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Edited Transcript of ATU earnings conference call or presentation 26-Sep-18 3:00pm GMT

Q4 2018 Actuant Corp Earnings Call

BUTLER Sep 27, 2018 (Thomson StreetEvents) -- Edited Transcript of Actuant Corp earnings conference call or presentation Wednesday, September 26, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Fabrizio Rasetti

Actuant Corporation - Executive VP, General Counsel & Secretary

* Randal Wayne Baker

Actuant Corporation - President, CEO & Director

* Ricky T. Dillon

Actuant Corporation - Executive VP, CFO & Principal Accounting Officer

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Conference Call Participants

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* Ann P. Duignan

JP Morgan Chase & Co, Research Division - MD

* Jeffrey David Hammond

KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst

* Joseph Michael Grabowski

Robert W. Baird & Co. Incorporated, Research Division - Associate

* Justin Laurence Bergner

G. Research, LLC - VP

* Peng Yao Wu

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Robert Scott Graham

BMO Capital Markets Equity Research - Analyst

* Seth Robert Weber

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to Actuant Corporation's Fourth Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, September 26, 2018.

It is now my pleasure to turn the conference over to Mr. Fabrizio Rasetti, EVP, General Counsel. Please go ahead, Mr. Rasetti.

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Fabrizio Rasetti, Actuant Corporation - Executive VP, General Counsel & Secretary [2]

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Thank you, operator. Good morning, and thank you for joining us for Actuant's Fourth Quarter 2018 Earnings Conference Call.

On the call today to present the company's results are Randy Baker, Actuant's President and Chief Executive Officer; and Rick Dillon, Actuant's Chief Financial Officer.

Our earnings release and slide presentation for today's call are available on our website at actuant.com in the Investors section. We're also recording this call and will archive it on our website.

Please go to Slide 2. During today's call, we will reference non-GAAP measures such as adjusted profit margins and adjusted earnings. You can find a reconciliation of non-GAAP measures to GAAP in the schedules to this morning's release. We also would like to remind you that we'll be making statements in today's call and presentation that are not historical facts and are considered forward-looking statements. We are making those statements pursuant to the safe harbor provisions of federal securities law. Please see our SEC filings for the risks and other factors that may cause actual results to differ materially from anticipated results or other forward-looking statements.

Finally, consistent with how we have conducted our prior calls, we ask that you follow our one question, one

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practice in order to keep today's call to an hour and also allow us to address questions from as many participants as possible. Thank you in advance for your cooperation.

I'll now turn the call over to Randy.

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [3]

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Thanks, Fab, and good morning, everybody. We're going to start today on Slide 3. As you read in today's press release, Actuant delivered a solid fourth quarter and full year result. Our year-over-year performance improved in all areas. In the quarter, EPS grew by more than 100%. Core sales increased by 10%, and we expanded margins by 65%. Cash flow was also very positive in the quarter and marked the 18th consecutive year of conversion of plus 100%.

So now let's turn over to Slide 4. As we came into the fiscal year, we were in the early innings of creating a more efficient company and reinvigorating our organic growth. Over the past 2 fiscal years, we've invested in our operations, restructured our commercial processes and significantly stepped up our new product development activity. We also have begun a strategic review of our portfolio and repositioned our businesses. We've made significant progress

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and led us to the results reported today. Our global teams have done an excellent job of focusing on our sales, our operations and supporting our customers and the results followed.

And now turning over to Slide 5, I was also very pleased with our share expansion and the continued introduction of new products. Enerpac introduced 12 new tools in the quarter, which brings our 2018 total to 30. This has been a primary area of investment, and we're now seeing the fruits of our hard work.

Secondly, Hydratight increased sales by 7% in the quarter, which was the first positive result in many months. And finally, our Engineered Components business launched an additional 6 new product platforms, which was a direct result of our effort to improve OEM support.

Our ultimate goal of achieving a 10% contribution from new products is now well within our grasp. And going forward, our ability to grow sales organically is a critical component of our strategy and will continue to be a focus of our investments.

From a portfolio perspective, we're moving forward with our focus strategy for Actuant. Today, we announced the structured process of divesting the Cortland Fibron business and movement to assets held-for-sale. We've improved the results of Cortland Fibron, but strategically, it does not fit our growth plans for both Tools & Services segment. Very importantly, this minimizes our exposure to upstream oil and gas in offshore exploration. We believe this is one more step towards refocusing our investment capital and our management resources.

Additionally, 2019 marks the start of the 2 segment reporting structure for Actuant. We have structured the company to concentrate on our outstanding Tools & Services business and expanded our Engineered Components & Systems segment to include all OEM-related companies. This will enhance our growth plans, while providing better focus on our strategy. Overall, we're achieving our objectives laid out in the strategy, and we have moved into the fiscal '19 with the organic growth initiatives will continue to be a driving force for Actuant.

I'll turn the call over now to Rick for the details in the quarter, and I'll come back with the outlook on 2019 and guidance.

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [4]

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Thanks, Randy, and good morning, everyone. First let's go through the one-timers that are excluded from the adjusted operating results this quarter on Slide 6.

As Randy noted, we're actively pursuing the divestiture of Cortland Fibron and, as a result, we've taken an impairment charge based on our expectations of the fair value of the business today. The $45 million charge includes the following. The noncash charges related to the write-down of the assets to their estimated realizable value and a $35 million accounting charge to recognize the cumulative translation adjustments from currency since the date of the acquisition. We will update these estimates when we finalize the divestiture. On the balance sheet, you'll see both current assets held-for-sale and current liabilities held-for-sale.

We also took an impairment charge on our concrete tensioning business of approximately $24 million. Prolonged operating inefficiencies and a resulting loss of margin share drove the write-down of goodwill and other intangible assets of the business as part of our annual review process.

We recorded a tax benefit this quarter from the unanticipated release of a valuation reserve on net operating losses given our improved profitability. This benefit was partially offset by $2 million adjustment for tax reform. The adjustment for tax reflects the legislative clarifications received during the quarter.

2018 was really about adjusting our balance sheet for the impacts of reform. The revaluation of our deferred tax liabilities resulted in a gain that essentially offset the estimated impact of the toll charge write-down of deferred assets based on what we know today. The real impact of reform on our financial statement, tax provision and cash taxes will be in 2019 as we discuss -- we will discuss later. While we don't anticipate significant balance sheet adjustments, we will obviously respond as further guidance and clarification is provided by the IRS. Restructuring charges in the quarter were more than offset by year-to-date tax benefits on restructuring actions.

Onto our adjusted fourth quarter results, turning to Slide 7. Fiscal 2018 fourth quarter sales increased by 9%. The impact of foreign currency partially offset the net benefit from acquisitions and divestiture and provided a headwind of 1%. Core sales, therefore, increased 10%.

Adjusted operating profit improved for the fourth consecutive quarter, up almost 360 basis points, reflecting the

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and flow-through on our core sales.

Our effective income tax rate was approximately 7% for the quarter and 10% for the full year, both in line with our expectation. The adjusted EPS for the quarter was $0.39 compared to $0.19 last year and $0.02 over our guidance.

If you turn to Slide 8. Strong core sales of 10% were well above the top end of our guidance range, with all segments exceeding our expectations. Industrial segment sales continued to be strong, driven by solid tool demand across all regions and increase in the standard heavy lift product sales.

Engineering solutions (sic) [Engineered Solutions] sales also exceeded expectations across all product lines with the exception being China truck sales. Energy core sales also rebounded with solid single-digit sales growth in Hydratight.

On Slide 9, as we noted earlier, we saw a substantial increase in year-over-year margins. This was largely due to strong incrementals on the improved Energy results, solid improvement in Engineered Solution margins and roughly flattish margins in our Industrial segment.

So let's review some of the segment details starting with the Industrial segment on Slide 10. Core sales for Industrial increased 10% year-over-year. We continue to see growth in Industrial Tools of high single digits despite very tough comps in the fourth quarter of last year. The growth remains widespread throughout geographies and markets. We continue to believe that this growth outpaces the market by a couple of hundred basis points, driven by our commercial efforts and continued focus on new products. We experienced a 32% increase in our heavy lifting business, reflecting the lumpy nature of the business and we focused on our standard lifting products. We saw modest growth in our tensioning business after 4 quarters of decline, as we anniversary the plant consolidation issues and resulting loss of share, which began in the fourth quarter of last year.

Profit margins within this segment were flat when compared to prior year. The year-over-year comparison is impacted by mix and an increase in compensation expense on strong operating performance. Incrementals on the Industrial Tools portion of the business, including the incentive comp true-up in the quarter, continued to fall in the range of 35% to 45%, in line with our long-term expectations.

Going forward, as we ramp up our new product launches, we may see some pressure on quarterly margins associated with launch costs before they achieve their long-term margin expectations.

Our heavy lifting business had a profitable quarter due to restructuring actions and the elimination of the profit drag associated with large custom products. Despite top line growth in concrete tensioning business, it remains a drag on operating margins due to the inefficiencies resulting from the loss in sales volume.

Now let's turn to the Energy segment results on Slide 7 (sic) [Slide 11]. Overall, core sales increased by 15% from last year, down only 1% sequentially

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quarter, which is the strongest seasonal quarter for this segment. We're very pleased to see the turnaround in Hydratight with its first quarter of growth in 8 quarters. Increase in maintenance activity was particularly strong in the Middle East and North Sea. North America continued to show declines, again, as a direct result of our shift away from commodity-type service work.

Cortland saw strong double-digit core sales led by increased activity in our oil and gas market as well as our medical business. Quoting activity remains brisk in our primary energy and non-energy verticals. Profit margins for the segment was up 970 basis points from the bottom experienced in the fourth quarter of last year, including the Viking losses, which accounted for 340 points of the expansion.

The segment saw flow-through for incremental sales as our service excellence initiatives and restructuring activities continue to drive improvements. We also benefited by a prior-year onetime charge for the write-off of a bankrupt nuclear customer that did not repeat in the current year.

Turning to our Engineered Solutions slide on Slide 12. Segment sales were solid, delivering a 6% core sales growth off of a difficult comparison in Q4 last year. The sales growth is broad-based in off-highway markets, including agriculture, mining and forestry. European truck production levels also continuing to be solid, fueling strong performance.

China was down 40% on very tough comps from the prior year as production levels continued to drop higher than our expectations coming into the quarter. This brings our overall decline for the year to 15%, a little bit better than our expectation going into the year. We do, however, expect to see year-over-year sales declines for the majority of 2019 and the comparison will get easier in the back half of the year as production levels move back to historical norms.

Profit margins in this segment improved at a strong rate. Incremental profitability was solid on pricing, favorable mix of product sold and reduced warranty cost year-over-year. The favorability more than offset the impact of higher commodity, labor and other manufacturing costs, including tariffs in the back half of the year.

If we turn now to Slide 13 on liquidity. Our cash flow for the quarter was robust. Strong quarterly profitability combined with solid working capital management drove growth in cash balances. Working capital improvements came from strong collections and strong inventory management. Although inventory is up from the prior year, our focus on carrying the right inventory or products in the appropriate regions to support demand aided our core sales growth and resulted in a $10 million reduction in inventories from our third quarter.

Our net debt to pro forma EBITDA leverage was down significantly in the quarter and now stands at 1.9x versus 2.6x as of the end of May and 2.7x as of the end of August. This positions us well to execute our capital allocation priorities well within our comfort zone of 1.5 to 2.5x.

With that, Randy, I'll turn the call back over to you.

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [5]

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Thanks, Rick. Turning over to Slide 14. We believe 2018 was a turning point for Actuant. As you can see, our core sales -- our sales grew by 8%, exceeding our 2018 original guide. EBITDA improved by 19% and EPS increased by 31%. Overall, our operating leverage increased to 26%, which is in the range of our objectives. The bottom line, the backdrop of positive market condition, coupled with our organic growth, have set a positive trajectory for sales and earnings.

So turning over to Slide 15. As I discussed earlier, the fourth quarter was very dynamic in terms of new product launches. Enerpac introductions included a major improvement in our bolting pump product line and new -- a new line of handheld electric tools. The new pumps included an advancement in pressure control and operating range, which gives Enerpac a distinct competitive advantage. Product development coupled with our recent acquisitions has expanded our product line by more than 100 tools.

Engineered Components & Systems also introduced many new products in the year, which played a very important role in our...

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Our success in developing new product applications for OEMs has resulted in sustained growth above market rates.

So now turning over to Slide 16. The macroeconomic factors affecting our business continued to be positive. General economic lead indicators such as GDP, commercial and general construction, industrial productivity continue to strengthen. On the Tool & Services front, our dealers are reporting good retail activity and almost all vertical markets are reporting growth. Additionally, service maintenance is improving oil, gas, renewable energy and in nuclear.

Oil prices have fluctuated between $60 and $70 a barrel, which is fueling a more positive maintenance spending environment. Off-highway mobile equipment is also strengthening and all of our major OEM customers are experiencing good growth dynamics and retail activity.

And finally, on-highway truck sales have declined significantly in China, and we expect some slowing in truck sales as we advance through 2019.

Now turning over to Slide 17. The positive market conditions provide confidence in the continued growth rate for Actuant. We're projecting consolidated core sales growth for the company of between 3% and 5%. Industrial Tools & Services is projecting a healthy 3% to 5% core sales growth with contributions from both new product introductions and market expansion. And finally, Engineered Components & Systems is projecting core sales growth of between 2% and 5%, helped by strong dynamics in off-highway equipment, new platform wins, but in moderating on-highway sector.

So now turning over to Slide 18. Our projections for 2019 are reflecting our positive view of the market and our continued advancement of the strategy. Sales will be in the range of $1.210 billion to $1.240 billion. EBITDA will increase to $155 million to $165 million. EPS will be in the range of $1.09 to $1.20 per share, which is impacted by the increased tax rate and the effect of exchange.

Cash flow is expected to be in the range of $80 million to $85 million. And our first quarter sales will be in the range of $295 million to $305 million, with an EPS of $0.20 to $0.25 per share. Our expectations for operating leverage will continue to be in the range of 25% to 30%.

I'm going to turn it back over to Rick now to provide a detailed bridge to cover the impact of the new tariffs, tax rate, currency impact and define what is the true performance improvement for Actuant. Rick?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [6]

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So starting with tariffs on Slide 19. We've already felt the impact of the Section 232 tariff and the first wave of Section 301. We have been proactively working with our customers on pricing actions, but those actions come through differently in each of our segments given the nature of each business.

Price increases initiated to date have been part of what we would call our normal pricing rhythm in response to rising commodity, labor, freight and tariffs announced in fiscal 2018.

In the tools businesses, we have implemented 2 price increases, one in January and one effective September 1. In the EC&S business, our price actions are negotiated on a contract-by-contract basis and the process was substantially complete for all of our large OEMs during our fiscal 2018.

The new tariffs, which went into effect on September 24, will create a significant headwind. Based on our initial assessment, without consideration of any pricing or surcharge action, the income impact lever could be in the range of $3 million to $4 million. This includes the implemented 10% and the expected 25% hike. We will continue to refine our estimates and work through our mitigation actions and will provide an update on our first quarter call in December.

If we turn to taxes on Slide 20. As Randy noted, we expect the 2019 effective tax rate to be approximately 20% for the fiscal year. This is also the rate that we should be using for modeling purposes in the near term.

The increase in the rate is directly attributable to the new incremental minimum tax on foreign earnings and limiting of foreign tax credit usage as a result of reform. We'll continue to evaluate the new tax rules and future guidance as received. We'll also continue to execute tax planning strategies within the new landscape that align with our business activities to reduce the effective tax rate.

So turning now to Slide 21 and the EPS bridge. First, just note that the projections for core growth that Randy mentioned, is provided in our 2-segment structure: Industrial Tools & Service and Engineered Components & Systems. We'll be providing the restated financial statements in the new segments shortly after the wrap up of our year-end activities. We'll restate 2018, 2017 and 2016 for comparability purposes. Those financial statements will be filed in an 8-K and made available on our website in the coming weeks. Our 10-K will also be cast in the 2-segment format as well.

Now let's walk through the guidance bridge, which highlights the major drivers of our full year guidance, starting with the 2018 adjusted EPS of $1.09 at 10% tax rate. We expect the base business growth will add $0.09 to $0.12 per share this year from continued market growth, new products and share capture. Portfolio actions from acquisitions, Mirage and Equalizer, and the Viking divestiture are expected to improve EPS by $0.03 to $0.05. The restructuring done to improve our operational efficiencies is expected to add $0.04 to $0.06. Note this is the incremental benefit from actions taken in 2018.

As you can see, we expect the strategic actions we have taken along with market growth will add, rounding these numbers out, about $0.15 to $0.25 per share in 2019. We expect a headwind from foreign exchange of $0.01 to $0.02 per share. And lastly, our tax rate increase from 10% to 20% fiscal 2019 will result in $0.10 to $0.12 reduction of EPS. This brings our net guidance to $1.09 to $1.20 per share for fiscal 2019.

I'll turn the call back over to Randy for concluding remarks.

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [7]

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Thanks, Rick. As you can see, we remain optimistic about 2019 and beyond. We have taken actions to position the company for success, and as we progress through 2019, our priorities remain consistent. We intend to grow at a rate greater than market. We drive incremental profitability at our stated range, 35% to 45% for Industrial Tools & Services and 20% to 30% on Engineered Components & Systems.

Lastly, we discipline -- our disciplined capital allocation to drive superior returns to our shareholders. We believe, we're on the right path, and we appreciate the support of our employees, our shareholders, our customers and our suppliers.

With that, operator, we'll turn it back over to you for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Jeff Hammond with KeyBanc Capital.

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Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [2]

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So just on the bridge. It seems like if I'm doing the math correct, the base business incrementals are kind of 20% to 25% versus kind of what you were talking about. And then, you had a number of headwinds, kind of heavy lift, concrete tensioning, some warranty that would seemingly go away, and I don't see that as kind of an offset. So I just want to see how you're thinking about those within the context of incrementals?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [3]

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So Jeff, if you go back to our EBITDA targets of $155 million, $165 million and you do the math based on those, the incrementals would be an implied plus 30%. So we've pegged it a little higher than our stated range of 25% to 30% for the consolidated bit and the reason for that is as those one-timers we just mentioned are not going to repeat. And particularly, if you recall our first quarter of last year, we had significant costs and those costs carried to the second quarter. So that's why we're pushing the business to have a little higher incremental operating leverage going into '19 because we think it can handle it.

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Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [4]

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Okay. And then I know you said you're going to give the segment detail here upcoming, but can you just give us what the EBITDA margins are of the 2 segments for fiscal '18? And then, kind of how you're thinking about what the long-term EBITDA margin opportunities are for each of those segments?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [5]

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So when you look at EBITDA margins for year-over-year under the new segments, we're looking at those margins in that for Industrial Tools & Services in the low to mid-50s plan to '18 or topping the guide to '18 and low to mid -- or mid-20s to high or low-30s for EC&S. And so those are kind of the blended margins. With the -- and keep in mind, as Randy mentioned, the margin profile of these 2 segments shifts and the inclusion of Cortland and PHI, with the legacy Engineered Solutions bring that incremental margin, or the EBITDA actual margin, up. And then similar but to a lesser degree for Industrial Tools & Services, it's a little bit of creep in the margin. And so when you think about the incrementals, it's in the 20% to 25% range for IT&S; incrementals for EC&S in the 9% to 10% range.

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Operator [6]

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Our next question comes from the line of Scott Graham with BMO Capital Markets.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [7]

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Several questions for you all. The first one is maybe just more accounting than anything, Rick. The sizes of the charges taken this quarter relative to the sizes of the business kind of outsize, could you just sketch a couple of things out there for us?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [8]

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Sure. On the Fibron piece, the

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it all ties back to what we -- the purchase price of -- at the time we acquired the business. So the goodwill and the intangibles are reflective of what was a purchase almost at the peak, which makes it a much higher purchase price. So I think that's what you're seeing. The $30-some million of CTA, that is, I call it, accounting noise, but it is the cumulative translation of the results -- the balance sheet of the operation since the date or time. But in terms of the PHI impairment and the Fibron impairment, the size of the impairment is really reflective of the -- on Fibron, it's purely how much we pay for the operation given current fair value and it was at a much higher price. PHI, similar scenario, but does not include the accounting piece.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [9]

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Yes, got it. Randy, I'm sure you're shaking your head at those 2. Anyway, the tariffs, the $3 million to $4 million, is that a grossed up number or is that net of pricing?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [10]

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That's gross.

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [11]

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That's gross.

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [12]

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That includes no pricing. If you think about our pricing we took in 2018 and September 1 here for Industrial, all of that pricing was to cover known tariffs and commodity freight and labor activity. This new announcement here mid-September, we've taken no price to directly cover that. And so while our guidance does have some price reading through, it doesn't reflect this 3% to 4%, which would be a gross, call it, worst case scenario.

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [13]

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Right. And that's the number that we calculated to figure out what type of pricing we do need to push through the market to cover it.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [14]

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That's helpful. How did you -- how do you exit this fiscal year? Is that a -- are you pricing plus 1%, 1.5%? What's the exit rate for the company?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [15]

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Price realization?

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [16]

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Yes.

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [17]

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Realization kind of in that 1%, 1.5% range as we exit. When you think about the majority of our pricing, certainly on the Engineered Solutions business and really this September 1 pricing for Industrial, vast majority of that pricing was to cover known cost increases. And so that puts us, like I said, back into a normal 1%, 2% pricing rhythm you would get on an annual basis.

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Operator [18]

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Our next question comes from the line of Charley Brady with SunTrust Robinson Humphrey.

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Peng Yao Wu, SunTrust Robinson Humphrey, Inc., Research Division - Associate [19]

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This is actually Patrick Wu standing in for Charley. Just wanted to just follow up on the previous question on pricing. And as I look at Engineered Solutions, can you sort of bucket sort of the year-over-year margin improvement for us in terms of volume, mix and price? And it sounds like you guys were able to successfully push through most of the pricing that you guys wanted to into the normal pricing. But are you hearing -- are you putting in any escalation clauses that you sort of set some expectations with your customers, in case the tariff situation sort of worsens a little bit more or if inflation continues to ramp up? Can you give us some color on that?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [20]

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Sure. When you think about the OEM contracts, first, each contracts, each platform is different. Some have escalating clauses, others have very complicated cost out inflationary clauses within the contract. And so from an EC&S perspective, you're really going contract-by-contract. And our ability on events like this, surcharge, tariffs, to go back, in some cases, it is still subject to negotiation. So when you look at year-over-year for EC&S, the -- it's really a story of volume.

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favorable for us. We got several new product launches coming out that will assist volumes. We got market improvement as well across all of those verticals, and so all of that is really driving our activity. We had significant productivity baked into the plan and that's some of the one-timers you saw last year with warranty issues, labor efficiencies as we had the flood of volume, those things leveling out from a profitability perspective. Pricing is really offsetting tariffs, known tariffs as of the end of 2018.

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Peng Yao Wu, SunTrust Robinson Humphrey, Inc., Research Division - Associate [21]

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Okay, that's helpful. And just quickly on, I guess, new products. I mean you guys have done a pretty solid job there, rolling those out in fiscal '18. It sounds like there's going to be some ramp-up costs in the near term for that. How should we think about new product development going into the next fiscal year? Are you guys continuing to accelerate that? Or should that be moderating somewhat versus '18 levels?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [22]

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Well, we have a base level of SA&E expense associated with our problem and now. If we do add any incremental costs in there, it will be an opportunity to bring in a new product idea. What we have budgeted right now and what we have on our new product development streams are covered in terms of our outlook for next year and reflected in our guidance. So we're not saying another incremental ramp up, and Rick and I are watching of the new products or new platform launches, what are the incremental revenues coming off it because there's a justification process that has to continue to happen so that we

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how much we're getting back from that investment. So we're managing it quite tightly. And I think our engineers are feeling the freedom to be creative now, but we also want have to a controlled ramp up and launch pattern for our new products.

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Operator [23]

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Our next question comes from the line of Ann Duignan with JPMorgan.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [24]

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Randy, could you talk a little bit about your revenue guidance, first in the context of for each of your segments, core revenues came in better than expected in Q4, but your guide going forward seems very conservative, particularly in Industrial Tools & Services where you say you're going to outgrow the end markets and yet the guidance is for 3% to 5%. It doesn't seem like that's outgrowth of anything we're seeing out there. So can you just talk about where was the surprise in Q4 and how conservative is the guide you're giving today?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [25]

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Well, what I've -- look, Ann, you can well imagine, I look at all of our 14 vertical markets that we serve for Industrial Tools and I look at each individual growth rates and how fast did they grow last year, and at one point, we anniversary those growth rates. So on the 3% to 5% -- consolidated in the 3% to 5% for Industrial Tools, particularly, we feel that, that is an estimate that's realistic and it's supported by all the major vertical markets. Now, what we saw was a heavy ramp-up over the last couple of years. And as we anniversary, particularly, in the first and second quarters of last year when we came to full stride, there was a double-digit growth rate. So to compound that again and say again that we would either have high single digits or low-double digit growth rate on Industrial Tools sales, I think would be somewhat too optimistic, and we're trying to be conservative relative to what will pricing do with the tariffs and will there be any tempering in the marketplace. So I personally believe a 3% to 5% ramp-up on a year-over-year basis is in a range that's not extraordinarily aggressive, but it's realistic given the market conditions.

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Ann P. Duignan, JP Morgan Chase & Co, Research Division - MD [26]

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And what would have to happen for it to be on -- at the 3% and what would have to happen for it to be at the 5%?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [27]

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To jump to -- to higher the range? Largely, I think if you look at the various vertical markets we do participate in, some of them are getting to a mature level. So if you look backwards in time, aerospace really started going double-digit growth all the way back into '17, so that's a very mature market. And then, certainly, mining is on -- it's still on the major demand. I think there's a lot of tools and equipment being taken into the mines and that certainly has some upside to it. But it's only 1 market of the 14 that we sell in. So I think if we were going to come to the very top end or beat the top end of our guide, we'd have to see some fundamental changes in the commercial construction, residential construction markets and particularly in Europe. Europe has definitely tempered a bit over time, where we were in the high double digits to lows -- or the mid-double-digit growth rates, it has tempered back; and the same with Asia Pacific. So you'd need to see the European market and the Asian market really continue to hit on a double-digit market growth to support that level. But -- and we're watching them very closely in terms of the -- what type of revenue and what type of growth we're getting every single month.

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Operator [28]

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Our next question comes from the line of Mig Dobre with Baird.

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Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [29]

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Joe Grabowski on for Mig this morning. I wanted to start out asking about incremental margins in Industrial. They're about 23% for the second quarter in a row. If Industrial Tools are 35% to 45%, obviously, the smaller businesses are continuing to provide a drag on incremental margins. What's the outlook for the next few quarters? When do those drags start to normalize and maybe even turn to tailwinds?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [30]

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If we just talk about the -- you have heavy lift, which we believe the majority of that is behind us. In fact, the impact of large products -- projects, rather, was negligible in the quarter, so standard projects, though lower than our standard tools, still keep us, from a segment perspective, in that incremental zone that we like to see. When you look at Cortland, the other -- I'm sorry, so from a tools perspective. that is what we expect to see going forward in those incrementals. Now getting into the new segment structure when you look at 2019, similar product-related margins for Energy products as we have in our legacy Enerpac segment-type products. And then on the service, we do see service growth and some improving market conditions. So those margins will blend nicely into what Randy has given as our normal incrementals, we'll be right there in the midpoint of that range. The drags in the Energy segment, slightly lower margin would be Cortland, and that's on lower volume, but you see that improving. We saw significant improvement in the fourth quarter. And when you think about going forward ex Fibron, even with Fibron, because of the rebound in the market, those margins come with -- those sales come with large margins, so that is actually part of the view, again, of the standard view of EC&S going forward. And it helps lift that EC&S margin from the low to mid-teens, up into the 20s when you add in the Cortland business and the PHI business. PHI loss in share, we do expect some of those to regain some share and a little bit of market growth in 2019. The margins will be in -- still in that low to mid-teen zone if we're able to get back some share as forecasted.

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Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [31]

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Got it, okay. And then my follow-up question would be on first quarter guidance. The EBITDA guidance is pretty consistent with our expectations, but the EPS guidance was a little bit below where we were. Looking just at the midpoints, it looks like EBITDA guidance is up 50%, but EPS guidance is only up about 20%. It looks like the tax rates are comparable year-over-year. So is there something below EBITDA that's impacting EPS in the first quarter?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [32]

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Nothing below EBITDA impacting it. The year-over-year should be driven -- you have little bit of mix impacting overall EBITDA margins. But the guide is driven off of the tax rate and the flow, so I don't know the disconnect with your model actually so.

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Operator [33]

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(Operator Instructions) Our next question comes from the line of Justin Bergner with Gabelli & Co.

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Justin Laurence Bergner, G. Research, LLC - VP [34]

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First off on the subject of capital allocation, is the goal to still focus on bolt-on acquisitions going forward? Would you buy back shares if you don't find such deals? And is there any benefit from balance sheet in your guidance?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [35]

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So our primary objective is still to find good acquisitions. Now whether it's a bolt-on or a larger more meaningful acquisition, we believe in the tool sector, that is well within the bandwidth of the company. So we've spent the last 2 years preparing ourselves to handle larger acquisitions if they were available. From the perspective of share buybacks, we track that. That certainly is in our capital allocation strategy and priority. When the opportunistic price is there, we will get into the market and buy shares. But it's -- the priority has always been pretty clear of: number one, is invest in ourselves, which we've been doing; number two, is making good acquisitions that support the tool and service strategy; and number three, share buybacks and debt reduction. Now from a balance sheet perspective, I'll let Rick cover that.

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [36]

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Sure. There's -- to make a comment, there's no plan at this point to buy back shares. When you look at what we have before us, the debt structure is in good shape. We will likely just, as normal course given the maturities, restructure our debt, but it will come out with a similar fix versus variable. So from a balance sheet perspective, certainly, at this leverage, we feel pretty good. It does give us the capital to really focus on acquisitions and those acquisitions could be bolt-on, could be larger and more meaningful. We obviously have a strategy that says 50% of our growth will come from M&A. So as we sit here today, we think we can execute that strategy, which does not include a share buyback.

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Justin Laurence Bergner, G. Research, LLC - VP [37]

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Got it. So just a follow-up there then. The EPS guide assumes that the $80 million to $85 million of free cash flow either pays down debt or builds up this cash?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [38]

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Yes.

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Operator [39]

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Our next question comes from the line of Seth Weber with RBC Capital Markets.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [40]

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I just have actually a few clarifications, if I could. Rick, on the free cash flow guidance for the year, can you just tell us what that $10 million of other positive contribution of free cash flow guidance is meant to be?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [41]

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Sure. You're referring to the walk back to GAAP?

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [42]

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It's on the last page of the press release, I think, yes.

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [43]

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Right. What we typically do is, we know EBITDA, we know CapEx, and there usually are a bunch of other items that come through impacting cash flow from operations, things like taxes, incentive comp, interest expense, all of those things come through. And so the $10 million is kind of our other that we know will have an impact on cash flows. The overall number, we do the bottoms-up build, and we're trying to reconcile to the GAAP number, which shows cash flow from operations as a stand-alone item. So it's just our walk back.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [44]

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Okay, all right. And then, in the prepared remarks, I think, I don't know if it's Randy, you mentioned sort of launch costs could be a headwind going forward. Is that an incremental headwind or that's just sort of your normal cost of doing business? I'm just trying to understand if you think these launch costs are going to get more -- to be a bigger headwind going forward versus what we've seen?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [45]

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No. I think, look, 2 things. In 2019, we have more new product coming than we did -- certainly than we did in '18. And as Randy's described, it's more than we've historically had. But launch costs are consistent with all new product kickoffs similar to what we saw both in ITS and what we saw in prior years with Engineered Solutions as we brought on new platforms. So I don't think they're incremental headwinds. I think when you look at the guidance and the volume of new product that's in our 3% to 5% growth, the NPD helps us outpace the market. Those costs will mean, as I think the comment was, the margins, the incrementals on those specific items may not be exactly at that run rate, but certainly factored into our overall guidance.

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Seth Robert Weber, RBC Capital Markets, LLC, Research Division - Analyst [46]

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Okay. And then just -- sorry, just going back. And sorry, if I missed this, but was there something in the Energy mix this quarter, fourth quarter margin versus the third quarter margin? And I'm just trying to understand is this a business that should do, on an EBIT basis, high single digits going forward or is this kind of a mid-single-digit business in aggregate today as you're thinking about next year?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [47]

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I think we view Energy as it's presented historically would be in that low double, high single range going forward, absent large projects. And there was no significant mix, if you will, in Q4. It was more so just the rebound and the efficiencies created by -- through our service organization and our product sales, but no real mix contributor to those numbers.

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Operator [48]

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Next, we have a follow-up from the line of Scott Graham with BMO Capital Markets.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [49]

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I have questions on mix for all 3 segments. You've answered several of them. But I did want to maybe just revisit Industrial where, on a sales basis, how does heavy lifting end up in 2018 as a percent of the total in this -- in the old segment format here?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [50]

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Yes. It would be about a 10% or 12% of the total. It's roughly about a $40 million business. And it would track in -- we've got -- you can see in our fourth quarter, we got the business profitable. And that our objective is to get that as a normalized heavy equipment-type company, which would be operating profits in the teens. So it's not a big contributor. We think that a lot of the standardized products can be even more profitable as we go forward. But we've done a lot in the third quarter and started in the second quarter, completely restructure that business and to make it a profitable entity.

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Robert Scott Graham, BMO Capital Markets Equity Research - Analyst [51]

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Understood. And at that level of percent of sales, I guess I'm wondering why mix was negative in the segment. Does that suggest that the tools sales were mix negative?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [52]

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Well, there's 2 things going on. The percent of sales is lumpy on a quarterly basis and so it's the jolt of heavy lift in the quarter. We also have significant bolting year-over-year growth and that comes in, again, at a slightly lower gross margin than at the normal set of tools. So those 2 combined are the -- really, the mix issue within the Industrial piece.

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Operator [53]

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Our next question is a follow-up as well coming from the line of Justin Bergner with Gabelli & Co.

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Justin Laurence Bergner, G. Research, LLC - VP [54]

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A couple quick ones here. So the $3 million to $4 million tariff impact per Section 301 was $3 million. That assumes that the 10% kicks up to 25% at January 1 and there's no pricing vis-à-vis any of those tariffs for the 12-month period?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [55]

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Yes.

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Justin Laurence Bergner, G. Research, LLC - VP [56]

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Okay. Second clarification on the tax side. Is the 20% also sort of an indication of cash tax rate going forward more or less?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [57]

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Assuming no change, yes, but keep in mind, there's a lag on the rate and cash impact. So payments this year won't equal the 20% rate, but it will be a blend, if you will, of the prior rate and the current rate.

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Justin Laurence Bergner, G. Research, LLC - VP [58]

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Okay, great. And then just lastly, on the M&A side of things. I realize concrete tensioning sort of wasn't an acquisition done by the current management team but there were sort of higher hopes for how it would perform. Any lessons learned from that deal in terms of what went wrong and how that informs future M&A decisions?

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [59]

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Well, I'm not going to critique prior management, but I will tell you that our strategy going forward on any M&A activity has to be clarity on trying to dominate share space within the tool and/or service sector. So as we build out the 5 vertical markets that are associated with our targeted tool companies, that's where our M&A dollar is going. It will be broken into 2 buckets, large, transformational style acquisitions and smaller more tuck-in, which are really a supplemental activity to R&D. And you saw that in some of my prepared comments that the smaller acquisitions, although they don't move the revenue needle as much as we would like, but you get an injection of tools into your catalog that are then marketed through the vast number of Enerpac dealers globally. And so you can take a regional small company and give them the breadth of our entire distribution channel, and it is a great supplement to the R&D. And in fact, it's a very efficient way to bring new products to the market quickly and get a nice revenue pop. So that's things to be thinking about from our end in the M&A activity. If we've made an acquisition, you can be very assured that it was in the tool space.

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Operator [60]

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Our next question is also a follow-up from the line of Mig Dobre with Baird.

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Joseph Michael Grabowski, Robert W. Baird & Co. Incorporated, Research Division - Associate [61]

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Joe Grabowski, again. Just a quick question on the tax rate. If it's 10% to 15% in Q1 and 20% for the full year, any initial thoughts on cadence kind of Q2, Q3, Q4? Is it sort of a calendar year issue why the tax rate is lower in Q1 or kind of how that flows through for the year?

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Ricky T. Dillon, Actuant Corporation - Executive VP, CFO & Principal Accounting Officer [62]

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It is quite lumpy throughout the year as it has been in the past. It's more of a function of how some of the planning items come through and less of taking the 20% and

(technical difficulty)

So there will be this movement, if you will, throughout the year. We also have first half of the year lower earnings, so that's going to give you naturally a higher percent

(technical difficulty)

at the end of it, we'll be 20%. And then we again have back half of the year. That's our highest year, so you have a lower rate in the back half. But there is no specific cadence. It's definitely going to be as lumpy as it has been historically.

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Operator [63]

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There are no additional questions at this time, gentlemen. I'll turn the presentation back to you.

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Randal Wayne Baker, Actuant Corporation - President, CEO & Director [64]

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Okay. Well, thank you very much, and thank you, everybody, for your interest in the company. And we'll talk to you at our first quarter earnings call. Thank you very much.

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Operator [65]

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Ladies and gentlemen, that does conclude today's presentation. We thank you all for your participation and ask that you please disconnect your lines.