SPX Technologies Inc

F:SPW0

Earnings Call Transcript 2017-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Q4 2017 SPX Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference Mr. Paul Clegg, Vice President of Investor Relations and Communications. Sir, go ahead.

[Paul Clegg, VP, IR & Communications]

Thank you, Jimmy, and good afternoon everyone. Thanks for joining us. With me on the call today are Gene Lowe, our President and Chief Executive Officer; and Scott Sproule, our Chief Financial Officer.

A press release containing our fourth quarter and full-year 2017 results was issued today after market close. You can find the release and our earnings slide presentation, as well as a link to a live webcast of this call in the Investor Relations section of our website at spx.com.

I encourage you to review our disclosure and our discussion of GAAP results in the press release and to follow along with the slide presentation during our prepared remarks. A replay of the webcast will be available on our website until February 22nd.

As a reminder, portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. Please also note the Risk Factors in our most recent SEC filings.

Our comments today will largely focus on adjusted financial results. Specifically, we will focus on core operating results, which exclude the results of our South African projects, and we will separately provide an update on those projects.

There are other adjustments to our GAAP results that we will discuss in more detail during our prepared remarks. You can find detailed reconciliations of adjusted figures to their respective GAAP measures in the Appendix today's presentation.

Finally, we will be on the road visiting with investors in the Mid-West and in the Northeast during the second half of February.

And with that, I'd like to turn the call over to Gene.

[Gene Lowe, President & CEO]

Thanks, Paul. Good afternoon, everyone. Thanks for joining us.

2017 was a very positive year for SPX and I'm proud of the work our team has done to drive substantial improvement in our operational and financial performance. On the call today, we'll give you a brief update on our overall results, segment performances, end market conditions, and 2018 guidance, before going into Q&A.

Overall, solid execution in 2017 resulted in a very strong year-over-year performance with significant improvements in our earnings and free cash flow. Our balance sheet is the strongest since the spin and we are very well-positioned to invest for sustainable double-digit earnings growth. The timeline for the completion of our South Africa projects remains on track for next year and we are reducing our overall expectation for future cash usage associated with South Africa which Scott will go into in his section.

Today, we're increasing our overall estimate of capital deployable for value creation initiatives over the next three years by 50% to more than $600 million. We've also been increasing the resources behind our inorganic growth initiatives and would anticipate seeing positive results on this front during 2018.

Finally, we are introducing full-year 2018 guidance of adjusted EPS in the range of $2.03 to $2.18 and are significantly increasing our financial targets for 2020.

Turning to our results for Q4 and the full-year 2017. For the quarter, we reported adjusted earnings per share of $0.60 bringing us to a full-year adjusted EPS of $1.78 or towards the upper end of our guidance range. Adjusted operating income margin for the quarter was 10.2% and 8.6% for the year reflecting 160 basis points of improvement.

A very strong performance in our Detection & Measurement segment was a significant driver of the quarter and full-year performance. In addition, the continued solid execution in our Engineered Solutions segment reflects the benefits of our business model shift in process cooling. We did experience a mix and execution issues in our HVAC heating business in Q4. Overall though, we feel good about our efforts to address performance issues and remain on track to achieve our long-term goals.

As always, I'd like to give you a recap on the progress of our value-creation initiatives. We've made a lot of progress since the spin and we now have three healthy platforms with strong brands and leading positions in attractive growth markets.

Our strong performance is a result of effective operational and product initiatives including several new product introductions.

During Q4, in our HVAC segment, within cooling, we continue to see more customer orders for NC Everest which delivers 50% greater capacity than similar cooling towers with substantially lower energy and installation costs. Building on this best-in-class solution, in December, we introduced a counterflow product line extension of the Everest platform to further broaden end market applications. The MD Everest offers 85% more cooling capacity than any other preassembled counterflow cooling tower and can be installed up to 80% faster than fuel directed cooling towers filling an important market niche for larger applications.

Within our heating business, we continue to see stronger customer orders for our high efficiency AquaBalance Combi which provides combined heat and hot water, an attractive application within the commercial and multifamily residential markets.

In our Detection & Measurement segment, we remain focused on our innovative designs and solutions to help drive customer demand for our products.

Within our cable and pipe locator business, we continue to get strong customer traction with our innovative cloud-based system for tracking and monitoring the performance data of underground locators, which allows customers to improve safety, save time, and reduce costs.

In our communication technologies business, we have developed leading edge solutions to help customers deal with drone intrusions near airports and other sensitive air spaces which is driving significant customer interest and a number of orders.

In our Engineered Solutions segment, we continue to make good progress in our initiative to reposition our process cooling business toward sales of components and services including higher margin, more stable demand products like our proprietary Geareducers, fans, heat exchange media, and other OEM and aftermarket components. With each new voice of the customer driven product launch, we broaden our reach into new market opportunities and increase customer share of wallet.

And now, I'll turn the call to Scott to review our financial results.

[Scott Sproule, CFO]

Thanks Gene. On a GAAP basis, we reported earnings per share of $1.35 for Q4 and a $1.91 for the full-year. On an adjusted basis, our earnings per share for Q4 was $0.60 and $1.78 for the full-year. As we typically do, our adjusted earnings per share excludes the results associated with our South African operations and non-service pension items. I'll get into details of South Africa in a moment.

In addition to these items, we have also adjusted our Q4 results to exclude certain favorable one-time discrete tax benefits as well as items related to the amendment of our credit facility during the quarter. Full details of the reconciling items from our GAAP results can be found in the Appendix to today's presentation.

Regarding accounting for tax reform on a net basis the initial estimate had little impact to our Q4 results. We currently do not anticipate a transition tax on foreign earnings and the negative effect of the remeasurement of our net deferred tax assets was offset by the reversal of a repatriation reserve, we had previously recorded. We will continue to revise our estimates around the effect of accounting for tax reform during 2018, but do not expect that the net impact of any changes will be material.

Now getting into South Africa, which was the most significant driver of our adjustments for the quarter. Earlier this year, we set out certain objectives for both the second half of 2017, and the substantial completion of the projects by the end of 2019, and we are progressing well against these objectives.

In Q4, we substantially completed one of the major scopes of our construction activities and reduced our direct labor associated with this. We're now focused on completing our last remaining scope of work. We also completed our initial restructuring action to partially reduce the overhead costs of the operations.

Looking at the cash flows associated with South Africa, the net outflow in Q4 was lower than previously indicated and on a full-year basis, this negative impact of the company was $49.5 million compared with the estimates we provided on the Q3 call of upwards of $57 million. This is mainly due to a tax benefit associated with South Africa.

During the quarter, we recognized P&L adjustments associated with items we've been managing throughout the second half of the year. The net favorable impact was recognized on our GAAP results and is comprised of a tax benefit and an operating charge both of which we have adjusted out.

The tax benefit was approximately $66 million. During the fourth quarter we determined that the historical investments that our U.S. companies have made into South Africa have no recoverable value and the benefit represents the write-off of these investments for U.S. tax purposes.

We worked on this position during the second half of 2017 and were able to finalize our analysis conclusions during the quarter. The charge was $29.9 million and it is associated with further revisions to our estimates of cost to complete our construction activities and changes to assumptions around the recoverability of certain deferred project costs.

On our Q2 earnings call, we provided an estimate of the impact of remaining cash flows to complete the projects. We provided this estimate to give investors a sense of the liquidity impact South Africa is expected to have on the company which is consistent with our view that this is a legacy debt like obligation that will reduce over time.

When developing our estimate, we considered various scenarios associated with factors that could impact us, both positive and negative, and we took a generally conservative point of view. As we revisit our scenarios at the end of the year, we determined that we are in better position today than we were in Q2, and are reducing the remaining expected net impact to our liquidity associated with South Africa to a range of $25 million to $30 million over the next couple of years, the majority of which will impact us in 2018. This compares with an applied range of approximately $38 million to $48 million based on our prior disclosures.

As we've said before, these are large complex projects subject to the risk of operating in a difficult environment and that remains the case.

Turning now to our core results. For Q4, core revenues increased 4.8% resulting in full-year revenues at the upper end of our guidance range of $1.35 billion to $1.4 billion. The key for increase was driven primarily by strong order conversion in our Detection & Measurement segment, with HVAC revenues up modestly, and Engineered Solutions recording similar revenues to Q4 of 2016.

Q4 segment income was generally in line with the prior year. On a full-year basis, segment income increased approximately 16% with 180 basis points of improvement in margins.

Solid full-year results were due to the strong performance of Detection & Measurement and Engineered Solutions, both of which experienced full-year segment income growth in the vicinity of 40%.

Now I'll walk you through the details of our results by segment, starting with HVAC. For the quarter, revenues increased modestly with a solid increase in cooling and a favorable currency effect largely offset by lower heating sales. The cold weather experienced at the end of 2017 did not result in overall increased sales for heating products in Q4 as we experienced cautious ordering patterns from our channel partners in the early part of the quarter.

We did see strong order demand begin late in the quarter and this has continued into the early part of 2018. Overall, we are expecting higher volumes over this winter heating season, but concentrated in Q1. Segment income margins of 16.5% represent a decline of 340 basis points from the prior year.

During the quarter, we experienced an execution issues around management of costs related to a shift in product mix and associated production volumes. We understand these issues and have already taken steps to mitigate them. A charge associated with legal matters also negatively affected Q4 segment margins, but this is a non-recurring item and we expect margins to improve in 2018.

For the full-year revenues were modestly higher than the prior year and segment income margins were approximately 14.5% with a decline from the prior year largely attributable to the Q4 performance.

In Detection & Measurement revenues increased 28.5% including a modest currency benefit with all businesses recording double-digit organic increases. Segment income increased approximately 28%, while segment margin was similar to the prior year. Each business contributed meaningfully to the growth in segment income, but particularly strong results from sales of fare collection products and communication technology systems.

For the full-year, segment revenues increased approximately 15% including the effect of a small currency headwind with sales of fare collection products and communication technology systems driving largest portion of the increase.

Segment income margin was 24.4%, an increase of 440 basis points from 2016, driven primarily by operating leverage on higher sales. As we discussed last quarter, the exceptional full-year revenue growth and margin increase in Detection & Measurement 2017 was in part due low starting point of some of the more project-based businesses within the segment which operated closer to cyclical trough in 2016. We look at 2018 as the segment getting back to a more normalized level of performance with a steady demand environment and we would expect future growth to be more in line with our long-term expectations of 2% to 6%.

In Engineered Solutions revenues for the quarter were generally flat with the prior year. The decrease in revenues associated with our business model shift and process cooling largely offset by higher sales of transformers. Segment margin declined 70 basis points largely due to a less favorable mix compared with the prior year.

For the full-year, segment revenues declined by approximately 4% net of a modest favorable currency effect. The decline in segment revenue was in line with our expectations and largely driven by the business model shift we have been implementing in process cooling. We also had a modest decline in transformer sales associated with shipment timing.

Our business model shift and process cooling is progressing well, but as we were still executing on backlog projects in 2017, we report another year of reduction in segment revenues in 2018 after which we would expect underlying GDP like growth to become more visible in our results.

Full-year segment income increased approximately 42% and margins rose 230 basis points primarily due to the improved performance of process cooling. We were very pleased that the positive impact we've been able to deliver in this segment. As a reminder, for 2015 Engineered Solutions reported core margins of only 1%. We now have a much stronger value-creating segment delivering double-digit EBITDA margins that we expect to continue to improve in 2018 and beyond.

Turning now to our financial position at the end of the year. For the quarter, core free cash flow which excludes our South African related cash usage was approximately $60 million bringing core free cash flow for the year to $93 million or conversion rate of about 118% of adjusted net income.

As we look into 2018, we are expecting our core free cash conversion to be approximately 110% of adjusted net income. We ended the year with cash of $124 million and our net leverage ratio was 1.5 times or at the low-end of our long-term target range of 1.5 to 2.5 times.

As previously announced, during Q4, we amended our credit agreement with terms that enhanced our financial flexibility, extended our maturity schedule, and reduced near-term cash debt service requirements.

Our balance sheet is significantly stronger today than at the spin and we are well-positioned for deploying additional capital for growth which we expect to do starting in 2018. As Gene mentioned, we now expect to have more than $600 million of capital available between now and the end of 2020 compared with a prior estimate of more than $400 million. This 50% increase is a result of continued strong operational execution, the benefit of lower cash taxes under new legislation, and the favorable impact of lower cash usage associate with South Africa that I discussed.

As a reminder, our method for calculating targeted capital available for deployment includes a combination of free cash flow and borrowing capacity under our credit agreement without exceeding net leverage of 2.5 times the top end of our target range.

With that, let me turn the call back to Gene, to talk through the backdrop of our 2018 guidance.

[Gene Lowe, President & CEO]

Thanks, Scott. Turning to an update of our end markets. Overall we continue to be well-positioned for 2018 and beyond. In HVAC cooling, we continue to see a solid order pipeline supported by healthy levels of development across commercial and institutional markets reinforced by a robust economic environment.

In HVAC heating, we experienced a nice increase in orders in December, and the initial part of Q1, with the cold snap that hit the U.S. Commodity and freight prices have trended higher as we discussed last quarter and we have initiated responses to mitigate the impact.

In Detection & Measurement, we continue to see steady demand for run-rate products and a continued solid level of order for larger projects. Transformer pricing and overall demand levels remain stable for medium power units although we have seen some increase in lead times following competitor actions to consolidate plant capacity in certain regions. Our current lead times are in the 40 to 45 week range and we are seeing orders extend into late 2018 or early 2019 and we are assessing the market impact of the recent reinstatement of higher anti-dumping tariffs on certain foreign competitors.

In our process cooling business, we continue to see the benefits of our business model shift and are experiencing favorable customer responses to our new product introductions of parts and components which have a higher margin profile and projects.

Before we get into our guidance for 2018, and updates to our longer-term targets, I wanted to take a moment to review the transformation of our company since late 2015. At that time, our adjusted operating margins were less than 4%. Three of the five original scopes of work on South Africa projects remains to be completed and we had less certainty on the remaining amount of cash usage and time required to bring our role in these projects to substantial completion.

While we continue to work vigorously towards our long-term goals, I'm very pleased that the success of the actions we have taken to focus the company on our most attractive growth markets and substantially strengthen our profitability and financial position. SPX is now comprised of three healthy platforms all generating double-digit ROICs and we have well-positioned businesses with strong brands, leading market positions, and a high level of replacement revenue.

In two years, we have nearly doubled our adjusted operating income and have improved our adjusted operating margins by approximately 500 basis points to 8.6%. And we have increased our forward liquidity profile from $200 million to more than $600 million of capital available to deploy for growth and value-creation initiatives.

With our balance sheet in the best shape in years, the company is well-positioned for further growth.

And with that, let me turn the call back to Scott, to review our 2018 guidance and updated 2020 targets.

[Scott Sproule, CFO]

Thanks, Gene. Let me first take you through our 2018 guidance. For the full-year we expect to achieve adjusted earnings per share in a range of $2.03 to $2.18. This represents an 18% increase at the midpoint compared with 2017 results. We're targeting revenues of $1.35 billion to $1.4 billion or similar to the prior year and segment income margin in the range of 14% to 14.5%, with adjusted operating income margin of approximately 10% both significant year-over-year increases.

Turning to segment guidance. In our HVAC segment, we expect to achieve full-year organic revenue growth within our long-term target range of 2% to 4% and an increase in segment income margin of about 100 basis points. We continue to expect solid growth in our cooling business and modest growth in our heating business which is benefiting from a strong start in Q1. We expect to see a recovery of our margins based on the incremental volumes and the operational initiatives across the segment.

In Detection & Measurement, we expect organic revenue growth within our long-term target range of 2% to 6%. We expect segment income margins to increase 50 to 100 basis points over 2017 levels based on the operating leverage effect of increased volume. As a reminder, when modeling Detection & Measurement's 2018 quarters please take into account that in Q2 2017 segment margin was exceptionally strong due to mix. In fact, we would not expect to repeat this year.

In Engineering Solutions, we expect modest growth in transformers revenue more than offset by the decrease in process cooling I referred to earlier. Overall, we expect a high-single-digit reduction in core segment revenues. We would expect Engineered Solutions core income margin to increase by 80 to 130 basis points reflecting the shift to a more favorable mix of business and process cooling, as well as a margin improvement in transformers. This will bring the core margins Engineered Solutions within our long-term target range of 8% to 10%.

With respect to taxes, as a result of the recently passed tax reform legislation, we expect that during 2018, our average effective rate will be approximately 23%. As a reminder, in 2017, we benefited from a number of favorable discrete tax items arising from matters concluded during the year. These items reduced our effective rate to approximately 23.4% from a structural base rate in the high 20s. So while tax reform has provided us with a meaningful improvement in our structural rate, the year-over-year benefit toward 2018 earnings is not expected to be significant.

As always, you'll find details to other factors driving guidance in the Appendix to today's presentation.

To summarize our overall expected 2018 performance and give us some broader context, we expect the improvements in our business model and Engineered Solutions as well as continued benefits from operating initiatives and sales growth in HVAC and Detection & Measurement to drive 200 basis points of improvement in our company gross margins to approximately 30% in 2018. At the mid-point, we expect margin improvement to drive an increase in adjusted operating income of 15% to approximately $137 million and a 16% increase in core EBITDA to approximately $166 million and this is before any capital allocation.

Now I'll turn to the changes we have made in our core 2020 financial targets which we believe represents significant incremental value for shareholders. By 2020, we now expect core revenues in a range of $1.7 billion to $1.8 billion, an increase of $115 million at the midpoint reflecting increased capital deployment for acquisitions in our model.

As we increase our revenue growth, we expect this to have a favorable operating leverage impact on our margins and we're increasing our 2020 adjusted operating income margin target to 10.5% to 11.5% or by 50 basis points from the targets we gave almost a year ago.

Our adjusted EPS range increases to $2.65 to $2.90 a compound annual growth rate from 2017 of above 16% at the midpoint. This increase is due to enhanced operating performance, increased capital allocation in our model, and the benefits of tax reform and lower net cash usage associated with South Africa.

In the Appendix of today's presentation, you also find additional details of our long-term segment expectations.

And with that, let me turn the call back to Gene for his closing comments.

[Gene Lowe, President & CEO]

Thanks, Scott. Before turning the call back to Paul for Q&A, I want to say that I'm very pleased with our full-year performance and the state of our business as we drive towards another year of growth and value-creation. The actions we have taken since the spin have reshaped SPX into a much stronger, more profitable company, and this is reflected in our strong operational and cash flow performance in 2017.

As you saw from our updated 2020 targets today, we expect much more improvement ahead. With the strongest balance sheet since spin and a very attractive cash generation profile, we now expect to have 50% more capital available to invest for growth initiatives both organic and inorganic to continue driving sustainable double-digit earnings growth.

We believe we have an attractive opportunity to build out our platforms in HVAC and Detection & Measurement. We have also deployed additional resources towards our inorganic growth initiatives and expect to see an impact during 2018. We feel good about our positioning to reach our 2018 guidance as well as our long-term goals and I look forward to updating you on our further accomplishments in the coming months.

And now, I'll turn the call back over to Paul.

[Paul Clegg, VP, IR & Communications]

Thanks, Gene. Jimmy, we are ready to go to questions.

[Operator]

Understood. [Operator Instructions].

Our first question comes from Damian Karas from UBS. Your line is now open.

[Damian Karas, UBS]

Maybe if we could just start with HVAC. Talked a little bit about the timing of the winter starting a little slower on the heating side of business but picking up, orders picking up late December but maybe you could just elaborate a little bit on the heating mix issues in the fourth quarter and maybe just any more color on the 2% to 4% organic growth for 2018. How you are arriving at that? And maybe kind of how -- what you're thinking in terms of heating versus cooling and anything else in 2018?

[Scott Sproule, CFO]

Sure. This is Scott, I'll start and Gene, can have anything that I miss.

So start with Q4 and on the margin performance there what you're asking about really there were some additional costs and some mix shift in our products that changed the volumes for the facility and really led to some under absorption there and it just wasn't seen in time to be able to address timely enough. So that was isolated for the quarter, we've kind of adjusted our planning models accordingly and feel as though we have that issue isolated to Q4.

And then as far as the growth rates go, we’re expecting as we said in the middle of our 2% to 4% range there for the year which is really representative of higher growth in cooling as we still see continued solid demand of growth from commercial construction markets, and then modest growth in heating, partly due to some of the heating season here and then some initiative driven growth.

[Gene Lowe, President & CEO]

Yes, and Damian I'd say this is pretty consistent with what we've said since spin where in our range of growth for HVAC, we've always said cooling is at the higher end of that range and we would expect that to be consistent for 2018 and the forward years we have in our model where heating is a little bit at the lower end of that range predominantly driven by the fact that there is a lot of replacement revenue there which is a great asset, great stability, but it does lower the growth rates there a bit.

[Damian Karas, UBS]

Okay, great. And obviously the 2018 guidance doesn't have any capital allocation baked in there, but you seem to have a bit of confidence in the ability to get some M&A done here and you mentioned some internal resources being sort of allocated there. Just looking though at where you're at now in terms of net leverage however kind of low-end of your target and you've got this additional capacity $600 million. I'm just kind of wondering if there's sort of a floor on the leverage side of things if some of that M&A that you're looking at maybe doesn't transpire if there's a point where you might look at buyback or any investment that are sort of outside of the M&A realm?

[Gene Lowe, President & CEO]

Yes, sure Damian. I think it’s a great point, I mean I think that we're in a very, very strong financial position I think we're at $1.47 or so EBITDA and that’s despite the ramp down of South Africa and some of the impacts that we've had there. As we look at the opportunity in front of us, we really are pivoting towards growth and we see a very attractive opportunity in particular to build out our HVAC and Detection & Measurement platforms.

We have been applying resources to this, as we announced around six months ago. We have a new leader for Business Development and I feel good about our strategy and I feel good about our ability to execute against our strategy. So we think we have a very good opportunity in front of us.

And Scott you want to comment on capital allocation?

[Scott Sproule, CFO]

Sure. When we look at what our pipeline is, we do feel like we do have an attractive pipeline, we've seen some acceleration of activity through there, we have things at different stages of development within the pipeline, so that gives us more confidence of course nothing is done until it's done.

But when we look at capital allocation, we really focus on -- we are focused on the inorganic growth side as we see as the best way to provide long-term value creation for shareholders. If we are unsuccessful in that of course will consider other pass and share buybacks would be part of that.

[Damian Karas, UBS]

Okay, it makes sense. And one last quick one here, so there's a lot of talk heating up on potential infrastructure bill, I'm not sure if you guys have had a chance to sort of review the proposal coming out of the White House, but have you given any thought as to how that might impact your business, your businesses I should say and is there any expectation for any fiscal stimulus infrastructure related baked into your 2018 guidance? Thanks.

[Gene Lowe, President & CEO]

So Damian, we don't have anything right now. We're currently studying what that potential bill could be. I do think that we do touch infrastructure in a lot of different areas obviously all of our HVAC equipment is very linked to commercial and institutional growth. You think of our locators, you think about our transformers, we do have a lot of what I would characterize as Engineered Infrastructure. So this is something that we're keeping our eyes on. We don't have anything in our 2018 models for this and Scott, you have anything else on?

[Scott Sproule, CFO]

I think when we look at it obviously it's a pretty net positive and exciting opportunity, I think it's early stages here to see how it actually gets funded in dollars applied and what parts of the infrastructure build out happen. So it would naturally if it goes forward be a positive catalyst for us but it's still too early to predict how it's going to happen and when? So we have -- we’ll just keep monitoring and update as more details come out.

[Operator]

Thank you. And our next question comes from Brett Linzey from Vertical Research Partners. Your line is now open.

[Brett Linzey, Vertical Research Partners]

Hey just want to come back to the 2020 revision and you're taking up the top-line it looks like for some M&A. Could you maybe just help us bridge the different components, I mean it looks like tax is about half of that raise, are you taking up the underlying operational piece of that too for the base business maybe just a little bit more color on those moving pieces?

[Scott Sproule, CFO]

Sure, Brett, this is Scott. So, yes, about half of it is going to be the impact of taxes particularly as you are looking at the EPS side of that. The other side as far as it relates to capital allocation is a combination of stronger say organic performance to-date than what we had modeled going back. So we're kind of -- we're ahead of plans there, stronger cash conversion. So that's giving us more flexibility to deploy capital as well as we're getting some benefits from both reform and the other benefits I talked about. So it's loosely half rate, half capital allocation.

[Brett Linzey, Vertical Research Partners]

And just to be clear, do you have the full $600 million baked into that model?

[Scott Sproule, CFO]

We do not, it's a substantial portion of it, but it's not -- it's not all fully baked in and it's similar to how we set the original 2020 targets where we did not deploy full capital model which gives us some leverage to be able to do other capital allocation to achieve the EPS.

[Brett Linzey, Vertical Research Partners]

Okay. And then just shifting to D&M another strong quarter here, you said all businesses were up double-digits seems like a pretty good exit rate but you're guiding 2% to 6% range, I get there's a tough comp but maybe just a little bit of color on visibility there is their upside to something better than even the top end of that 2% to 6%?

[Gene Lowe, President & CEO]

Yes, sure. Brett let me take a crack at that. I think we were very pleased with our Detection & Measurement segment that that's a great segment and I think improving your segment earnings by 40% in one year is very solid performance. We do think that there is a little bit of a comparison where we did believe we're at trough levels in 2016 and we do feel good about where we're going.

So I think after the substantial growth we had in 2017, we still feel really good about those businesses and the initiatives and the new products that we have going out there. We're going to keep our eyes on if there's further opportunities to drive growth beyond let's say the mid-point and we're going to push for everything we can get. But I wouldn't anticipate a similar year as we had the prior year, but we really like that business and that business is becoming a core focus of our company.

[Brett Linzey, Vertical Research Partners]

Okay, great. And maybe just one more regarding the HVAC performance and mix issues. How big of a drag was that those efficiency or the issues in the quarter and then maybe separately you called out a legal charge if you could maybe quantify that? And then, as we strike our models for Q1, do we see some leakage into the first quarter of 2018 that would change the kind of normal 21% seasonality there?

[Scott Sproule, CFO]

When you look at HVAC on full-year basis, kind of both of those matters that I talked about are probably driving around -- each around 40 bps of impact for the full-year. And then when you think about for Q1, I don't see a leakage effect from this. I think the one matter we called out really is an isolated matter for the quarter, and the other is around we've already implemented corrective actions and feel confident that we're not going to have the same type of operational issues.

[Operator]

Thank you. [Operator Instructions].

Our next question comes from Robert Barry from Susquehanna. Your line is now open.

[Robert Barry, Susquehanna]

Congrats on a solid year.

[Gene Lowe, President & CEO]

Thank you.

[Scott Sproule, CFO]

Thank you.

[Robert Barry, Susquehanna]

So just on the tax, I understand year-over-year not much impact but I assume if there wasn't tax reform you probably would have guided the tax rate in 2018 to be like 30%; is that right?

[Scott Sproule, CFO]

No, not that high. We're structurally at a upper 20s, so call it 28 or so percent effective rate was what we were at on a pre-reform basis.

[Robert Barry, Susquehanna]

Got it, okay. And in terms of the revenue on Engineered, can you unpack what's happening there if I missed that in the call and we could skip that, but it looks like the implied decline in the process business is pretty severe and more than it was this year?

[Scott Sproule, CFO]

Yes, we said --

[Robert Barry, Susquehanna]

In the high-single?

[Scott Sproule, CFO]

In the mid-single-digits for -- mid-upper-single digit sorry for the total group which you have some modest improvement there growth in transformers and the rest is the decline there. And there was still some projects that we're executing through, they were in the beginning backlog for 2017 that are the of the nature of projects that as we moved our business model and focus more to providing components to the market versus taking out full scope projects that were no longer really bidding on.

So that’s really the driver and it is a fair amount from a top-line perspective but we’re at a much healthier business, and as I said, the segment getting to 8%, above 8% margins for 2018 and we still see some runway from there.

[Robert Barry, Susquehanna]

Got it, got it. And in terms of modeling the detection growth, I mean given it was kind of a tale of two cities this year, I mean should we expect kind of a mirror image of that like really strong in the first half and then declines in the back half just given the comps are just roughly how we should think about that?

[Scott Sproule, CFO]

No, I don't think it's going to be a flip of that of really strong in the first half and declines in the second half, it'll be a little bit more growth in the first half, but then overall it's going to be probably pretty fairly even the first and second half. It's really the difference in the project portion of the business remember that roughly two-thirds of that business is going to be more run-rate type driven, but the third that is project oriented is lumpier on a quarter-to-quarter basis. So it doesn't normalize until you look at it from a full-year effect.

The one thing as I say it in the prepared remarks is from a margin perspective Q2 of 2017 was exceptionally high margins and we don't expect that level of margins this year. So that'll affect the earnings profile on a quarterly basis.

[Robert Barry, Susquehanna]

Got it, got it. Just finally can you at least in the past or can you remind us how much capital deployment is assumed in this 2020 earnings outlook?

[Paul Clegg, VP, IR & Communications]

No, sorry, Rob, this is Paul. No we have not actually discussed it in detail, what we have said is that at the upper end sorry at the mid-point really, we're looking at roughly two-thirds of the growth from where we are today being capital driven, and one-third being organic.

[Robert Barry, Susquehanna]

Got it. Great, thank you.

[Gene Lowe, President & CEO]

Thanks, Robert.

[Operator]

Thank you. And I have one more question from Elie Mishaan from Corsair Capital Management. Your line is now open.

[Elie Mishaan, Corsair Capital Management]

Hey guys. How are you?

[Gene Lowe, President & CEO]

Hey, Elie.

[Scott Sproule, CFO]

Hey, Elie.

[Elie Mishaan, Corsair Capital Management]

I have a couple of questions. The first one starting with the 2020 guidance, I was just doing back of the envelope math here and would love to hear why I'm right or wrong on this, because it's -- if you're assuming I'm not just going to through a number of the $600 million deployment, let's call it $400 million is being included in the assumption on the 2020 guidance. If I -- I hope you guys get a much higher return than this but if I assume a 10% return annually on the capital deployed that's $40 million of income after tax would be like roughly $0.75 or so. I'm curious how you get to that guidance range for 2020, if you are including capital deployment unless the return is going to be much worse than the number -- than the 10% and if I missing something, I'm trying to understand that?

[Scott Sproule, CFO]

Yes, this is Scott. I think there is obviously a range of outcomes in there that can happen looking at capital, how much capital actually gets deployed and whether you're towards the mid-point of that range or the upper end of that range. And as far as returns go, we’ve been I would say prudent in the level of return that we're expecting in those numbers, those are GAAP numbers so they’re going to have the amortization impact in there. And then there is a level of share creep that you have to model in as well as the fact that as you look at acquisitions for our company, we're mostly focused or mostly going to be domestic acquisitions which would negatively impact the 23% tax rate, I noted for 2018.

[Elie Mishaan, Corsair Capital Management]

Got it. Those all makes sense. It still seems to be extremely, extremely conservative, but if you're -- I mean if you're assuming that the $400 million number in the as deployed. Another question I have is just back to the capital deployment. Obviously you guys are focused on M&A and I think another question is kind of brought up buybacks as well. And I think you guys mentioned if we don't find something obviously we're willing to look at other touch options. I think my question is actually bolstered by the guidance. If that’s the guidance we’re getting to assuming capital deployment, then isn’t buyback a stock significantly more attractive than investing in whatever you guys are assuming you’re investing in? Just given the multiple disparity between your company and a lot of the industrial peers, in the U.S. it seems like there's a very big gap there and if the numbers we're getting to on our guidance are what they are assuming capital deployment it doesn’t seem like that would be the best allocation of capital, just curious what your view on that would be?

[Gene Lowe, President & CEO]

Elie, this is Gene. Let me take a crack at that. We were always going to be looking at the best way to deploy capital to drive value for shareholders. As we look forward, I actually think it's probably going to be some combination of building out our platforms, but also could be buybacks as well. When we sit here today and the opportunity we have in front of us, we think we have some very attractive platforms, we actually think we can build those platforms with very synergistic opportunities and really drive a lot of shareholder value over the long-term.

So I think your point is very valid particularly when we are -- our debt is so low sitting at a $1.47 today and we are generating a lot of cash flow. So I think it's a great question and we're going to constantly look at that and I think it's going to be, end up being a combination of those as we look forward over the next couple of years.

And Scott, on this, do you have anything else you'd like to add?

[Scott Sproule, CFO]

No, I think that's right. And as we've talked obviously, not just to reiterate we do think that we have the best opportunity to drive value-creation, long-term value creation through M&A inclusive of clearly opportunities to drive synergies through deals that we acquire. Again that's something that we have modeled this on specific targets, we've modeled this more broadly. So we've taken some relatively conservative prudent views around those synergies those are obviously deal specific.

[Elie Mishaan, Corsair Capital Management]

Right, okay and I appreciate the color there. And the only thing I would just reiterate as a shareholder is that think obviously I think the stock is trading at a very big discount and seems like you get a great return on a buyback and not to the exclusion of doing M&A because now there is $600 million to allocate. So there is plenty there and then the one other thing and then I’ll turn it over to the next caller, would be buying back stock is also a long-term creation of value, if there are 45 million shares outstanding today and there is 40 million for the rest of time that creates value for everyone forever. So I'll just -- just going back that I think they're both great long-term creators of value and seems like both can be done simultaneously as long as you're not restricted by talks with other companies which is obviously possible, so I appreciate the color. Congrats on a great year. Thanks.

[Paul Clegg, VP, IR & Communications]

Thanks, Elie.

[Scott Sproule, CFO]

Thanks, Elie.

[Gene Lowe, President & CEO]

Thanks, Elie.

Operator

Thank you. And I’m showing no further questions in the queue at this time. I’d like to turn the call back over to Paul Clegg for any closing remarks.

[Paul Clegg, VP, IR & Communications]

Thanks very much for joining us and we look forward to talking to you again next quarter.

[Operator]

Ladies and gentlemen, this does conclude your program. And you may all disconnect. Everyone have a great day.