Curtiss-Wright Corp (CW) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Curtiss-Wright second-quarter 2016 financial results conference call. (Operator Instructions) As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Jim Ryan, Senior Director, Investor Relations. You may begin.

Thank you, Tiara, and good morning, everyone. Welcome to Curtiss-Wright's second-quarter 2016 earnings conference call. Joining me on the call today are Dave Adams, our Chairman and Chief Executive Officer, and Glenn Tynan, our Vice President and Chief Financial Officer.

Our call today is being webcast, and the press release, as well as a copy of today's financial presentation are available for download through the Investor Relations section of our Company website at www.curtisswright.com. A replay of this call also can be found on the website.

Please note today's discussion will include certain projections and statements that are forward looking as defined in the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and are not guarantees of future performance. We detail those risks and uncertainties associated with our forward-looking statements in our public filings with the SEC.

In addition, certain non-GAAP financial measures will be discussed on the call today. A reconciliation is available in the earnings release and at the end of this presentation. You also will find some additional charts on sales by end market at the end of this presentation.

Finally, our discussion today of current and future results except for cash flow are on a continuing operations basis, which excludes all previously announced divestitures. For the sake of a proper comparison, when reviewing growth rates for 2016, we are comparing 2016 guidance to pro forma 2015 results, which excludes the one-time AP1000 fee from both sales and operating income within our power segment and Curtiss-Wright overall.

Now I would like to turn the call over to Dave to get things started. Dave?

Thank you, Jim. Good morning, everyone. For our agenda today, I will begin with the key highlights of our second-quarter 2016 financial performance, followed by Glenn, who will provide a more thorough review, along with updates to our 2016 guidance. Then I will return to provide some additional commentary on the AP1000 and margin expansion programs before we move on to Q&A.

Second-quarter EPS of $0.88 topped our expectations. We continue to mitigate the challenging market conditions. Despite a 2% decline in sales, operating income improved 4% overall, while operating margin improved 80 basis points year over year to 12.8% and increased 140 basis points sequentially. Our results were led by a strong performance on the AP1000 program, including the achievement of certain milestones earlier than originally anticipated, and the benefits of our ongoing margin improvement initiatives.

In addition, our second-quarter results reflect yet another solid cash flow performance as we generated nearly $80 million in free cash flow, equating to free cash flow conversion of nearly 200%. Efficient working capital management and higher advance payments on the AP1000 program drove our quarterly performance.

I am pleased to say that we are increasing our full-year free cash flow guidance by another $10 million to a new range of $300 million to $320 million. As you likely saw in our press release last night, we reduced our full-year sales guidance by $50 million. However, through cost containment actions and our ongoing margin improvement initiatives, we will continue to mitigate the impact to operating income.

As a testament to these efforts, we are increasing our operating margins guidance, which represents a 90- to 110-basis-point improvement over pro forma 2015. Overall, despite the drop in sales guidance, we are maintaining our full-year EPS guidance. Glenn will expand upon the key puts and takes to our guidance in a few minutes.

In summary, we remain confident that the diversity of our end markets and our tenacious focus on controlling costs will produce yet another solid year for Curtiss-Wright.

Now I would like to turn the call over to Glenn to provide a more thorough review of our second-quarter performance and updates to our 2016 financial outlook.

Thank you, Dave, and good morning, everyone. I will begin with a review of our second-quarter end market sales.

Overall, we experienced a 1% increase in sales to our defense markets and a 4% decline in sales to our commercial markets. However, sales in both end markets improved sequentially.

Starting in defense, sales for the aerospace and defense market were up slightly from the prior year, but much improved from the first quarter. We experienced higher demand for embedded computing products on several key C4ISR programs, including the Global Hawk UAV, the Apache, and Seahawk helicopters, although those gains were largely offset by lower foreign military sales.

In ground defense, our results primarily reflect lower sales of turret drive stabilization systems, as expected, as the prior year included a one-time benefit related to a large production contract award. Excluding that benefit, ground defense sales were down only 2% year over year.

In naval defense, we experienced solid growth of 4% due to the ramp-up and development on the new Ohio-class replacement submarine program, partially offset by reduced CVN-79 aircraft carrier revenues, as production nears completion.

Moving on to the commercial markets, I will begin in commercial aerospace, where sales were up 5% in the second quarter. This growth was led by higher sales of actuation systems and sensors and controls products to Boeing that were partially offset by lower shot-peening sales to Airbus. As previously discussed, Airbus elected to shift wing-forming on the A320 program to a supplier in South Korea, resulting in lower revenues in 2016. A320 sales in the second quarter declined approximately $3 million from the prior year. Please note that this impact is now essentially behind us.

In power generation, our performance reflects higher revenues on the AP1000 program from new nuclear power plants in the US and China, partially offset by reduced demand in the nuclear aftermarket business.

In the general industrial market, our performance once again reflects lower sales of severe service industrial valves, principally to the oil and gas market, as anticipated. Second-quarter valve sales improved slightly compared to the first quarter and are still expected to improve modestly in the second half of the year.

Moving to industrial vehicles, on-highway sales were down approximately 5% as lower Class 8 truck revenues were partially offset by higher medium-truck revenues. Off-highway and medical sales were essentially flat in the quarter.

Elsewhere, the balance of our more economically sensitive general industrial businesses were relatively flat as higher surface treatment revenues were offset by lower industrial automation sales.

Next, I will discuss the key drivers of our second-quarter operating income and margin performance. Overall, Curtiss-Wright's second-quarter operating income increased 4%, which led to an 80-basis-point improvement in margin to 12.8%. We produced sequential operating margin improvement in all three segments, driven in part by the benefits of our ongoing margin improvement initiatives.

I will begin with the commercial/industrial segment, where both operating income and margin declined compared to the prior year. Similar to the first quarter, the primary driver was lower overhead absorption due to the lower sales in our industrial valves businesses.

Next, to the defense segment, which produced lower year-over-year operating income and margin, including a $2 million favorable impact from FX. The organic decline was primarily driven by a prior-year benefit from the transition from a development to a production contract for our turret drive stabilization systems in the ground defense market. This resulted in a $4 million one-time benefit to both sales and operating income in 2015, which did not recur in 2016.

In addition, we also experienced lower sales and the associated lower overhead absorption primarily on the 747 and various commercial helicopter programs. And finally, the $2 million in restructuring costs that we originally expected during the second quarter in this segment has shifted to the third quarter.

Next, in the power segment, operating income and margin were up considerably compared to the prior year, reflecting significantly improved profitability on the AP1000 program. As a reminder, in the prior year we spent $11 million in engineering and endurance testing and design costs for our AP1000 RCPs, which did not recur this year.

Excluding those costs, our comparable second-quarter segment results were solid, driven by higher absorption on the domestic AP1000 production, as well as initial revenues on the new China contract. And similar to last quarter, the benefits of the AP1000 program outweighed reduce profitability in our nuclear aftermarket business, which continues to be impacted by lower outages and deferred spending in the industry.

Moving on to our 2016 guidance, although we remain firm on our full-year EPS guidance, we made several updates to the remainder of our 2016 guidance. We reduced full-year sales by $50 million and now expect an overall decline of 1% to 3%, down from a prior range of down 1% to up 1%. Approximately $10 million of that decline is related to the weakening of foreign currencies resulting from the Brexit vote, the majority of which impacts the commercial/industrial segment. The balance of the sales decrease is from changes across all three segments, which I will elaborate on in a moment.

We also reduced full-year operating income by $3 million. We lowered segment operating income by $5 million, reflecting the reduced sales outlook, partially offset by lower corporate and other costs due to $2 million of lower pension expense.

As Dave noted, we expect to mitigate the impact to operating income from lower sales through additional cost containment actions within our segments to maintain or improve profitability. As a result, we expect overall Curtiss-Wright operating income to grow 4% to 8%, and we are increasing operating margin guidance to expand 90 to 110 basis points, to a range of 14.2% and 14.4%, a 20-basis-point improvement compared to our prior guidance.

Next, I will walk you through the adjustments to each of the segments. Within the commercial/industrial segment, we have trimmed our segment sales by $15 million to reflect slower growth within industrial valves and vehicles and now expect a year-over-year decline of 3% to 5%. We also reduced the operating income associated with the lower sales by $3 million. However, we are holding our prior margin guidance range of 14.6% to 14.8% as we continue to control our costs and mitigate the slowdown in our industrial markets.

On a sequential basis, we will also benefit as we move beyond the first-half restructuring charges related to facility consolidations, which will benefit profitability in the second half of the year.

Next, to the defense segment, where we have trimmed our segment sales by $15 million and growth rate to a range of flat to up 2%, the change is principally driven by lower system solutions orders on various programs in aerospace defense, as well as delayed contracts for US modernization on the Bradley program and ground defense. Overall, second half sales to these end markets will be up, just not as robust as initially expected.

As a result of the new sales guidance, operating income was reduced by $1 million. Operating margin is now expected to range from 19.5% to 19.7%, reflecting a 40-basis-point improvement over our previous guidance. This improvement is driven by a better sales mix of higher [margins across] business. It is also inclusive of the $2 million in restructuring costs anticipated in the second half of the year.

In the power segment, we now expect sales growth to range from down 2% to up 1%. The decline in sales guidance of $20 million was driven by order delays in the nuclear aftermarket business. As a result, operating income was reduced by $1 million. However, operating margin is now expected to range from 13.2% to 13.4%, reflecting a 30-basis-point improvement over our previous guidance, and an increase of 270 to 290 basis points compared to 2015. This improvement is driven by better absorption due to the higher production volumes on the AP1000 program and cost containment actions. Lastly, the aforementioned adjustments to our 2016 end market sales guidance and the updated waterfall chart can be found in the appendix.

Continuing with our 2016 outlook, we now expect an additional $2 million reduction in pension expense, down to $20 million, which will result in lower corporate and other costs. Offsetting this improvement, we have increased our forecast for interest expense by $2 million due to the unwinding of our interest rate swaps earlier this year. We have also lowered our forecast for diluted shares outstanding to 45.2 million shares, reflecting our ongoing share repurchase activity.

In summary, despite all of the aforementioned changes to our guidance, we continue to expect diluted earnings per share of $4 to $4.15, which represents growth of 7% to 11% over pro forma 2015 results. Looking ahead, we continue to expect a strong second half of the year, with our operating results following a similar trajectory as we have done historically. For purposes of your quarterly EPS modeling, we expect modest sequential improvement in the third quarter, followed by a very strong fourth quarter.

Next, to our cash flow, I will cover our performance through the end of the second quarter, as well as an update on our guidance for the year. Second-quarter free cash flow was strong at approximately $80 million, generating free cash flow conversion of nearly 200%. Year to date, we have generated approximately $141 million of free cash flow. We are very pleased with this strong start to 2016. Our second-quarter and year-to-date performance were primarily driven by higher advance payments related to the new China AP1000 order received in late 2015, as well as solid reductions in our working capital. We remain on track to meet our working capital percent of sales reduction guidance of 180 basis points to 23.6% in 2016 as we continue our march towards top-quartile performance.

Meanwhile, second-quarter capital expenditures of $7 million remain flat to 2015. However, we anticipate that the pace of capital expenditures will ramp up in the second half, including planned facility consolidation. Finally, we are raising our full-year free cash flow guidance to a new range of $300 million to $320 million, up 10% to 18% compared with 2015, and now expect the free cash flow conversion rate to range from 166% to 170%.

Now I would like to turn the call back over to Dave to conclude our prepared remarks. Dave?

Thanks, Glenn. I will begin with some updates on the AP1000 program.

We are currently in full-rate production of our RCPs and are satisfying both our Chinese and US customers on the initial 2007 and 2008 orders, respectively. Thus far, we have shipped 10 of the 16 pumps to China, four each to Sanmen 1 and Haiyang 1, as well as the first pair of pumps to Sanmen 2. We expect to ship the remaining six RCPs to China by year end.

During the past few months, both the Sanmen and Haiyang plants have completed their cold hydrostatic tests. This is a critical milestone test of their primary reactor loop to test the pressurization and watertight integrity of the system as it is started for the first time. Underscoring the significant detail involved in these tests, over 1,700 precision wells joints were successfully tested during Sanmen Unit 1's primary loop hydro test. Key next steps in the process include the functional test, followed by fuel load and eventual connection to the grid.

These are exciting times in the process, as the first AP1000 reactor in the world approaches full startup. In addition, we recently began shipment of RCPs to our domestic customers. Thus far, we have delivered four RCPs and expect to ship the remaining 12 RCPs by the middle of 2017.

Regarding the new China order, which we received at the end of 2015, we continue to receive advanced cash payments to support long-lead material procurement. Most of the manufacturing activities to support the ramp-up in production are expected to begin in the fourth quarter of 2016 and continue through 2019.

At this time, we do not have any additional color to share regarding potential new orders from China, but I will remind you that the opportunities for future AP1000 plants over the next eight to 10 years could be quite large from this country.

With regard to India, following the President's June meeting with India's Prime Minister, there is a growing possibility of an initial agreement between Westinghouse and India, with the potential for six AP1000 reactors, which could equate to 24 Curtiss-Wright RCPs. At the conclusion of that meeting, they issued a June 2017 target date to have a deal in place, effectively giving them a year to decipher the ongoing liability and cost constraints. As with China, the potential opportunity in India is also quite large, and the AP1000 is likely to play a significant role here as well. For our purposes, we believe orders for RCPs to support AP1000 construction in India would come directly from Westinghouse.

Finally, on the topic of the AP1000, we will be hosting an investor day at our plant outside of Pittsburgh on October 6. The event will include an overview of our newbuild and aftermarket nuclear technologies, along with a facility tour to showcase our reactor coolant pumps. Please be on the lookout for the agenda and registration details in the next few weeks. We hope that you can attend and look forward to seeing many of you there.

Next, I will review our strategic margin drivers, where, as a reminder, our goal is to maintain top-quartile status compared to our peer group. Thus far, we remain on track with our operating margin improvement initiatives for 2016. For the sake of simplicity, we are now classifying our margin improvement initiatives into three primary categories.

The first category is operational excellence, which includes supply chain and lean initiatives. I will remind you that these are enterprisewide initiatives put into place in 2014 with new systems, training programs, and assessments, which we knew would take some time to be reflected in our financials. It's not an overnight process, but a journey, and our teams are fully aligned. We expect that the bulk of our future margin improvement is likely to come from this category over the next few years.

The second category is global footprint, which includes consolidations as well as the shifting of labor to low-cost economies. As Glenn noted earlier, the facility consolidation efforts within the commercial/industrial segment are underway, and we expect to recognize incremental savings by year end. However, since we elected to defer the consolidation activity in the defense segment from the second to the third quarter, we will begin to realize more of that segment's savings in 2017. In total, we now expect to incur approximately $7 million in upfront costs in 2016 to support all of our consolidation restructuring initiatives.

As a result, we now expect these actions to generate approximately $12 million in annualized savings, a $2 million increase compared to our prior guidance. We will begin to realize these savings in the second half of this year, contributing to our anticipated second-half margin expansion.

The third category is corporate efficiency, which includes shared services and asset and capital efficiency. Through all of these initiatives, we will continue to focus on long-term opportunities to reduce our costs and improve our margins. We remain committed to a total of $40 million in savings between 2016 and 2018, inclusive of the consolidations mentioned thus far in 2016. We have a good line of sight to achieve these expected savings, which will position us to maintain an operating margin in the top quartile compared to our peers.

In summary, we remain on track for another strong year in 2016. In the near term, we have plans in place to mitigate the impact of topline headwinds on our profitability. Through improved execution and cost control, we expect to produce solid operating margin expansion in 2016, up to a range of 14.2% to 14.4%, enabling us to maintain solid growth in EPS as well.

In addition, we are focused on continuing to generate strong free cash flow, as evidenced by our year-to-date performance and improved full-year outlook. We remain committed to a balanced capital allocation strategy, between operational requirements, returning capital to our shareholders, and strategic acquisitions. Thus far, we have committed $100 million to share repurchase activity in 2016.

We also continue to review potential acquisition candidates and have a fairly full pipeline. As a result, we are maintaining the current balanced approach, which assumes the possibility of a potential acquisition by year end. We will update you accordingly on our progress during the next conference call and reallocate our cash distribution as necessary should no acquisitions materialize.

Finally, we look forward to delivering on our strategy and generating solid financial results that drive long-term value for our stockholders.

At this time, I would like to open up today's conference call for questions.

(Operator Instructions) Myles Walton, Deutsche Bank.

This is actually Lou on for Myles. So, obviously, great free cash flow. Do you guys see that -- anything that prevents that going forward, I guess, as we look out to the future? Again, maybe not the 160% level, but maintaining the 120% level?

Well, yes, I think we've said we're comfortable, I think, over the next couple of years, averaging out about 125%. What swings it year to year are the advance payments, as we've been saying, which is what you're seeing here having influence this year. But I think we are comfortable at 125%.

Is that contingent on an India order coming in, or is that one of those potential swing factors up?

That would be a potential swing factor.

All right, and then just one other one; obviously the -- looking for a pretty steep margin ramp in the second half, and appreciate that you guys have a lot of cost savings. But the one area that looks challenging more so is the commercial/industrial, just going from sort of a 12% in the first half to sort of 17% number in the second half. Anything really driving that? I know you mentioned the restructuring, $2 million in defense in the third quarter. Anything else in the commercial, though?

Yes, there are several factors. There's a lot of things going on in commercial/industrial. First, they will get X million dollars from the increased sales and absorption, and from half to half, you're going from underabsorption in the first half to overabsorption, I'll say, in the second half.

They are also leaving in, from a half-to-half viewpoint, in our margin improvement initiatives. So we've got about $7 million of incremental improvement in that segment in the second half. Then, they have a benefit from more favorable mix in the second half, where they are going to have more sales sensors and controls products versus actuation. That's about, say, $5 million.

From a restructuring standpoint, it's a $6 million swing. They are going to go from $3 million in costs of the first half to $3 million of benefit, net benefit, in the second half. So that is also contributing to the half-to-half. And last, they have a couple other different things. They have some capitalized NRE on the new contract they won, a couple million dollars. So they've got a number of things influencing them in the second half. But that's about it.

All right, sounds good. Thank you very much. Good quarter.

Michael Ciarmoli, KeyBank.

It's actually Kevin on for Mike. Looking at the guidance by end market, a pretty big uptick in commercial aerospace going from down 2% to 4%, now expected to be flat. Any specific programs or drivers there?

No, it was a -- actually, it was a conglomeration of a couple different things. We did reclass some of our items from general industrial into commercial aerospace that were, quite frankly, just in the wrong bucket last quarter. But other than that, we remain pretty much the same. There was no particular program.

Okay, that's helpful. And then ground defense also saw a pretty big swing the other direction. I know you mentioned a couple programs there, I think the delayed Bradley and aerospace defense. Same kind of question: Any specific programs there? Obviously the Bradley, but on the aerospace side in defense?

No particular programs. I will say it is mostly in our systems solutions side of the business versus our COTS. But there is no -- there is no big individual. It is just slower orders is really what it comes down to, based on the incoming orders.

Okay. And then on naval defense, a couple questions here. I will just kind of wrap into one. It sounds like things are progressing pretty well on the Ohio class. I think previously you mentioned having roughly $90 million of content there. Is that generally still what we should be looking for? Any potential development risks that are still out there?

No, that's still the content. And again, I can see that the development now is starting to ramp up as we think we are going to get the first boat in the water by 2019, I think, or 2020, somewhere around there. But no, nothing has really changed. It's just Ohio class ramping up and the lumpiness on the other side of the Virginia class and the aircraft carrier, which is typical for us.

Yes, transition to my next question there on the carrier. So it sounds like CVN-79 wrapping up. I know typically I think you guys like to look at that as kind of a bell curve over a five or so year period. Any gap that we should expect to see between 79 and CVN-80 as they start construction on that over the next couple years? Or is it going to be a pretty smooth transition?

Well, yes, I think the bell curves meet, I think, in 2017. So we will be down this year, but next year will be the end of CVN-79 for us, and the beginning of CVN-80, so probably flat 2017, and then it will ramp up in 2018 and 2019. So next year, we think, is the crossover, the trough, if you will.

Okay, perfect. Thanks. I will jump back in queue.

Ryan Cassil, Seaport.

Nice quarter. Just looking at the industrial valves business, could you talk about pricing that you are seeing? Is it getting any worse in the second quarter from the first? And what are your expectations in the second half?

We see pretty much a repeat of what's been going on for the last several months in terms of price competitiveness. There are those that attempt to get in with let's say new product introductions. The legacy tends to prevail. We are able to mitigate most of those with regard to specifically our low-cost economy approach, which allows us some flexibility there.

But I would say it hasn't increased any more than what it has been. I will say that generally, there has been a slight -- we are going to call it internally a very slight glimmer of hope in second quarter, pickup in some orders versus first quarter, but bearing in mind first quarter was pretty low to begin with. But it does look somewhat promising that there is some light at the end of the tunnel. And again, we are not calling the trough a trough at this point. We're saying that it has picked up slightly. So, a little increase in orders and the request for quotes. So that is a positive sign for us.

Okay. Are your volume expectations in the second half pretty similar to what you saw in the first half? Or is it slightly lower in the outlook?

Well, again, we started off with sequential improvement quarter to quarter, for the year, which is still essentially true. But we only lowered our guidance by $5 million in that area, so it's not quite as robust, but we are still expecting an improvement in the second half. I will say encouraging to us, to follow on to what Dave said, if you look at the book to bill -- this is in our industrial balance business -- it has been over 1 every month this year. And if you go back to the second half of last year, it wasn't over 1 any month in the second half of last year.

So we feel pretty good about this year, but the orders still have to come. They are coming. But the reason we lowered our guidance is because they weren't where we expected them to be. But at least they are moving in the right direction. So that was good.

Okay, all right. Thanks. And then lastly, on M&A, you touched on it a little bit, but could you just talk about the bigger deals, the $100 million-plus deals, what the pipeline looks like there, and perhaps where some of the more interesting opportunities you are seeing are out there in terms of the products you want to add to the portfolio?

We are seeing, as I've indicated in the past, more opportunities for the greater than $100 million that we've been living on for the last couple years. And it's because a little bit more focus has been applied there. And we have looked at quite a few and turned away some. We've got a few in the pipeline that look very intriguing to us, referenced my indication of that sort of that the end of my narrative this morning.

So if things pan out for us, if everything looks good and continues to go the way we might hope it would, then we could see some activity. These things do take some time; you are aware of that, and it's -- some of these we've been nursing for a considerable amount of time. But appetite-wise, it remains, as I've stated in the past, in some of the industrial sectors, even though they are down right now, there's some real opportunity out there for strategic implications to Curtiss-Wright. And that's what we look at, really, is five, 10 years out, what can someone do for us, what can a Company do in our hands better than someone else.

And then also and more specifically, I have talked about valves that have been of interest. It's not talking about the huge valve companies, but there's very niche, some of them are environment related type valves and/or water, that sort of municipal kind of activities, that are of interest. And sensors are always of interest to us. So we look at those. Those tend to be smaller in size.

But in any case, we are actively engaged in looking across the platforms that we participate in today, and across all segments. And it is very opportunistic. If they meet the hurdles that we've set forth, which are high, then we might continue onward. But I'm encouraged by what I am seeing so far.

Okay, great. Thanks, guys. Appreciate it. Nice quarter.

Kristine Liwag, Bank of America-Merrill Lynch.

Dave, I know you provided your capital allocation plans for 2016. But as I look out the next few years, and unless there are significant changes in the end markets, it looks like you will generate conservatively around $200 million of free cash flow per year.

So, for a company of your size, there is a point at which sustaining share repurchases would have adverse effect on your float. So can you perhaps discuss how you think about capital deployment in the long term in the next couple of years and share your vision of what you think the Company will look like then? Is it a bigger and more profitable company? Or is it a company of similar size with just a significant capital return story, perhaps, and dividend increases and things like that?

I appreciate the question, Christine. That's loaded with a bunch of things, and I will try to cover them all in a general answer.

All of the above I am really interested in. I have talked in the past on my desire, my strong desire, to do more strategic acquisitions than share repo, because you are right. There will become a negative implication or effect at some point with share repo, and I think industry at large needs to be concerned with that. But specifically, Curtiss-Wright, from an enterprise perspective, we have and will maintain basically our allocation strategy that we've set forth with.

However, I am really looking forward to some of those acquisitions that I just talked about in response to Ryan's question, what it is that we can do to morph this Company into its next view or next look in this journey. We are not going to turn the ship around. It's already going in the direction we want it to. So we don't have a big fixer-upper. This is a well-positioned, well-oiled machine at this point. You can tell by margin expansion; we are doing a phenomenal job there. The team should be credited with all of that. And we will continue that march.

It's now a matter of feeding the animals in the cages, and that's the way we lovingly describe them amongst ourselves in the corporate offices, and that is bringing in opportunity for them to make better with companies that are perhaps not in a great position strategically with present owners, and/or entrepreneurs want to see that next step in growth with their privately held businesses.

I think that going forward, from a size perspective with the Corporation, I said two years ago, three years ago, I wouldn't be mind being a smaller corporation with higher profitability. And we've taken it to about the bottom of where we want to be, notwithstanding some of the issues we've had market-wide. We would have seen some great organic growth, had we had some nudge from our markets. And I do expect that is going to turn around one of these days. And when it does, we will really see some healthy margin gains out of that, plus the organic growth side.

But I think from the acquisitive side and/or just where we would position this Corporation five, 10 years now, I would like to see a larger corporation that has got even further critical mass in our chosen markets, end markets and product spaces. And like I said, that doesn't mean that we are going to add a fourth or fifth leg to the Company. It's going to be building on the core.

But, again, I am not also talking about a specific number. I am not talking about doubling, tripling the size. I have indicated in the past that I am willing to look at greater than $100 million, up to $1 billion-type acquisition. But you know my search criteria is very selective. And those are hard to achieve. So we will have a lot of dry powder to be able to accommodate that, given the statement that obviously you made and we are looking forward to, and that's great conversion over the next several years, because we believe that we will be able to maintain that.

Then lastly, I will just toss in there, you get the effect of the -- call it a one-off, but one-off strategic long term with some of these AP1000 contracts. You look at China, you look at India, you look at rest of world, there are some huge opportunities out there that will do exactly what we want. And that is to fuel the opportunity for more growth and/or lovingly refer to as throwing meat into the cages of our lions, who do a very good job of running those businesses.

So I really appreciate that question. It does give me an opportunity to expand on what we view as the strategic versus the quarterly kind of outlook.

That's very helpful. And to follow up on that, M&A seems to be your answer. It will take a bigger part in your future strategy. So when you first took on your role, right, M&A was one of the things you put a hiatus to, and you wanted to focus on improving margin. So, with M&A back on the table, can you discuss maybe how that process has changed and how you would maintain discipline? Or is it just pursuing the metrics that you have already outlined in terms of your requirements for targets?

We will continue to maintain the metrics and will continue to remain in the top quartile of our peer group. So that's a must. And I will say that you're going to have some let's say speed bumps that are very positive speed bumps in that when we acquire a company, given the hurdle rates that we've established internally, and the required performance metrics from the target companies, you are going to have a little bit of dilutive effect in that year, the first year of acquisition. There's some acquisition costs and so forth.

But if you look at those, the ones that we look at do transpire and we are actually able to execute on them, might pay a little bit more than what we normally would have paid in years past, but that's because we are buying companies that are producers. They are high-margin performers. They are niche oriented with IP in their chosen fields and technology, high-tech kind of companies, highly engineered.

So we will not return to a serial acquirer like we used to be. I think we did a great job at that. However, you did indicate, and rightly so, that we had some negative effects of that as being a serial acquirer. That's what happened. But when you acquire companies that are accretive versus dilutive, you won't experience that for a protracted period of time. So, the outlook is that they are going to be high-quality companies and they will establish a significant benefit to us.

Great, thank you very much.

George Godfrey, CL King.

Thanks for taking the question. Dave, I just want to dig in a little bit focusing more on the commercial/industrial. You said you were not ready to call a trough, but if I look at -- or you weren't ready to call for growth. If I look at the first half of this year versus the first half last year, looks like in just commercial/industrial revenue, down 6%, but then even with the guidance, the revenue reduction in the second half of this year versus second half last year, it's flattish or 0%. So, as we go into 2017, is growth really on the -- or more likely to have growth rather than declines on the table as we look at that segment heading into 2017?

Well, we are like everybody else, the glass half-full to an extent that it's got to turn eventually. And we are seeing a little bit of pickup, not in heavy duty Class 8s. That has been tough on us, and as everybody else. And we've been talking about that. Medium-duty has done a little bit better. So in Europe in particular, it's showing pretty good. The off-highway, that has picked up a little bit. Construction has been on the good side for us domestically, and global ag obviously has been down.

And so I am not looking at that to be coming back anytime soon, but construction is a positive note there. And then, just general industry, GDP-type activity, it's pretty flat. And our weathervane just tells us that looks to be around that flattish note. So, we are not looking for much there, but [GI] is going to be tough all the way around, I think, for everybody. But we do have some little niche pockets of interest that look like they will pick up.

And I did indicate with some fear and trepidation about the valve side. I am not going to be the first one to call that sucker. It is a difficult one. I listen to all my peers and those outside of the box, but closely related, and they are somewhat giving some signs of life. And as I indicated, we did see a sign of life and a pickup in the last quarter. And Glenn indicated that things have picked up over the last couple of months as compared to last year.

And so I think that what we are going to look at is the pickup in industrial production, plus the GDP, is going to help in 2017. So I think we are coming out of 2016 into a stronger 2017, with a pretty decent outlook. So we are optimistic, and I believe that most of my peer group is trying to hang in that same category, but based on facts rather than smoke and mirrors and some hope.

Got it, thank you. That's very helpful. And then the capital allocation strategy, which I know you will fine-tune as we head into the end of this year, but I believe coming into this year, you dedicated at least one-third of free cash flow for capital returns. Is that on the table for 2017, or potentially could we see no share buybacks if the acquisition opportunity really presents itself? Or is some level of dividends and share buyback still on the table, regardless of what you do on the acquisition front?

We are going to try to maintain a balance there. And I hate to say no share buybacks, because as soon as I say no, then I will announce, yes, we're going to do some. And then I'm going to have to go back and explain that. So we are really sticking with a balanced approach. I would love to have that. It has worked well so far for us. We've done extremely well with the buyback side so far, and then the dividends and so forth.

On the acquisitions, it has been a little bit slow. That's not because we didn't want to spend the money there. It's because, like I've been saying, our hurdles are pretty high, and we are real stingy with our money. And so until and unless I find something that I am really willing to spend the money on, then it will be out of balance with regards to the M&A side. But, like I said, that's looking better, and I am feeling pretty good about it right now. So long term, it's all about balance.

Got it. Well, that's a nice, high-class problem to have: What do we do with all the cash? So, well done.

Yes, we like that. Thank you.

Jim Foung, Gabelli & Co.

Good quarter. Good quarter there. I just want to start off with your margin driver, Dave, because you kind of consolidate that into three initiatives now. And maybe I could just go over the first one, the global footprint. I guess you announced that you are going to spend $7 million this year to consolidate plants, and then $12 million of savings, you expect. Is that -- I guess I wasn't sure. Is that total savings that's going to begin in the second half of this year from the global footprint?

Yes, that really is what's going to happen in this year for -- under global footprint.

Okay. Is there anything else beyond that in terms of beyond issuing just a global footprint consolidation, say in 2017/2018?

We don't have them identified that far out. It has been really from -- we did identify this one that we are doing this year and targeted it because that was leaseholds and things that -- all the moon and stars had to align themselves. But that's not to say that we have given an acquisition that we don't have in mind. Like I said, it's very opportunistic in most cases. Something might come up that that would offer that opportunity to reduce some footprint out there by consolidations. But it's not there right now, but -- so it is always on the lookout for us, and that is a good area of achieving a lot of efficiency improvements.

Okay, very good. And then on the -- I guess the first one, the operational excellence, you didn't identify the amount of savings there. I thought maybe you could help us get an idea of what the potential savings could be this year or next year.

Yes, we haven't gone that level. We've stated that it's $40 million across all three.

Okay.

2016 through 2018. And I will say that the order provided on that slide and in my narrative, the op excellence was number one in terms of being a highest payback ongoing over these next three years inclusive, and then global footprint second, and then corporate efficiency third. So, yes, it's -- you can evenly -- roughly evenly spread that around there, of those three years inclusive.

Okay. And then when you talked about your M&A, as you see a number of opportunities in the pipeline, are these opportunities over $100 million? I wasn't sure, because you're kind of increasing the range of the --

Some of them actually are over $100 million, and that's encouraging. That's great. We've been looking for these for a while, and so let's hope we can execute and they meet our stringent requirements.

Right. And would you consider getting back into the energy market or expanding into that market? You got out at the right time with the sale of Cimarron, which was one of the biggest in the supertankers. And now that the properties have -- pricing of these properties have come down substantially, these things could be 14% margins in a year or so, if the energy market turns back.

Yes, I would agree with you that there are some real deals to be had out there, cents-on-the-dollar kind of thing. But it's just not in it for us. I've stated in the past that one of our problems that we had was we don't have and did not have the bench strength and talent that was from that industry. We've got wonderful talent, but they are not oil and gas people, and they never were oil and gas people. And that is one of the biggest impediments to a success of a company, is hiring the wrong talent to put in place in companies that are at their bottom. It's a tough row to hoe.

And so we have avoided that. So the answer is no, I'm really not interested in getting back into that sector, although I really like the element. We have 5% of our businesses tied to oil and gas still, and that's downstream. And I like those that we are in, severe environments, and we do well at niche oriented. So I wouldn't mind getting into more of those like the ones we already have as core.

Right, okay, so you still have exposure there, but you probably want to just keep it at that level, then. And lastly, just could you give us an idea what pension expense may look like in 2017? With rates still at low levels, do you think you might be a higher expense in 2017 or contributions to your pension, or you have to make contributions to your pension fund?

We are not really ready to talk about the pension for 2017 yet, but we don't think we are going to need to make contributions, primarily because of the big contribution we made last year. But we know there is going to be pressure on the discount rate and probably the rate of return, but we won't know that until later in the year, probably fourth quarter.

Okay. Okay, great. Thanks a lot.

(Operator Instructions) At this time, I am showing no further questions in the queue. I would like to turn the call over to Dave Adams for closing remarks.

Thanks, everyone, for joining us today. We look forward to seeing you in October at our investor day, and we hope you have a great rest of your day. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.