The Quarterly. Analyst themes of quarterly industrial products earnings 4Q17. New tax and accounting rules led 4Q17 analyst conversations

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1 The Quarterly Analyst themes of quarterly industrial products earnings 4Q1 The industrial products (IP) sector continues to hold an optimistic view on growth. Nearly all peers devoted time to discussing the impact of new US tax laws, where near-term financial effects are expected to be outweighed by long-term opportunities for growth and investment in the business. The success of portfolio management programs, combined with improved cash flow, is creating an even stronger drive for companies to plan investments in technology. tax and accounting rules led 4Q1 analyst conversations Welcome to The Quarterly, a review of the top themes discussed by leaders of 20 industrial products (IP) sector companies during earnings calls with analysts. The Quarterly tracks the movement of these themes from quarter to quarter to provide perspective on shifts in the industrial sector landscape. We view the themes in The Quarterlyas providing a timely snapshot rather than a universal assessment of importance, revealing insights into the minds of both industrial leaders and sector analysts during the quarter. Themes that stood out in 4Q1 include: Changes in tax legislation/regulation, which made its debut on the list in first place. The US Tax Cuts and Jobs Act is providing US-based industrial products peers with opportunities to repatriate overseas income. While near-term issues such as the management of deferred tax liabilities were prevalent in 4Q conversations with analysts, company leaders also shared ideas about long-term growth plans such as new investments in workforce development. Accounting issues, also debuting on the list. standards for revenue recognition, retirement benefits, leasing and other activities affected peers across the sector, particularly in aerospace and defense. Leaders discussed with analysts the ways in which these changes are likely to affect quarterly results. Business reorganization/restructuring, which returned to the list. The last quarter of the fiscal year provided an opportunity for reflection for most peers. Peers reviewed the results of the year s portfolio management efforts, many of which concentrated on streamlining and on the integration of recently acquired assets. Working capital and cash flow management. Efforts by industrial products peers to use working capital more effectively and to increase free cash flow have been yielding results. With greater insights into working capital and increased cash reserves, leaders are in a strong position to pursue more active investments in technology in order to stay competitive and respond to market disruption. Jerry Gootee EY Americas Advisory Sector Leader, Industrial Products Page 1

2 Top themes from quarterly earnings calls 4Q1 1. Changes in tax legislation/regulation 2. Developments in end markets 3. Working capital and cash flow management 4. Change in financial outlook 5. Geographic developments 6. Innovation and new product/service launches. Accounting issues. Business reorganization/restructuring. Critical projects. Cost reduction 3Q1 1. Developments in end markets 2. Geographic developments 3. Change in financial outlook 4. Working capital and cash flow management 5. Competitive environment 6. Supply chain management. Innovation and new product/service launches. Cost reduction. Critical projects. Transaction strategy (future plans) Key themes 1 Changes in tax legislation/regulation ly enacted tax legislation or regulations; new tax regimes in a country US tax code draws questions from analysts on 1 of 20 calls Repatriation of income earned outside the US is expected to increase tax expenses for many peers in the short term but provide higher levels of capital for investment locally in the long term Capital expenditures to include technology, workforce development Management of deferred tax liabilities under new rules also increasing shortterm expenses for several peers Leaders optimistic about potential for macroeconomic growth, increased spending by IP sector customers due to lower tax rate The 201 Tax Cuts and Jobs Act (US tax reform) has changed the competitive landscape for industrial companies as they advance and strengthen their positions in the global market. There has been a renewed focus on capital deployment strategies as companiesinthe industrial sector determine how to allocate their US tax savings between infrastructure spend, investments in innovation, workforce development and corporate giving. Now more than ever, there is a need to take a fresh look at the talent agenda, supply chain, treasury and cash management, M&A agenda, and global structuring as companies are realizing that US tax reform impacts all areas of their businesses. Priyanka Chaudhry, Partner, Tax, Ernst & Young LLP 2 Developments in end markets Trends in key customer segments impacting demands for products and services Stable oil prices and US tax reform driving investments across multiple end markets Strong growth in air traffic and high load factor driving demand for commercial aircraft; helicopter market remains under pressure Expanded defense budgets in many countries pushing up demand for defense equipment Demand for advanced materials driven by automotive and smart devices; composites in greater use by the aerospace industry Growth in power grid development, particularly in Middle East Increased demand for specialty chemicals from semiconductor, nutrition, construction and automotive markets Page 2

3 Key themes 3 Working capital and cash flow management Significant changes in working capital and cash flow Cash flow improvements for several peers due to strong prioritization of working capital discipline Productivity and cost control programs continuing to yield positive results Cash flow reduced for some peers due to increased pension plan contributions, fueled by changes in available tax benefits Balancing of capital-heavy investments in long-term growth, such as technology improvements, against quarter-to-quarter revenue and profit goals Employee engagement programs raise consciousness of the importance of improving working capital and cash flow through performance scores, bonuses tied to key metrics Reallocation of internal talent into a cash management office at one peer supports better engagement by business units, external financial advisors Improved collection of receivables continues to be an area of focus There has never been a more acute focus on cash conversion in the industrial sector. Investors and analysts are rewarding top performers and driving down share prices of the laggards. In the past year, we ve seen iconic industrial companies fall from grace largely because they have not aggressively managed the balance sheet and allowed their cash conversion cycles to increase. A comprehensive focus on working capital will also reveal opportunities to improve cost structures and support organic growth. Leading companies are establishing cash management offices that report directly into the CEO, demonstrating their understanding of and commitment to the generation of free cash flow. Peter Kingma, Principal, Transaction Advisory Services, Ernst & Young LLP 4 Change in financial outlook Changing forecasts for revenues or earnings per share Outlooks revised upward by some peers on confidence that new US tax laws will spur increased economic activity; others taking a wait-and-see approach until later in 201 Uncertainties mentioned by leaders include volatile exchange rates, a potential slowing of growth in China and protectionist trade policies Earnings-per-share guidance raised by some industrial manufacturing peers, encouraged by expectations of lower tax rates Positive sales and EBIT outlooks for A&D companies backed by strong backlogs and anticipated growth in orders for defense equipment 5 Geographic developments Changes in market conditions by region Optimism on growth across geographies, led by Asia-Pacific and Europe China faces pricing pressures, particularly in the construction sector, while demand in Asia grows Chemicals players continue shift to Asia and Latin America Middle East remains a strong market for defense; IP companies have a more mixed outlook for the region US tax reform expected to drive growth in infrastructure projects, general spending by IP sector customers as well as investments in operations by IP peers Innovation and new product/service launches Strong focus on digital across all subsectors, both for internal operations and for products and services offerings Health products and insect control products performing well in Asia, lifting sales for chemical companies 6 Focus on digital technologies, R&D and product innovation Increases in capital expenditures targeting the development of new technologies, positioning peers for future growth Robotics, factory automation and smart devices remain focus areas for peers across subsectors product launches and focus on highgrowth segments remain priorities for agrochemicals and specialty chemicals manufacturers Sustainable solutions and products sourced from renewable resources seeing increased demand Industrial companies are innovating and adopting new digital technologies at a pace and scale faster than ever before imagined. Responding to these forces requires a new level of integration and collaboration across product design, manufacturing, supply chain and the end-to-end systems to support those functions. Today, what used to be back-end cost-of-doing-business systems have become critical customer-facing digital capabilities that drive customer value and differentiation. Mike Kanazawa, Americas Enterprise Innovation Leader, Advisory, Ernst & Young LLP Page 3

4 Key themes Accounting issues Changes in accounting methods and policies; revenue recognition standards for revenue recognition from customer contracts being implemented by several peers starting in January 201; impact has been especially strong in the A&D sector due to contract size Clarification by leaders about how new standards are likely to affect companies 201 financial results (e.g., revenues from specific product lines) partnerships and joint ventures creating need for accounting changes Changes to reporting standards for retirement benefits to affect operating income for at least two A&D peers The recent pace of accounting change involves complex areas such as revenue recognition, leasing and pensions and has been a challenge for most companies who have limited capacity in their accounting and finance departments. In addition to the obvious challenges involved in complying with the new requirements, many are struggling to dedicate focus to other key finance initiatives and transactions that are occurring around the same time. This is particularly relevant given the rise in recent M&A and IPO activity, tax reform, and the digital transformation of the finance function. Companies must make sure they carefully monitor, prioritize and balance multiple workstreams in the finance department during this period of rapid change. JP Klaffky, Partner, Financial & Accounting Advisory Services, Ernst & Young LLP Business reorganization/ restructuring Operational streamlining, business function reorganization and divestments Reorganizing portfolio through spin-offs, acquisitions and divestments to achieve a more focused business structure Streamlining operations to accelerate decision-making as well as to drive productivity and efficiency Management of pressure from activist investors to reorganize or divest businesses defined by the activist as underperforming IP players modifying business models and restructuring business segments to ensure streamlined business processes, strong revenue growth and higher profitability Critical projects Two competing priorities for Successful test flights and ongoing Production updates and milestones for key projects crucial to company strategy manufacturers: invest in resources to support new products with advanced technologiesor focus on improving productivity and operating efficiencies; secret lies in balancing both certifications for new aircraft models and defense platforms at multiple A&D manufacturers A&D players adjusting production rates and ramp-up plans as several key projects transition from development to delivery phase Cost reduction Focus on controlling costs in all parts of the organization cost and efficiency programs announced by several IP peers including reduced executive compensation Ongoing productivity programs credited for improvements in cost reductions as well as working capital and cash flow management IP companies serving the energy sector are rationalizing their workforces and manufacturing footprints in response to uneven demand from customers Post-deal and restructuring costs cited by several IP peers Scope, limitations and methodology This analysis examines key themes from the 4Q1earnings reporting season among 20 global industrial products peers, including companies from the chemicals and aerospace and defense sectors. The identification of the top themes is based solely on an examination of earnings calls held from 24 January through 2 February 201. Page 4

5 201 year-end review 201 top themes 201 top themes Developments in end markets Working capital and cash flow management Geographic developments 1 Change in financial outlook 15 Innovation and new product/service launches Supply chain management Cost reduction Business reorganization/restructuring Competitive environment Critical projects Q1 2Q1 3Q1 4Q1 Developments in end markets were prominent in discussions on nearly all earnings calls throughout the year in 201. Many company leaders provided more details about the verticals being targeted for growth. Shifts in demand from key customer segments, especially governments, consumer electronics manufacturers, and oil and gas companies, were topics of frequent discussion. Working capital and cash flow managementalso received considerable attention from both leaders and investment analysts. The effective deployment of working capital and the increase of free cash flow were priorities for several peers. Productivity programs supported these efforts, with a few peers offering incentives to individual employees for making noteworthy efforts to increase cash flow. Change in financial outlook was a topic that evolved over the course of 201. Uncertainty at the beginning of the year, especially after election outcomes in some of the world s largest markets, was clear in leaders comments and stated plans for the rest of 201. As investor confidence returned and demand for industrial products began to grow more quickly with the economy, peers were more likely to revise their outlooks upward and announce increases in dividends. Innovation and new product/service launcheswere described regularly by industrial peers, both in the innovative improvement of their own operations and in the expansion of services provided to clients such as predictive maintenance tools. The topic was also covered by A&D companies when discussing development of new aircraft and defense systems. Overall, industrial companies produced strong results for shareholders in 201. Optimism continues to grow as improving economic conditions support growth in capital investment and potentially greater infrastructure spending in many key global markets. The challenge looking forward: with the pace of change and disruption quickening across most end markets, getting the balance right between meeting current demands and driving near-term results and investing in longer-term market and operational capabilities will separate theindustry 4.0 winners and losers. Jerry Gootee, Americas Advisory Sector Leader, Industrial Products, Ernst & Young LLP Page 5

6 Key contacts EY Americas Jerry Gootee Americas Advisory Sector Leader, Industrial Products Priyanka Chaudhry Central Region Tax Leader, Industrial Products EY Asia-Pacific Karambir Anand Transaction Advisory Services Leader, Industrial Products karambir.anand@sg.ey.com Chee Soon Tham Assurance Leader Singapore, Industrial Products chee-soon.tham@sg.ey.com David Gale Americas Transaction Advisory Services Leader, Industrial Products david.gale@ey.com EY Europe Magnus Kuchler Advisory Leader Nordics, Industrial Products magnus.kuchler@se.ey.com Christian Schibler Assurance Leader GSA, Industrial Products christian.schibler@ch.ey.com Aymeric De la morandiere Assurance Leader WEM, Industrial Products aymeric.de.la.morandiere@fr.ey.com Marco Mignani Assurance Leader Med, Industrial Products marco.mignani@it.ey.com EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. 201 EYGM Limited. All Rights Reserved. EYG no Gbl ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com Page 6