SPX Technologies Inc

F:SPW0

Earnings Call Transcript 2019-Q1

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Q1 2019 SPX Corporation Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Paul Clegg, Vice President of Investor Relations and Communications. Sir, the floor is yours.

[Paul Clegg, executive]

Thank you 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, Chief Financial Officer. A press release containing our first quarter 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 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 May 9.

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. You can find detailed reconciliations of adjusted figures to their respective GAAP measures in the appendix to today's presentation.

As a reminder, our segment reporting structure combines the results of our Heat Transfer and South African operations into an All Other category, which is excluded from our adjusted results. It is -- our intent is to report these entities as discontinued operations at such time as they meet the accounting requirements to do so. For the Heat Transfer business, we are targeting this to occur in the second quarter of 2019. For South Africa, we anticipate reaching substantial completion of our scope of work on the projects by the end of this year.

Consistent with how we establish our guidance, our adjusted earnings per share also excludes non-service pension items, amortization expense, onetime costs associated with acquisitions and a gain on the revaluation of an investment.

Finally, we will be meeting with investors during the second quarter and presenting at the Oppenheimer Annual Industrials Conference in New York on May 7 and the UBS Global Industrials and Transportation Conference also in New York on June 5.

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

[Eugene Lowe, executive]

Thanks, Paul. Good afternoon, everyone. Thanks for joining us. On the call today, we'll provide you with a brief update on our overall results, segment performances and end-market conditions before going into Q&A. Before getting into the highlights of the quarter, I want to comment on the South African projects.

During the quarter, we continued to progress towards substantial completion of our work there by the end of this year. This is a significant milestone that substantially reduces our operational exposure to the risk and volatility that we have seen historically over more than a decade of work. I am very pleased with the work our team has done there. As we reduce our footprint on the remaining project site, we are increasingly focused on the dispute resolution process that is typical of large power projects. As discussed at our Investor Day in March, as we manage through the dispute process, you will see increased disclosures and could see some variability in results depending on dispute outcomes.

In the first quarter, our GAAP results were affected by an asset impairment associated with this dispute process. However, we do not see any material impact to our liquidity or to our recently provided capital availability target. Scott will provide more detail on the accounting in his section.

Now I'll touch on some of the highlights from the quarter. Overall, we had a solid start to the year, and we're on track to achieve our full year guidance for 2019. During the quarter, on an adjusted basis, we experienced a significant increase in revenue and solid operating margin expansion.

Our balance sheet remains strong, and we have substantial capital to deploy for our growth and value-creation initiatives. In early February, we completed the purchase of Sabik, our third acquisition in the last 12 months. It is also our first strategic step to further build out our communication technologies platform, where we see attractive options for platform expansion.

Turning to our adjusted results for the quarter. Revenue increased 9.5% from the prior year to $352 million, and EPS was $0.51. We experienced revenue growth across all of our reportable segments. We also experienced strong operating income growth driven primarily by higher volumes in our Detection & Measurement segment and improved operational performance in our Engineered Solutions segment.

Now I'll briefly touch on our value-creation framework and the progress we made during the quarter. In our HVAC segment, within our heating business, our new product offerings are performing well, and we have seen early competitive wins in our new high-efficiency commercial boiler product line. In our HVAC cooling business, our new counterflow Everest tower continues to see share gains against field-erected solutions, especially for time-sensitive replacement applications.

In our Detection & Measurement segment, a newly introduced locator product line from Schonstedt is receiving a favorable customer response. At our CUES business, our new manhole inspection technology solution is changing the way municipalities and contractors inspect critical infrastructure. Within our Engineered Solutions segment, our process cooling business and component order trends remain favorable, and our transformer business continues to benefit from operational improvement initiatives. And now I'll turn the call over to Scott to review our financial performance.

[Scott Sproule, executive]

Thanks, Gene. I'll start with our net results for the quarter. Our GAAP EPS for the quarter was $0.01, and on an adjusted basis, our earnings per share was $0.51 or an increase of 18.6% from the first quarter of 2018. While Paul reviewed our typical adjustments, we also adjusted our GAAP earnings during Q1 to exclude a charge for the settlement of certain matters associated with the prior sale of our Dry Cooling business.

In addition, our adjustment for South Africa this quarter includes the impact of an asset impairment of $0.39 per share. As Gene discussed, we're increasing our focus on the dispute resolution process of the South African projects. We saw increased claims activity in Q1. Accordingly, we have expanded disclosures in our 10-Q to include details associated with these claims. We continue to feel confident in our ability to successfully assert our rights and defend against claims. However, from an accounting perspective, based on guidance under the new revenue recognition standard, we determined the need to take an adjustment to earnings of $17.5 million to reduce our net asset position.

Turning to our cash flow expectations for South Africa. In the first quarter, we used approximately $5 million of cash, and we are now realizing our full year expectations for net cash usage of up to $15 million, which is moderately higher than our prior estimate.

Beyond 2019, the settlement of disputes may create some variability in our cash flows, but we remain confident in our ability to deploy approximately $500 million towards growth initiatives by the end of next year.

Turning now to our adjusted results. Revenues increased 9.5% during the quarter. This included 7.5% growth from acquisitions in our Detection & Measurement segment, 2.5% organic growth driven by our Engineered Solutions and HVAC segments and a modest unfavorable currency effect. Segment income grew $4.8 million or 11.6% driven by higher revenues in Detection & Measurement and improved performance in Engineered Solutions. Adjusted segment margins expanded 30 basis points due to a favorable shift towards higher-margin Detection & Measurement revenues as well as the improved operating performance of Engineered Solutions.

Now I'll walk you through the details of our results by segment, starting with HVAC. Organic revenues for the quarter increased 1% driven primarily by strong demand for our heating products. We feel good about this performance, given that we experienced very strong winter heating demand in the prior year. We are also pleased with the solid traction we have been seeing on competitive wins and new product introductions. Segment income was similar to the prior year, while margins declined modestly due to sales mix.

In Detection & Measurement, revenues increased 29.7%, including a 34.2% increase from acquisitions and a negative currency effect of 1.1%. Organically, revenues decreased 3.4% due to project timing. Adjusted segment income margins were 23.3% or a decrease of 110 basis points. The decrease was largely due to sales mix, including the effect of the CUES acquisition, which has a somewhat lower margin profile than the segment average.

We remain on track for our full year segment guidance and continue to expect typical quarter-to-quarter variations in reported margin associated with sales mix and project timing.

In Engineered Solutions, revenues for the quarter increased 8%, reflecting higher revenues in both transformers and process cooling. Segment income increased $1.2 million and margins increased 50 basis points to 5.8%, due to stronger revenue performance.

Our transformers business continues to benefit from improved throughput and utilization, and our process cooling business continued to see traction with our focus on component sales.

Turning now to our financial position. Our balance sheet remains strong. In the first quarter, we generated adjusted free cash flow of approximately $14 million, which excludes the net cash used in South Africa as well as a modest amount of cash used for Heat Transfer. We ended the quarter with cash and equivalents of approximately $39 million, and we continue to target greater than 110% adjusted free cash flow conversion for our adjusted net income for the full year.

Our net leverage was 1.9x at the end of Q1, which includes short-term financing for the Sabik acquisition. As we generate cash and expand our EBITDA during 2019, we expect our net leverage to decline, particularly the second half of the year, to the low end of our target range of 1.5 to 2.5x, remaining well-positioned for further capital deployment this year.

Turning to our 2019 guidance. We continue to expect full year adjusted earnings per share in a range of $2.50 to $2.65 or a 14% increase at the midpoint over 2018 results. Based on the anticipated timing of certain Detection & Measurement projects, we expect the cadence of earnings to be back-half weighted, which is similar to last year. Beyond the Q1 earnings improvement, the remainder of this year's EPS growth is expected to occur in the second half.

In summary, we're off to a solid start and feel good about our full year outlook. Now I'll turn the call back to Gene for a review of our end markets and his closing comments.

[Eugene Lowe, executive]

Thanks, Scott. Turning to an update of our end markets. Overall, we are on track for the remainder of 2019 and beyond. In HVAC cooling, our order pipeline and backlog continue to be steady. Overall, economic fundamentals for commercial and institutional construction markets remain stable. Market data suggests low single-digit growth this year and this is consistent with our frontlog and our guidance assumptions.

In HVAC heating, we experienced a strong Q1. Seasonal demand was solid and channels appear to remain balanced overall. New product and channel initiatives continue to help drive sales, and we are excited about recently launched product introductions and initiatives that are already contributing to our 2019 results.

In Detection & Measurement, our run rate product lines continue to perform well and our project frontlog is shaping up favorably, particularly in our communication technologies business. The market for transformers remains steady with similar lead times in medium transformers.

Lastly, with respect to input costs, inflation and pricing, we started off 2019 anticipating a full year benefit on our margin due to price and cost inflation of about 50 basis points. Or a recovery of the headwind we experienced last year. For the quarter, we continue to see benefits from our pricing actions that were in line with our expectations.

Before I turn the call back to Paul, I'd like to say that I'm pleased with our performance for the quarter and our full year outlook. End markets continue to broadly reflect steady demand and our portfolio provides us with well-balanced positioning our across the cycle. Our financial position remains strong, and we expect to have significant available capital to deploy for further growth initiatives, both organic and inorganic. We have an active M&A pipeline, and the integration of our recent acquisitions is going well, as we begin to see synergies and strategic benefits across our growth platforms. Overall, we remain on track to continue generating double-digit earnings growth and driving value creation for our shareholders.

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

[Paul Clegg, executive]

Thanks, Gene. Vinieta, we are now ready to go to questions.

[Operator]

[Operator Instructions] And your first question comes from the line of Damian Karas with UBS.

[Damian Karas, analyst]

I was hoping you could just give a quick clarification on the South Africa charge. And so it sounds like about $10 million of additional cash usage this year. So just so we understand, that is going towards litigation or settlement of some of these claims or just the completion of the project or all of the above?

[Eugene Lowe, executive]

Yes, let me start, Damian, then I'll let Scott give a little more color. I mean, as you know, these projects have been going on for a long time, north of 10 years. And what I'd say is I'm very pleased with where we are. Right now, we have line of sight to substantial completion by year-end. Work that's been done over the past 4 years is very substantial, very, very good work, and I really applaud our team on that front. But as you know, with most large power projects, you typically have -- have to resolve claims between the employer, the contractors, the subcontractors. And this is really the phase that we're moving into now as we complete the work. We have reached interim settlements over the course of the project with both of our customers. However, we have to resolve a number of open items. So this can drive short-term variations or choppiness, as we talked about, and you will see additional disclosures. But right now, we feel very good about our positions and where we stand.

[Scott Sproule, executive]

Damian, this is Scott. So as it relates to the quarter, so on the accounting side, this is something that, under the rev rec rules, we have to do each quarter and kind of go through and determine the recovery of the assets we have on our balance sheet for certain assets. So in the quarter, as I said in my comments, we did have more claim activities. So you have to take that in consideration. And it's a pretty high standard in the rev rec guidelines of what you have to meet to be able maintain the balance sheet position. So we determined the prudent thing was to take this impairment in reserve to take our balance sheet down to that net position. And as it relates to the cash, there is an interrelation between this and the cash. As you mentioned, there is additional legal costs that we're looking at as we defend our positions and assert our claims. So there is a relationship with the -- between the 2.

[Damian Karas, analyst]

Okay. That's helpful. And then, I guess, just thinking about the progression as you move through the year here. Obviously, a strong start, first quarter. How should we be thinking about kind of the quarters as -- in particular, on Engineered Solutions with that 8% organic growth? Just wondering if you're kind of expecting maybe the second quarter for -- to see an offset there? Or how should we just think about the growth progression now moving forward?

[Scott Sproule, executive]

Yes, this is Scott. So from a total earnings and EPS perspective, as I'd kind of said in the guidance, really, if you look at it from a half-over-half perspective, in the first half, it was really Q1 is driving the year-over-year improvement, and then the majority of the year's improvement is going to come in the second half. A lot of that has to do with the timing of how the Detection & Measurement projects are lining up for execution this year versus last year.

[Damian Karas, analyst]

Okay. And you've got pretty good visibility on those projects at this point?

[Scott Sproule, executive]

Yes, we're feeling good about how both the run rate portions of the Detection & Measurement business is going as well as the frontlog or the order book on the project side of the business as well.

[Damian Karas, analyst]

Okay. And one last question. So you mentioned that Sabik is going well integration-wise so far. You're about a year in on CUES, just wondering if you could maybe give us an update on where you stand on the synergies, where those are relative to initial expectations?

[Eugene Lowe, executive]

Yes, sure. And we've actually done numerous reviews internally and making sure that we're achieving our targets, both on the cost side and the revenue side. And to cut to the punch line, we're ahead of where we had expected that we would be. We actually -- there are some more, I'd say, innovations there that we're actually very excited about. We talked a little bit about the SPiDER, the manhole inspection, which we actually think is a leapfrog technology. They have new micro pan-and-tilt technology coming out. There's actually a very robust pipeline. But to get to your specific question, the cost synergies that we built into our model in developing our thresholds, we've exceeded those. And we're -- revenue synergies in our model, we did not put a significant amount of revenue synergies, but we actually see some very attractive opportunities. Those usually take longer to come to fruition, but we actually have some nice successes there in selling across different channels. And we also have some active teams working on globalization of some of our products, specifically, where we have a lot of strength from our Radiodetection product lines, so that would be in areas like the U.K., Australia, some areas of Southeast Asia, and we see some very intriguing opportunities there. So yes, I would say, CUES is ahead of where we would -- thought it would be, and we feel really good about the future of that business.

[Operator]

Your next question comes from the line of Brett Linzey with Vertical Research Partners.

[Brett Linzey, analyst]

Just wanted to come back to cooling. Maybe just an update on the tone of the customer, how orders looked in April or frontlog? I think you said low single-digit market growth is the expectation, but maybe just a finer point on the markets and the backdrop between institutional, commercial and maybe some growth markets like data center?

[Eugene Lowe, executive]

Sure, sure. I mean as a reminder, on the cooling business, that's a fairly diversified business. Commercial is the largest business, and we do track the Dodge very closely. And at the latest data that we have seen implies that '19 is low single-digit for commercial. We also sell a lot into health care, a lot into data center, a lot into institutional. We also sell some into some heavy industrial and some power end markets there. So it's actually a very diversified product. Also, just as a reminder for our cooling business, a substantial portion of that is aftermarket, is replacement. So it's not really related to greenfield. So I'd say what we're seeing there is steady demand. And then we also have the Everest product line, which is a cooling product that's really expanding the market. That's taking share from what would traditionally be done in a field-erected manner. So you're building the cooling towers stick by stick as opposed to an engineered product coming out of a plant. So I'd say, right now, it's steady. We're keeping our eyes on it. We have seen a few other comments from other people in other segments of the commercial market. So we're keeping an eye on it, but it looks steady. We have a solid frontlog, and we feel like we're tracking this year.

[Brett Linzey, analyst]

And then just a follow-up on HVAC, what was the gross price, roughly, that you got in Q1? And are you going to be back out with price increases? I know we've seen some moderation in just commodities and in inputs and raws, but are you -- have you been -- have you announced an additional price increase for 2019?

[Scott Sproule, executive]

Yes, Brett, this is Scott. So we haven't given that detail by segment, but I will tell you, it is -- it was positive in the quarter. And we overcame the headwind from the prior year quarter. So why you didn't see margins expand was really more of a result of the mix of different products within the HVAC segment that mostly impacted that offset. And then we're feeling very good about the full year. We talked last year about, from a total company perspective, about a 50 basis point headwind, and we've built our plans with the assumption of taking that -- recovering that. And our pricing actions are sticking and are in good position. And we did come up within our heating business and did put in more pricing actions in the quarter that are now in effect.

[Eugene Lowe, executive]

Yes, and we're also seeing a benefit in cooling. So yes, we feel good about price cost.

[Operator]

Your next question comes from the line of Robert Barry with Buckingham Research.

[Robert Barry, analyst]

Can you hear me?

[Paul Clegg, executive]

We can hear you now Rob, a little bit faint.

[Robert Barry, analyst]

Oh, sorry. Sorry to repeat from earlier, but I just did want to clarify. So the comment about 2Q or an improvement in back half, that was an earnings comment, right? So you expect earnings in 2Q to be flat year-over-year?

[Scott Sproule, executive]

Yes, that's right.

[Robert Barry, analyst]

And it was mostly on the cadence of Detection projects?

[Scott Sproule, executive]

That's correct.

[Robert Barry, analyst]

Got it. So should we just assume like kind of down sales and margin in Detection in 2Q and continued kind of cadence in the other segments?

[Scott Sproule, executive]

Yes, I mean, obviously, we haven't gone to that detail, but I mean from -- you can imply that certainly from the comments.

[Paul Clegg, executive]

Yes, and Rob, you'd know from our historical results in Detection & Measurement, that there's a lot of variability in the margin depending on the mix in the individual quarters as well.

[Robert Barry, analyst]

Got it. And then I know -- just maybe to follow up in a little more detail on the end-market question. I think you had some concern at the end of last year, or maybe just some incremental caution, around non-res and oil and gas, in particular, in that cooling business. Just any update on those 2 end markets, in particular?

[Eugene Lowe, executive]

Yes. The oil and gas, we actually have not seen issues this year. We're actually feeling pretty good this year. One of the things I always do is talk to all the presidents and go into detail on each of the end markets and get a lot of color on everything they're seeing. But no, we're actually seeing a steady demand profile there. We have to keep an eye on that for 2020 and beyond, but we're feeling really good about what we're seeing in front of us now. And really, for all of our end markets, as a reminder, we have a lot of drivers that are asynchronous with the overall macro, right? We have a lot of stuff that's government spending, regulatory driven, and approximately 70% of our revenue stream comes from replacement revenue. So we think that we're a lower beta or a less cyclical type of company driven by end-market variations. But I would say, from where we sit today, 4 months under our belt, the demand profiles across our businesses feels pretty solid. We actually feel pretty good about where we're sitting right now.

[Operator]

I'm showing we have no further questions at this time. I'd like to turn the conference back to Paul.

[Paul Clegg, executive]

Thanks, Vinieta. Thanks all of you for joining the call today. We look forward to updating you again next quarter on our progress. Have a good evening.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.