SPX Corp
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Good afternoon, ladies and gentlemen, and welcome to the Q2 2019 SPX Corporation Earnings Conference Call. [Operator Instructions] And as a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host, Vice President of Investor Relations and Communications, Mr. Paul Clegg. You may begin.
Thank you, Laura, 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 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 disclosures and discussion of GAAP results in the press release and to follow along with the slide presentation during our prepared remarks.
A replay of this webcast will be available on our website until August 8.
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.
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. Our intent is to report these entities as discontinued operations at such time as they meet the accounting requirements to do so. Consistent with how we established our guidance and our adjusted earnings per share also excludes non-service pension items, amortization expense and investment valuation true-up and onetime costs associated with acquisitions.
Finally, we will be meeting with investors during the third quarter. On August 29, we will present at the Midwest IDEAS conference in Chicago. On September 5, we will participate in Vertical Research Partners Global Industrials Conference in Connecticut and on September 19, we will participate in Buckingham Research's Industrials Conference in New York City.
And with that, I will turn the call over to Gene.
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. For the quarter, we again achieved significant adjusted revenue growth, operating profit growth, margin expansion and free cash flow generation. Our overall execution in results for the first half of the year have been strong. The integration of our acquisitions continues to go smoothly and our pipeline of opportunities remains very active.
Our strong financial condition provides us the capacity to continue executing on our organic and inorganic growth plans and delivering on our performance targets. During the quarter, we secured an agreement with GE, one of our customers on the projects in South Africa that settled all material claims between us. While there is more work to do to settle claims with other parties, this is an important step forward in winding down our exposure to this legacy liability. Scott will address this agreement in more detail in his section.
Based on the strength of our first half results, our solid operational performance and our visibility into customer demand in the back half of the year, we are increasing our full year guidance for 2019 adjusted EPS to a range of $2.60 to $2.72 from the prior range of $2.50 to $2.65.
Turning to our adjusted results for the quarter. Revenue increased 6.3% from the prior year to $372 million and EPS was $0.67, an increase of 26% compared with Q2 2018. Our Detection & Measurement and Engineered Solutions segments were the key drivers of our revenue, growth and margin expansion.
As always, I'll briefly touch on our value creation framework and the progress we made during the quarter on our organic and inorganic growth initiatives.
In our HVAC heating platform, our new stainless steel high-efficiency boiler product line continues to gain traction, and we have received our first orders for our new 2 million to 3 million BTU size range. Customer feedback has been positive and interest remains very strong around these larger sizes, which now range from 750,000 to 3 million BTUs. This new line of boilers expands our addressable market in a faster-growing segment, where we had little presence just 12 months ago.
In our HVAC cooling platform, we continue to drive growth opportunities through organic initiatives, like our NC Everest cooling tower, which is named the 2019 Environmental Leader product of the year, and is a compelling solution for larger heat rejection applications.
In our Detection & Measurement segment, we continue to see strong demand for our innovative communication technologies products, including our Flash, Vanguard high-intensity LED lighting solution, as well as our airport ground lighting installations, which we acquired as a part of the Sabik acquisition.
Turning to our most recent acquisition. In July, we completed the purchase of SGS Refrigeration, a company we know well and have partnered with closely to produce a robust line of evaporative condensers. We are excited to have them join our team. On a full year basis, the acquisition of SGS would've increased our 2018 revenue by approximately $12 million. While small, this transaction is an important product line extension that expands our addressable market into industrial refrigeration solutions where we see favorable growth opportunities.
And now I'll turn the call over to Scott to review our financial performance.
Thanks, Gene. I'll start with our net results for the quarter. Second quarter results exceeded our expectations due primarily to projects in our Detection & Measurement segment, delivering earlier than anticipated and a lower-than-expected effective tax rate. Our GAAP EPS for the quarter was $0.43, and on an adjusted basis, our earning per share was $0.67 or an increase of 26% from the second quarter of 2018. Overall, we are pleased with the Q2 results, which put us in a strong position to achieve our updated full year targets.
Before going into more detail on our results, I'll provide an update on South Africa. As Gene noted, during the second quarter, we finalized the settlement agreement with GE. While we have more work to do to settle claims with other parties, we view this agreement as an important positive step forward in winding down our exposure to the projects. Included in the second quarter loss from the South African projects is a onetime charge of $6 million associated with this agreement. In the context of the overall projects, this settlement is significant as it lowers the amount of claims against us and it guarantees we are obligated to maintain, reducing the level of uncertainty associated with our future cash flows in South Africa.
From an operational perspective, the quarter progress is expected and cash usage associated with the projects was approximately $1 million. Overall, we feel good about the progress we have made to complete our construction work by year-end, and we are continuing to pursue opportunities to address outstanding claims with other counterparties.
Turning now to our adjusted results. Revenue increased 6.3% during the quarter. This included 7% growth from acquisitions in our Detection & Measurement segment, a slight organic decline and a modest unfavorable currency effect. Segment income grew approximately $7 million or 14%, driven by the acquisitions in Detection & Measurement as well as operating leverage from organic growth in both Detection & Measurement and Engineered Solutions.
Adjusted segment margins expanded approximately 100 basis points due to higher proportional of our total revenue coming from Detection & Measurement and improved operating performance in Engineered Solutions. Now I'll walk you through the details of the results by segments, starting with HVAC.
Organic revenue for the quarter decreased 5.7% and we also experienced a modest FX headwind. Lower cooling revenue was offset by moderate growth in heating revenue. As a reminder, HVAC revenue in the second quarter of 2018 was up 16% year-on-year primarily due to the concentration of cooling product shipments in Q2.
For this year, adjusted segment income decreased by $1.8 million in Q2 and margin declined 50 basis points. We are successfully capturing price in excess of input cost inflation, however, the favorable margin impact was offset by lower volumes and higher operating cost during the quarter.
As we pass the midpoint of the year, we feel -- continue to feel good about meeting our previously stated full year targets. While the SGS acquisition has only a modest impact on segment income for 2019, it does increase our segment revenue guidance of the full year by $6 million to a range of $576 million to $586 million.
In Detection & Measurement, revenue increased 3 -- 36.3%, including a 33.8% increase from acquisitions and a modest FX headwind. Organically, revenue increased 3.2% driven by strong project shipments and our communication technologies platform. We anticipated certain projects shipping in early Q3, but based on customer requirements, they were delivered in late Q2, resulted in better-than-expected results for the quarter.
Adjusted segment income margins were 24.5% or a decrease of approximately 70 basis points. The decrease was largely due to sales mix, including a full quarter of the CUES acquisition, which was completed in June of 2018.
Given the favorable project activity during the first half and our visibility into demand for the second half, especially in our communication technologies platform, we are increasing our full year segment revenue guidance by $5 million to a range of $395 million to $400 million, which also results in a higher segment income contribution.
In Engineered Solutions, revenue for the quarter increased 2.7%, reflecting improved execution in our transformer business, and segment margin income -- segment income increased $2.6 million and margins increased approximately 170 basis points to 9.4%, due primarily to the strong performance from our transformer business.
Turning now to our financial position. Our balance sheet remains strong. In the second quarter, we generated adjusted free cash flow of approximately $15 million, which excludes the modest cash usage associated with the South African projects in Heat Transfer operations. We ended the quarter with cash and equivalents of approximately $35 million, and we continue to target greater than 110% adjusted free cash flow conversion of our adjusted net income for the full year.
Our net leverage was 1.9x at the end of Q2, which continues to include some short-term financing for the Sabik acquisition. As we generate cash and expand our EBITDA over the second half of 2019, we expect our net leverage to decline to the low end of our target range of 1.5 to 2.5x leaving us well positioned for further capital deployment.
Turning to our 2019 guidance. We are increasing our full year adjusted earnings per share guidance to a range of $2.60 to $2.72 from our previous range of $2.50 to $2.65. The new range reflects growth of approximately 15% to 20% over our 2018 results.
As I noted earlier, we are modestly increasing our revenue guidance for the HVAC and Detection & Measurement segments. We continue to expect adjusted operating income margin of approximately 11%. We have also included additional details in the appendix to help you update your models, including a somewhat lower full year tax rate, specifically associated with higher R&D tax credits recognized in Q2 as well as adjustments to other below the line items.
Lastly, regarding input costs, inflation and pricing. We continue to anticipate a favorable full year margin impact from price and cost of about 50 basis points or recovery of the headwind we experienced last year.
In summary, we feel good about where we are for the full year outlook and our businesses are performing well. Now I'll turn the call back to Gene for a review of our end markets in his closing comments.
Thanks, Scott. We are on track for a strong 2019 and excited about the opportunities we see in front of us. For HVAC cooling, we continue to see solid order rates and backlog that support our full year outlook. Demand for our cooling products is driven by various end markets, including institutional, light industrial and data centers in addition to the commercial end market.
In HVAC heating, we had a solid quarter, as we continue to get traction on new products and initiatives. As a reminder, we are currently in the lower volume warmer months of the year and channels appear well balanced and preseason demand has been typical.
In Detection & Measurement, our frontlog of project opportunities in communications technologies and marine lighting solutions continues to grow nicely, and demand for our run rate products remains solid. The market for transformers remains steady, and we continue to see solid demand from our utility customers.
In summary, I'm very pleased with our year-to-date performance and our accomplishments throughout the organization. A strong balance sheet and significant liquidity provide us the capacity to continue pursuing attractive growth opportunities and value-creating capital allocation initiatives. Integration activities for our acquisitions continue to go smoothly, and we are very happy with the strategic benefits we are realizing in the companies we have acquired over the past 18 months.
Our M&A pipeline is the most active it has been in many years with significant opportunities to deploy capital and to build on our strategic platforms. The timing of acquisitions can be difficult to predict, but we will continue to pursue transactions with a strong strategic fit and attractive return profiles.
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.
Thanks, Gene. Laura, we are ready to go to questions.
[Operator Instructions] We have your first question from Brett Linzey with Vertical Research.
Just wanted to start with Detection & Measurement. You had the pull-in from Q3 into Q2, but you still only had 3% growth and that was against a flat compare, I would have thought a pull-in would've boosted result a little bit more. So maybe just talk about the project activity and what the cadence looks like for Q3 and Q4 for modeling purposes.
Brett, this is Scott. So, yes, we -- based on our customer timing, which we had set beginning of the quarter. Looked like there was going to be early Q3 and customer wanted it earlier, so we pulled it in. So, yes, it was positive for the quarter. Now, as a reminder, you look at the different project business between communication technologies and transportation, they operate differently, so we just had some timing differences in the transportation businesses year-over-year that kind of weighed on that Q2's organic growth percentages. And as you look at the -- you look at it from a first half, second half perspective, we were kind of flattish on an organic basis for the segment but we will see organic growth across the second half.
And in Q3, you actually expect some growth too, even though you had a pull in there? I mean, the comps really easy with that down 13%?
Well, the part of the guide is, clearly the Q2, Q3 is mostly -- is really just the timing, but the guide increase was driven by strength of the overall project profile of the -- how we see the orders developing. So even though we're trying to -- we had to pull some in, we were able to reload the second half for a good portion of that. And then...
Okay. And I know you guys don't guide quarterly, but in terms of Q2, I mean, how did Q2 shake up relative to your internal expectations?
Yes, Q2 was ahead of our expectations, as I said. It was predominantly ahead by segment income, a lot of that. Really, all of our businesses performed at or better than expectations, and really driven by Detection & Measurement. And then the other benefit was the tax rate, as I talked about. So we have -- we took higher research and development tax credits as we finalized our 2018 tax return. So there was a true-up there, and then we're increasing the amount we expect. So this is really tied to the elevated level of new product development that we've been doing over the last couple of years and our tax department working across the business to identify things that qualify for credits. So really good work across the group.
Okay. Good. And then maybe just shifting to Engineered Solutions. Beat my forecast, some really nice margins there. It does look like you did call out transformers is really driving that performance. Is that price cost that's snapping back and getting better? Or you're getting better productivity throughout. Any color there on the bridge?
It's predominantly better productivity and throughput in transformers.
Got it. And then maybe just one more. Regarding SGS. I get it does fit with sort of the HVAC-R theme, but relatively small sales base. I think it would be more of a distant 3, 4 or 5 market position for some of the larger players. Am I thinking about that correctly? And that typically isn't the characteristic of the asset you do buy or have in the portfolio. And I guess the follow on to that is, do you think you need more scale here in refrigeration? Or it's just more of a product angle that differentiates?
Yes, Brett, this is Gene. We know SGS and we've known them for a number of years. We basically have an evaporative condenser, Marley, evaporative condenser that we have jointly developed with them and put through that market. So they really have the channel there. The 2 really primary players in that market are our 2 competitors that we compete with in our cooling HVAC business. It's really BAC and Evapco are the 2 players there. So we actually see a very nice opportunity to grow that business. Their incremental revenue to us is $12 million. The revenue is actually higher than that because they sell our evaporative condenser products through their channel. So you obviously can't double count that. But we actually see a nice opportunity for growth there. We think that we know that market well. We know those competitors well, and we think that we can win and grow in that market.
The other thing that I'd point out is if you look at our cooling business, the largest portion of that market is called open-circuit cooling towers, and we're very, very strong in that market. We are the -- we believe we're the leader in that market. The smaller segment, really the fluid cooler market, is -- we're relatively newer into the market. And if you look at SGS, a lot of the same products for fluid coolers can be used as evaporative condensers or very close product with minimal changes. So we think this not only opens up a new adjacent market to us that we know well against 2 competitors that we think are good competitors, but it gives us growth opportunities but it can also help us in our core coil market segment, which is predominantly fluid cooler. So we really like this acquisition and we think it's going to provide some opportunities for us going forward.
Brett, this is Scott. I would also add. We think about the acquisition profile. You're right. Typically, where we're targeting is a little bit different profile than this, but this looked like this is a nice product line extension, a nice tuck-in, similar to a Schonstedt type of acquisition, not necessarily where we're focused, but when we see those opportunistically, we will go after that. And then we do see opportunities to further leverage their existing footprint in channel.
Your next question comes from the line of Damian Karas with UBS.
So congrats on the strong performance in the quarter and the guidance raise, the augmented outlook. I'd say that's a little bit of a different scenario than we heard from most industrials this quarter. Along those lines, it sounds like you're just about everywhere. Things are just where they were 3 months ago if not better in some places. Gene, I'm just wondering you have a lot of different moving pieces under the hood of your 3 segments. Are there any areas where you're maybe seeing some pockets or signs of weakness?
Yes. I think it's a good question, and we're keeping our eyes very focused on the end markets, but if you look at the markets that we serve, I think it always probably makes sense to remind everybody we're predominantly U.S-based. We have a very high amount of replacement revenue, right below 70%. And a lot of our end markets are driven by things that are asynchronous with just the broader GDP, a lot of regulatory and government, particularly in Detection & Measurement. But if you go to the different markets. On heating, we feel good, we had a -- we like where that business is. We think that business is in a share gain position and really focused on channel initiatives and product initiatives like the VRF, that's the stainless steel boiler that we talked about.
Cooling, we feel good about, that's steady. Having said that, we feel good about the year. We do see commercial market. Some questions out there about the commercial market. We don't see any slowdown in demand in our end markets. And as a reminder, that category does serve a lot of other markets as well, healthcare, light industrial, data centers and so forth. But from what we see in our frontlog, what we see in our backlogs, things are good on the cooling side. And then on the detection side, run rates have been steady. And actually the project level has been, I would say, healthier, frothier than we've anticipated. And we've seen some nice conversions and that's been a contributor to the raise in Detection & Measurement for the year.
And then in Engineered Solutions, I'd say, it's about what we expected. Transformers is very Steady Eddy. A good amount of steady demand there every year and process has been steady. So, yes, I'd say, if you look across all of our markets, pretty good. The only area that I think we've seen a little bit of softness would be in a geography would be the U.K., with some of the Brexit -- actually, I think of our Radiodetection business has been a little bit of slowness there, which people believe can be attributed to lack of capital investment or investment due to concerns over Brexit. But we've seen the flip side in the U.S. where there's been a lot healthier activities. So if you look across our markets, what we see in front of us, we feel good. Scott, you have other comments to make?
Yes, the only other one I would add is in Engineered Process and the process cooling side, you are seeing a bit less of the service work opportunity, really related to an acceleration of closure of coal plants. And that's -- so we're seeing a little bit of a sluggishness there. And that's weighing on current year and causing current year to be flat. But as Gene said, the other real market would be the U.K. but that's being compensated by the other markets.
Okay. That's really helpful color. And I guess on that subject of the process business, I wanted to ask you about the remaining part of Engineered Solutions. The non-transformer part of the business. I think we're, kind of, the 1.5, 2 years roughly into the strategic shift. You guys are doing less on -- less of the ENC type work and focusing more on kind of being a supplier selling components. Could you maybe give an update on where things stand there? Where -- have you seen some progress in terms of filling that out? Seeing some growth and proper building increase? Any color you could give.
Sure. Yes, Damian, I think about that business, I think you're spot on. So then that business, the way I think about it, and that business is in the neighborhood of, let's say, $150 million today. There is really components, there is service and then there is the new build projects. And you're right, we strategically brought down the new build projects. We didn't think they had an attractive return profile. We thought that was more of a commodity area of the market. And we really doubled down on growing our components and our services business. And that's been very successful. We've actually seen very nice growth in our components area over the past couple of years and as well as in our service. And so you've seen a business that was very low margin that each year has been increasing both its margin percentage and its margin dollars despite a decline in revenue, which is the strategic decision we made to exit the unprofitable segments of the market. So where we fit today, Engineered Solutions we've committed to 150 basis points of improvement this year. We feel good about that. That's obviously both businesses, transformers as well. But that's going to 8% operating profit, maybe 10% EBITDA, and we've committed to another 100 basis points next year. So we think the strategy has been working very well. We're seeing it in the results. And actually, we would anticipate the business moving into more of a growth mode, more of a normal. I wouldn't say a high-growth mode, but a growth, a normal industrial GDP growth business going forward with, again, a focus on continuing to enhance our margins there.
Okay. And one last quick one. Just since the whole tariff issue has emerged its head abruptly today, could you remind us, I think when this was front and center some time back, it kind of, like, you didn't anticipate any material impacts if, sort of the -- kind of the next final China around the tariffs did go through? Could you just give us an update on how you're thinking about that? And how it could impact business?
Yes. This is Scott. So you're correct. And again, looking at our profile and where we -- our supply chain is. You look at our cost of sales, it's low single digit, it's driven from China product, source product. So it really does not have a significant impact for the tariffs that had been inactive or whether we anticipate any significant impact from these potential new tariffs.
[Operator Instructions] Your next question comes from the line of Robert Barry with Buckingham.
Just a few things to clarify here. So it sounds like that HVAC decline in cooling nothing to do with weather. That was just an anticipated kind of comp issue. Is that right?
That's correct. It's more of the elevated performance in Q2 of last year.
Got it. And should we model the tax rate in the back half at that kind of 22% to 23%, did all those tax credit benefits come in the second quarter?
Yes, the most significant change in the tax rate was from the recognition of the benefit out -- as we finalized our 2018 tax return. So you'll get a more normalized rate in the second half.
Got it. And then can we change to the South Africa-related cash flow? I think the expectation was up to $15 million. Is that still the same post this GE deal?
Yes. No change. No change for that for the year.
Got it. And then just lastly. I think there was some common theory about the M&A pipeline being particularly robust. Just curious what you're seeing from a valuation perspective in what you're looking at.
You know, I think, Robert, not a lot of change from what we have seen prior. I don't think it is a, I would say, a -- it's not an inexpensive market. But we have been disciplined and we've been successful when we've been disciplined. As a reminder, all of our -- anything -- we always start with strategy, with strategy first on how we grow and how we build out our platforms. We think about how we can gain more competitive strength. We think about how we can serve customers better. And we think we can -- how we can really become stronger, and I think a lot of progress has been made in our growth strategies over the past year. And I think as a result of that, we see a very attractive opportunity set in front of us. You always have to caution timing, and obviously, valuations, because we will be disciplined on our valuations, and there has to be an attractive return profile for us to move forward. But what I would say is, you look at the strategies that we have developed, and you look at the first 4 bolt-ons that we have used to build out our platforms. We really believe in our strategy. And I would say that we feel good about the opportunity sets that we see in front of us. So back to your specific questions, we obviously have the return thresholds, and we will not change from those. But I haven't seen a lot of changes in multiples that -- over the past couple of quarters and what we've spoken about in the past.
Got it. Just lastly, I mean if you look at that portfolio about pipeline, just in terms of things that you'd consider, I don't know when the top quartile say of actionable. Give us a sense of just what the size range is of the things you're looking at? I think at the Analyst Day, actually, you had talked about wanting to maybe have an appetite for even starting to do some larger-scale acquisitions.
Yes. I would say, thinking tactically off the top of my head, we've said in the past, most of the opportunities that we see are probably in the $25 million to $75 million range. We see some pretty interesting opportunities in that range. We also see 1 or 2 interesting opportunities that could be a little bit larger than that as well. So the SGS acquisition, I think, is very strategic for us. It really -- it's a partnership that we've had in place for a number of years, and it's a very natural extension for us to bring into our business. But I think that our sweet spot is more in that range we've communicated in the past, and I'd say, most of the pipeline we see in front of us would be in that range.
Thank you. And I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Paul Clegg.
Thanks, Laura. Look forward to talking to all of you again next quarter. Thank you for dialing in.
Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.