughly $0.10 to our adjusted earnings per share in 2017, and we expect to increase that $0.10 by 2 to 3 times over the coming years. This is a natural and thoughtful step forward in the evolution of our industry materials business, and we are extremely excited to begin working with the talented men and women of SO.F.TER. to drive value for our customers. Scott Sutton, who runs our materials core, is here with me this morning to provide additional color and answer your questions about this exciting deal.

Shifting to our consolidated results, we generated a record third-quarter performance in both GAAP diluted earnings of $1.83 per share as well as adjusted earnings of $1.67 per share. We grew segment income by 4.6% year over year and expanded our margin by 250 basis points to 24.1%, our highest ever third-quarter performance. These results were driven by record earnings and profitability in Advanced Engineered Materials and resilient performance in our globally integrated Acetyl chain.

We successfully launched 351 new projects in Engineered Materials in the quarter, and remain on pace to meet our goal of 1,200 new project launches in 2016. We continued our pace of cash generation, with $237 million of free cash flow, and we returned $152 million of cash to our shareholders in the quarter.

As we enter the fourth quarter, we are pleased with the success we have had over the first three quarters of the year, and we're confident in our ability to draw value out of our businesses, generate productivity gains, and to continue to build momentum in new project launches. As such we have maintained our expectation to grow adjusted earnings per share by 8% to 10% for the full year of 2016.

As we begin to look to 2017, we will continue to extend and grow our Engineered Materials pipeline and leverage our low cost integrated global network in the Acetyl chain to best manage the current operating environment we're in. We have set our sights on at least 1,500 new project launches in the Engineered Materials space based on the success we've had to date and the capabilities added through the announced acquisition of SO.F.TER.

We have identified incremental productivity opportunities for 2017, targeting an addition $100 million of benefit for the year. And rolling it all together in net of the $0.30 to $0.40 of headwinds in the total previously discussed, we expect to grow our adjusted earnings per share by roughly $0.60 to $0.70 in 2017 versus 2016. We will refine this initial look as our planning process wraps during the fourth quarter this year and update you with a more informed view in January.

With that I'll turn it over to Chuck for Q&A.

Thanks, Mark. As a reminder, we'd like the callers to limit questions to one question and one follow up. Gary, let's go ahead and get started.

We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from Duffy Fischer with Barclays. Please go ahead.

Good morning. Question around materials solutions, very nice volume gain, price lower. Can you tease out in those numbers how much of that was your new push into non-manufactured molecules in AEM where you're sourcing those other areas? Maybe talk about if you just look at your own business year over year how might those numbers have looked different if you wouldn't have taken that strategy?

Scott, you want to give it a shot?

Sure. If you look at all of our business, of course we add the innovation and technology through compounding to all of it, but most of our platforms today we also manufacture the polymer as well. So all of that is ours and all of that comes through the pipeline. You reference price, and a lot of that smaller degradation you see is really driven by outsized volume growth in Asia related to the other regions.

So that was mostly a mix shift to Asia more so than a mix shift to different types of polymers that you are sourcing from new sources basically?

We grew volumes in every single region, it's just that Asia has been the source of our highest growth over the last couple quarters.

A question on the cash flow. You have guided to better than $850 million this year, but keeping the $2.5 billion over the next three years. If you just look at the run rate, if cash flow basically tracks at the same percentage of earnings and earnings grow the next couple of years, that $2.5 billion should be higher. Is there a reason that cash flow would basically diverge from earnings over the next couple of years and trend lower or no?

We we'll talk more about it when we come out with more complete guidance. But I think that it will not keep the same pace 2016 to 2017 the earnings will. The reason for that is we had a lot of capital expenditure with that methanol plant.

There are some bonus depreciation provisions in the tax code that allowed us to accelerate tax deductions on a cash tax basis. So on a cash tax basis we probably will have higher cash taxes in 2017. Out of the chute I would probably say earnings will grow but free cash flow would be flattish in 2017 and grow again in 2018 still on track for $2.5 billion.

Great. Thank you.

Thank you.

Gary, let's go to the next question please.

Next question comes from Vincent Andrews with Morgan Stanley. Please go ahead.

Good morning, this is Matt Gingrich on for Vincent. I was hoping if you could clarify the $0.30 to $0.40 headwind in 2017 tow and how it translated to pricing and volume forecasts?

You said it was Matt? Is that right?

Yes.

Matt, this is Mark. I think we said in the past that it's about 50/50 price and volume. We're still in the process of wrapping it up. So that is still the most contemporary data we have.

Okay. Great. I was also curious if you could clarify how the VAM margin contraction flows through the various segments and how you have mitigated some of the weakness there so far?

I am not sure I really can answer that. What I'll say is that VAM has been weak as we came off of the coatings -- the coating season started to slow down, but we're already starting to see some tightening in that business as we enter the fourth quarter. And we have some good expectations of a stronger market next year.

Great, thanks.

Let's move to the next question.

The next question comes from Laurence Alexander with Jefferies.

Good morning this is Dan Rizzo on for Laurence. Could you give some color on regional sales trends, particularly with automotive in the US and in Europe in September? Just what you are seeing, if there any -- things have cooled down, or how things are just faring there?

I will comment on autos and then maybe let Scott comment on the overall trends if that is okay. Everybody has access to the data. If you look at the trends, the year-over-year trends, we've had pretty flat in the US.

I think we're up one-tenth of 1% or so. In Europe maybe 4% increase. And in Asia maybe 4% as well increase. If you look at it from a year-over-year point of view, from a trend point of view looking forward the consensus view is that again the US is going to stay pretty flat. Grown a little bit.

Expectation is some slowdown in Europe, I think they're forecasting next 1.3% growth versus a stronger growth of about 4% this year. But again, we are so -- we are in so markets there I don't want you to over react.

You shouldn't over react, we don't over react to all the movement around because our real role in this business is to display some of the products. So we're not dependent on growth new-car builds per se to really drive value here.

Scott, you want to comment about regional growth trends in other areas?

I would just add in engineered materials in the third quarter we grew the volumes roughly 12%, but if you look at by region Asia is above 20%. Europe is running along that same 12% pace, and America is a bit below that. But I would say our growth in auto segment was actually a bit less than our growth in other segments.

Okay. But it would seem that given the strength in those numbers, particularly in AEM, that is more of a function of you guys taking share and then introducing new products versus the overall trend for the end markets, correct?

I don't really think it's so much about taking share, unless you think of it as coming up with a new solution to replace other out of time materials. I mean it's really about closing projects and gaining business through technology and solutions.

Okay. That is what I was referring to. Thank you.

Thank you. Gary, let's move to the next question please.

The next question comes from Frank Mitsch with Wells Fargo Securities. Please go ahead.

Good morning gentlemen, and congrats on a nice quarter. Mark, if I could try and get a better sense as to how the quarter progressed. My sense is that the start to the quarter might not have been as robust as you were ultimately able to achieve. Can you talk a little bit about the pace of business throughout the quarter and then as we enter into Q4 here?

I think we started the quarter with a view of little bit more flatness. I think we had talked about that with you. As we got into the quarter, it was just a lot of energy and effort primarily in materials to really be successful.

So we worked really hard with our projects. We worked really hard on our pipeline, we worked really hard with our customers. Had a few successes, more than we had planned, and that is what really drove the value question.

I think likewise we have been a bit concerned that the chain business could slide more, and they did a phenomenal job making sure that they kept it in check given the slowdown that we anticipated in third quarter in China. So it has been a really material story I think incrementally through third quarter.

And that continued into October, the better-than-expected business trends, is that correct?

Yes.

Great. And lastly, your 30% through on your $1 billion share buyback over 2016 and 2017, does the SO.F.TER. acquisition change the calculus there, or are you still committed to buying back $1 billion before the end of 2017?

No, it does not change the calculus. We're still committed to that.

Thank you so much.

Thank you.

Gary, let's move to the next question, please.

The next question comes from PJ Juvekar with Citi. Please go ahead.

Hi, good morning, Mark.

Good morning, PJ, how are you?

Good. You described the micro deflation within your comments. And your overall year-over-year pricing was down 9%. A big part of that was Acetyls, but AE was also down 4%.

Now that all parties are , what is preventing you from getting pricing? Is pricing just not sticking?

I think my comment -- I perhaps should have changed that comment. I think we have been in a deflationary environment. You and I have talked about that on a couple of occasions.

There are trends that would say that that's I won't say ending, but it certainly has bounced on the bottom and is trending back up. Everything from the movements we've seen recently in oil, if you look at the movements in coal which have been quite dramatic in China, we're seeing some movements in methanol. Of course ethylene is stronger.

I think we're moving back to some inflation. And to answer your question, is there a reason we can't go get that, the answer is no. We look hard to make sure we can find ways to go extract incremental value, and we don't like eating raw material inflation.

But what I will say is that there has been a bit of a -- these things happen very quickly, so sometimes you get stuck for a month or two. But generally speaking I think it bodes well for the establishment of a floor to the deflation that we've seen in the world and hopefully some growth is going to start to now occur.

Okay, thank you. And then on your SO.F.TER. acquisition, how do SO.F.TER. margins compared to yours, and can you give us some ballpark idea of what kind of multiple was paid given your cheap financing? Thank you.

Let me let Scott tackle the margins.

Hi PJ. I would say with regard to the margins, they are lower than our base business right now, but there's a lot of opportunity for synergy there, PJ. We still have to close this. We will get it closed in December, so we are really not disclosing the price; but just to give you a feel for the size of it, it's roughly $300 million a year in revenue.

Thank you.

Thanks, PJ. Gary, let's go to the next question please.

The next question comes from David Begleiter with Deutsche Bank. Please go ahead.

Thank you, good morning.

Morning, David.

Mark, you announced some price increases in sea gas the last week in China. Can you talk about right now what's happening in China from an acid perspective and how you see those market conditions progressing into next year?

I think it's -- right now at this moment the trends in China are good. We've seen some traction on pricing in there driven by I think, David, the residual effects of the inflation in coal and in methanol.

Capacity utilization rates are still quite low in China. But we are seeing some evidence of apparent tightening in the marketplace. I think the trends are good with that.

We also have by our math maybe three million tons of methanol consumption coming into that market through MTO expansions as we enter next year. So kind of like the first half of the year, which is also going to bode well for keeping the pressure on methanol and hopefully getting some more inflation there.

So I think -- what I will just say to you is that we are encouraged about what we see, but it is at the end of the day movements in what is a market that is still pretty sloppy. We will take it day by day here and give you a better update in January.

Very good. And Mark, just on the M&A pipeline, how is the pipeline now ex SO.F.TER? Are there solid opportunities out there going forward?

Yes sir. We hope to make this a habit of routinely announcing new deals.

Thank you very much.

Thanks David. Gary let's go to the next question please.

Next question comes from Bob Koort with Goldman Sachs. Please go ahead.

Thanks very much, good morning.

Good morning, Bob.

Mark, could you just talk a little bit about -- I know you mentioned coal prices are up, certainly up more than NAFTA, and methanol is up. Do you do better in that environment because you can produce out of Singapore, or how do you flex your plants and how do you optimize that given you're buying coal-based and methanol-based inputs in China?

If you look at it today there is probably order of magnitude, if you look at coal prices today in China there's anywhere between $50 and $100 a ton depending on how you do the math, the advantage of being in Singapore on oil-based versus the coal-based in China. Now of course when oil gets back in the $100 range that situation reverses.

So right now it is to our advantage. We are running very, very hard in Singapore and moving that material mostly outside of China, but we can also move it into China as well and compete in regions or areas of China we don't normally compete in.

Got it, thank you. And then on filter tow can you give us some characterization of how you see the market in and outside of China? Maybe some comments around pricing or operating rates? And I know you talk about resetting annual contracts and your competitors have talked about multi-year contracts; can you speak to any developments there? Thanks.

Scott, you want to give it a shot?

Sure. Thanks. I would -- overall I mean if you think about outside of China industry utilization is roughly around 80%, and we've said that before and it's sort of sticking there.

When you take a look at China, the assets that are on the ground in China run full out all the time. What has changed is the imports going into China, and we don't see that drop in imports changing over the next couple years.

Great, thank you.

Thanks, Bob.

Gary, let's move to the next question, please.

The next question comes from Jeff Zekauskas with JPMorgan. Please go ahead.

Thanks very much.

Good morning, Jeff.

Good morning, Mark. In your AEM business I think your revenues were flat sequentially but your volume was up 16% year over year. I think maybe it was 8% in the second quarter.

Why is it that there was so little revenue change sequentially? Were volumes up sequentially or were they flat, how do they compare?

Yes sure okay. Thanks. This is Scott. What I will say is sequentially Q3 is just not quite as big of a volume quarter for us traditionally, so you see some slight drop in volumes sequentially.

But what's interesting this year of course the volume drop is not as much as it has been in the past. Certainly just like you said year on year volumes are up quite a bit, and that is the perfect comparison to do because it's a demonstration of the pipeline.

Okay, great. And then for my follow up, is SO.F. TER. a competitor of yours, or who are SO.F. TER.'s key competition? And is the benefits that you expect to get from the acquisition more cost reduction, or is it from a faster rate of growth? Or if you had to balance those two factors, how do you see it?

What I would say about SO.F. TER., they're not a competitor of ours. This is very complementary. If you think about Celanese, we have nine different polymer platforms the we operate out of.

Well SO.F. TER. adds eight more to us. So we go from nine to 17. What's interesting is about three of their platforms are in engineered thermoplastics, which we are too, but six are actually in the soft stuff, elastomers or TPEs.

I think there will be very good integration of customers and channels as well as we get those additional selling opportunities. So following on that, the main uplift to our synergies, a lot of it is going to be more solutions, better business, bigger positions with customers. There is also going to be quite a number of manufacturing and supply chain enhancements too, so you get the lift from both cost synergies as well as revenue synergies.

And who are their key competitors?

I guess there's a number. But if you look at other people that are in elastomers that is really your best view of who might see SO.F. TER. as a competitor.

Okay great, thank you so much.

Thanks, Jeff. Gary, let's go to the next question.

The next question comes from Jim Sheehan with SunTrust Robinson Humphrey. Please go ahead.

Is your view that you expressed on the filter tow business for 2017 really any different today than what you've communicated previously?

No. It's still within that range and that is as good as we can call it today, Jim. I don't see it being better than $0.30 down, I don't see it worse than $0.40 down. So it's somewhere in that range.

Great. And in Acetyl intermediates, can you elaborate more on what you mean by commercial strategies benefiting you in 2017? How much of that is better supply and demand in the market and how much of that is strategies that you are bringing to bear?

I think the strategic way we work that business has not changed, Jim. We are very active and very aggressive in really making sure we understand the market, understand the windows of opportunity to move materials around, and we find ways to take advantage of that given our global mix in both production and distribution and logistics.

What I'm trying to say in there is I think we're seeing affirmation of the bottom and upside in that business. And as there is upside what we always see is more opportunities surface because of that.

You also see incrementally more margin appearing in the products which gives you more ability to benefit from the steps you take. So we think the platform is strengthening, but I am a little cautious in how much to boast about that right now because the market is really in a tremendously -- a situation of tremendous overcapacity, and we've not had a lot of weeks, even months of good performance yet.

Thank you.

Thanks Jim. Next question please.

The next question comes from Mike Sison with KeyBanc. Please go ahead.

Hello, nice quarter. Almost as nice as the Indians win. (laughter)

Thanks Mike.

You're welcome. But just curious in terms of AM you are on track to generate 200 to 300 new launches this year. You talked about another 200 to 300 for next year. EBIT went up $60 million to $70 million in 2016, so is that a good rule of thumb for what the launches produce in terms of EBIT as we head into 2017?

I think we're all shaking our head yes. I think that is pretty reasonable.

Does the 2017 outlook include SO.F.TER in terms of launches?

In theory it does.

Last question. In terms of how you're going to get this business to be two to three times better, is it just simply moving them into this launch -- new product launch process and just driving revenue in that business?

It's mostly revenue. That's right. We're not looking at this as having tremendous synergy effects, but we do think there's going to be tremendous impact on our ability to work together.

These are great men and women at SO.F.TER. and they do a phenomenal job, well respected by the customers like we feel we are, and we've already have a number of complimentary calls of folks that are one, glad we're doing the deal and glad to have more opportunities now to work with us. It's really all about growth and commercial performance.

Great. Thanks.

Thanks Mike.

Thanks Mike. Gary, next question please.

The next question comes from Arun Viswanathan with RBC. Please go ahead.

Hi, this is Dan DiCicco on for Arun. Thank you for taking my question.

Dan, how are you?

Good. As has been mentioned, we have seen spot methanol and all acetic VAM all tick up to begin the quarter, can you talk about how this could impact margins along the chain in the quarter? And then is there any lag affect that we should be thinking about?

Well there's always a little bit of lag affect, but margins have been so low that it's a pretty modest impact right now. We need to see -- to be honest we need to see more of it sticking, and we probably need the next round of increases really to start to see material impact. I think this is a 2017 story versus a 2016 story, Dan.

And then as a follow up, you provided expectations of $0.35 to $0.45 of EPS from new product launches in 2017. Do you have a similar number for 2016 just in terms of the new product?

Yes, I would answer the same way. You see the projected growth from 2015 to 2016, and all that was really predicated on the new project launches that we had and we grew in 2016 almost 300 projects over 2015. You get the same kind of cycle going.

Okay great, thank you.

Thanks, Dan. Gary, next question please.

The next question comes from Alexi Yefremov with Nomura Securities. Please go ahead.

Good morning, thank you. Just to confirm, the $0.35 to $0.45 growth that you expect next year, does that include the $0.10 contribution from SO.F.TER. acquisition?

We're saying yes. But understand this is the very early spin on that, so I wouldn't read -- I'd like us to be within $0.10 of being totally accurate on all these numbers. For right now we are saying yes.

Okay great. Thank you. And your press release mentions that you have some new products within orthopedic devices. Can this potentially be a much bigger business, and what types of devices or implants are you involved in right now?

That is a prior press release.

That's probably from a prior press release, but of course we're involved in a couple of things, knee implants, hip implants, these kind of things. We're also involved in drug delivery devices where our materials are actually the incipient.

We do have some new development in the drug delivery area. Most of our medical development is actually in devices that are outside of the body. And we have quite a number of projects in our pipeline for that.

Great, thank you very much.

Thank you. Next question please.

The next question comes from John Roberts with UBS. Please go ahead.

Back to the SO.F.TER. competition question, are most of the competitors back integrated into resin production or polymer production as well, or is SO.F.TER.'s competition primarily compounders that are not integrated like SO.F.TER.

John, this is Scott. I would say that you have both. You have some primary players that are back integrated into let's call it one or the other polymers, right. But you still have quite a number of independents that are involved in adding the technology through compounding and through solutions at the customers.

Okay.

John, let me just comment on that. I think what we have found in this business is there is pure unique polymer technology in some areas and there is pure and unique compounding technology in some areas. And in both cases they are generic materials. We are all about that technology.

So when we look at a group like SO.F.TER. and work with them, they bring a lot of unique and not easily reproducible technology through their compounding process like we do. And so we don't at all look at that as being a disadvantage of not being back integrated. In fact it does us a real advantage to not be because you can really go out and buy different materials and really play a pretty strong game in raw material base.

And then on slide 4 where you have step six, next project system step up, is there an easy way to remind me what that encapsulates?

Yes sure John. As we had more and more here, we are driving to an outcome where we are able to launch 2,000 projects a year instead of 1,300 that we're at now. It just involves adding capabilities to our unique model and our unique pipeline system where we are able to represent the broadest platform in the industry to customers.

And we are also able to juggle the 6,000 projects at the same time that it takes to launch 2,000. That is just enhancing our model. You see it as step 6 on the slide.

Okay, thank you.

Thank you. Gary let's go to the next question please.

The next question comes from Hassan Ahmed with Alembic Global.

I wanted to chat a bit about the AI guidance you had given for 2017. You talked about $0.25 to $0.35 of year-over-year increment in 2017. Just trying to get a sense with all of the moving parts, coal prices rising, methanol prices rising, and the like, what sort of a methanol pricing environment are you baking in this $0.25 to $0.35 increment?

And associated with that, purely directionally, are you talking about sudden increment in methanol pricing and then you being able to [parcel the long] and then some? Just tried to get a sense of direction?

What we do this time of year is we go through a process of range finding on what we think the value of our machine can deliver through the next year. So you need to appreciate these are pretty superficial numbers. We've not taken credit for any kind of extraordinary enhancement in methanol pricing and margin that could in theory roll through the chain if that happens.

What I will say is that the trends are encouraging with that regard, but there is not baked into these numbers a miraculous recovery in margins out there. It's just what we will deliver with things the way they are.

Fair enough. As a follow up, obviously much said about the tow business, and you're talking about continued weakness in 2017. As I look at it, it's obviously a relatively consolidated business. But are there opportunities out there?

Are people in the industry talking about further consolidation, if possible at all? And if that is the case, would you consider yourselves consolidators or would you if the environment continues to remain sloppy, would you potentially consider even divesting that business?

Let's start at the top. I think the business is -- has historically been well-managed by the players that are in the business. They've been very thoughtful and I think they will continue to be thoughtful as we go forward.

The offsets occur because of the reduction of imported material going into China, which we've talked at length about. And we've been very clear and as usual the first ones to talk about that stuff. We weighed that out pretty well.

So you've gone from 100% capacity to, as Scott said, roughly 80 percent capacity. So the choppiness you see now is really more that than fundamental decline in secret consumption. In fact we saw some data the other day that would indicate through all this mess and struggles with China, that they've gone from 2.5 trillion or 2.6 trillion sticks down to 2.45 to 2.5. So a 6% to 7% reduction in volume.

There has not been -- it's been disproportionate, the impact of this. So I think the fundamentals of the business are still very good. What I will also say is the industry has independently done a lot to rationalize capacity. This was a business that was in the fibers business, so you think infinitely larger capacity in terms of unit operations and what we have in place today.

My belief is the industry will continue to be good stewards. My belief is this very easy to understand sequence that we're going through will work its way through the system in the years to come out there.

Will the industry have opportunities to consolidate further? Yes, perhaps. [Resolve] is rumored to be selling their business. I don't know the status of that, but you can call them and see if that's true or not. So I think there are people that do look for whether they should have other options that are out there. As for us we're focused on what we do and what we can control and that is where our head set is.

You do consider your business pretty core?

Pretty core? Is that what you said?

As in you won't really be a sell out would you?

Yes we like it. It makes a tremendous amount of money. I know it causes people a little bit of anxiety, but I think if you look at it be mindful there's a zero tax base on this, be mindful that you're selling the business. Because we will have some consternation over its hard to see how it makes economic sense for shareholders to sell it.

Very helpful. Thank you.

Thank you.

Great, thank you. Gary, next question please.

The next question comes from Kevin McCarthy with Vertical Research Partners.

Yes, good morning. Mark, the SO.F.TER. deal is the first chunky one we have seen in a little while, and I was intrigued by your comment that you expect to make a habit of new deals down the road.

Can you talk a little bit about the recent upgrade to investment-grade and where you see balance sheet leverage trending over the next couple of years? Is it the case that you would consider yourself under leveraged, or more the case where you are looking at the pulling excess cash and keeping the balance sheet in the same ZIP Code?

Let me start with that. I'm going to put Chris in a box to say we're definitely under leveraged. Chris, why don't you take it from that point?

Now I know how to answer that question. How much we take on is really going to be correlated to whether we can continue to successfully close some acquisitions. And as Mark mentioned, we are excited about that becoming more of a habit.

Yes there could be some more leverage. We closed this last bond seven years at 1.8%, so that is extremely attractive for us. And we're just trying to think our way through how we turn that into an advantage. By the same token we understand the constraints of being an investment-grade company, and we will work with that.

Kevin, I think what we've been doing is we've been working for a long time to do two things. One is to build a model, if you look particularly in materials, build a model that is leverageable. So we think we have done that.

And part of that process, as Scott has outlined and shows on slide 4 I guess it is, is that we think the ultimate test of this process, the ultimate proof of this process, will be our ability to go out and acquire businesses that are good fundamental businesses but have not been levered the way we are levered. By that I mean it's with a customer breadth we have and depth we have of products.

So we believe that we'll be able to take this and multiply the value of this several times. And so you need to think of us as having a view that we can spend a little bit of money, a modest amount, a reasonable amount of money given our cash flow, take on reasonable leverage and get multiples out of that. And so we look at this as a multi billion-dollar accretive model for our shareholders, and that is what we are focused on doing.

This is the first and we believe there will be many more. And that is what our intent is both next year and the year after that and the year after that is to keep rolling this out. And that machine should add -- it's going to add a lot of value for our shareholders.

I appreciate the color there, Mark. Second question if I may, on productivity. Would you address where the $70 million in identified savings might be coming from across your portfolio?

Maybe on a segment basis? I don't know if it's premature, on the incremental 30 that would get you to 100, but if you've got any insight into fertile ground for digging there we would be interested.

I think we can provide a little more on that in the next call. It is all around the business though, it's not just focused in any one area. I think you can generally think of a lot of this coming from the supply chain.

The good folks at our plants just have a tremendous history of figuring out better ways to do things year in and year out. So a lot of this is energy reduction. A lot of it is figuring out how to use lower grade materials and in some cases that has been worth tens of millions of dollars on a given project.

It's pretty ingrained in the organization. It's a skill set that we'll bring to bear as we continue to do these acquisitions as well.

In January we'll give a better distribution of that.

Great, thank you very much.

Gary, we will take one last question.

The last question comes from David Wang with Morningstar. Please go ahead.

Thank you for taking my question. I just had one on the margins within. They've come up quite significantly over the past couple of years; I think we are at perhaps some record levels now.

I was wondering what you think about the sustainability of these margins considering we've seen pricing decline at least on a year-on-year basis. Are the products sufficiently differentiated that you think the current higher level of margin is the run rate going forward, or would you see some more pressure on that going as you look into the coming years?

Sure David. I would say that most of that margin expansion has come from upgrading portfolio, upgrading projects, upgrading commercial activity. The pricing decline that you do see is more about regional mix.

However, going forward you see us doing things like the next step of a SO.F.TER. acquisition here, there could be another one after that. You might see some decline in margin percentage, sort of a slow one over time. But of course that is completely offset by the absolute increase in profit.

The deals we're pulling in, generally speaking, David, it's impossible to match our margins and it's impossible to match our return on capital. So they will have a dilutive impact to some extent.

But as Scott said, we think that's going to be easily understood, easily pointed out to folks. I would think from a big picture point of view you're going to see it trend down, but that's not a bad thing. It's going to trend down for a lot of good reasons.

And as you make these further add-on acquisitions, because we are lower margin, I was wondering if you could talk about whether or not you think their products are sufficiently differentiated or have some competitive advantage versus what others might be offering. Is there some stability to their margins, or can those improve as well for the targets that you would be looking at?

I mean Scott could give a lot of color on this, but we do deals not to just do a financial leverage. We really do deals to create a better business model. And a better business model let's everyone prosper.

We take the best of what they do and they take the best of what we do and we combine those together and you get two and two equal five and you can perform for more customers better. Extract more incremental value because we're solving bigger problems.

We don't look at this like a can of soup on the shelf and we are just buying a different manufacturer of a can of soup. It's a different concept to us which is technology, access to markets, and application expertise and putting those together in a way that we are solving these problems. That platform is what we get when we -- the extension of that platform is what we get when we bring in a new great company like SO.F.TER., and that's how we extract higher value than let's say what the value of that can of soup is that they sell.

Okay, great, thank you.

Thank you.

Great. We will wrap things up here. Thanks everybody for your time today. We will be around for questions later today. So Gary, at this point I will turn the call back over to you.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.