Hillenbrand Inc (HI) 2016 Q4 法說會逐字稿

Good morning, everyone, and welcome to Hillenbrand's earnings teleconference for the fourth quarter of FY16. A replay of this call will be available until midnight Eastern December 1, 2016 by dialing 1-855-859-2056 toll free in the United States and Canada, or +1-404-537-3406 internationally, and using the conference ID number 42049462. This webcast will be archived on the Company's website at www.hillenbrand.com through December 18, 2016.

If you ask a question during today's call it will be included in any future use of this recording. Also note that any recording, transcript or other transmission of the text or audio is not permitted without Hillenbrand's written consent.

At this time it's my pleasure to turn the conference over to Joe Raver, President and Chief Executive Officer of Hillenbrand. Mr. Raver, please go ahead.

Thank you, operator. Good morning and thanks for joining us on our fourth-quarter FY16 earnings call. Kristina Cerniglia, our of Chief Financial Officer, is with me this morning. We'll be using a slide presentation which can be found on our website as we go through our prepared remarks.

Today I'll discuss highlights for the quarter and the full year. Kristina will then present additional details on the Company's financial performance and guidance for 2017 before we open up the call for Q&A.

Prior to getting into our prepared remarks about the business, I'd like to remind you that during this call we may use certain forward-looking statements that are subject to the Safe Harbor provisions of the Securities Laws. These statements are not guarantees of future performance and our actual results could differ materially.

Also during the course of this call, we'll be discussing certain non-GAAP operating performance measures. I encourage you to take a look at our 10-K which can be found at our website for a deeper discussion of forward-looking statements and the risk factors that could impact our actual results. For more information on our use of non-GAAP operating measures and the reconciliation to GAAP financial measures, please refer to our 10-K and the slides presented in this call.

With that, let me touch on some of the highlights for the quarter and the year. 2016 was a challenging year for Hillenbrand as we face significant headwinds in key end markets across both segments of our business. We experienced a decline in demand that was more severe than we had anticipated as we entered the year.

That environment put our businesses and our operating model to the test, and I am proud of the way our team responded. We took actions to protect profitability and to position our businesses to be successful when demand returns. We're maintaining a disciplined approach to margin improvement and operational execution through the application of our Hillenbrand operating model.

That model's becoming ingrained in our culture throughout Hillenbrand. It gives us a framework and process that we believe helps produce consistent and sustainable results across all of our businesses. Foundation is in the principles that have driven Hillenbrand since our inception, including lean business practices and the talent management process that we see as competitive advantages.

As Hillenbrand has grown and evolved, we've enhanced our operating model to strengthen its application to our business and bring focus to the critical few things with the most potential for creating sustainable value for our shareholders. The Hillenbrand operating model is central to our vision of transforming Hillenbrand into a world class, global diversified industrial Company.

Let me touch on some of the highlights of our results. As expected, the fourth quarter was our best revenue and profit quarter of the year. We also had the strongest order intake quarter of the year in the process equipment group, helping us finish 2016 with some positive momentum. We continue to experience soft demand in some markets that are significant to our process equipment group, especially as it relates to parts and capital equipment used in hydraulic fracturing and they the power and mining industries.

However, we are also seeing some bright spots. In particular, there's been a healthy flow of large projects in our plastics business which lifted results in the quarter. Those projects helped propel the process equipment group to its firsts quarter of organic revenue growth this year. On top of that, the flow control acquisitions we made earlier in the year are now fully integrated with the business, provided an additional boost to our results.

The growth in our process equipment group was more than enough to offset a decline in Batesville, driven by lower burial demand. Overall, our results for the quarter were solid and helped us deliver full-year GAAP earnings per share of $1.77 and adjusted earnings per share of $2.01 which was within our revised guidance range.

Taking into account the full year, we finished FY16 with revenue that was down compared to 2015 in both the process equipment group and Batesville, reflecting the difficult end markets in both segments. However, our commitment to operational execution and profitability improvement is evident in the margins that were up for the year, despite lower volumes.

We did not reach our goal of 100 basis points of EBITDA margin expansion for the year in the process equipment group, as we were not able to reduce our fixed costs quickly enough to match the volume decline. However, we did achieve modest margin expansion and we executed a number of structural changes to help us operate more efficiently going forward.

Batesville managed costs well enough to deliver year-over-year margin improvements despite significantly lower volumes. The business did not sacrifice performance in achieving that result. Batesville earned the top ranking for quality, service and innovation for the third consecutive year in an annual survey of funeral professionals by the funeral service insider and industry trade journal.

We finished the year with another solid quarter in terms of cash flow. We've been focused on improving our balance sheet and making more efficient capital investments and that showed in our operating cash flow which reached a record of $238 million for the year.

The robust cash flow keeps us in good position to execute on our strategy of paying down debt and staying active on the M&A front as we seek the right opportunities to invest in our business for profitable growth. We have a very structured approach to capital allocation and we're constantly evaluating the best use of cash to ensure we deploy capital in a manner that will drive shareholder value.

We continue to be active on the M&A front as we pursue acquisitions that help us build leadership positions in our core businesses and accelerate our profitable growth strategies. We think about M&A in three basic categories. The first is add-on acquisitions. These are typically smaller deals that would fit nicely into one of our current businesses. Second would be an adjacency. This would be an acquisition that is closely related to our current businesses and would benefit from being in our portfolio. And the third category would be a new platform.

Right now, we are especially focused on acquisitions that will help us drive profitable growth in our core markets and near adjacencies. We're optimistic that we'll identify additional actionable targets in the future, but as always, we're taking a disciplined approach to ensure that when we do execute our next opportunity, it will be right for Hillenbrand and for our shareholders.

The strong cash flow performance this year also provided the flexibility for us to contribute $80 million to our US pension fund in early October. This contribution provides a sustained reduction in our pension expense and the cost of financing the contribution is low relative to the long-term savings we expect to achieve. Most importantly, funding the pension at this level is in service of the commitment we have to our employees and retirees.

Let me spend a couple of minutes talking briefly about what we're observing externally. First, the current political environment has created added uncertainty globally. Too early to predict how the results of the US election could affect our operations in the year ahead, but we are paying close attention and working hard to understand how potential policy changes under the new administration may affect our business, especially related to global trade and energy.

In terms of our key end markets, the macro environment has not changed appreciably from what we've been seeing throughout 2016. We expect some of the same challenges to continue into next year.

Generally, commodity prices remain low and demand for parts and capital equipment in power and mining, fracking and fertilizer production remains weak. We've experienced some stability in those markets over the last couple of quarters which is encouraging. However, significant over-capacity limits our expectations for any meaningful growth in the near term. Looking forward, we expect most of our process equipment businesses to face flat to slightly lower demand over the next year, with some segments experiencing modest decline and others experiencing modest growth.

One notable exception to that is our plastics business where we are forecasting growth in 2017. We had good momentum in large capital projects coming out of the fourth quarter and we have visibility to a healthy order pipeline with continued strength in the US and additional opportunities in the Middle East and Asia. Growth in this segment will be driven by large poly olefin projects. Keep in mind, these large projects generally come at lower margins and will affect our mix in 2017.

The parts and service business linked to these large plastics projects remains an area of focus for us as well. It's a profitable and predictable portion of the business and following an exceptionally strong 2016, we continue to pursue long-term growth in this part of our business.

Before I turn the call over to Kristina, I want to comment on our recent announcement regarding the consolidation of one of our casket manufacturing facilities. You've heard me say that lean is a never-ending journey for Batesville and is essential to the business as it navigates a declining market.

As you saw in our press release, we are closing our casket manufacturing facility in Mississippi. We're taking this action in response to changing consumer attitudes and preferences in the funeral industry. Consumers are increasingly opting for cremation which has left the industry with excess capacity for burial casket production. We expect to generate greater efficiencies in manufacturing as a result of this transition which will help us continue to deliver the highest-quality products and service to our customers.

The plant in Mississippi is expected to cease production at the end of the second quarter in FY17. We continually evaluate our cost structure across all of our businesses with the goal of optimizing our footprint to provide the best possible products and service to our customers in the most cost-efficient manner. With that, let me turn the call over to Kristina to discuss our results and guidance in more detail.

Thanks, Joe, and good morning, everyone. We ended the year with a fourth-quarter consolidated revenue of $429 million, up 9% from last year. The process equipment group was up 17% which was partially offset by a 4% decrease in Batesville's revenue.

GAAP net income of $36 million was 88% higher than the prior year, resulting in earnings per share of $0.56. Adjusted net income of $37 million was approximately 5% higher than prior year and resulted in adjusted earnings per share of $0.58.

Adjusted gross profit of $156 million was up 7% and gross margin of 36.5% was down 60 basis points from the prior year. Adjusted EBITDA of $74 million increased 1%, although the EBITDA margin of 17.4% was lower by 140 basis points. I will talk more about our margin performance when I review the segment results.

Our adjusted effective tax rate for the quarter was 29.3%, 470 basis points lower than the prior year. The decrease in the rate was driven by a nonrecurring prior-year discrete item in addition to a tax benefit related to the adoption of an accounting standard for share-based compensation and a favorable geographic mix of pretax income this year.

The balance sheet remains healthy and cash flow remains strong through the fourth quarter. Operating cash flow of $49 million was up $19 million driven by higher net income this year.

Moving to the next slide, I will discuss segment performance beginning with the process equipment group. The process equipment group delivered revenue of $284 million in the fourth quarter. That is an increase of 17% over the prior year. Revenue increased 10% organically and our current-year acquisitions of ABEL and Red Valve contributed an additional $19 million in the quarter.

You will recall from our discussion last quarter that we experienced a shift in the timing of some of our large projects in the plastics industry. We continue to face extended decision cycles for those projects. However, we did make notable progress in the fourth quarter, particularly in our Coperion compounding and extrusion system. That progress was the biggest driver of our year-over-year top-line growth in the quarter.

On the other hand, many of the industrial end markets we serve continue to face sluggish demand. Lower volumes for equipment used in hydraulic fracturing as well as parts and equipment for the power and mining industry offset some of the growth from our businesses serving the plastics and flow control markets. Order volume in the fourth quarter was up 36% over the prior year and up 28% when we strip out the flow control businesses for an organic perspective.

Backlog of $500 million was down about 5% from the third quarter but finished $41 million, or 9%, higher than the prior year. On an organic basis, backlog was up 5%. As with revenue, the organic growth in backlog is being driven by our plastics business. It is important to keep that in mind when we discuss our outlook for the next fiscal year.

The large plastics projects in backlog will convert to revenue over multiple quarters through percentage of completion accounting. Additionally, the margin profile of those large projects is more modest than other capital equipment, so we expect to see margin pressure as a result of the mix impact of the projects in the backlog.

The process equipment group adjusted gross margin of 35.6% was down 10 basis points, and adjusted EBITDA margin of 18% was down 20 basis points from the fourth quarter of last year. You'll recall that our mix was particularly strong in the process equipment group in the third quarter and that was due in part to a low volume of large projects.

As expected, revenue in the fourth quarter was comprised of a higher mix of large systems projects which typically carry lower margins than our small to mid-size projects and spare parts. We continued to see progress in our pricing and productivity initiatives in the fourth quarter which contributed positively to margins and partially offset the mix impact.

Let me turn to the Batesville business. Batesville revenue for the quarter was $145 million, down 4% from the prior year, largely due to the estimated volume decline in North American burials, primarily due to an increase in the rate at which families opted for cremation. Batesville's adjusted gross margin of 38.1% for the quarter was down 130 basis points from last year and adjusted EBITDA margin was 23.6%, 90 basis points lower than the prior year, in part due to volume declines in line with the market as well as cost inflation driven by healthcare and insurance.

Batesville continues to leverage the Hillenbrand operating model to identify opportunities to improve productivity and drive cost out of the business as it addresses steadily declining burial volumes. It is always a challenge for them to stay ahead of the cost curve. The decision to close the casket manufacturing facility in Mississippi was not an easy one. However, it was the right decision to enable our business to continue to compete effectively in the face of a declining market and manage the long-term health of the business.

Moving on to the full-year results. Consolidated revenue of $1.54 billion decreased 4% which included approximately 2% of unfavorable foreign currency. On an organic basis, revenue was down 7%.

Process equipment group revenue of $965 million decreased 3% as key industrial end markets remained challenged throughout the year. Demand for equipment that processes proppants and parts and equipment used in power and mining was severely affected by low commodity prices. The acquisitions of ABEL and Red Valve contributed $57 million for the year, offsetting a portion of the decline.

Batesville's revenue of $574 million decreased 5% as a result of lower volume associated with a decrease in the number of North American burials. Keep in mind, that burial volume was unusually strong in 2015 which helps explain a year-over-year change that was more than we typically experience.

Adjusted EBITDA decreased about 1% to $267 million and as a percentage of revenue was 17.4%, an improvement of 60 basis points over the prior year. Both segments contributed to the margin improvement. In the process equipment group, the part of our business serving the plastics industry made positive gains from strategic pricing initiatives, favorable mix and ongoing productivity improvement projects.

The additions of ABEL and Red Valve provided a boost to the overall process equipment group margin as well. Those margins were partially offset by lower margins in the industrial businesses as a result of significant volume declines.

We are very pleased with Batesville's margin performance for the year, especially in light of the burial unit volume decline. Despite the lower volume, Batesville continued to execute on productivity improvement efforts across the supply chain and executed restructuring actions to resize its operating expenses. Those efforts were instrumental in delivering a bottom line that was only off 1% from last year's results.

This year we faced some difficult decisions in restructuring our businesses to compete effectively, given the current state of the markets we serve. We achieved approximately $5 million in savings in 2016 from those restructuring activities and we are on track to realize an incremental $5 million of savings in FY17.

For the year, consolidated GAAP net income of $113 million increased 1%, resulting in earnings per share of $1.77. On an adjusted basis, consolidated net income decreased 2% to $128 million or $2.01 per share.

Our adjusted effective tax rate for the year was 29.5%, 170 basis points lower than the prior year. Again, tax benefits on share-based compensation and the shifting of income to lower tax rate jurisdictions drove the lower rate.

Operating cash flow of $238 million for FY16 was $133 million higher than the prior year, driven by the timing of changes in our working capital requirements, as well as the nonrecurring payment of the litigation settlement in the prior year. One of our financial goals is to deliver free cash flow which is our operating cash flow less capital expenditures that is greater than net income. We easily surpassed that target in 2016 with free cash flow that was 190% of our GAAP net income.

We are taking actions throughout our businesses to invest our capital and manage our working capital more efficiently and we are making progress. However, timing is also a factor in the working capital needed to fund large projects and we do not expect to see the same level of working capital improvement next year.

The timing of working capital requirements for projects was favorable in 2016. In contrast, last year we had a substantial use of working capital for large projects in the process equipment group.

We returned over $51 million to shareholders in 2016 in the form of quarterly dividends and increased the per-share amount. We also repurchased approximately 700,000 shares of our common stock at a total cost of about $21 million. Additionally, the strong cash performance in the fourth quarter and for the full year put us in a good position to move forward with an $80 million contribution we made at the beginning of FY17 to fund our pension plan, as Joe discussed.

In summary, we are pleased with the results in the fourth quarter that helped us end a difficult year with some positive momentum. Despite the extensive challenges of depressed demand in several of our key end markets, we were able to control margins and generate very strong cash flow. And just as importantly, we have taken prudent steps to enable our business to more effectively navigate those market challenges while they persist and to grow profitably as demand returns.

I will now turn to our outlook for the FY17. As we look forward, we expect revenue growth of 1% to 3%. Revenue from the process equipment group is projected to grow 3% to 5%, with growth being driven by continued strength in large plastics projects.

Looking at our current backlog, we have visibility to a number of those large systems projects as a result of orders we received in the fourth quarter. And as Joe said, the order pipeline is healthy.

In contrast, we continue to experience a tepid environment for capital investment in the industrial markets we serve across the rest of the process equipment group. We expect volume to be slightly down in the power and mining and commodity-related product lines, with modest growth in municipal and general industrial businesses.

Batesville is expected to deliver revenue that is down 1% to 3% which is in line with our expected annual decline in burial volume. We do not expect foreign exchange to have a significant impact to revenue compared to 2016.

We relentlessly pursue better margins across our businesses through the application of the Hillenbrand operating model. On the Batesville side, we expect slightly lower margins as a result of lower volume as well as commodity cost inflation, offsetting the savings from last year's restructuring actions.

In the process equipment group, we are targeting 50 basis points of EBITDA margin expansion, driven by pricing and productivity initiatives as well as the restructuring savings. However, partially offsetting the improvement, we anticipate pressure to margins resulting from mix which will be more heavily weighted towards large systems projects. Those large projects come at a much lower margin than small- to medium-size equipment and after-market parts.

The closure of our casket plant in Mississippi is not expected to affect adjusted earnings in 2017. We expect this action will help maintain our current gross margin levels over the long term in light of further volume declines and cost pressures in the business.

Restructuring and related charges are estimated to be between $9 million to $11 million. Those charges account for the majority of the difference between our projected GAAP and adjusted earnings per share.

The $80 million contribution to our US pension plan made at the beginning of October is expected to be neutral from an earnings perspective in 2017. We expect to generate savings from reductions in pension insurance premiums and compliance costs. In the current year, savings will be offset by a non-cash tax charge we will incur as a result of the funding, in addition to some incremental interest expense.

We do expect a $30 million reduction in tax payments as a result of the contribution, making our net capital outlay for the funding approximately $50 million. Our tax rate, as mentioned earlier, is planned to be approximately 31%. The rate will be higher in 2017 due to the charge resulting from the pension funding.

GAAP EPS for 2017 is projected to be $1.80 to $1.95 and adjusted EPS for 2017 is projected to be $1.95 to $2.10. We remain focused on driving strong cash flow performance and excluding the impact of the one-time pension funding, we expect to deliver free cash flow that is greater than our net income.

Lastly, let me remind you that our two segments have different quarterly performance profiles. As I said earlier, we have a significant balance of large systems projects in our current backlog. Those projects can have a sizable impact on revenue during quarters when a large portion of the work is completed. The work on these projects can span 12 to 18 months and the revenue is not recognized evenly. Additionally, in our process equipment group, the second half of the year tends to be larger than the first and we believe this trend will continue in 2017.

Batesville has a very different profile, one that is driven by the seasonality of death. The largest quarter is generally the second quarter, driven in part by the severity of the flu season. In summary, we have plans in place to build on the improvements we made in 2016 and continue Hillenbrand's transition to a world-class industrial Company. At this time, I'll turn the call back to Joe for his concluding remarks.

Thanks, Kristina. There is no doubt that this has been a difficult year, characterized by declining demand and limited capital investment in the industrial sector, and a lower burial market on a year-over-year basis.

I am proud of the way our team responded to address those challenges and protect the bottom line. Not only have we shown we can weather the storm, we've executed structural changes that will have a lasting impact on our ability to operate more efficiently and compete more effectively going forward.

Currently we're seeing some stability in the number of the markets that declined significantly this past year but we're not planning for any of those markets to rebound in any meaningful way. Generally, we expect demand for capital in our industrial markets to be flat to slightly down in 2017. We're encouraged by the positive momentum we're seeing in some areas of our business, especially the large plastics projects that we discussed earlier.

At the same time, we are under no illusions that the year ahead will provide any easy path to return to growth but we believe we're in a good position to get there. We're constantly striving to execute our strategy with excellence in driving efficiency and profitable growth through the application of the Hillenbrand operating model, thereby moving us closer to our vision of becoming a world-class global diversified industrial Company.

That concludes our prepared remarks. At this time I will ask the operator to open the lines, we're ready to take your questions.

(Operator Instructions)

Daniel Moore, CJS Securities.

Good morning, Joe. Good morning, Kristina.

Good morning, Dan.

Wanted to talk about the guide a little bit. First, Batesville. If you look over the last couple of years going back to FY14, it was down 5% and then we had a recovery year. And this year it's down 5% and yet we're guiding to down 1% to 3% versus arguably easier comps.

So is the slope of the cremation curve changed at all? Is that accelerating? Is there some sort of trading down to lower price points or just conservatism? Help us think about what you're seeing in the markets there.

Yes, Dan, before I answer the question, I apologize. I failed to introduce Chris Trainor. He's joining us for the Q&A part of the call which is perfect for your question. He's the President of Batesville. Kim Ryan, who is the President of Coperion, our other really big platform, she is traveling internationally so she won't be with us today but -- why don't I pass that question to Chris?

Hey, Dan, good morning. So as you said, it's been bouncing around a little bit. The long-term trend is about 2% down but nothing ever goes up or down in a straight line. And so in 2016 we had a flat market due to a heavy flu season but we expect that trend to go back to an average of being 2%. That's why we're guiding to 1% to 3%.

On the lower price points, each year we see a trend to shift towards lower-priced caskets, but obviously what we've talked about in the past, at Batesville we spend a lot of money on customer research, understanding what the customer wants, putting merchandising programs to improve mix to offset some of that down-side pressure.

Dan, this is Joe. I would also just add that we had a big 2015, so we're down in 2016. The market's down in 2016. It's not unprecedented to have a couple of years in a row where you have a down market, a big down, then a modestly down. The other thing is, it's been an extremely warm -- as we're heading into the winter months, it's pretty warm.

The early indications on the flu, which as you know is the big driver of -- whether it's a good -- let me say that differently. A high -- a bigger burial market rather than a lower burial market, the flu vaccine match looks pretty good right now. So we're staying with that long-term trend of about 2% down as we're looking forward to 2017. But as you know, it's impossible to predict with any certainty, a year-over-year movement with death.

That's very helpful color. And in terms of pricing or mix, are you seeing within those caskets, those remaining burials, any change there?

No, no change in the trend that we see in the marketplace. Obviously it's something that we monitor very, very carefully. And as I said, we put programs in place to help our customers drive better mix year over year. So we'll continue to do that, Dan.

Helpful. Turning to the process equipment group, you're looking for 3% to 5% growth next year. Help us think about the cadence. You've got pretty easy comps the first quarter or two and then you're up against a pretty healthy growth comp Q4. But obviously in terms of the visibility, what you have in your backlog, how should we think about that growth as we roll through FY17?

I think we're expecting a similar flow-through in terms of revenue as we saw this past year, with a stronger second half of the year. We'll see, in terms of mix, more of the larger projects. And on the service side as well we expect a stronger second half of the year.

We have a little bit of visibility out into some projects. I would say it's going to flow through the same way it did this year with, again, a stronger second half and a relatively softer first half. So year-over-year comparisons will be sort of similar.

I think the only thing that I would add to that, Dan, is we'll have a quarter's worth of revenue for Red Valve in the first quarter that we didn't have last year. Aside from that, the trend is very similar to this past year.

Helpful. And those large plastics projects in the pipeline or the growing pipeline, is it mainly North America? Or are you seeing any uptick in Asia or other areas as well?

It's both. We've been surprised at the strength of the North American market. We expected this market to be -- run its course by now but the North American market remains relatively strong. And then Asia, as oil prices have dropped, oil as an input becomes a more viable feedstock for Bates resin, so we're seeing strength in Asia and the Middle East in terms of projects heading into this coming year.

Got it. I will jump back in queue. Thanks for the color.

Sure. Thank you.

John Franzreb, Sidoti & Company.

Good morning everybody. Circling back to Batesville, in your press release you mentioned that part of the reason for closing the facility is that increased use -- customer preferences of metal versus wood in caskets. Can you talk a little about how that impacts the margin profile, given rising commodity costs?

Yes, this is Joe. Let me take a shot at that and then Chris is here. I think in the press release, the reason that was in there, is that wood facility did not have a ton of volume. It was a pretty significant volume for our wood side of the business but it's a much smaller portion of our overall business.

I don't think we're seeing any appreciable shift in the mix from metal to wood. So we're not really seeing that. I would say that the burial business is declining evenly across metal and wood. It's just that our metal operations are much larger because we sell a lot more metal caskets than wood caskets on an annual basis.

Just a little bit more color to that. There's no significant margin differences between the metal and wood, John. When you think about what we have, we have five world-class manufacturing facilities. We've got two metal plants operating at full capacity for 75% of our volume. And then we have three wood plants supporting 25% of our volume.

So we just got to a tipping point where we had -- we were actually running a lot more inefficient. It was a difficult decision because of the impact on the associates but the right one for the long-term health of the organization. Not only will it help us long term in the efficiency side, but it will help us on the effectiveness side to further strengthen our number-one rating in quality and service.

Okay. Got it. And is there any impact at all in Batesville right now on the commodity side of the business or is it really just the status quo?

On the commodity side --.

On the commodity side as we think about commodities this quarter, John, in the fourth quarter of 2015 it actually flipped on us. Up through 2016 we had three quarters --

Up through Q4.

I'm sorry, up through the third quarter we had favorable commodities in 2016. In the fourth quarter we didn't see that favorability. As we move into 2017 we are going to see unfavorable commodity prices, primarily because of when we locked in our steel contracts, we locked them in for a 12-month period.

And so we're in the process of renewing those contracts right now. When we locked in, we had a pretty low price so we're expecting that the price of the contracts to go up. So that's where we're going to see some commodity inflation.

Got it. Thank you. And on the process side of the business, given the mix change more coming through in the large projects side, do you still expect the 50 basis point of margin improvement in that business in 2017? Or is that going to be another tough bogie like it was in 2016?

We are targeting our 50 basis points of margin improvement and that is inclusive of the mix impact. Again, it's a target. So we are still making very good progress on some of our productivity initiatives. We're making good progress on strategic pricing. The business is very focused on delivering those initiatives. But obviously it will be offset by this unfavorable mix that we're talking about in the large projects.

Okay, got it. And one last question. Red Valve and ABEL, can you give us an update on the performance of those two acquisitions relative to your expectations? And a little bit about the consolidation efforts that are going on there?

Sure. Those businesses have been really fully integrated into Hillenbrand and that's gone pretty well. As a reminder, we did close the facility, North Carolina facility, and that went very well, actually. Sorry, Pennsylvania, we moved it to North Carolina. I apologize, Pennsylvania. And so the integration has gone pretty well and some of the initial actions. We're now working on sharing sales channels, particularly in North America.

In terms of performance, the businesses, that group, the flow control group, is doing about as we expected. We're seeing a little bit more strength in the municipal markets. So there's solid growth and good spending in the municipal markets. We do sell some pumps into mining and power generation. We've seen a little bit of softness there, mainly on the larger projects.

But both of those businesses, they're, I would say, exceeding our expectations in terms of the value proposition that they bring to the customer base. They're both exceptional businesses, have terrific value propositions and continue to drive very strong margins. Over the long run we feel very good about both of those businesses and their role in our portfolio.

Okay. Perfect. Thank you very much.

Thanks, John.

(Operator Instructions)

Liam Burke, Wunderlich.

Thank you. Good morning, Joe. Good morning, Kristina.

Good morning, Liam.

Good morning, Liam.

Joe, you touched on some of the international business when you talked about the polymer business, but could you give us a sense on how the international business is doing in general? And also how the after-market business has done internationally as well?

Sure. I think generally we're seeing about the same trends that we've seen through the course of the year. North America remains pretty strong for us in general. Europe is stagnant. And then we're seeing strength in Asia and quite frankly, particularly outside of China, we're seeing some strength in Asia.

From a comparison, for example, what we expect in 2016 versus 2017, a pretty similar mix of geography for the process equipment group. So I think that's the first part of the question. And was there a second part of the question? Oh, service. Service, yes.

Right.

Service, we've really had some good success in service. Our business that relates to frac sand, potash and coal-powered mining, those businesses have just been down significantly, both on the capital and the parts and service side of the business. We think we've held our share, if not gained share in those businesses. It's just that the markets have dropped.

On the Coperion side of the business, the plastic side of the business, they had a very strong service year. Exceptionally strong year-over-year growth, a number of large projects, large, profitable projects came to fruition in 2016. It will create a little bit of a tough comparable going into 2017 but we expect to see growth.

Really, that growth has been around the world. We've had success, really, all over the world in terms of service growth. But as you'd expect, it's really happening mostly in the Middle East and Asia and North America, as we see some of the capacities, particularly for plastics, come offline in Europe. And so we're constantly moving resources around to make sure we can get ahead of where the demand is going to be on parts and service. Does that answer your question?

Yes, it does, Joe. Thank you. And Kristina, you talked about working capital with the project nature of the businesses in 2017 being a little more challenging to manage. On the capital expenditure side, is there any additional projects you have on the docket or is the budget pretty much going to be consistent with 2017?

No, generally the guidance we give around CapEx is about 2% of revenue. I think as we look at 2016, we did -- as we were just -- given the economic climate, we were a little more cautious in our spending on the CapEx side in 2016. So I would say that we're going to see an increase in CapEx in 2017. Roughly, the rule of thumb we use is about 2% of revenue.

Great, thank you, Kristina.

Dan Moore, CJS Securities.

Thank you again. Joe, I'm going to ask you a tough question, and it's incredibly early days but as you think about the new administration and potential policies that are being kicked around, what are the top one or two positives that you're potentially -- potential positives that you're excited about? And what are the top one or two potential negatives you might be concerned about?

Boy, that is a tough question. I think the first thing is the two points at the beginning. One is, I think it's really unclear. We've spent quite a bit of time trying to understand and connect the dots between what was said during the campaign and what we're hearing post election.

I think everyone would agree -- and we talked to some experts in the world that -- big names that you'd recognize in terms of banking, investment banking, policy people, some of our trade associations. I think the conclusion is that nobody really knows what's going to happen with the Trump administration.

So with that said, I think on the downside -- we're a global Company and we do a lot of global trade. We have operations in Mexico as well and we sell a lot of caskets in Canada, for example. And so I think the global trade agreements and what happens with the trade agreements will be a big part of what impacts us going forward. I think the second part of that -- as well, that also involves foreign exchange, et cetera.

Then I think the second part is we are involved in the energy and the power businesses, not a really huge degree, but we have some profitable businesses that operate in coal-powered mining and in frac sand. And so there could be some impact in those businesses as well.

It's a complicated web. I was just reading about NAFTA yesterday and I didn't realize how much natural gas goes from the United States to Mexico and what happens with natural gas and what does that do to the price of natural gas in the US if something happens with NAFTA. So it's a complicated economic web of factors.

I think the upsides would be a more positive energy approach in the United States for our businesses which may lead to some benefits. I think on the down side it's really the global trade agreements. We are a global Company, we operate globally. So there's a lot of uncertainty there and there may be some negative impact from that.

And then I guess the final thing is tax reform. The corporate tax reform, if that comes through, I think that will help all American companies. It's something that I think everybody recognizes needs to happen. If that can get through, I think that will be a positive as well.

Extremely helpful.

It's really early. Don't take too much away from that because nobody knows what's going to happen, I don't think.

All those experts that you talk to, they don't have a clue either, so don't worry about it (laughter).

That was a funny thing. We had different people to be on different -- our banks and investment banks, they host these conference calls and so we all got together and came back and said it's been a few days since the election and pretty much it's the same speculation as before the election. Nobody really -- everybody had their categories, but nobody really had a lot of insight in terms of what's really going to happen.

Indeed. Then the last one, the non-plastics process equipment businesses, and we'll leave ABEL and Red Valve to the side as well. But when you think about potash and frac sand and related equipment and coal, could you rank order those in terms of which one of those you expect inevitably has to come back, whether it's FY18 or beyond versus those that are structurally depressed and it's more difficult to say?

Sure. You didn't ask this question but I'll just -- we've already talked about the Batesville piece of it. But significant headwinds on the Batesville side this year. I think that returns to a normal flow over a couple of years. There will be some ups and downs but we don't see anything that takes the market trajectory off track. So I think that's relatively -- if you can call it positive news, some positive news going forward.

I think, then the ranking, those big categories that were really down this year, I think the best opportunity would be for the frac sand market to return. A number of things could drive that but the technology that's being utilized now out in the field tends to use more proppants, so that's a positive thing. And so if we see some comeback in terms of demand, while there's still a lot of over-capacity, that's probably the place it could come back the fastest.

Next, I would say fertilizers. We're involved in a number of fertilizers, the biggest being potash. Crop prices remain low. Those fertilizer prices remain low. But generally there could be a slight bounce over the course of the year, 12 to 18 months in fertilizers.

And then I think the biggest question really is what's happening with coal, power and mining in North America. Right now we're not seeing -- we're seeing stability in those markets but we're still seeing a slight downward trend on the coal side of things. The EIA predicts somewhat flat to slightly down. We're seeing a little bit more aggressively down right now, but not nearly what we saw over the last 24 months with volumes dropping pretty significantly on the coal side. So I think that's how I would rank what's going to happen over the next 12 or 18 months.

Very helpful. Thank you again.

Sure. Thanks, Dan.

And we have no questions left in queue at this time. I'll turn the call back to the presenters for any closing remarks.

Thanks for joining the call today. I know our prepared remarks were a bit longer, but that happens at the end of the year and guidance and everything. But I appreciate everyone staying on the call and participating. And we look forward to speaking with you again in February when we report our first quarter results for FY17.

This concludes today's conference call. You may now disconnect.