福斯 (FLS) 2016 Q4 法說會逐字稿

Welcome to the Flowserve 2016 fourth-quarter earnings call. My name is Paulette and I will be your operator for today's call. (Operator Instructions). I will now turn the call over to Jay Roueche, Vice President of Investor Relations and Treasurer. You may begin.

Thank you, operator and good morning, everyone. We appreciate you participating in Flowserve's call today to discuss our fourth-quarter and full-year 2016 financial results. Joining me this morning are Mark Blinn, Flowserve's President and Chief Executive Officer; Tom Pajonas, Executive Vice President and Chief Operating Officer; and Karyn Ovelman, Executive Vice President and Chief Financial Officer.

Following our prepared comments, we will open the call up to your questions. And as a reminder, this event is being webcast and an audio replay will be available.

Please be aware that our earnings materials do, and this call will, include non-GAAP measures. Please review the reconciliation of our adjusted metrics to our reported results prepared in accordance with generally accepted accounting principles, which can be found in both our press release and earnings presentation.

Please also note that this call and our associated earnings materials contain forward-looking statements, which are based upon forecasts, expectations and other information available to management as of February 17, 2017. These statements involve numerous risks and uncertainties, including many that are beyond the Company's control. And except to the extent required by applicable law, Flowserve undertakes no obligation and disclaims any duty to update any of these forward-looking statements.

We encourage you to fully review our Safe Harbor disclosures contained in yesterday's earnings materials, including our Form 10-K filed yesterday with the Securities and Exchange Commission, which are all available on our website at flowserve.com in the Investor Relations section.

I would now like to turn the call over to Mark Blinn, Flowserve's President and Chief Executive Officer, for his prepared comments.

Thank you, Jay and good morning, everyone. Our 2016 fourth quarter played out largely as we expected, delivering adjusted EPS of $0.72 and representing about one-third of our full-year 2016 adjusted EPS of $2.19.

Highlighting the quarter and the full year is the stability we delivered in our aftermarket franchise with constant currency bookings flat with prior-year periods. For the full year, our aftermarket book-to-bill was 1.02 and we built aftermarket backlog during the second half of 2016 even as our customers remained cautious with their maintenance spending.

We believe the Company has largely reached the foundational level in aftermarket activity despite a multi-year downturn in the business cycle that's been longer and deeper than most industry participants have ever experienced. Our higher margin aftermarket work at year-end represents over 30% of our backlog mix, well above the historical trend of roughly 25%.

During the quarter, our focus remained on delivering value for customers and shareholders by driving our transformational realignment program. 2016 completed the second year of our three-year program, so we are deep into the heavy lifting of transforming our global operational footprint.

This initiative was more than a response to the challenging market environment, but was intended to utilize the declining levels of activity to better position the Company geographically for our customer base, lower the total cost and increase the flexibility of manufacturing, help minimize the annual underabsorption we've experienced for over a decade and enhance our profitability and competitiveness when the cycle turns.

As we have communicated the last few quarters, these structural changes to our business have created some disruption in operations, including both the expected and unforeseen. Last quarter, we discussed some of IPD's realignment challenges, which we actively addressed through several leadership changes, including appointing Tom Pajonas to lead the segment. He now directly drives IPD's day-to-day operations and is implementing strong controls, gate checks and accountability in our realignment processes. I have great confidence that the risk of bottlenecks similar to those experienced at IPD facilities receiving new productlines will be minimized in the future, both from a manufacturing and commercial standpoint.

As we have continued to progress on our plan, I am pleased with our ability to apply and leverage lessons learned from completed actions throughout the enterprise to deliver improvement and help stabilize our past-due backlog.

Of note, we have significantly enhanced the governance in all phases of the realignment process, including adding third-party expertise, which together has improved execution and accountability across each discrete project plan companywide.

As such, we expect to work through the past disruption early in 2017, which will begin to abate in the second half of 2017 and be behind us going into 2018.

Some of our actions during the fourth quarter included initiating the planned closure of an IPD German manufacturing facility and we are transferring certain productlines from higher cost facilities to Latin American facilities.

Additionally, we closed two QRC operations and consolidated their operations into nearby Asian and Latin American facilities. From a savings perspective, we delivered approximately $93 million of incremental savings during 2016 and remain on track to deliver $230 million run rate savings in 2018.

To help achieve this target, we expensed about $104 million for the full year of 2016 and we expect to complete the vast majority of the $400 million investment in 2017 as it represents the heavy lifting period of our realignment program and an operational inflection point for the Company. Our plans are gaining traction and will better position Flowserve for success and profitable growth to drive shareholder value.

Turning to our markets and bookings within our served industries, for the quarter, total constant currency bookings declined approximately 4% as OE bookings declined approximately 8%. As discussed, aftermarket bookings have remained resilient despite the caution we saw in the fall of 2016 that continued in the fourth quarter. However, as we mentioned last quarter, 2016 aftermarket sales are behind bookings due to the timing of certain longer leadtime upgrade projects awarded in the first half of 2016, which are expected to ship this year.

Turning now to specific end markets and looking at bookings on a constant currency basis, for the second consecutive quarter, the oil and gas markets were our strongest contributor with nearly 13% growth in the quarter, a positive data point considering full-year bookings to this industry were down approximately 5%.

While we are pleased with this improved second-half performance, in light of a continued guarded macro environment, we are not calling a bottom yet. That said, if crude markets remain stable as they have over the past few quarters, we anticipate that many of our customers' budgets may improve, which would increase the likelihood of a return to more normal maintenance and upgrade schedules with operational spending stabilizing or accelerating.

Additionally, our efforts to increase localization of certain productlines in emerging regions has made Flowserve more competitive with established local competitors in the industry, which we expect will further improve our marketshare over time.

Our bookings also increased year-over-year during the fourth quarter by approximately 7%. Again, this is a positive development considering full-year bookings were down 3%. We continue to expect steady combined cycle natural gas investment in North America as coal plants are retired and nuclear life extensions appear less likely.

Fossil projects continued in Asia and while they tend to be very competitive, our initiative to increase our local capabilities have improved our ability to compete profitably. China continues its aggressive nuclear plans where we participate in both the Western and Chinese designs.

Finally, we are seeing increased bidding activity in solar and desalination markets.

In our general industries, constant currency bookings decreased approximately 11% in Q4 resulting in the 4% decline for the year largely due to valve distributors managing their year-end inventory levels.

On a positive note, we are pleased that our strategic initiatives to increase bookings through the pump and seal distribution channel, particularly outside North America, have begun to gain significant traction evidenced by our solid bookings growth in the quarter and full year.

Consistent with our belief that destocking has largely occurred, we have seen signs of some Gulf Coast distributors investing in inventory during the first six weeks of 2017 for all products.

Chemical bookings were up 1% in the quarter, but down 7% for the year. We continued to see delays in the expected ethylene-driven derivative plants, as well as the second wave of crackers, but we expect these projects to progress in North America and the Middle East, supported by low-cost feedstock.

Looking forward, while we are cautiously optimistic regarding the relative stability we have seen and the potential for improvement in our customers' maintenance budgets, as well as the improved general sentiment for the overall industrial market, our 2017 planning does not assume a significant recovery in our customers' capital budgets.

Accordingly, the Company will continue its internal focus, controlling what we can. That means continuing to execute on our transformational realignment program, improving operational performance, maintaining a disciplined approach to the work we pursue and leveraging our technology, comprehensive product portfolio and driving strategic customer growth initiatives.

In short, 2017 is an important year for Flowserve and one which we believe will position Flowserve for the eventual recovery in our markets.

Let me now turn the call to Karyn to discuss our financial results and 2017 guidance in a little greater detail.

Thanks, Mark and good morning, everyone. Looking quickly at our 2016 fourth-quarter adjusted earnings, we delivered adjusted EPS of $0.72 per share, in line with the expectations discussed on our third-quarter call. Our sequential increase we delivered this quarter included the typical pickup we see in shipping levels from seasonality. Our reported EPS of $0.50 includes realignment expense of $0.20, $0.01 of Brazil inventory write-down, $0.01 of SIHI purchase price accounting, integration and other expenses and $0.03 of negative currency translation.

Turning to our bookings, on a constant currency basis, we declined 4.2% in the quarter. As most of you know, aftermarket activity is among the most profitable work we do, so we are pleased that the aftermarket bookings remained flat year-over-year and this higher-margin work comprised 49% of total bookings. Original equipment bookings continue to reflect the current industry environment and declined 8.2% on a constant currency basis year-over-year.

Regionally, strength in the Middle East and Europe was offset by ongoing challenges in the distressed Latin American market. Sales were $1.1 billion in the seasonally high fourth quarter sequentially, delivering a 13.9% increase. However, year-over-year, fourth-quarter sales declined 14.7% on a constant currency basis.

Aftermarket sales were less impacted, down 8.7% on a constant currency basis versus an OE sales decline of nearly 20%. For the full year 2016, Flowserve's constant currency revenues decreased 10%.

Turning to gross margins, in the fourth quarter, adjusted gross margins decreased 20 basis points versus prior year to 33.2%. Loss of sales leverage, increased underabsorption and pricing headwinds weren't fully covered by our incremental realignment savings.

On a reported basis, excluding the realignment charges of $22 million and $32.5 million in the 2016 and 2015 fourth quarters respectively, and $1.4 million of Brazil inventory write-down in 2016, our reported gross margins increased 10 basis points to 31.0%, demonstrating the benefits from our realignment actions and a 400 basis point mix shift to retire margin aftermarket.

SG&A remains a critical focus with volume challenges continuing at this part of the cycle. Our fourth-quarter SG&A declined $36 million year-over-year or 13.8%. Excluding realignment and other adjusted items for both the 2016 and 2015 fourth quarters, SG&A declined almost $30 million or 12.1% despite a modest variable compensation increase versus prior year.

Fourth-quarter adjusted operating margin decreased 130 basis points to 13.2%, excluding adjustments of $34.5 million and 50.1 million in 2016 and 2015 respectively as loss of top-line leverage and sticky SG&A impacted results.

Reported operating margin decreased 60 basis points to 10.0% reflecting lower realignment expense. Fourth-quarter and full-year adjusted tax rates were approximately 25.2% and 28.3% respectively and were modestly below our full-year guidance rate of 30% to 31%. Reported tax rates were elevated as they included accrued exit taxes for site closures of $4 million and $9.4 million for the fourth quarter and full year respectively.

Turning to cash flow, Flowserve generated total operating cash flow of $169 million in the fourth quarter, demonstrating the normal seasonality we see despite $40 million of realignment cash outflows. Capital expenditures were $25 million in the quarter and $90 million for the full year as we continue to make disciplined investments in our business to support long-term growth.

For the full year 2016, cash funding for realignment initiatives was $128 million. We also returned $98 million to shareholders through dividends, repaid $60 million in debt and contributed $40 million to our defined-benefit pension plans. We ended the year with cash balances modestly improved year-over-year despite the lower earnings profile.

Turning to our 2017 outlook, we are targeting full-year adjusted EPS of $1.55 to $1.85 a share, which includes approximately $0.10 per share of above-the-line currency headwinds. The largest factor in the expected EPS decline from 2016 is derived from lower anticipated organic revenues of down 6% to 11%.

As in past years, our 2017 adjusted EPS guidance excludes realignment expenses, expected to be approximately $155 million, as well as below-the-line foreign currency effects and the impact of potential other future discrete items, which we can't forecast at this time.

Beyond the lower top line and currency headwinds, our 2017 adjusted EPS target range reflects year-end 2016 foreign currency rates, current commodity prices and market conditions, stable to improving aftermarket and book to ship work, an annual reset of incentive goals and merit increases and consistent US tax and regulatory policy.

We provided a few other guidance metrics, including net interest expense in the $60 million to $63 million range and a tax rate of 30% to 31%. While we anticipate continued seasonality in our quarterly earnings profile in 2017, the second-half weighting is expected to be more pronounced in recent years. This belief is based on expectations that the first quarter will represent a substantially lower percentage of full-year earnings than in past periods as a result of lower beginning backlog, the loss of top-line leverage combined with increased underabsorption and an increased SG&A quarter relative to the remaining 2017 periods.

With regard to 2017 cash usage, we expect investing in our realignment program will again be our top cash priority with anticipated spending of approximately $140 million. We also plan approximately $100 million of cash dividends, capital expenditures in the $80 million to $90 million range, about $60 million of scheduled debt repayments and global pension contributions of approximately $26 million to mainly cover service cost as the US plan remains largely fully funded.

With that review, let me turn the call back to Mark for his remaining comments.

Thanks, Karyn. Wrapping up, I believe our industry appears to be moving towards better days ahead. While 2017 is largely expected to be a reset year, I believe 2018 and beyond look more promising.

We have seen some initial signs that y give us confidence such as last year's performance in aftermarket. In 2017, we are participating in an improving number of FEED studies and customers are beginning to schedule more final investment decisions for projects, which could be a positive catalyst in future periods.

The relative stability of oil around the $45 to $50 level for the past couple of quarters has been an encouraging development for our industry and could potentially serve as the catalyst needed to start releasing pent-up maintenance activity.

Flowserve and others in our industry have taken actions to be more efficient and pricing while competitive is rational. Further, the ongoing macro factors and trends that help support the long-term growth proposition for Flowserve remain intact, such as a growing world population; an emerging global middle class that requires more transportation fuels, clean water, electricity and chemical products; aging infrastructure in developed regions combined with the need for new facilities in emerging markets; and the requirement to service existing assets to maintain production levels. Finally, there is a general market view that growth is on the horizon.

However, it is important to note that Flowserve is a late-cycle beneficiary. In 2017, we expect a nearly $300 million decline in revenues from beginning backlog versus prior year, a reset in annual variable compensation performance goals and expect increases in merit compensation, which together make for a sizable headwind.

While we have identified and expect to implement a number of additional cost initiatives beyond realignment, we still anticipate that our customers will remain cautious with their capital and operating budgets in the near term.

Our 2017 guidance reflects our best expectations at this time, taking all these factors into consideration. We expect the first half of the year to be challenging, but also positioned well for the second half of 2017 and beyond.

I've always considered Flowserve's people its most important asset. The last couple of years have been challenging, both due to industry conditions and our realignment program, but our leadership and associates have addressed the situation head-on, professionally and with a sense of urgency. It's been a pleasure working with them over the years. I remain confident that Flowserve has the right strategic plans and the right team in place to build upon its leadership position in the industry while delivering value to our customers and shareholders.

Finally, as you know, last week, we announced that Scott Rowe will succeed me as the Company's CEO and President. He is truly an excellent choice. I am honored to have been part of Flowserve for more than a decade and to work with you. I believe in recent years that we have positioned the Company for a strong future despite current market conditions and I am very proud of the organization. I expect continued success from the Company and our employees and very much look forward to the next phase of Flowserve's performance under Scott's leadership.

As this is my last earnings call, I want to reiterate that I remain confident that Flowserve has the right strategy and the right team in place to build upon its leading position in the industry and achieve increased profitable growth while delivering value to its customers and shareholders through the current market cycle and beyond.

With that, operator, we would now like to open our call to questions from our listeners.

Thank you. (Operator Instructions). Charley Brady, SunTrust Robinson Humphrey.

Good morning, guys. Mark, let me just say congratulations on retirement and good luck to you in the future. It's been nice working with you for these past several years. I think you've done a lot of good things for the Company since you came on board. So thanks for that.

I just want to touch on the aftermarket commentary. I get that aftermarket was constant currency flat, but it was really driven by IPD. EPD, I think it is the second or third quarter where you are still seeing aftermarket bookings down. FCD had a decline this quarter. So I guess I'm truly trying to score up your confidence as we go forward that aftermarket really has stabilized because, with the exception of IPD, the other two segments are still seeing a bit of a struggle in aftermarket.

Well, it comes and goes amongst the segments if you go quarter by quarter. It is probably better to look at it in the aggregate and the reason is we do manage aftermarket across primarily our rotating equipment businesses at a consolidated strategic level.

So the point is don't look at them necessarily as discrete within the segments because we manage it from an end-user standpoint, so you are going to see puts and takes within the segments. I wouldn't read anything into that.

Now I can tell you, if you look at the compares in IPD, especially over the coming quarters, we do expect you'll see some good movement, mainly because of the improved execution, whether it's aftermarket, run rate business, projects. If you are not executing to customers' expectations, they are not going to give you orders.

Fair point. And just as a follow-up, your commentary on getting the past-due backlog out the door, can you quantify how much of the backlog is considered past due and what the margin impact is from any potential penalties or LDs on that?

Well, it has spiked up, as you would expect during a realignment. There's handoffs; there's some that was anticipated. There's some that wasn't. What I can do is point you to IPD and if you look at their margins this last year, they were, even in this part of the cycle, probably 400 to 500 basis points below where they should be.

Why is that occurring? Because you have bottlenecks in the plants. You are not getting the top-line leverage because customers aren't giving orders the way they should. You are spending more money on rework, scrap, all things around cost of poor quality. That feeds into past-due backlog.

The reason I don't want to just use past-due backlog I will explain in a second, but that's one way of illustrating that unexpected execution challenges can have an impact and they do take a while to work through them. The reason I don't want to spend a lot of time on past-due backlog is keep in mind the way we measure past-due backlog is to the committed contractual date.

As you have heard on prior calls, we've said a number of times customers weren't ready to receive it. We go ahead and put that into past-due backlog. So we hold ourselves to a fairly high standard. I think the issues are we look at it holistically around operational issues and IPD has had their challenges.

The other businesses have as well. This happens when you are doing this kind of heavy lifting and that's why I made the comments that while we haven't called a market turn, we do see a couple of inflection points in the business and that is we are getting through a lot of the lifting on our restructuring and the ones that are ahead are the longer leadtime planned restructurings that we can plan better into and you can execute more carefully and slowly.

The second thing is -- we've talked about this for a period of time. Managing your SG&A against declining revenues is difficult and the fact is companies like us, you are behind the curve; you cannot be on the curve. It's very difficult to manage to revenue decline, but we do start to see that abate over the next couple of quarters as well. So those are the things that we have talked about, and as you think about our business this year.

That's a good answer. Thanks. It was helpful.

Andrew Kaplowitz, Citi.

Mark, congratulations and good luck. Mark or Karyn, can you give us a little more color into the puts and takes of the 2017 margin executions? If we were to strip out incentive compensation and adjust for the realignment savings that you gave us for 2017, it looks like you are tracking to 30% to 40% decrementals in the business and that's with some positive mix expected.

So maybe you can quantify how much of the margin pressure embedded in your guidance is related to price or is it just lower volume, (inaudible) on absorption?

Well, as we talked about on our quarter one, you are getting into fixed cost leverage challenges because of the ending backlog and the way that backlog is going to roll out during the year. So that starts you in the hole in terms of EPS and margin.

As you look out over the year, I think what we've talked about before in terms of the incentive compensation -- and let me just make a point here. Don't view incentive compensation as a one-time item. This is completely aligned with our commitment to shareholders. But if you remember when it was a benefit in 2015, Karyn had talked about, through the first three quarters, about 100 basis points of margin benefit with an expected 50 to 100 additional for the year. So that helps you understand that impact in terms of margins, which would be a headwind this year.

Mix is a benefit, as you talked about, as are realignment savings when they are achieved -- a lot of these are going to be achieved during the course of the year. And then as I talked about, catching up on the curve on SG&A. When you are behind the curve, it puts pressure on margins. When you get at the curve, it can sustain the margins and then the mix as well.

Finally we talked about this last quarter, improving IPD, which we are looking to start getting some good traction on in the second quarter. Those are all the puts and takes, but right now when you have fixed cost leverage issues, that's going to put a lot of pressure on your margins over the short term and your earnings as well.

So Mark, just following up on that. Is it fair to say pricing and backlog is again relatively stable in aftermarket and down -- while I don't want to put numbers in your mouth -- but 10% or something like that on the OE side?

Well, we don't want to oversimplify. We look at our business in three forms. There's project business; there's run rate business; and there's aftermarket business. Aftermarket has been relatively stable. That doesn't mean that on some of these project upgrades customers don't want some pricing concessions, but it is still profitable business.

On the run rate, it's been relatively stable. We've seen some pressure. I will tell you a lot of the run rate business is some of our MRO business and also some of the product that IPD puts out. Our best pricing opportunity in IPD is going to be execution to the customers' expectations.

If you look at the project business, it is and has been competitive. The project we talked about recently, the Hengli project, which is the first one we've seen of that size in a number of years, I think three or four years, that was competitive, but we can still make a profit on it and absorb our factories. So as you think about that.

The other thing is, with lower backlog, even though we are doing a lot of restructuring, it will put pressure on absorption.

Just a quick follow-up. You hired Scott last week, so it's a tough question to ask, but did he get to see the guidance that you put out today, Mark, given that he is going to be expected to deliver it over the last three quarters of the year?

Well, I want to point out this is the Company's guidance, not anyone's individual. Scott is definitely -- he is finishing up a role and executing that, but has certainly been engaged in this transition. But I want you to just take a step back and see this is the folks around the table here in the Company, 18,000 people that are providing guidance.

Understand. Thank you very much. Good luck.

Scott Graham, BMO Capital Markets.

Mark, you have been a great leader and a great representative of the Company. I wish you luck. You've been as forthcoming as they come; so thank you for that.

The oil and gas, up bookings last couple quarters. Obviously, that's not coming from the base business. Sounds like you are getting into some businesses which were maybe smaller as a percent of the total, but maybe just grabbing some opportunities.

Can you talk about the interplay between some of the markets that might be smaller, yet still enable you to have an up bookings number, for example, in oil and gas and the interplay between that and your network of QRCs?

Yes, listen, probably the best way to look at oil and gas is to go back to the compare in the prior year and think about it from that perspective because that was a time of great uncertainty. Remember, oil at this time last year went into the $20s and the markets see that. So in the third and the fourth quarters of 2015, people were really holding on tight. By this period a year later, they are still very tight, they are still deferring things, but as we talked about at least we sold some kind of emergency repair work and activity occurring. That contributed.

Also, our broader footprint as we brought some of that online, we were able to participate in some more markets as well. So while we like the increase, especially considering the fact that that market has been challenged for a while, I think it had more to do with the lack of visibility in 2015 as a compare, which is why in our comments right now we are saying the fact is we are three years into a cycle. This has been a brutal, brutal cycle, particularly in the oil and gas industry. The fact is these things come back.

So two things happen. One, as time passes, you get closer to the end of the downturn in the cycle. That's just the way the math works. The second thing is some of the things we have seen in some of the distributors, some of the other activities, in some of the feed work and everything indicate that there is a little more comfort, as we anticipated, now that oil has stabilized. Four, we are almost into the fourth quarter of stabilized oil.

So I think it's more the compare in 2015. There are some strategies that we have executed on that have allowed us to grow those bookings really in all those segments, but if you look at the segments that grew, it had more to do with 2015 uncertainty than anything else, keeping in mind in 2015 and we talked about this, we had a couple of big projects like in our valve business and pulp and paper, some things that you don't see necessarily on a recurring basis.

Yes, that's a good answer. Thank you. My follow-up question is simply, you and Tom, Tom with his long-term relationship to the valves business, have historically had a pretty good bead on the chemical market globally. What do you think is going to get -- the feedstocks, they are not going to get lower. What do you think are going to be some of the -- a catalyst? Is it global GDP? Is it US or Europe GDP? What's the catalyst to get some of those crackers going again? I know that the projects have been drawn up, ready to go in a lot of cases, but just put on hold. What's the catalyst in chemical?

Tom will follow up on this, but global GDP is typically a really good proxy for evaluating those markets. Obviously, you will have pockets based on opportunity. I think just generally looking at the chemical market, the uncertainty that occurred in the last half of 2015 and the first half of the last year was indiscriminate across industries. And so you would hear all companies just not knowing where things were going; there was so much volatility in markets.

So I think when we talk about the oil and gas industry seeing some stabilization at least in the feedstock or the underlying crude and the abating uncertainty, but not the ambitious spend yet, that applied to all industries. Tom, do you have anything else?

Yes, I would just add that there is a discussion going on now within the chemical companies in terms of a next wave of build coming in terms of ethylene, propylene projects. Obviously, they are weighing that against the capacity that has built up over the last couple years.

I would add one other comment also on the chemical, but the same thing applies to the oil and gas that Scott brought up is we are seeing a requirement for more localization of product in the oil and gas area and the chemical area, which bodes very well for our network that we have established around the world for low-cost sourcing, as well as localization of the product. So that is a push that is coming in the oil and gas and that is increasing in the chemical area.

Great. Thank you both. Good luck, Mark.

Robert Barry, Susquehanna.

Mark, I will echo the earlier sentiments. Good luck. Nice working with you.

I did want to just start with clarifying something you said earlier on the incentive comp and merit increases. Should we be assuming in the guide it's about a 50 to 100 basis point headwind on margin? Is that kind of the ballpark?

I will put out what is out there is if you think about headwinds that were specifically mentioned, about $0.10 on the currency, $0.10 on the merit across the Company and what we talked about when we were receiving a benefit in 2015 is about 100 basis points through the first three quarters and 50 to 100 additional through the year.

So with what we've put out there -- and the reason -- we are not trying to not go into specifics. I think what's important about variable comp is it is aligned with shareholders. The other things that we mentioned that we will give you specifics around we can put in penny terms because they are fairly specific and identifiable. If we don't achieve our objectives fully delivering to shareholders, it impacts our incentive comp and it is broad-based across the entire Company. Over 60% of our folks get incentive comp. So I think that's the reason we are being fairly specific, but that will serve as a guide based on what Karyn has indicated. Karyn, anything else?

Yes, just, as Mark was saying, that 150 to 200 basis points, that's really just to give some context on what it has been as it relates to 2014. If we look at 2015 and 2016, they are fairly comparable. 2016 was slightly higher, about 17 basis points at the [line] margin, although both through 2016 and 2015 substantially less than what we were experiencing in 2014.

And as we go through and we look at 2017, as Mark indicated, compensation structure aligned with shareholders at lower earnings, lower variable component and vice versa at the higher end. But the actual dollar amount not determined until the end of the year. It's based on numerous factors, so it's not just earnings; it's bookings, working capital. Platforms may have different results from companies. So there is a range of possibilities; it's not linear.

And simple way to look at it is if you look over the last couple of years, our initial guidance has been impacted by markets and everything and that has impacted our incentive comp.

Yes, okay. Makes sense. I did also want to follow up on a comment you made earlier that we are into the very heavy lifting period of executing the restructuring now. Across what percent of the footprint during this time of heavy lifting would you say leadtimes and on-time delivery are at market-competitive levels?

That's a great question, Robert. If I think about -- for example, in IPD, a disproportionate amount of their facilities were impacted by the realignment and some of the unanticipated inefficiencies. Some of our bigger, very profitable plants were impacted.

Within the custom engineered segment, that has been very organized and thoughtful. That's been a multi-year plan. There has been some impact and less so in the valve business. The primary impact from what I would say the anticipated inefficiencies have been in the industrial business and to my comments earlier, you can see the margin impact versus what it should be at this point in the cycle.

Robert, just to add to that, we are also beginning to bring the leadtimes back in in the IPD business as we execute our recovery plans for those earlier realignments.

Yes. The spirit of the question, I guess, was just the extent to which the orders are temporarily suffering because you are just unable to bid for some things that may actually be out there.

Yes. Quite a bit in the last three quarters of last year and it is still the case right now. Customers don't forget overnight, but as you start to improve, they like the product, they like the way you deliver the product. You don't assume anything, but you can earn them back and Tom is doing a good job of that now. But we're not going to sound the all clear on it yet.

Yes, so it sounds like we are at the trough though, like the leadtimes are maybe (multiple speakers).

They are improving. Yes, they are improving. They are definitely improving, but not at the levels where they need to be.

Okay. Thank you.

Joe Ritchie, Goldman Sachs.

Echo the congratulations and best wishes, Mark. My first question, I just want to touch on the comments on the substantially lower 1Q because those comments can leave a lot to the imagination. And you guys called out lower backlog and higher SG&A. Is there a way you can give us a little bit more detail, some quantification on the higher SG&A because some of that I would imagine is one-time as well due to the CEO transition? So any color you can give is there that would be helpful.

Well, the best thing I can do is to look at trends, the way things have been trending and why they've been trending that way. And what you see in the first quarter is some costs, as you just mentioned, associated with the transition.

We also, if you remember last year in the first quarter, have the [55 and 10], the retirement program, which, because of the way the grants occur, are in the first quarter of every year and until we get into a full three-year cycle, it's going to be an impact, particularly in the first quarter and then it smoothes out because you are cycling through all the grants at that point in time.

So those are the two primary impacts that you see in the first quarter of this year, a couple of other items, but part of it also in the G&A is, as we mentioned in the call, there are some actions that we started taking at the end of the year, which we couldn't do necessarily before the holidays, so we are implementing a lot of those this year. That also has an impact. So that's on the SG&A line.

As you walk up the P&L and you look at where backlog is and our commentary around some of this is longer leadtime and will be in future quarters, particularly in the aftermarket project, there is a point in time where you get tight to your fixed costs and every dollar of revenue has a disproportionate impact and that's what you are seeing in Q1 this year is that impact on G&A, which will certainly -- not only will that trend abate because of the expenses that I just mentioned to you in the first quarter, but also some of the cost leverage that we are going to get.

That's why I referenced the curve on G&A. We've been behind it even in the trend. It will be a little setback in Q1 because of the things I just talked about, but we will catch up with the curve. Companies can't get ahead of the curve, but we will catch up with the curve during the next few quarters. Does that help?

The color is definitely helpful, Mark. I know historically 1Q would imply that, based on your guidance, that you'd be closer to $0.30 and because of the wording and -- I'm struggling with the quantification here. I guess the follow-up I have is are we talking that 1Q could potentially be negative, or is that being a little too draconian based on the cost structure and the backlog that you see today?

Joe, that's trying to give me -- you want me to give you Q1 guidance, which I won't give you. But I think the way -- and Karyn made these comments -- is again think about fixed cost leverage. You do get to a point where it has a disproportionate impact to the downside, but, by the way, as you start to lower that fixed cost leverage, you get leverage on the way up. And what we are saying in Q1, if you looked at it historically, it was much more variable to that fixed cost as we were moving down in Q1 because of where revenues were. And look at our year-end backlog. This year, we are much tighter to that fixed cost point for the reasons we talked about in Q1, but we will lever up during the course of the year.

So that's probably the best context I can give you because we don't provide specific guidance, but we want to just be clear with you what's going on with the business, especially around fixed cost leverage.

Got you. And maybe if I could ask one more follow-on. You mentioned that the first six weeks you were starting to see some improvement from your Gulf Coast distributors. That's a really good sign for the first quarter. Is your expectation then as we progress throughout 1Q, it would seem the backlogs should be up or orders should be up at least sequentially? Is it possible that you guys could actually see some growth year-over-year as well, or is it too early to tell?

Well, I think as we look at it, we don't have any heroic assumptions in terms of the order book this year. We remain cautious and that's what you heard in our comments. We do see some encouraging signs, but I just want to remind you we saw this and the industry saw this in the summer of last year and then we were surprised by what happened in September and during the remainder of the year.

So while we see some encouraging signs, I think we are going to just remain cautious because we don't want to go through that discussion again.

Nathan Jones, Stifel.

Congratulations, Mark. Best wishes for the future. It's been my pleasure working with you for the last seven or eight years. Can we talk a little bit more about the aftermarket short-cycle activity? It sounds like that is trending a little bit better. We have been hearing talk about a material pickup in turnaround activity coming given crack spreads are down a bit. Curious what you are seeing there.

A lot of the big refiners have talked about taking downtime on their 4Q calls. Some of those distributors down there have talked about adding significant amounts of inventory. It looks like maybe the turnaround season gets started a bit earlier. Just your thoughts there.

In the Gulf Coast, as we mentioned, we've seen some of the inventories come up in our distributors and I will tell you that is a good early sign because they tend to get out of the blocks first because they have to have it in inventory and ready to deliver when the customer wants it.

We have seen some of the other things in terms of the spend and that's why we talked about expectations around normal maintenance levels. What we haven't called for is anything really accelerated in terms of pent-up demand. If that were to occur, that is certainly going to be a benefit. I think it goes back to where we were, Nathan.

A lot good has happened since the election, I think we would all agree, in the markets. I think we want to just see some of it on paper before we start getting more bullish on things and I think everybody else is. The stock market seems to be ahead of reality at this point, but reality may catch up.

If we were thinking about a normal level of activity for your aftermarket business, wouldn't that imply some fairly significant growth from where you are right now?

Yes, if you get back to normal activities, absolutely, because what you have seen in the order book in the last couple of years is strict cash management from all the way up the value chain, from the large integrateds to the smaller players. Just think about it this time last year, Nathan. Folks were wondering if they could issue equity to shore up their balance sheets. The question was were banks going to start having to adjust loan covenants. It was a completely different environment and when industry gets into that situation, it's frightening for them.

And so you are seeing some of that abate and as we talked about stable oil prices help and a little more visibility, perhaps even visibility into regulation. We will see what happens with the US pipelines. They have certainly become much more viable in the last month in terms of discussions than they were before.

So I think all these things play well. We just look forward to seeing it in action, but the good early sign, as you mentioned originally, is some of the distributors in the Gulf Coast.

And then my follow-up is actually for Tom. If we could just get a little bit more detail on the actions taken so far in IPD. You talked about getting good traction there beginning in the second quarter, but margins currently were probably 400 or 500 basis points below where you thought they should be at this point in the cycle. Can you give us some idea of how you would expect those to progress through the year and maybe what kind of exit rate we'd be looking at at the end of 2017?

Yes. So maybe just in general terms some of the things we are doing on IPD. First of all, all the issues, they are not systemic unsolvable issues. These are all things that we can deal with. If you look at -- I would characterize the situation we got into as a little bit of choking of the businesses. We do have some system changes where we were going from one SAP to an Oracle change and the bill of materials wasn't done. So these are all solvable issues in the business.

What we are doing is we are mapping out in a very specific detailed form all the things that need to be done on these early realignments, and I would stress that these are on the early realignments that we've done. So our governance now has been I would say significantly upgraded with a lot of specifics overall in the business.

So I would expect obviously the past-due backlog coming down over time and we've already made progress already in the last several weeks on the past-due backlog.

Nathan, you asked the question on margins. We talked about before getting this business back to where it was before, the 14% to 15%. I had talked about the 400 to 500 basis points just based on qualitative work, looking at what it should have been and looking at the impact. When your two biggest plants get choked, as he used the term, it's very, very expensive in the business.

I think the other thing -- I do want to remind everybody, we are not calling out SIHI PPA or anything like that because it's integrated into the business, thank goodness. That is a really good company with a good product. We are a little slower integrating it and the reason was we found we integrated more into them than originally anticipated, but it's high-margin product, it has high demand from customers. Admittedly, one of the plants that got choked was one of their plants, one of their high production, high volume facilities. So as we look holistically, life without SIHI wouldn't be good right now. We are so thankful we have that company.

Is there any kind of quantification you can give us, some margin progression or exit rate by the end of the year kind of thing with these improvements that you are making?

We have plans for that. What I would tell you is, when we get the traction -- we talked about in Q2 and I certainly don't want to lay this out there for future conference calls, but I think, if appropriate, that's the time to talk more about what rates will look like because I think you can hear on this call we are very thoughtful on making sure that we put out commitments we are going to deliver to you because we don't take it likely when we miss them.

Andrew Obin, Bank of America.

Mark, congratulations and thank you for your leadership over the years. So I have a question because I am a tad confused this morning. I went to Emerson's Analyst Day yesterday; they were talking about their project funnel being up 50%. They also stated very explicitly that they now have visibility on MRO for the next two quarters and that backlog just basically inflected earlier than I thought.

Earlier today, I listened to a conference call for one of your largest distributors and they are guiding to revenues up 10% to 20%, highlighting how they have great visibility, how turnaround season is much stronger this year. And I'm just a little bit confused because Q1, it seems there's an air pocket and you guys are being very conservative. So are you guys being conservative or are you losing marketshare because that would be another explanation that, as you said, you are out of capacity, you lost marketshare and you are just not getting the orders? It's a direct question, but I'm just confused.

That's fair. I would tell you to -- and by the way, Emerson is a fine company and a fine competitor, so take this for what it is. You look at our valve business and how it has performed, it's not losing marketshare and we've actually seen opportunities where we are.

A lot of Q1's pocket is what is in backlog. I think that's the point we need to make. We do have book and ship, but some of that MRO doesn't book and ship necessarily within a week. Some of it does. The distributor you are talking about is the one I think we referenced in our comments where we are seeing some activity in the Gulf Coast region.

So not completely different. We talked about the FEED work, but just keep in mind we are longer leadtime items than some of the compares you just enumerated there. And so the fact is some of our products are going to take a little longer in these projects to get in, so we do have some visibility around the FEED work.

And I think the other thing is our approach is when we make commentary looking forward, we want to see things turn. We are not good at calling the day things are going to turn, but the day that we see it, we will be happy to let you know about it.

So, just to make sure, if the cycle turns, you are ready to take advantage of it?

Oh, absolutely. If we've done nothing else over the last three years, we have improved our capacity in terms of localization, where it needs to be. We've definitely made it efficient. We are working on our fixed cost leverage. For this business, it doesn't take too much top line -- we've talked a lot about fixed cost leverage on the way down. I think we need to think about it on fixed cost leverage when the markets come up. Even if it's a gradual incline, we will get a lot of leverage. If you look at the G&A that has been adjusted out of this business despite merits over the last number of years, despite taking on four or five companies with all of their people, organizationally and have we've been able to manage G&A, that should give you an indication that while it may look flat over the last couple of years, it's actually a lot more efficient than it was before and we have a broader footprint, a broader product portfolio and when we see the turn, we will let you know.

And just a follow-up question. Can you just comment on how short cycle or seals are trending so far in Q1?

Generally, and it goes to the comment earlier about distribution and everything. We have seen some improvement there. We don't discuss that necessarily as a separate segment, but the seal business has seen some activity and there's a reason for that.

In the meantime between failures of all rotating equipment, the seals tend to be the shortest, so you will need to act on those regularly. But if you have -- not discretionary -- but incremental OpEx, it will tend to go to your seal turnarounds in your business because if a seal fails, your system is down.

Right. So if OpEx goes up, we should (inaudible) -- so if I believe OpEx is going up, seals should pick up?

Oh, yes, absolutely. Seals should pick up. And seals, they've been a good, stable business, as you can see with competitors.

Fantastic. Thank you very much.

Jim Giannakouros, Oppenheimer.

Mark, echoing others' best wishes as well. Aftermarket resilience, the bookings comparison sequentially, I understand. I understand obviously higher margin versus OE. That I get. But just to better understand margin mix implications, and if you could put some numbers around how do margins in current aftermarket bookings compare to last year and was there a trend that you can call out that occurred through 2016? Any shifts there?

Aftermarket margins, particularly in the gross margin line, have historically ranged from 43% to 49% through cycles and that's remained fairly consistent. So they can move a couple hundred basis points up and down. This is on run rate aftermarket. Some of these upgrade projects you can see a little more dramatic of a move, but the point is aftermarket business is relatively stable and if you think about why, it is around the critical nature of the operating facility and being able to respond and serve them quickly, which is why QRCs are important.

Where you see the more dramatic price moves are going to be in the large projects just because of the dollar amount of the project and the competitive nature. Pricing in the run rate business does get impacted by markets, but again those are a lot about being able to deliver quality on time. So if you can execute well, you can command more price on the margin.

But aftermarket has been relatively stable. The reason we emphasize it is companies, operators have been doing everything they can over the last couple of years to hold onto cash, everything they can. And you have seen when companies do that and so they will push everything they can in terms of repairs as long as possible. They will never put their people at risk in terms of safety. So I'm not suggesting they'll go beyond that, but if they can defer a scheduled maintenance, they will. Other things, factors come in, crack spreads over the short term, but over the long term, the fact is, as long as this equipment continues to rotate and flow goes through it, they are going to need repair, they are going to need upgrade. It's just a function of time.

Got it. Thank you. And one follow-on if I may. Just understanding that you are not just consolidating your facilities, you are likely upgrading just flow, etc., but smart technologies, other things that you could call out incorporated into these new facilities? To what extent are new processes, technologies driving efficiency gains let's say in 2018 and beyond? And I guess near term to what extent does it represent the temporary disruptions to the processes that your leaner workforce now needs to get up to speed on leveraging or just working with new tools introduced in plant? Thanks.

It's a really good question because you think in terms of technology within our manufacturing capability. For those of you who joined us in Raleigh a couple years ago, you saw some sophisticated computerized machinery and why is that important? Well, one, because if you think about the precision around the process conditions and the engineering drawings and the castings, much higher level of precision, less scrap, more efficiency, better tolerances.

I think the other thing is, if you look at the labor associated with that, the labor force is changing. We still have some, fewer than we did before, but we have some old vertical and horizontal lathes in our plant and that is an art and the individual has been doing it for 30 or 40 years and the chance for error is higher.

So, yes, in our facilities that we've been standing up, we have much more efficient computerized machinery that's doing a lot of the manufacturing for us. If you are talking about technology within our product, absolutely and we always maintain the product matters because that's where the process conditions are determined. That's where the algorithms are created from. That's where you can put the sensors in. It is really the intelligence of the operation that passes along to a DCS, a system.

So on both ends, technology has been very important and it will help us both in manufacturing and in selling our products. The last extension is just using technology in terms of computers to sell to customers. Increasingly, now, especially on the run rate business, customers want to be able to go online, configure the product, order it and our commercial organization and sales organization have been working very hard. The big beneficiary when we get in that place is going to be IPD.

Thank you.

John Walsh, Vertical Research.

I will echo everyone else's sentiment and say best of luck going forward, Mark. So a lot of ground covered, but just wondered, given what's going on with the realignment in IPD, are margins up in Q1 relative to the 4.7% from last year? Should we expect that they are up?

Yes, to my comment earlier, I don't want to give any quarterly guidance and we talked earlier in terms of what exit margins could be. I will go back to, in the IPD business, we still think that that is a business that should be at 14% to 15% levels. How and when we get there, obviously if the market were to ramp up quickly over the next quarter, that's going to help you, but in terms of operationally, we have certainly turned the corner, but not completely in terms of improving the business and bringing it back to the levels it should, keeping in mind that two of our most profitable largest revenue plants were impacted, as Tom described.

So I think around expectations, it's getting those processes in place, but let's pull the market aside at this point in time continuing to improve that, winning back our customers, which will help top line absent a market, driving more efficiency. When a plant gets choked, it can become -- it impacts margins dramatically.

So I think I just want to give you some context and -- but I will take a step back moment -- the person who is doing this has done this before and with great success and that's Tom Pajonas.

Great. And then a larger-picture question, one of your competitors actually talked about seeing a little bit more increased China competition on the aftermarket business. Not sure if you are seeing that, if they are being more aggressive. Any color there that you can provide would be helpful.

Not really. If you look at some of the equipment that we operate, it's fairly sophisticated. I don't know what competitor you are referring to, but, no, we haven't seen it.

All right. Thank you very much.

Ladies and gentlemen, we have reached our allotted time. This concludes today's conference. Thank you for participating and you may now disconnect.