SPX Technologies Inc

F:SPW0

Earnings Call Transcript 2018-Q2

[Operator]

Good day, and welcome to the Second Quarter 2018 SPX Corporation's Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. Paul Clegg, VP, Investor Relations and Communications. Sir, you may begin.

[Paul Clegg, VP, Investor Relations and Communications]

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

A press release containing our second quarter 2018 results was issued just 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 Web site at spx.com. I encourage you to follow along with the slide presentation during our prepared remarks. A replay of the webcast will be available on our Web site until August 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 Form 10-K and most recent SEC filings.

Our comments today will largely focus on adjusted financial results. Specifically, we will focus on core operating results, which exclude the results of the South African projects and we will separately provide an update on those projects. Beginning this quarter, we are also removing the Heat Transfer operations from our core results, following our recent actions to exit the business including the sale of key brands and technology .we anticipate reporting Heat Transfer's results as discontinued operations upon completion of the wind down of the business, which we expect to occur by the end of Q1 2019.

There are other adjustments to our GAAP results this quarter, including those related to our acquisition of CUES which closed in June. Our standard practice with acquisitions will be to adjust out certain acquisition related items from our core results, including deal fees, integration costs, and one-time purchase accounting items such as inventory step up charges. You can find detailed reconciliations of core and adjusted figures to their respective GAAP measures in the appendix to today’s presentation. Finally, this quarter we plan to be on the road meeting with investors. On August 30, we will present at the Midwest IDEAS Investor Conference in Chicago. On September 6, we will participate in Vertical Research's Global Industrials Conference in Connecticut and on September 20, we will participate in Cowen's Industrial Innovation and Technology Conference in New York.

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

[Gene Lowe, President and CEO]

Thanks, Paul. Good afternoon, everyone. Thanks for joining us. On the call today, we will provide you with a brief update on our overall results, segment performances and end market conditions before going into Q&A.

I will start by touching on some of the highlights from the second quarter. Overall I’m pleased with our accomplishments during the quarter. In June, we closed on the acquisition of CUES within our detection and measurement segment, giving us one of the leading brand in the pipe inspection market and prompting us to raise our full-year adjusted EPS guidance range by about $0.10 per share.

More recently we substantially completed the reshaping of our Engineered Solutions segment and our move away from power generation focused businesses with the sale of the major brands and technology of our Heat Transfer business. Overall, our results for the first half are solid and we are on track to deliver significant earnings growth for the full-year. As is the case with many companies, we are facing higher input costs associated with tariffs and freight, but have taken actions to mitigate them and are confident in our second half plan.

During Q2, our HVAC segment experienced strong revenue growth and margin expansion. We had another solid quarter of operations in our detection and measurement segment including the results of our recent acquisitions and we continue to move forward at full speed on integrating these businesses. We remain well positioned to achieve our full-year guidance of adjusted EPS in the range of $2.15 to $2.25 and to execute on additional capital allocation opportunities.

This quarter we're very excited to welcome the CUES team to the SPX family. The acquisition of CUES positions SPX as a leader in equipment for the inspection and rehabilitation of water and wastewater pipe systems all the way from mainline pipes up to those leading into homes. We already have a long history in the pipe inspection business and CUES significantly strengthens our competitive position. It also broadens our customer base which is made up largely of municipal water authorities and contractors that inspect, service and repair wastewater systems.

CUES fits very nicely into our Detection & Measurement portfolio with highly engineered niche technology driven products. Along with our Q1 acquisition of Schonstedt, our purchase of CUES significantly enhances the earnings and cash flow generation power of our company as a whole. As we highlighted in our June presentation, our Detection & Measurement segment is becoming the largest EBITDA contributor of our three segments.

On a pro forma basis, the combined full-year impact of these acquisitions would enhance our 2018 adjusted EBITDA guidance by approximately 10% to more than $180 million, which is approximately 45% higher than in 2016.

Turning to our results for the second quarter. Core revenues increased 5.6% from the prior year to $357 million. Adjusted EBITDA was $0.53. The primary driver of the increase in core revenue were strong volumes in our HVAC segment and acquisitions in our Detection & Measurement segment. These were partially offset by lower core revenues in our Engineered Solutions segment. The HVAC segment experienced margin expansion supported by favorable volumes. And Detection & Measurement achieved another solid quarter with strong margins.

Before turning the call over to Scott, I'd like to give you a brief update on the progress we made during the quarter on the initiatives in our value creation framework. In our HVAC segment, our new high-efficiency heating products have strengthened our competitive positioning and we are seeing the benefits in our sales volumes.

Our NC Everest Cooling Tower product is helping us broaden our market opportunity by offering better economics to customers and expanding our participation in applications with attractive growth opportunities such as data centers. And our newly introduced MD Everest line expansion is generating substantial interest that we are seeing convert into orders.

In Detection & Measurement within our communications technologies businesses, we see a solid pipeline with interest from multiple customers including continued strong interest in our new drone detection solution. Within our Location & Inspection businesses, we are off to a strong start integrating our recent acquisitions and we feel good about the level of excitement we see from our new team members at both Schonstedt and CUES.

Although we are still in the early stages of integration, we see signs of significant channel and product line synergy opportunities and the customer feedback we are receiving is very positive. In the Engineered Solutions segment, we anticipate revenue growth next year after our recent actions to exit the Heat Transfer business, which will substantially complete our move away from businesses focused on power generation end markets.

And now I will turn the call over to Scott to review our financials in more detail.

[Scott Sproule, CFO]

Thanks, Gene. I will start with our net results for the quarter. On a GAAP basis, we reported earnings per share of $0.44. On an adjusted basis earnings per share was $0.53, a 23% increase from the second quarter of 2017. As Paul mentioned, in addition to our customary adjustments for South Africa and non-service related pension expense, we are adjusting out the results of the Heat Transfer business and one-time acquisition related items.

In addition, we have said that we would provide the impact of amortization expense associated with our acquisitions on an adjusted EPS. In Q2, we had only a partial quarter results from CUES, so the net impact was only about a penny. On an ongoing basis, we'd expect the impact to be about $0.02 per quarter. Overall, we are pleased with Q2 results which position us well to reach our full-year goals.

Moving on to core segment results for the second quarter. Our revenue performance reflects continued organic growth in our HVAC businesses and acquisitions in our Detection & Measurement segment, partially offset by reduction in revenues in Engineered Solutions. Core segment income increased modestly, while segment income margins declined 40 basis points. The less favorable margins were driven by Engineered Solutions and Detection & Measurement, which offset margin growth in HVAC.

Now I will walk you through the details of our by segment starting with HVAC. Revenues for the quarter increased approximately 16%. This included a favorable currency effect of 40 basis points and an organic increase of 15.6%. Revenue grew across the segment with the largest increase coming from HVAC cooling in part due to the timing of shipments that were more concentrated in the second quarter of this year compared with the prior year.

We also experienced solid growth in HVAC Heating. Segment income was up approximately $3 million and margin increased 40 basis points due to the operating leverage on higher sales. As we discussed in our Q1 earnings call, we've been experiencing rising input costs including freight and commodity inflation. During Q2, we implemented additional price increases to offset these higher costs. We started to see positive results from these pricing actions late in the quarter and expect these to continue benefiting us in the second half, hoping to mitigate the full-year impact.

Given our first half strength and confidence looking into the second half, we expect revenue to exceed the upper end of our prior guidance range of 2% to 4% and now expect revenue growth in the range of 7% to 8%. In Detection & Measurement, revenue increased 15.7%, primarily from the impact of the CUES and Schonstedt acquisitions.

Adjusted segment income margin was 24.5%, a strong performance but still represent a decrease of 230 basis points. This decline was primarily driven by particularly strong mix of projects in the prior year as we noted in our Q1 call. Consistent with the full-year revised margin guidance for Detection & Measurement we provided in June, our recent acquisitions of a lower margin profile after being fully burdened by intangible amortization.

In our Engineered Solutions segment, excluding the results of the South African projects and the Heat Transfer business, revenues were approximately $143 million, down 7% driven by lower process cooling revenues associated with our business model shift. Core margins declined approximately 160 basis points due primarily to less favorable mix across the segment. And we also experienced higher net input costs.

The impact of higher input costs principally associated with the effective tariffs and transformer orders -- transformer orders and backlog contribute approximately $1 million of the core income decline. When we gave 2018 guidance in February, we expected 80 to 130 basis points of core segment margin improvement with the impact of tariffs and higher net input costs in our backlog, we now anticipate achieving the lower end of this range or approximately 8% core segment income margin for the full-year. This include sequentially higher second half margins.

Regarding the South African projects, our overall Q2 results were in line with our expectations with net cash usage of approximately $11 million. You can find more details on these results in the appendix of this presentation.

Turning now to our financial position. Our balance sheet remains solid. We ended the quarter with cash and equivalents around $67 million. Following the financing of CUES, our net leverage was 2.3x which is within our target range of 1.5x to 2.5x. In Q2 2018, we generated core free cash flow of approximately $12 million which excludes net cash every core free cash flow of approximately $12 million, which excludes net cash used for the South African projects.

Based on our expectations of strong cash generation from our core businesses in second half, we expect to significantly reduce our existing short-term borrowings by year-end and bringing our leverage closer to lower end of our target range. We continue to feel good about our acquisition pipeline and our ability to source transactions and deploy capital to drive incremental shareholder value. We are actively pursuing additional opportunities and have the capacity to execute during the second half of the year.

As previously communicated, we are targeting at least 110% cash flow conversion of our adjusted net income and following the recent acquisitions, we expect to have capacity of more than $400 million of capital available for deployment through 2020.

Turning to our guidance. For the full-year, we continue to expect adjusted earnings per share in the range of $2.15 to $2.25 or an increase of 25% at the midpoint over our 2017 results. As discussed during our segment overview, based on the strong first-half we have significantly increased our HVAC revenue guidance to growth in the range of 7% to 8%.

And as I already noted, we now expect our Engineered Solutions core segment income margin to be approximate 8%. We expect full-year core revenues for this segment in a range of $550 to $560 million with growth to resume in 2019. For the first half year, net input cost inflation for the company was a headwind to segment margin of approximately 80 basis points. Based on our pricing actions and other initiatives we put in place, we anticipate sequentially higher margins for the second half and approximately 40 basis points of net decline for the full-year.

We’ve included additional detail in the appendix to help you update your models, such as interest expense and tax rate as well as an overview of this key sensitivities driving the upper and lower ends of our guidance.

And with that I will turn the call back over to Gene.

[Gene Lowe, President and CEO]

Thanks, Scott. Turning to an update of our end markets, overall we remain well positioned for the second half of this year. Many of our businesses are benefiting from broad secular growth trend -- growth drivers and we continue to see demand strength across our end markets.

In HVAC cooling, strong commercial and institutional construction markets continue to support healthy order activity. In HVAC heating, end market strength carried into Q2, as a preseason sales and run rate orders were solid for both boilers and electrical heating products.

In Detection $ Measurement, our spectrum monitoring and fair collection products continue to benefit from favorable project demand and our run rate product lines are performing well. In our location and inspection businesses market reception to our acquisition of CUES has been very positive and we continue to see a favorable customer reaction to our broader product offerings.

Conditions in the transformer market remains stable. Our backlog continues to cover our production plan through 2018 and into 2019. We continue monitoring the impact of tariffs on imported units and market level -- market price levels as well as on commodity and other input costs. In summary, overall I am pleased with our second quarter and our year-to-date performance which positions us well to achieve our guidance for 2018.

Our balance sheet and liquidity position give us ample capacity to continue pursuing inorganic growth opportunities. Our target pipeline remains active and we like the prospects in front of us. As always, we planned to wave these prospects opportunistically against other capital allocation actions to maximize shareholder value.

We are executing on our plans to driven sustainable double-digit earnings growth. And I remain very excited about our path forward. And now I will turn the call back over to Paul.

[Gene Lowe, President and CEO]

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

[Operator]

Thank you. [Operator Instructions] And our first question comes from the line of Damian Karas from UBS. Your line is now open.

[Damian Karas, UBS]

Hey, good evening, everyone.

[Gene Lowe, President and CEO]

Hey, Damian.

[Scott Sproule, CFO]

Hey, Damian.

[Damian Karas, UBS]

So you mentioned the tariff impacts that you’re in the process of addressing. Could you perhaps elaborate a bit on how sizable that cost impact is? What level of price increases you’ve passed through to your expected businesses and where are you with respect to other mitigation actions you might be taking.

[Gene Lowe, President and CEO]

Sure. Damian, let me start with that. As a reminder, if you look across our portfolio of businesses, the majority of our products are engineered or configured to order with a very short lead time. And if you look at you history historically we've seen very little impact on our profitability either positively or negatively due to input cost changes. Having said that with the size and the magnitude of some of the material and freight changes this has resulted in a headwind for this year and as Scott mentioned in the script, we believe that’s about 80 basis points in the first half and that's approximately 40 basis points for the full-year. We actually believe this is mitigated for the second half. We’ve undertaken a lot of aggressive actions across our businesses, in a lot of different areas. This includes pricing steps in a number of product lines, it includes tightening our costing and proposal processes to make sure that all proposals are using absolutely real-time up-to-date information. We are expanding our escalation clauses in a number of areas, we’re expanding fixed pricing from a number of our key suppliers. So, when you look at it we've actually seen a lot of the benefit in the back half of the second quarter. We actually saw a lot of these benefits coming through on the pricing actions that we're taking both on the products and on freight and we feel good about where we are going forward into the back half of the year. And Scott, I don’t know if you anything else there?

[Scott Sproule, CFO]

I think that, I mean, that covers our full processes and as you said, 80 basis points of the company at this point and then mitigating that down with the actions that are in place to 40 basis points for the full-year.

[Damian Karas, UBS]

Okay. That’s helpful. Thanks. I guess looking at the HVAC segment, obviously you had two straight quarters here of some really strong organic growth. Just looking at guidance for the full-year, it looks like you’re kind of thinking that’s going to be quite a bit more subdued. Just wondering, was there anything kind of happening as the quarter ended or since to suggest that you might have a little bit of a cool off, or just any thoughts on kind of what your expectations are for the underlying growth for both heating and cooling in HVAC.

[Scott Sproule, CFO]

Sure, Damien. This is Scott. So you’re right. We’ve had a great first half of the year in part, led by higher demand in the heating business. Some of that being seasonal in nature, other partial being a commercial activities. But obviously it was more seasonal driven than what we had planned from the beginning of the year. The cooling though has been really the bigger driver for the first half organic growth and that -- part of that is just the timing of how shipment came in as Q2 this year versus how they relate out for the balance of the year. So if you will see that kind of tempered down in the second half, level of growth there for cooling. But still organic growth from the second half, but the dynamic you’re seeing is that we have not estimated a warmer winter for the heating businesses in the second half. We don't want to introduce the risk associated with weather into the forecast -- sorry, colder winter in the forecast. So we’ve kept it more similar to last year.

[Damian Karas, UBS]

Okay. Thanks.

[Operator]

And our next question comes from the line of Brett Linzey from Vertical Research. Your line is now open.

[Brett Linzey, Vertical Research Partners]

Good evening, all.

[Gene Lowe, President and CEO]

Hi, Brett. How are you doing?

[Scott Sproule, CFO]

Hi, Brett.

[Brett Linzey, Vertical Research Partners]

Good, good. I just want to come back to D&M. Maybe you could just unbundle some of the divisional level activity you are seeing and just a little more color on how those businesses performed in the quarter. And then just expectations for those as we move through the balance of the year here.

[Gene Lowe, President and CEO]

Yes. Sure, Brett. Let me start with that. I'd say overall we're very pleased with Q2's Detection & Measurement performance this year. As a reminder and we've been talking about this for 9 months, we had a -- if you look at the comp for Q2 last year, it was an extremely high comp to -- due to very, very attractive mix. Actually our businesses performed ahead of plan, but if you look at all of the Detection & Measurement businesses, we usually think about it in the project oriented businesses and the run rate oriented businesses. The project oriented businesses are about two thirds of the revenue rate and in both of our businesses that have project exposure. We see nice front logs and we’re seeing steady conversion there. So we’re feeling good in our comm tech projects as well as our fair collection projects. And then if you look at the more steady-state run rate business, we’re seeing health across all four of our product lines. This is also where we obviously just added to our portfolio, so Schonstedt is a really nice bolt on to the radiodetection business. We think the strategic logic there is very powerful and we're already seeing some nice opportunities there and while CUES is relatively newer that's only been -- I think we only had three weeks of CUES in the quarter. The integration activities are going very well and we’re very glad. We think that's a very strong company and there are some nice synergies in both directions there. So when I step back and look at the Detection & Measurement businesses, I’m feeling good. We did mention in our post-acquisition call that you will see margins trend down a little bit because of -- predominantly because of the amortization impact on the two acquisitions.

[Brett Linzey, Vertical Research Partners]

Okay, great. And then you had mentioned in the slides a favorable preseason signal in the HVAC heating business. Maybe you could just elaborate what you're seeing there as an early channel fill? And then separately just your pricing power in that piece of the business?

[Scott Sproule, CFO]

Yes, Brett. This is Scott. So I think we are just -- we saw a good demand, nothing exceptional from a preseason perspective. Don't feel as though there's anything exceptional going on in the channel. Feel like the stocking levels are in good position there. So we're not -- we saw demand met our expectations, so I wouldn't -- nothing overstated there. And then as far as pricing opportunities within the heating side, we do have pricing power there and we're able to effectively manage, balance out that the impact of commodity and cost increases on a full-year basis.

[Brett Linzey, Vertical Research Partners]

Okay.

[Gene Lowe, President and CEO]

Yes, and one thing I would add, Brett, is if you look at our heating portfolio, a lot of our initiatives are really to drive growth and high efficiency and to build our commercial business. We have a nice starting point, but we’ve seen nice progress on both of those. So some of the new product introductions that we brought into the market have done well and we feel good about our product roadmap and what the teams doing there.

[Brett Linzey, Vertical Research Partners]

Okay, great. Well I had [indiscernible] follow-up, so I will leave it there. Thanks, guys.

[Gene Lowe, President and CEO]

Thanks.

[Operator]

And our next question comes from the line of Damian Karas from UBS. Your line is now open.

[Damian Karas, UBS]

Hey, guys. Just a quick follow-up. I know there was a charge on South Africa during the quarter. I just wanted to see what your expectations are at this point for future cash usage associated with the projects winding down there?

[Gene Lowe, President and CEO]

Yes, Damian, no charge in the quarter on South Africa. I mean we do have normal levels of operating losses that we forecasted out as we’re winding down the operations. As a reminder, by the end of this year, we will have one scope of operation activity left which includes the closure of our manufacturing facilities, and that's where you’re seeing some of those excess cost coming through. As far as the expectation from cash, coming end of the year, we said there will be $25 million to $30 million of net cash outflow across the projects with the majority -- life of the projects with the vast majority that coming in this year and that’s not changed. And really -- so you see this year we step it down with the only one scope left going into 2019 and that’s why the cash outflow really started mitigating in 2019 forward.

[Damian Karas, UBS]

Okay. That’s helpful. Thanks for clarifying. And just a quick follow-up on the tariffs. I was curious on the demand side, particularly in transformers, given that that's largely an import market and certain parts, certain voltages, have your expectations changed at all in terms of sort of the demand side as a result of tariffs?

[Gene Lowe, President and CEO]

Yes, that’s something we're keeping our eyes on and there are some actions that are currently under way where the -- some of the Korean OEM providers are under evaluation. What I would say is that something and that would be for the large or the EHV size, which would be the 60 MVA and up class, as really the large transformers. That market has a heavy percentage of import. And as a reminder, that's a relatively small portion of our portfolio that's maybe 20% of our portfolio, whereas our core business is really in the medium power. So that’s something we're tracking very closely. What I would say is on the pricing, we have been pushing pricing and transformers, but frankly we haven't seen any improvement in pricing. So pricing remains very competitive for what we see. Our focus right now is to continue on productivity improvement to drive margin enhancement there and we're still pushing on price, but at least, where we sit today, we see pricing in a steady situation. And my understanding on the duties that are currently under review by the U.S government, those should get clarity over the next couple of months. What I would say just as a reminder though, the one area of long lead time business that we have in our portfolios is really transformer. That’s the only place that we can extend more than a year typically. And the larger class or the EHV or the large power transformers, those are typically on the longer side as it pertains to lead time and so forth depending on the configuration. So if there is a ruling that would impact Korean imports, we would probably see some impact on proposals and pricing over the next quarter or two. But it would take a while for it to show up in the P&L, probably more the back half of next year.

[Damian Karas, UBS]

Okay, great. Thanks again.

[Gene Lowe, President and CEO]

Okay. Thanks, Damian.

[Scott Sproule, CFO]

Thanks, Damian.

[Operator]

And that conclude today’s Q&A session. I will now turn the call back to Paul Clegg for closing remarks.

[Paul Clegg, VP, Investor Relations and Communications]

Thank you all for joining us. We look forward to speaking to you again next quarter. This concludes our call.

[Operator]

Ladies and gentlemen, thank you for your participation in today's conference call. This concludes today’s program. You may all disconnect. Everyone have a great day.