Enovis Corp (ENOV) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Colfax Corporation fourth 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 call is being recorded. I would now turn the conference over to your host. Mr. Scott Brannan, you may begin.

Thanks, Mimi, and good morning, everyone. Thanks for joining us. My name is Scott Brannan and I am Colfax's Chief Financial Officer. With me on the call today is Steve Simms, our President and CEO. Our earnings release is available in the investor section of our website, www.ColfaxCorp.com. We will be using a slide presentation to supplement the call, which can also be found on the investor section of the Colfax website. Both the audio of the call and the slide presentation will be archived on the website later today and will be available until the next quarterly call.

During the call, we will 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 might differ materially from any forward-looking statements we might make today. The forward-looking statements speak only as of today, and we do not assume any obligation or intent 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 Reg G related to those measures can be found in our press release, and in the supplemental slide presentation, again in the investor section of the Colfax website.

As a reminder from previous calls, it is important to note that while we are able to report pro forma sales including Howden and ESAB for 2011, we do not have pro forma adjusted operating income, adjusted net income or adjusted earnings per share for 2011. Accordingly, we are unable to make comparison of results other than sales on a pro forma basis to 2011. And with that, I like to turn it over to Steve.

Thanks, Scott, and good morning, everyone. Today I will review our fourth quarter results and provide a brief operational update, and then Scott will provide more detail on the financials and our guidance for the 2013. And then, we will open it up for questions. We are pleased with the progress made in the fourth quarter on our improvement plans and growth initiatives though actual results fell short of our targets. As you will see, however, this mostly due to factors specific to the quarter. Overall, we believe the strong order rate at Howden, as well as the actions taken in 2012 position us well for 2013.

In Gas and Fluid Handling, bookings were in line with expectations, with orders up 4% for the quarter. This was driven by Howden, whose bookings hit an all-time quarterly high, partially offset by the decline in fluid handling orders which we have been experiencing all year. Revenues were down slightly year-to-year due to the very strong 2011 fourth-quarter at Howden. Despite this, profit margin percentage for the segment was in line with expectations as cost control and the benefits of our restructuring initiatives offset the impact of lower volumes.

In Fabrication Technologies, sales were down 1% compared to the 2011 fourth quarter. We were extremely pleased with the performance of our Soldexa acquisition in November and December, which contributed over $3 million in operating profit before transaction costs and acquisition accounting items totaling $5 million. With the bulk of these non-operating charges behind us, we expect Soldexa will make a substantial contribution to 2013 performance. Most other ESAB regions continued to experience relatively soft demand consistent with the third quarter, due to the weakening of the global economic environment. As discussed on last quarter's call, we expect a slight decline in operating margins at ESAB, as we planned a number of factory shutdowns for December.

Margins declined a bit more than expectations, but these declines were largely related to lower absorption associated with the significant inventory reductions and other actions taken to benefit the business going forward. And I will discuss this in more detail later. Our working capital performance in the fourth quarter was outstanding. We generated $163 million in operating cash flow in the quarter. Inventory balances were reduced by $56 million, accounts payable increased by $56 million, and a significant improvement in construction contract funding was achieved. This accomplishment was broad-based across all three businesses, and shows what focused application of the CBS tools can deliver.

Now for a look at specific results. Adjusted EPS for the 2012 fourth quarter was $0.42 per share, which includes $0.09 per share related to a favorable non-cash adjustment to deferred tax balances. Net sales of $1.03 billion were down 2.1% versus the prior year pro forma period for Howden and ESAB. This includes a 3% year-on-year reduction in revenues due to a stronger US dollar in the fourth quarter. This was largely offset by acquisitions. On an organic basis, that is excluding FX and acquisitions, net sales for the 2012 fourth quarter decreased 2.5% compared to pro forma sales for the 2011 fourth quarter.

Turning now to our business segments. For gas and fluid handling, orders for the fourth quarter were $520 million, an organic increase of 2%, resulting in a quarter end backlog of $1.4 billion. As I mentioned before, bookings for Howden reached an all-time high in the quarter. Net sales for the fourth quarter were $514 million, an organic decrease of 3% compared to $530 million pro forma revenues in last year's fourth quarter. With respect to end markets, please refer to the slides for specific growth rates. As you review that data, you will see that there was significant variation across sectors. This is caused by two things. First, certain trends specific to the individual sectors, which I will discuss in a moment. And secondly, the timing of large project orders and contract accounting driven revenue recognition. Overall, we believe the underlying market drivers remain positive and will result in bookings and revenue growth in 2013.

Focusing on our largest end market in the gas and fluid handling segment, power generation. For the 2012 fourth quarter sales increased by 2% organically. It is notable that the 2011 fourth quarter was extremely strong. So this level of sales growth was in line with expectations. Continuing the trend we have seen throughout the year, sales were particularly strong in China and South Africa. In China, -- growth in China continues to benefit from compliance with aggressive environmental regulations, while a series of large maintenance projects has provided growth in South Africa. As expected, fourth quarter orders decreased 11% organically due to some unusually large orders for air preheaters in the fourth quarter of 2011. However, order intake for all other significant products in the 2012 fourth quarter increased. We expect this end market to show strong growth in both orders and revenue in 2013.

Next, oil, gas and petrochemicals, which is the second-largest market for gas and fluid handling. Sales for the 2012 fourth quarter decreased 13% organically, while orders increased 6.5% organically. The revenue decline was driven by two factors. First, continued volume declines in fluid handling which is focused on certain upstream and midstream applications. As we have discussed at length in previous calls, this is largely due to a slowdown in the construction of pipelines for heavy crudes. Howden's downstream compressor business also experienced a sales decline compared to the 2011 fourth quarter. Much of the Howden decline relates to a large project -- much of the Howden decline relates to large project accounted for under contract accounting, and reflects less project work done in the 2012 quarter, and thus less revenue recognition. In addition, the fourth quarter of 2011 had an unusually high level of activity that related to revenue recognition. However, the oil and gas project list remains strong and is on par with the levels at the end of 2011.

Turning now to Marine, which is primarily served by fluid handling. Sales for the 2012 fourth quarter were up 7% organically versus the pro forma 2011 quarter, driven largely by strength in vessels serving the offshore oil and gas industry. Given the continued decline in overall shipbuilding activity, we are pleased that orders in our Marine segment increased for the third consecutive quarter. We expect continued modest growth in orders and bookings in 2013, despite the challenging market environment.

Next let's turn to the mining end market. The timing of large projects in this sector makes comparisons on a quarterly basis rather challenging. Sales for the 2012 fourth quarter decreased 18% organically, while orders increased 54% organically. However, sales were up 46% in the 2012 third quarter, so the fourth quarter decline does not reflect any underlying trend. In fact, fourth quarter bookings include the largest single contract of secured by Howden in the past 15 years. We remain cautiously optimistic about the prospects for bookings over the next several quarters, given project activity and certain strategies Howden is implementing, and expect overall 2013 mining revenues to increase modestly.

Finally, the general industrial end market for the fourth quarter of 2012, sales increased 4% organically, and orders increased by 1% organically. Sales and orders grew both -- I am sorry, sales and orders both grew in gas handling with steel industry fans performing particularly well. This is partially offset by the declines in fluid sales for the period. We expect flat sales and orders for this market in 2013.

Turning to profitability. Adjusted operating margins for the gas and fluid handling segment increased as expected to 12.1% from 11.1% sequentially, primarily due to volume and the implementation of CBS tools. As an example, our compressor plant in Glasgow, Scotland began a series of [Kaizen] events in February 2012, focused on reducing lead time and inventory levels using the CBS tools of set up reduction, standard work, transactional process improvement and demand pull. The team was able to reduce lead time by 33% for custom products, 30% for standard products. Inventory levels were reduced by over 40%, resulting in a reduction of working capital of $3.4 million by November of 2012.

Another example of CBS making a dramatic difference in business performers is within Howden's process compressor business. The team in Scotland led by James Brown, leveraged the tools of transactional process improvement to create a new process for the control of cash throughout the whole contract lifecycle. The results have been impressive in 2012, with these actions producing a full-year reduction in working capital of $43 million. While each of these examples is impressive, what is perhaps more encouraging is that we literally have dozens of such activities occurring around the Company on a weekly basis. From our perspective, the cumulative impact of a hundreds of associates using CBS to drive process improvements in every area of the business will ultimately result in dramatic gains in quality, delivery, cost and growth for our customers and shareholders.

Now let's turn -- a review of results to the fabrication technology area. Fourth quarter sales for fabrication technology were $513 million, down 2% organically versus pro forma sales for the fourth quarter of 2011 and in line with the guidance that we provided on the last call. At $513 million, ESAB sales were flat with the third quarter, net of the Soldexa acquisition. On a regional basis, revenues versus the previous year were up mid single-digits in South America and Russia, and were flat to down in all remaining regions. We believe that sales were largely in line with regional economic activity, with the notable exception of North America. In North America, which accounts for less than 20% of ESAB's revenues, the decline was driven by continued start-up issues in our newly commissioned solid wire plant which were continued -- anticipated in our guidance and discussed on previous calls. With the CBS-driven improvements we have achieved at this site, we now expect to meet 2013 customer demand.

Adjusted operating income for the quarter was $33.9 million. As discussed earlier, Soldexa contributed over $3 million of operating income before transaction costs and acquisition accounting items totaling approximately $5 million. Excluding Soldexa, ESAB's adjusted operating margin for the quarter was 7.2%, a sequential margin decline of 180 basis points. This was largely driven by three factors. First, using the CBS demand pull tool, the ESAB team drove out over $50 million of inventory during the quarter. While this helped to improve working capital and cash flow, the inventory reduction resulted in lower production levels, which in turn resulted in more than $3 million of under absorption.

Second, incremental cost in excess of $3 million relating to certain production equipment which was out of service in the fourth quarter and which is now back in production, as well as development and promotion costs for the launch of the Warrior equipment line in the fourth quarter. And third, price increases for raw materials in purchased components of over $1 million for certain specialty product in South America, which were passed through to the customer effective on January 1.

While profit margins were down sequentially, we remain confident in our ability to achieve the low teens operating margins over the next three years, that we have spoken about on previous calls. To this end, over the course of 2012, ESAB closed seven manufacturing sites, began aggressively structuring plants in South America, India, China, Europe, and started significantly driving down material costs through product redesign and vendor negotiations. We believe the momentum that we have established positions us well to deliver the $55 million to $65 million in incremental cost savings in 2013. And now I will turn it over to Scott to provide more details on the financials.

Thanks, Steve. As Steve mentioned earlier, sales were $1.03 billion, down 2.5% organically as compared to the pro forma 2011 fourth quarter sales. Adjusted operating income was $88.9 million, representing an adjusted margin of 8.7%. Excluding Soldexa, ESAB's operating margins were 7.2% as Steve just discussed. Gas and Fluid Handling's adjusted margins were 12.1%, in line with expectations. Corporate and other costs were lower than typical, as about $2 million of transaction costs recorded in corporate in earlier quarters were allocated to the operating segments as deals closed, and certain litigation claims and costs were resolved for about $1 million less than previously provided for.

Excluded from adjusted operating income are restructuring costs of $17 million, incurred in connection with the cost reduction projects discussed earlier today and in previous calls, $15.6 million of significant year-one fair value adjustments related to acquisition-related inventory and contract backlog which is now complete at the end of this quarter, and $4.1 million of cost associated with the asbestos insurance coverage litigation. Interest expense was $23.3 million, and that includes about $4 million of non-cash amortization of debt discount and deferred issuance costs, as well as facility fees, the cost of bank guarantees and letters of credit. We made $2.25 million of debt principal repayments this quarter.

Our effective tax rate for adjusted net income and adjusted net income per share for the quarter was 15%. This rate was reduced by 15 percentage points by the impact of a 4.3% reduction in the Swedish corporate tax rate which was enacted into law in December. This is a non-cash benefit, as the lower tax rate is applied to our net deferred tax liabilities in Sweden. There is no impact on tax -- taxes expected to be paid for 2012.

Operating cash flow of $163 million in the fourth quarter was an extremely solid result. As Steve discussed earlier, this excellent performance was broad-based across all of our businesses. We were particularly pleased with inventory management where the tools from the CBS toolkit were particularly effective in driving down finished goods and the work in process inventory. Inventory balances decreased $56 million in the fourth quarter, and net working capital decreased by $142 million from the third quarter end. Finally, backlog was a strong $1.4 billion at year-end. Our book-to-bill ratio for the fourth quarter at 1.01 to 1 was stronger than the typical fourth quarter. That reflects strong bookings in the gas handling business, as Steve mentioned, a record quarter offset by continued weakness in fluid handling.

Turning now to our guidance for 2013. As a reminder, our defined adjusted operating profit excludes asbestos coverage litigation costs which are expected to approximate $5 million in 2013, and restructuring costs which are expected to approximate $30 million in 2013. Foreign exchange rates in 2013 are on average expected to approximate the 2012 averages, and therefore have no material impact on revenue or operating profit. Overall, organic growth is expected to be 1% to 3% for 2013, with revenue expected to range between $4.175 billion and $4.25 billion. On a local currency basis, organic revenue growth by businesses is expected to be, for fabric technology flat to up to 2%, Howden, up 4% to 6%, and fluid handling, from down 4% to flat.

In addition to organic growth, other major changes in 2013 from the 2012 levels which are quantified in the slide deck are, there are two additional weeks of sales for ESAB and Howden, the full-year effect of the Soldexa and COVENT acquisitions, and the second year of our restructuring program which Steve mentioned which is, as we have said repeatedly on earlier calls expected to deliver between $55 million and $65 million of incremental improvement in operating profit. Other key assumptions are laid out in the slide deck. All this results in an increase in margins from 8.6% in 2012 to over 10% in 2013. We expect adjusted earnings per share of $1.70 to $1.90, representing a 27% to 42% increase from 2012 results, on just 1% to 3% organic revenue growth.

As is our practice, we are not giving quarterly guidance. Nonetheless, our business is seasonal, and we believe some direction would be helpful to investors. We currently expect the first quarter of 2013 sales to be flat organically, with additional sales reflecting the additional two weeks for ESAB and Howden, and the effect of the Soldexa and COVENT acquisitions. Adjusted earnings per share for the 2013 quarter is expected to approximate the 2012 first quarter, as higher expected operating profit will be offset by higher interest expense and a higher share count. Adjusted earnings per share should be significantly higher than the first quarter in the second and third, with the second and third quarters being essentially equivalent on an adjusted EPS basis, and the fourth quarter should have slightly higher earnings than the previous two quarters. With that, I will turn it back to Steve for some closing remarks.

Thanks, Scott. As I said at the beginning of the call, we are not fully satisfied with the results we delivered in the quarter. But we are pleased with the progress we continue to make in our improvement plans and growth initiatives. A key pillar of our Charter acquisition pieces was the potential for cash flow and margin enhancement through restructuring and process improvement. This has been a top priority throughout the year, and as we discussed earlier on the call, the results are generally reading through well with more to come. We also recognize that organic growth needs to be an essential element of our shareholder value creation. Accordingly, over the course of the year we have intensified our focus on innovation and the customer experience.

I am excited at the results we are beginning to see. Just a few examples are ESAB's new Warrior product line, which was developed in record time with the support of our CBS accelerated product development tool. While we are pleased with the improved speed to market of the ESAB product development process, we are equally excited with the market acceptance of the Warrior product line, which includes user-driven features like improved set up, easier operation and improved well quality versus competition. We are also pleased with the project wins which Howden continues to chalk up, including an Australian coal mining order, which is the largest contract the Company has received in the last 15 years.

None of our efforts will be successful without a world-class team, and I together with our most senior leaders, spend a substantial portion of our time on this critical priority. Supporting this over the past year, we have significantly strengthened our talent management process, which has resulted in nearly 20 internal promotions. In addition, we continue to attract top external talent, and have added nearly 70 associates at the mid- to senior levels of management. One key recent addition is Lynn Clark from Mead Johnson, who joined our leadership team as our Senior Vice President, Global Human Resources. So in short, one year into the transformation of Colfax, which as we have said before will be a three-year journey, we remain very excited about the future. Both our opportunities to improve and grow the business organically, and the opportunity to strengthen and expand our business through acquisition, where the pipeline remains strong for each of our operating units. With that, I will open it up for Q&A.

(Operator Instructions)

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

Can you start off talking about -- your revenue forecast for fluid for next year is a little bit lower than I thought it was going to be. Can you talk about what the main drivers are for the reduction in revenue in 2013 there?

Yes. I think as we have been saying, consistently over the last three or four quarters, the bookings level has simply dropped off a bit in the fluid handling segment. And in light of the level of backlog in that segment, we have estimated revenues to fall within that range. If we were to get some pipeline orders or some improvement that we have not yet seen, we could perhaps be at the upper end of that range or even exceed it. But, based on what we know today and the backlog that is in place, we think that would be a prudent estimate.

Would Keystone be a big opportunity there?

That would be an opportunity, yes.

If I could get just a couple things on the guidance. The non-cash portion of interest next year?

About $15 million.

And your noncontrolling interest line, what are you forecasting to come in there?

That's up a little bit due, as we have talked consistently, the strength in South Africa and China, where we do have minority shareholders. And there is also a minority interest in the Soldexa business, so that the -- that is only about 9%. That's the reason for the increase in noncontrolling interest.

Okay. And can you could just talk about why the absorption in the fourth quarter was lower than you thought it was going to be? Kind of what happened there?

I will take the accounting answer, and I will let Steve give the operational. We did -- we have been decreasing inventory since the first quarter, so our guidance expected a certain level of inventory reduction. Because we were able to successfully implement the demand pull technique, we were able to bring the inventory down by about twice as much as we originally planned. And, in order to do that, we shut some plants earlier. We did some things to eliminate variable cost, but there was a certain level of fixed cost that flows through into the result. So, that is the accounting answer. I will let Steve give a little operational detail.

Yes, I think, as we have spoken on previous calls, specifically, Clay Kiefaber and his team have done a great job of using demand pull as a way of driving down inventory and improving responsiveness and service level. They were unbelievably successful within our Vamberk facility in the Czech Republic. They have accelerated the rollout of demand pull toward the fourth quarter and certainly will pick up additional momentum in the first part of 2013. So, because of that success, we were able to drive up far more inventory then Scott mentioned. The loading on the facility was down below what we anticipated. We think that, that's clearly the right thing to do. We believe that, that is the right position to set ourselves up for 2013. We will always reduce our inventory and improve our free cash flow as best we can. And we think that is the right decision, or the right trade-off to make.

The next part of the question probably is, what do we think in terms of overall sales? And, how do we think about our manufacturing footprint in light of our flexibility and responsiveness? One of the things that Clay and his team are doing -- in fact, we are doing that in all of our businesses -- is to continually examine and re-examine our manufacturing footprint. As we gain this flexibility, as we gain the responsiveness, we certainly have the opportunity to leverage more volume. And in the instance of ESAB, as you have seen already, to aggressively reduce that manufacturing footprint with seven sites coming out in the last nine months. So, the key driver was our flexibility from demand pull. We took the trade-off consciously to experience a hit from an absorption standpoint, with the objective of improving free cash flow, while improving service level.

I agree that it's the right trade-off to make. Is there an anticipated impact from similar shutdowns in 2013?

That is factored into the guidance. There is a planned inventory reduction, but it is factored into the guidance.

Okay. Thanks.

Our next question comes from Mike Halloran of Robert W. Baird. Your line is open.

Good morning.

Good morning.

So, could you just talk a little bit about how you are expecting the cost savings that you have anticipated to ramp through the year? Is that more back-end loaded as it stands today, and just maybe a little thought on the progression there?

As we have said before, and I think I alluded to it in the comments, we have targeted a range of $55 million to $65 million. The projects that we have identified sort of fall in to those broad buckets that I outlined before. Some of those projects, like the manufacturing restructuring, are well underway. In fact, most of those have been completed in 2012. Others, like the restructuring that I spoke of in China, India, Europe, so forth, will continue on in 2013. So, we really don't seasonalize that, but I think we will see a stronger improvement in margin beginning in the third quarter and hitting in the fourth quarter as well. But we do expect to see that full impact, in the fiscal 2013, of that $55 million to $65 million improvement -- slightly stronger in the third, stronger again in the fourth.

That makes sense. And then, on the incremental margin assumptions, the 20% to 25% that you put in your 2013 guidance. When I think about the blended average, I would have thought something maybe a touch higher than that, so could you talk about what you view the sustainable incremental margins at -- are? Not necessarily for '13, but as you push through these restructuring initiatives, if you expect that to start tracking higher, and any thoughts on that side?

We do. It is obviously dependent on the specific products expected to be sold in each division. I think, looking on a post restructuring, longer term, something in the higher 20%s would probably be realistic.

Makes sense. Appreciate the time.

Thank you.

Thank you. Our next question comes from Jeff Hammond of KeyBanc Capital Markets. Your line is open.

Hi, good morning.

Hi, Jeff.

Just a follow-on, on Nathan's question on fluid handling. Is oil and gas the primary detractor within the end markets? I mean, it sounds like commercial marine, a little bit of growth; general industrial, kind of flattish; and power gen, generally pretty good. Is that right?

I think, Jeff, I think that is a pretty good summary. We have continues to struggle in oil and gas all year long. It hasn't improved. We see some glimmers of improvement, but nothing to really factor in, to change our outlooks. So we continue to believe that this is going to be a slow sector for us through most of -- I would say the first half of 2013. So, unfortunately, that trend has been with us, and we expect it will continue at least for the next six months.

Okay. I was a little surprised at the 4% to 6% number for Howden, just given that I think that has been talked about as kind of a high single-digit grower and just all the regulatory tailwinds. What is driving the maybe a little more conservatism to that growth rate?

Well, we have scheduled the jobs out over the year. As you know, some of the Howden jobs take longer than 12 months to complete. And, as Steve mentioned in the comments on the fourth quarter, there were a couple of very large compressor jobs that got started a little later than we expected them to. So, we are highly confident in that number, but having looked out at the schedule of jobs, that is a growth rate that we were comfortable we could achieve.

Okay. Great. And then, just finally on fabrication technology, can you maybe just go around the different global regions, and talk about where you are seeing demand strength or demand weakness into '13? Or any inflection points in the demand trends?

Well, I think as we have alluded before, we don't get into the details on a market-by-market basis. And I think as I alluded before, I think that in fabrication technologies, we see the industry sort of falling in line with the local strength of the economy. So, for us, if we look at it on a year-to-year basis, we have seen strong performance in the higher-growth or emerging markets, but that growth rate isn't as strong as it had previously been. So certainly in Russia, South -- excuse me -- South America, Africa, those regions continue to perform very well, with most of the other markets being sort of flat to slightly down. And we think that, as we get into 2013, we will see somewhat of a continuation of that, certainly through the first half of the year, where it will certainly be slower in the first quarter, certainly slower in the second quarter, and perhaps a slight improvement in the back half. But, at this point in time, we see things generally in line with what we saw in the fourth quarter.

Okay. Thanks, great.

Thank you.

Our next question comes from Kevin Maczka of BB&T Capital Markets. Your line is open.

Good morning, Kevin.

Good morning. First on footprint, you mentioned always evaluating it. And, of course, you have taken some actions here, closing seven plants in '12. The new facility that you are opening, the consumables facility in the US, can you just talk a little bit more about that? We have talked a lot about reducing footprint with all the cost initiatives you have at ESAB, but what about future adds? Are there more of those that need to happen yet that we should expect in '13?

Yes, thanks, Kevin. That facility is -- that project began under the Charter leadership and was associated with the shutdown of our Ashtabula operation in Ohio. So, that plant was up and running when the acquisition started. As we've pointed out several times before, the startup of that plant has not been a very smooth one. It, frankly, hurt us in North America, in terms of our deliveries. We certainly have lost some business as a result and have not been able to fully participate in the growth in the North American marketplace. I think we have been open about that, and that is just where we are today.

However, we have improved the performance of that plant. And in talking with Clay and his team, they believe that we will be back on track to meeting our demand on that particular site. So, we have been able to get that plant back to where it needed to be. And we think the shift from Ohio to our Midway facility will produce, ultimately, the kind of savings and benefits that were originally targeted. So, we feel good about that.

Answering the second part of your question, we are continuing to shift volume from different plants around the world, typically to lower-cost facilities, wherever that may be. We don't see a lot of new construction on the horizon for our manufacturing sites. We have a very strong manufacturing footprint to begin with. And, ideally, what you see with the benefits of CBS is that we are able to produce more product more efficiently and more effectively in the same footprint that we had a year ago. And so, we are able to produce more and more product in the same footprint. So, as the volume and the business grows, we are hopeful and believe that there will not be a significant investment in new manufacturing facilities. We do not see putting up a greenfield site for quite some time.

Okay.

Did that -- did I answer your question there Kevin?

You did. That was helpful, thank you. Second question, you are ramping up. You mentioned innovation. You are focusing more on that now. You are calling out the Warrior line specifically. I don't know if you can talk to that one specifically or not. But can you just kind of comment on new product innovation, new product introduction? What kind of contribution we ought to expect over the next year or couple of years from those type of efforts?

Yes. That -- the way we think about it is that, for ESAB, they have totally revamped their product development process. They have installed the accelerated product development tool that we use in the Colfax business system. The Warrior product has gone over extremely well. We are having, certainly, all the orders that we can take. It was launched into North America, South America, and the Middle East. That product line will deliver a nice, healthy boost to the overall business. It carries with it solid margins. Being in the equipment side of the business, it's one of the first significant new products from ESAB in many years.

What we have done now, is to start to integrate our product planning to include consumables, as well as our equipment. We think that there are opportunities to create unique value-added products when you bring our consumables and equipment together to provide an end-user experience that's vastly superior to his using of competitive equipment or using competitive consumables on our equipment. So, we believe bundling our consumables and our equipment together, long term, will offer a unique value to the customer and an advantage to our competition. That is a major driver in our product development strategy that Ken Konopa and his team are leading.

So, we focused on a couple of things -- one is, speed to market; two, improving the quality of the voice of the customer integration with our product development process. I think, historically, ESAB had taken the -- an approach where they designed products from a fairly narrow perspective. In many instances, it was sort of what we felt was right, as a team of engineers, as opposed to integrating the end market and the end-user feedback to really drive those designs and drive our product planning.

Under Ken Konopa's leadership and the addition of Steve Argo and a number of resources that we have we been adding to product development, we are seeing a complete change to that philosophy. There is far more time spent on the upfront end-user portion of the product development process, much more effective in integrating that user-driven feedback in the product designs. And then once we have locked in on that, we want to bring those products to market in 12 months or less. And that is compared to a three- to four-year time frame that ESAB was dealing with before the implementation of accelerated product development. So, we are focused on establishing those global product roads that integrate consumables and equipment. We are focused on, once we have locked in on a new product, we want to drive that based on end-user driven features, and we are focused on bringing that to product to market as quickly as we possibly can.

We think -- and what we are beginning to track in each one of our businesses is a vitality index. Pretty basic in most companies, but not something we have driven hard at ESAB and Howden. So, we will see that number click up over the next few years, and we will see that move into a level that you would expect for a growth company. We see organic growth for our business at ESAB, as an example, over the long term, in the low single digits, low to mid-single digits. We think that at Howden, certainly capable of mid-single-digit organic growth as well, driven by new projects at Howden, but also new products at ESAB.

Okay. Also very helpful. And, can you give -- with all that said, so in your guidance for fab tech for '13, do you have any share gain built into that as a result of this, or anything else you are doing?

No, we have pretty much forecast as what we think the overall markets will be in the regions we participate. We haven't factored that share gain into the guidance.

Kevin, what we've tried to do, here, is to build our plans for 2013 around an assumption that these markets don't improve, and that our growth is minimal going into 2013. We want to deliver the operating improvements that we have described, without the reliance on volumes. And so, we are not counting on volume to achieve these numbers. It certainly would help, but we are not counting on that. And we don't see a significant change in the pattern of growth that we have experienced in the 2012, or, frankly, in the first -- fourth quarter of 2012.

Okay. Great. Thank you.

Thanks.

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

Good morning, everyone.

Good morning, John.

So, if we have taken all this working capital out, why are our variable contribution margins only 20% to 25%? Is that just because volumes are still pretty sluggish at 1% to 3% on an organic basis? Is that really the crux of the reason?

That is the major principle, as well the -- we are not finished with the working capital reduction. So, we have factored that into this guidance, continued inventory reduction next year, as well.

Is that based, Scott or Steve, on historical observation? Or is that just what you think you are going to do?

(Multiple Speakers)

I realize it is -- sometimes it is a bit of an art and science. I am just trying to understand, and I realize you are conservative. I am just trying to understand the context of your guidance.

Well, no, we have -- it's not based on historical, because ESAB does not historically have the track record of delivering. This is based on the application of the CBS tools. And, as I think we have tried to be very open about, we got off to a bad start last year in the first quarter. But, we have been making good improvement on working capital, beginning with the second quarter of 2012, and we had a very strong fourth quarter. We expect to keep that momentum going, and the incremental margin does include a continued expectation of that momentum going up. There is some seasonality to it. It is not going to be equal acrosst every quarter. But, we do expect to have a significant inventory reduction in 2013, based on our plan and our CBS tools, not based on history.

And, John, what we are doing is really changing a culture, which I think is what Scott's also mentioned there. And that is, not only being able to brute force these improvements, but to be able to do this quarter to quarter, every single time. So, as I mentioned in the third quarter, we weren't happy with what we delivered in cash flow, and inventory was a major, major part of that. We really drove aggressively with CBS, and we really went through a weekly series of meetings, with every facility, to look at those tools and how they were being used. And I would say that we saw a significant improvement in the fourth quarter. I would say it is a combination of both CBS and, frankly, still some brute force. As we get this further behind us, we continue to change the culture, we will see a culture where this just becomes a continuous way that we run the business. So, we are getting there. We are not there yet. But there are certainly positive signs. I hope, as you see, with over $160 million in cash flow here, that is a pretty good start.

No, I don't disagree. Clay has been very optimistic, though, about the restructuring and profit upturn prospects at ESAB. Based on what you have seen thus far, could there be upside to the $55 million, $60 million -- $55 million, $65 million this year, or even the long-term target?

Now, I am sure if Clay was here, he'd probably want to commit to over $100 million. (Laughter) But, I think that $55 million to $65 million target in the next year is a good target, a stretch target, and I think Clay would reinforce that point. I believe we have targeted additional improvements in 2014 and '15. Keep that in mind, John. I think we've been in the neighborhood of another $70 million coming out after this. So, that $55 million to $65 million is a robust target here for this year. And we have another plus or minus $70 million to go, in the next two years after that.

Yes, I would just reaffirm, I think that is a pretty balanced range. If everything went perfectly, we might do a little better than that. But, realistically, everything doesn't hit exactly on the day you think it's going to hit. So, I think it's a pretty balanced range.

What were your startup costs in the quarter associated with Warrior? And, are there incremental costs in '13 versus '12 again associated with this product?

Well, I think Steve gave some comments in the script that there is $3 million of costs along that nature, of which about half of that number is specific to Warrior.

Yes, I just meant -- but actually my -- the context of my question was, were there other associated costs that were not perhaps direct costs of the $1.5 million -- and then just -- are there -- I don't know that you actually said this, are there incremental costs in '13?

No, is the answer to the '13. I think we tried to isolate the additional costs when we did that sequential quarter-to-quarter comparison. I am sure we didn't get everything, but that should be the bulk of it.

My other sort of last question is here, did the quarter miss toward the end? I mean, the obvious sort of question is, if you exclude your -- the tax benefit, why didn't you preannounce? And -- I don't know -- I am just -- to try and build a track record -- companies that tend to have very significant earnings beats or misses typically sort of pre-announce. Is your philosophy not to do that? Or, did things just sort of come together at the end of the quarter? How would you like to --?

Well, I mean that is obviously a judgment call that you have to consider the facts and circumstances each time. We are on a 4-4-5 reporting cycle. December is obviously a key month to us, and we considered that, and decided not to do it. Certainly, we like to be transparent with the market and keep everybody well informed. We didn't feel the need to do that, this time.

I'm sorry, I don't understand, Scott. You didn't feel the need because you thought things were going to be better as December played out? Or you didn't think $0.09 of miss -- or whatever, $0.08, $0.09 a miss was enough?

No. I mean, we were obviously, as Steve said, not satisfied with that performance. We tried to get the information into the market as fast as we could, and when we had numbers that we were confident in. And we felt this was the appropriate course of action.

Got it. Okay. Thank you.

I think, John, in the future, as we go forward, when we have a miss of this magnitude, and as I alluded to that, we feel good about many of the things that we have done here. We feel that we are well positioned for 2013. We don't like the way that the fourth quarter ended for us. I think, in the future, we will probably be able to communicate a little bit more, if and when we have a miss of that magnitude. So, philosophically, I think we are closer to that. As Scott points out, we want to be transparent, and we will certainly be able to do more and more of that, as we get into the next year.

Thank you. Our next question goes to Jason Feldman of UBS. Your line is open.

Could you comment a little bit on your expected use of cash this year? I think you have got nearly $500 million of cash on the balance sheet. Interest expense in your guidance, as forecast, only nominally decline relative to '12. I am sure part of that is based on rates. But how do you think about balancing debt paydown this year versus M&A?

Well, I think we've been fairly open that we have a reasonably robust M&A pipeline. We are looking to do bolt-on acquisitions, not transformational acquisitions, but bolt-on acquisitions that we could do out of our cash flow. We can't really forecast acquisitions. Hopefully, there will be a reasonable split between how much of that cash will go towards acquisitions, and how much of the cash will go towards debt paydown. So, presumably, either one of those activities should be beneficial to the overall guidance. But, since we can't forecast the timing of acquisitions, we just let -- we didn't assume that either of those things would happen.

Okay. Got it. So that the $90 million interest expense assumption, and you gave us kind of the rate assumptions underlying that, assumes no incremental paydown this year?

It assumes only the required mandatory paydown, which is a small paydown on the term loan B. And we prepaid a significant portion of the term loan A, so the amortizations are reasonably minor. So, I think there should be some upside, there.

Okay. Now, you've talked a couple times in this call about organic growth initiatives, new products, product development cycles, and whatnot. When you think about funding those projects going forward, have you built into your guidance kind of a ramp-up or an increase in the amount of spending there? Is that one of the reasons why the incremental margins are kind of where they are? Or, is that just kind of netting the cost savings? Or is this kind of at a constant level relative to '12?

I think we've built that into our guidance already. And, part of what we are doing, I think, again, ESAB is a good example. They are aggressively examining the SG&A structure, have made a number of reductions in that area, much of which will go toward improving our operating income margins here. But part of it will be redeployed in those areas where we can grow the business more aggressively. We are redeploying those dollars in some instances, both geographic -- from a geographic standpoint, where some markets have more opportunity than others and so we are moving more investment into those areas. We are also focused on products like Warrior, which seem to be going extremely well and we are putting extra investment behind that. But that's included in the guidance that Scott has provided, and we are freeing up those dollars through leveraging CBS. We are freeing those dollars up by reductions in SG&A. And that is how that is sort of being funded.

Okay. That's helpful. And then, lastly, I am sure once we get the 10-K we will get some of the details. On pensions, it sounds like, again, you are funding a fair amount above ongoing expense. How much of an EPS headwind in 2013 is the incremental pension expense itself?

There's no EPS headwind. The pension expense is very comparable for 2013 versus '12. As you know there are significantly lower interest rates, which essentially offset each other. They increase the level of the unfunded liability. But you then apply a lower interest rate against the larger target, and you end up with fairly close to the same answer. So, from a GAAP -- our plans are frozen, so the interest is the largest component of cost. So, there is no significant change in GAAP. The disclosure in the slide deck is for cash flow modeling purposes. We do have fundings greater than the GAAP expense. The numbers come down a little bit from last year, as we had higher top-up payments in the UK in 2012. But, due to the underfunded nature of the pension plans, and the difference in funding assumptions versus GAAP earnings assumptions, there will be a cash flow headwind for pensions for the next few years.

Got it. Thank you.

You are welcome.

Our next question comes from Joe Mondillo with Sidoti & Company. Your line is open.

Good morning, Joe.

Just -- the $55 million to $65 million of cost cuts. I was wondering if you could just break out how much of that is related to closing, consolidating facilities versus other costs? And also, the $70 million in the out years, how do you see that sort of playing out in '14 and '15?

First, on the $55 million to $65 million, we really have not -- we don't -- we haven't broken those savings out by project area. I think the bullet-point list of activities that we are involved in are pretty good examples of the kinds of projects that we are implementing and successfully executing. So, that's the -- that's sort of where we are dealing with in terms of the external communication. In terms of the additional $70 million, we haven't really provided guidance on that. It is probably split almost evenly between those two years. But we are focused, for the most part, on the $55 million to $65 million that we are delivering in 2013.

Okay. And, just in terms of the fab tech margins that you saw in the fourth quarter. It seems like the sales were pretty comparable to the first quarter, and the operating margin was also very comparable. I was sort of thinking that, given the closing, consolidating and the cost cutting that you have already done throughout the year, that you might see some higher margin there. So, I was just wondering if you could talk about that, and is it a product mix, or what is going on there?

No, I think we tried to cover that in the prepared remarks. We have a big difference in manufacturing activity. We had inventory build in the first quarter. We had a substantial inventory takedown in the fourth. We had those other costs that Steve mentioned in the first quarter -- I mean, in the fourth quarter. They were not there in the first. And, those are the main differences. There aren't any other particularly significant items.

Okay. And those plant shutdowns, what is the status on those, going into the first quarter?

Could you ask that one again, Joe?

The plant -- the 10 plants shutdowns that you were seeing in the fourth quarter, what is the status there, right now? And (Multiple Speakers) -- and what is the expectation in --?

There were actually 7 plants that were closed. They are essentially complete. There is a final transition of [Laksa] into Poland, which is continuing to proceed. But that is really -- we've almost unwound that completely. I have talked about Midway, which is the other one. The Midway transition started earlier in the year, as I mentioned, under Charter. We've picked it up, and it's been slow in coming up the curve.

We think we will eventually get the savings and the ongoing benefit associated with that. But, it has been a pretty painful startup. So, the heart of your question, out of seven facilities and transitions involved here, I think the team at ESAB has done a pretty good job. Six have been executed without any disruption to service level. They certainly are in the zone -- have delivered the kind of gains or improvements in the bottom line that we anticipated. So, seven sites done, six down and up, and the others that picked the volume up, have come up very nicely. One that is a bit of a struggle, but it will be online here in 2013. In fact, toward the end of the first quarter.

Okay. Great. And then, just lastly, the corporate expense line, I don't know if you mentioned this, but -- was considerably lower than past quarters. What's going on there, and expectations going forward?

Yes, the prepared remarks did address that. We have acquisition costs that were transferred from corporate. We hold the acquisition costs at corporate, not knowing whether a deal is going to succeed or not. Once a deal closes, we transfer that to the segment. And then we had some settlement and cost related to some legal matters that were left in previous accruals. So, I don't think you should expect any significant change in our corporate run rate. The fourth quarter was abnormally low for those two reasons.

Okay. Great. All right, thanks a lot.

You're welcome.

Burke of Janney Capital, your line is open.

Yes, thank you. Good morning.

Good morning.

On the power generation side, both Howden and Colfax serve that vertical. Did you see continued strength in coal, particularly in China? Or were there any other areas that saw strength?

If we look at the coal markets, two things are going on there for us, as you probably remember from prior calls. When we look at our Howden business, in terms of coal production, they -- power production, they are benefiting from environmentally driven compliance, particularly in China. So that's had a very, very positive impact on the business. We are also seeing -- we have seen some new build activity in Southeast Asia, and certainly a lot of great improvements on the maintenance side of things in South Africa. So, those are the largest driver in what we have seen in the coal segment for power generation. We think the trends that we have experienced will generally be with us and continue into 2013. I think we highlighted on our last call the forecast for a lot of the environmentally driven opportunities, that, that will go out through 2017, if I recall correctly. So a significant opportunity, not only in China, but increasingly in the US, as well.

And on the fluid side, the pump business benefits from natural gas and combined cycle stations. So, you have a little bit different dynamic, but we have had, particularly here in the US, we've had positive demand on the pump side, as well. So, that's been a very good end market for us, both in pumps and in the gas handling.

Great. Thank you. On fabrication technology, you mentioned South America was stronger. In some of your other emerging markets, are you seeing any price competition, or has that eased up?

We have been -- I think that the team in ESAB has been pretty thoughtful in their strategy for pricing. We were pretty aggressive with that in the spring of last year. We have not seen any pricing erosion in any of our key markets, at least thus far.

Great. Thank you.

Our next question comes from Jim Krapfel of Morningstar. Your line is open.

Good morning. What does your 2013 guidance assume for segment level adjusted operating margins? And, if you can't give numeric ranges, would it be correct to assume that fabrication technology sees the largest year-over-year advance, given the large cost reduction efforts there?

We do not give segment-by-segment guidance. However, if you look at slide 35, which gives the detail, most of the organic growth is coming in the gas and fluid segment. And the specific cost actions are principally related to the fabrication technologies segment. So, I believe we have given you sufficient information that you should be able to come up with a reasonable estimate of that.

Jim -- the only thing I would add, Jim, is, don't forget that we have talked about taking Howden from the high single digits to mid-teens operating income. And we feel comfortable with our ability to do that. Ian Brander leads that business and has put together a very compelling strategy to get there over the next three years. So, the margin improvements are nearly as significant, in going from the high single digits to mid-teens on Howden, as they are at ESAB going from the single digits, mid-single digits to low teens. So, significant opportunities on both sides of the business, to be sure.

All right. Thanks for the color. And the second question was, to what extent does your relatively high exposure to Europe constrain your organic growth expectations for 2013? And, generally, what have you seen there?

Well, I would challenge the premise to your question, to start with there. Our exposure to Western Europe is less than the Western Europe's contribution to worldwide GDP. So, although Europe is a very important market for us, we do not feel that -- particularly on the developed portion, that we have any sort of over-exposure. We do have an over-exposure to Eastern Europe and Russia, which we believe to be positive. Growth-wise, Europe has been reasonably flat all year. We haven't seen any -- we don't have any expectation of that changing in 2013.

Okay. Thank you so much.

Our final question comes from Jeff Hammond of KeyBanc Capital Markets.

Just -- you gave some good qualitative color on working capital and targets on '13 and the pension. Can you just give us a sense for how you are thinking about free cash flow for the year?

Well, we are thinking that working capital should contribute at least 1% of sales as a contribution. The principal headwind is the pension funding. And then we do have $30 million of restructuring planned, which is in the slide deck. So if -- those are the main non-operational -- or non-profit-related cash flow items. So, I think the --

And the restructuring number is a cash restructuring?

That is a P&L restructuring. But I think the cash number will be expected to be similar to that.

Okay. Thanks.

Thank you.

I am showing no further questions in the queue. I will hand the call back to management for closing remarks.

Well, thank you, everybody, for attending. We look forward to speaking with you again next quarter. Have a good day. Thank you.

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect, and have a wonderful day.