SPX Management Discusses Q4 2012 Results - Earnings Call Transcript

| About: SPX Corporation (SPXC)

SPX (SPW) Q4 2012 Earnings Call February 14, 2013 8:00 AM ET


Christopher J. Kearney - Chairman, Chief Executive Officer and President

Ryan Taylor

Jeremy W. Smeltser - Chief Financial Officer, Chief Financial Officer of Flow Technology and Vice President of Flow Technology


Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Julian Mitchell - Crédit Suisse AG, Research Division

Nigel Coe - Morgan Stanley, Research Division

David L. Rose - Wedbush Securities Inc., Research Division

Christopher J. Kearney

Good morning, everyone. Happy Valentine's Day. Sorry about the technical difficulties, but it sounds like we've got them sorted out. Okay, great. So welcome to our Annual Investor Meeting. Joining me here today, you know at least a couple of these guys, so Jeremy Smeltser, our Chief Financial Officer, and Ryan Taylor, who manages Investor Relations...

Ryan Taylor

I'm going to manage the audio right now. If you guys don't mind turning off your BlackBerrys or iPhones. There's a little bit of feedback going through the webcast. Thank you very much.

Christopher J. Kearney

It helps to have a multitalented guy on your team. And then Zac Gordon who is our VP of Finance who many of you have not met, but you'll get to know Zac very well.

So before we begin, let me point out the cautionary language regarding forward-looking statements. In the Appendix, we have provided reconciliations for all non-GAAP financial measures referenced here today.

Looking at the agenda for this morning. I'll begin with a brief summary of the key messages in today's presentation and then review our long-term strategy. Jeremy will provide a detailed analysis of our Q4 and full year 2012 results, as well as our 2013 guidance. He will also discuss our financial position and capital allocation plans for the year.

So beginning with our key fourth quarter results. We reported revenue of $1.4 billion, up 14% year-over-year and slightly better than we had targeted. Segment income was $174 million, up 8% year-over-year and at the high end of our target range. As we expected, ClydeUnion's operating performance improved significantly in Q4. ClydeUnion reported $176 million of revenue with operating margins increasing to over 10%. The acquisition of ClydeUnion was $0.19 accretive to earnings per share in Q4 and modestly accretive to the full year EPS. Our earnings from continuing operations included a $5.19 noncash impairment charge related to our Thermal segment, primarily reflecting the continued challenging dynamics in the global power generation market. Excluding these charges, Q4 adjusted EPS was $1.57.

During the quarter, we also completed the sale of Service Solutions for $1.15 billion. We recorded a gain on this sale of $313 million or $6.32 per share. Shortly after receiving the sale proceeds, we completed the balance of the capital allocation actions that we had announced in 2012.

We paid down $450 million of debt during the fourth quarter, reducing our total debt position to $1.7 billion at year end. That's down about $300 million from the prior year.

During December and the first 2 weeks in January, we also repurchased 4.1 million shares for $275 million. This completed the $350 million share repurchase plan that we entered into in Q1 2012. In total, we repurchased 5.1 million shares under this plan or approximately 10% of our outstanding shares.

The sale of Service Solutions completed our transformation out of the automotive industry, a significant milestone in our company's history. As we move forward, we're excited about future growth opportunities, as we continue to build out our position in the power and energy, food and beverage and industrial flow markets.

Throughout last year, we steadily improved the operational performance at ClydeUnion, and we remain encouraged by the opportunities to expand in the oil and gas market.

In 2012, we also successfully completed the expansion of our large power transformer plant. We shipped our first 13 units out of the new facility and received positive feedback from our customers. In 2013, we expect to more than double the production, as we continue to grow into the new capacity. 2012 was a year of strategic transition for SPX, and we believe we succeeded in that effort.

We began 2013 as a more focused company with over 50% of our revenue from our Flow Technology segment.

We're also in a very strong financial position with well over $1 billion of liquidity. This year, we plan to reinvest an additional $450 million of capital. As part of this plan, we intend to make a voluntary pension contribution of $250 million that will reduce our future pension obligations and earn an attractive rate of return. There is a cash tax benefit of approximately $90 million related to this contribution, reducing the net impact to $160 million.

We're also targeting $200 million of share repurchases. We believe these actions will increase earnings per share by $0.30 in 2013 and by approximately $0.50 on an annualized basis. Following these actions, we're projecting $1.2 billion of liquidity at the end of the year.

Looking at our 2013 operating expectations. We're targeting revenue to be flat to up 5% year-over-year, with segment income margins increasing 80 to 130 points to about 11%. Our EPS guidance is $4.60 to $5.10 per share. This includes the $0.30 benefit we expect from the 2013 capital allocation actions.

Taking a brief look at our capital allocation history. In aggregate, we've deployed over $5.6 billion of capital since I became CEO in 2004. About 1/2 has been returned to shareholders through share repurchases and dividends. We've invested about 1/3 of our available capital on acquisitions. And we've reduced our total debt by about $1 billion.

As you can see, we raised over $4 billion of capital through divestitures. These proceeds funded a large portion of our allocated capital and unlocked value for our shareholders. We have redeployed the proceeds from asset sales into higher-growth investments, as well as opportunistic share repurchases.

Moving forward, we plan to continue to execute the strategy that has made us successful while maintaining the financial discipline we have demonstrated in the past. As a result of this approach, we have significant liquidity to continue building a stronger SPX and add customer relevance in our strategic end markets.

Now let's take a closer look at our long-term growth strategy. We significantly transformed SPX over the last 16 years. When I joined the company in 1997, we were focused on diversifying beyond automotive into higher-growth markets and expanding our international presence. We accomplished this by executing a number of acquisitions, including the large transformative acquisitions of General Signal and United Dominion. These 2 transactions were catalysts for our globalization and established our initial presence in the flow space. We also divested legacy automotive and noncore businesses, in particular, the divestiture of EST, Kendro, BOMAG and Service Solutions played an important role in narrowing our focus and providing us the flexibility to grow our Flow segment. The acquisitions of APV and ClydeUnion were defining acquisitions that broadened our flow offerings and global presence.

Today, we have 3 distinct flow platforms: in food and beverage, power and energy and industrial end markets. Our strategic focus is on expanding these platforms. When we look at our current group of businesses, we believe the future earnings potential for our company today is stronger than it has ever been due in large part to the strategic actions we've taken as well as our continuous improvement programs.

This chart illustrates the significance of our transformation. We now have divested 56% of our 2004 revenue base. As a result, we have simplified our company from 9 platforms and 5 reporting segments in 2004 to 3 segments with Flow representing over 50% of our revenue.

Looking at our end market and the geographic profile. Over 60% of our revenue last year was generated from sales in the power and energy and food and beverage markets. Due to our high concentration of power and energy revenue, our business, in aggregate, is late-cycle. In food and beverage, we are a leading provider of integrated process systems and engineered components. Demand on our food and beverage markets, particularly for components, has historically had a more linear growth profile.

From a geographic perspective, 46% of revenue in 2012 was from sales into North America and 21% was from sales into Europe. We continue to focus on expanding our presence in emerging markets. Last year, our sales into emerging markets increased 17% with over $1.5 billion or 30% of our total revenue. Asia Pacific continues to be a key driver of our revenue growth. Last year, our sales into Asia Pacific grew 23%, to nearly $1 billion or 19% of our total revenue.

We've worked diligently to build a better SPX, capable of more sustainable and consistent financial performance by increasing our customer relevance on a global basis. Going forward, our strategy is focused on continuing to meet the critical needs of a growing world population. Our technology offerings in food highly engineered products and full line solutions that support our customers in the global power and energy, food and beverage and industrial flow end markets. We believe these 3 markets have excellent long-term growth drivers, and our existing offerings have the technology, customer loyalty and high quality necessary to maintain a competitive advantage in the service base for future growth.

Internally, we're focused on several initiatives that support our end market strategy. We continue to emphasize expanding our geographic presence with a focus on localizing capabilities to support regional demand. Innovation is a key growth initiative across all our businesses. Through our Innovation Council, we're driving a cultural shift at SPX to cultivate new ideas and technologies that meet new end market opportunities. We remain focused on Lean principles to improve the efficiency of our operations and drive continuous improvement throughout our organization. As part of our Lean journey, we're migrating common support functions to regional shared service centers. Additionally, we have reduced the number of information technology systems used throughout our company, moving to new systems in a consistent manner while improving processes and security. And we're promoting our SPX brand to increase awareness and leverage our global scale. This initiative has been very successful, particularly in our Flow business.

As I mentioned, acquisitions have played a key role in our development. We evaluate bolt-on and large acquisition targets with strategic fit as our primary screen. Since 2004, we invested $1.9 billion on 14 acquisitions with 85% of our acquisition capital focused on building out our Flow platforms. We've also made compelling investments to enhance the value or competitive position in some of our non-Flow businesses. From a financial perspective, we have 2 primary criteria: acquisitions must be accretive to earnings within the first 12 months; and have returns above our cost of capital within a reasonable time frame. We have consistently used a 9% hurdle rate in our EVA calculations to evaluate acquisitions.

Beyond strategic and financial criteria, we also evaluate integration risks and opportunities. 12 of the 14 acquisitions we've done since 2004 have been bolt-ons, which generally have a lower integration risk. When we evaluate larger acquisitions, such as APV or ClydeUnion, the size and complexity of the target is a key consideration. We evaluate the resources and time needed to integrate the target, as well as the potential cost and revenue synergies that could be realized. As a normal part of our strategic review, we expect to continue to evaluate acquisitions of various sizes that represent a potential fit with our long-term strategy.

This strategy is centered on expanding our Flow platforms. We define the flow space in general as market sectors that require highly engineered system solutions and components that enable our customers to process, transport, meter, filter or dehydrate across a variety of applications. Our Flow offerings include a broad array of engineering components that can be combined into modular and fully integrated system solutions that are also adaptable across multiple end markets. We think there are very good organic and acquisition growth opportunities for Flow.

One of the more attractive organic opportunities is building out our aftermarket business, which typically has higher returns. As many of you know, there has been a consolidation in the flow space in recent years. Despite this, we still view the industry as very fragmented with many public and private participants. Also, as evidenced by recent acquisitions in the industry, flow companies are generally valued at a premium to multi-industrial companies.

Taking a closer look at our Flow Technology segment. Flow reported $2.7 billion of revenue and approximately $350 million of EBITDA in 2012. We have a well-balanced geographic end market profile with close to $1 billion of annual revenue in each of our Flow end markets. The growth rate in these markets has been higher in emerging regions of the world, driven by new infrastructure investment and an expanding middle class. And in mature markets, we expect growth to be influenced largely by the need to replace aged infrastructure along with an increased focus on reducing waste and environmental impact. As our global presence has expanded and we have localized our capabilities, we have benefited from these trends.

As I mentioned, many of our flow technologies are adaptable across multiple end market applications, as illustrated on this chart. We have a broad product offering and we're well positioned in our end markets.

Looking now at our food and beverage platform. Last year, we had $947 million of revenues split fairly evenly between dairy and nondairy applications. Our customers include large multinational manufacturers and we've also increased relationships with many local customers, particularly in Asia Pacific. One of the key drivers behind our customers' capital investment is population growth and the growing middle class, which is demanding a higher quality of processed foods and beverages. In China, consumer demand for liquid and powdered dairy products is driving new capacity investments with an emphasis on product safety. In all regions, government safety standards regulate how foods and beverages are processed. We help provide our customers with solutions that meet or exceed these standards. We also work with them to provide solutions that enhance the value of their products or increase the efficiency of their operations. In addition, we collaborate with customers in our research and development labs to test recipes and demonstrate that our equipment can provide consistent flavor and quality to their products.

To provide you context of where SPX participates in the broader flow -- food and beverage industry, our technology is used by manufacturers to process raw ingredients into a wide variety of consumable products. The larger projects that we work on have been concentrated in dairy. For a broader set of applications, we supply components and smaller skidded systems. Some of the more well-known consumer products made using our equipment include Danone yogurt, Kerrygold butter and Heinz ketchup.

As you can see, we offer a full suite of food and beverage technologies ranging from components to full line systems. Our full line system technologies include various forms of liquid processing, as well as evaporation and extraction capabilities. This allows us to serve customers who require both liquid and drying technologies as part of a full line processing plant. We have the capabilities to engineer, design and install an integrated dairy plant that produces multiple consumer products. We also manufacture the process components, such as separation and dispersion technology that make up the core of a system design.

APV was the defining acquisition for us in food and beverage. The combination of APV and our existing process equipment business created a global food and beverage platform and established our position in dairy processing markets. After a multi-year integration, we expanded our process system offerings by acquiring Gerstenberg, Anhydro and Murdoch. These acquisitions broadened our process capabilities into fats, oils and powdered products. The most recent acquisitions of e&e and Seital extended our technology offerings in extraction and separation, and we believe over time, our global capabilities will allow us to add scale in these areas. These acquisitions significantly increased our competitive position, and the recent awards we've seen -- that we've won have validated this strategy. Our internal focus in this market is on accelerating our organic growth initiatives and improving profitability. There are also attractive bolt-on opportunities that would extend our capabilities.

We have seen significant benefits from our acquisition strategy in food and beverage and our development has been very well received by our customers. Our increased capabilities have given us the opportunity to participate in more complex projects that have higher contract value. Over the last 3 years, our system revenue has more than doubled to $528 million in 2012. Growing our systems business expands our brand and our installed base. It also boosts the organic growth for our component business. However, as we've described in past investor presentations, growth in systems revenue has had a dilutive impact on Flow's overall margins. This is due primarily to the third-party pass-through content such as vats, tanks and piping which, along with outside construction labor, can account for more than 50% of the total cost of a typical large scale system. This dilutes the more attractive profit margins we earned for the value of our engineering and critical process equipment.

These process components typically account for 20% to 30% of the value of a full line system. These components are refurbished or replaced on a periodic basis. The frequency of replacement varies and it's largely dependent on the viscosity of the product being processed and also on the conditions of the plant operating environment. Generally, the aftermarket service and replacement demand in the food and beverage market is steady year-to-year.

As an example of our food and beverage capabilities, I want to highlight a very large dairy plant we're building in Shanghai for Bright Dairy, a leading dairy provider in China. When completed, the new plant is expected to be one of the largest dairy plants in China with the ability to produce fresh milk, long shelf life milk and yogurt. This new state-of-the-art facility will have the capacity to produce more than 2.1 million liters of product per day. The primary types of yogurt to be produced by the new dairy facility are projected to grow by as much as 20% in China over the next few years.

Our contracts on this project total over $40 million with 28% of the value related to our process equipment. As illustrated on this slide, we're designing and installing a series of process systems that utilize multiple SPX technologies. This design also includes the separation technology from Seital, our most recent acquisition.

Moving on now to Flow's power and energy platform. Flow recorded $876 million of power and energy revenue last year with 72% from sales into the oil and gas market. We saw very good growth in sales of pipeline valves into the downstream oil market, where demand remains strong, particularly in the U.S. Enbridge is one of our key domestic oil and gas customers. We're also serving many of the large global power and energy companies, as well as several EPC firms. The outlook for oil and gas investment remains positive, and we're also very well positioned for recovery in power generation markets.

Flow's power and energy offerings include a variety of critical pump technologies, specialty valves and closures focused on a variety of applications. We also sell chemical injection skids, filtration equipment, metering systems and dosing pumps used in oil and gas processing. And we have a variety of dryers and air dehydration equipment that are used in gas processing as well as power plants.

We're excited about our opportunities in the oil and gas market. Our products are critical to oil and gas processing and they're used throughout upstream and downstream processing. Many of our products are complementary to each other, and last year we began to market them as a combined offering.

For example, an upstream oil processing on offshore platforms, our seawater injection pumps work in conjunction with our chemical injections pumps and filtration products. In midstream processing in the oil pipeline, our booster pumps work in combination with our valves and filtration products.

As we increase our installed base, we see a steady future aftermarket opportunity. We estimate that the typical oil and gas pump has an aftermarket revenue stream that spans over 25 years. The aftermarket revenue can be 2 to 5x the value of the original sale and at much higher -- and with a much higher profit profile.

Similar to APV's impact on food and beverage, ClydeUnion was a defining acquisition for us in power and energy. ClydeUnion has given us a foundation to build out Flow's power and energy platform and we're using a playbook very similar to the one we used in food and beverage. Over time, we evaluate acquisitions to further expand -- we will evaluate acquisitions to further expand our capabilities and our customer relevance. However, first and foremost, our focus is on continuing the integration of ClydeUnion and improving its operational performance.

Looking specifically then at ClydeUnion's 2012 results. For the full year, ClydeUnion reported $571 million of revenue at a 5% margin. This included approximately $100 million of revenue recognized on lost contracts that were part of the acquired backlog. We made steady, sequential, operational improvement throughout the year and finished with a solid fourth quarter in which we reported $176 million of revenue and operating margins above 10%. As compared to the prior quarters, the fourth quarter performance benefited from increased throughput and savings from the restructuring actions completed earlier in the year.

Underlying the financial results, we made several positive changes in ClydeUnion that are helping us to better serve our customers. Our focus on Lean initiatives has increased throughput and improved quality. We've also made good progress on integrating ClydeUnion's sourcing initiatives into Flow's global supply chain. We believe ClydeUnion is a better business today than it was a year ago, and we expect that continued focus on operational excellence will benefit performance and profitability going forward. In 2013, we're targeting low to mid-single-digit revenue growth with margins improving about 250 points. Over time, we believe ClydeUnion will achieve double-digit operating margins.

To summarize, we made steady operational improvements to ClydeUnion last year, and we're encouraged by the initial customer response to this acquisition. The high-end pump technology that ClydeUnion supplies are a critical component in upstream and downstream oil and gas processing, a market with excellent demand characteristics, all consistent with our continued acquisition strategy.

Moving on then to Flow's industrial markets. We supply a variety of global customers with products that are used in general industrial and compressed air applications as well as chemical processing, marine and mining markets. These products are highly engineered and generally have attractive margin profiles. Our sales into these markets are short cycle in nature and demand typically follows GDP and industrial manufacturing trends.

Our key Industrial Flow offerings are used primarily in mixing, blending, heat transfer and air treatment applications. These products are often used to enhance the plant productivity and optimize efficiencies. We believe there are many different strategic paths to grow Flow's Industrial platform. When we evaluate the opportunities here, we look at expanding the geographic reach of our current product offerings; we also look at adding adjacent technologies to broaden our Industrial product portfolio within Flow; and we analyze extending vertically into specific end markets, similar to our strategy in food and beverage and power and energy. Of the 3 Flow platforms, we believe the industrial flow market offers perhaps the broadest opportunity for future acquisitions.

So to conclude, Flow Technology is the foundation of our long-term strategy and our core growth engine, and we believe there are attractive growth opportunities in all 3 of Flow's end market platforms.

So at this time, I will turn the call or turn the presentation over to Jeremy. Thanks.

Jeremy W. Smeltser

Thanks, Chris. Good morning, everyone. I will begin with a review of Flow's financial performance. For Q4, Flow reported $728 million of revenue, up 29% over the prior year period. This was driven by revenue from acquisitions of $168 million, a 30% increase.

Analyzing the year-over-year organic performance, it is important to point out that in Q4 2011, we recognized $17 million of revenue related to a higher-margin nuclear squib valve project. This headwind contributed to a modest organic decline in revenue in Q4 of 2012.

Year-over-year revenue in Asia Pacific increased, driven by execution of large dairy projects in our food and beverage business. And in the U.S., we continue to see strong component growth, most notably from sales of pipeline valves into the oil and gas market. This growth was partially offset by organic revenue declines in Europe.

Flow's segment income increased 6% over the prior year to $91 million. Segment margins were 12.5%, including 50 points of dilution in ClydeUnion. Core margins were 13%. This was down from the prior year due to the organic revenue decline in Europe, as well as the increased mix of lower-margin food and beverage system revenue. Q4 2011 margins also benefited from the nuclear squib valve revenue.

Looking at Flow's results on a sequential basis. Revenue increased $80 million or 12% from Q3 to Q4. The increased revenue at ClydeUnion contributed a little more than 1/2 of the sequential growth. We also experienced sequential growth across each region of the world.

The ending backlog was $1.36 billion, down 5% from Q3. This was due to the large sequential revenue increase, as well as continued disciplined order acceptance at ClydeUnion.

We also experienced customer delays on order placement for some large OE oil and gas projects. Overall, Flow experienced good order momentum heading into 2013 with sequential orders up 14% in Q4. This has continued in January with positive order trends particularly in the Americas and in Europe.

Looking at the full year results for Flow. Revenue increased 31%, driven largely by acquisitions. Organic revenue grew 5% and currency was a 3% headwind. Segment income increased 6% to $285 million. Margins were 10.6%, down from 13.1% in 2011. ClydeUnion's results diluted margins by 210 points, including 40 points of dilution from purchase accounting adjustments.

In 2013, we expect Flow's revenue to grow 2% to 7% to about $2.8 billion. 43% of this revenue estimate is in the ending 2012 backlog that's comparable to the prior year. We are targeting segment margins to increase 130 to 180 points to between 11.9% and 12.4%. This is expected to be driven largely by continued operating improvement at ClydeUnion and also by increased profitability in Europe.

Moving on to our Thermal segment. In 2012, Thermal reported approximately $1.5 billion of revenue with just over 1/2 concentrated in the Americas. Throughout the rest of the world, 22% of its revenue was from sales into Africa and the Middle East, 17% was sales into Europe with 9% of sales in Asia Pacific. Power generation is the primary end market for this segment, representing 57% of Thermal's revenue last year.

Thermal's key power generation products include large scale cooling systems, heat transfer technologies and pollution control systems. These products are primarily long-cycled and project-oriented. In contrast, about 1/3 of this segment sales relate to short-cycle projects that are used in HVAC and industrial markets, and the majority of our HVAC revenue is generated in the U.S.

In Q4, Thermal reported $447 million of revenue, down modestly year-over-year due primarily to currency fluctuations. Organic revenue was up 2%. This was driven by very strong year-over-year growth in sales of our residential boilers. These sales are typically seasonal to the fourth quarter. However, this year, we experienced elevated demand in support of the Hurricane Sandy relief efforts. We are very proud of the efforts by the team at Weil-McLain who were quick respond to the urgency caused by the hurricane. They were able to expand production quickly to provide critical heating products in the winter months.

Thermal's segment income increased 15% to $51 million with margins expanding 160 points year-over-year to 11.4%. The increased profitability was driven by the leverage on the increased boiler sales.

On a sequential basis, Thermal's revenue was up $71 million in Q4. In addition to the ramp-up in boiler sales, revenue from our cooling and heat transfer equipment also increased quarter-to-quarter.

Thermal's ending 2012 backlog was $787 million, down 11% sequentially and 25% over the prior year. Execution on the large power projects in South Africa accounted for a little more than 1/2 of the total year-over-year backlog decline. In terms of order activity in power generation markets, we continue to see steady order trends at historically low levels. We have seen fewer large project opportunities and a shift towards an increased volume of smaller scale power projects.

For the full year, Thermal reported just under $1.5 billion of revenue, down $145 million or 9% from the prior year. This included a 4% currency impact. Organic revenue declined 4% due to decreased sales of power generation equipment. Segment income was $107 million, down $36 million from the prior year and segment margins were 7.2%. The decline in profitability was driven by the reduced revenue and reflects the overall weakness and low levels of investment in the U.S. and European power generation markets. We anticipate that these markets will remain depressed in 2013.

All in, we are expecting Thermal's revenue to be down low to mid-single digits in 2013 with margins between 6.5% and 7%. The primary driver of the revenue decline is the ramp-down in revenues from our South African projects.

Outside of South Africa, we are focused on improving the profitability and competitive position of our power generation businesses, and we'll continue to take action to improve our overall cost position.

Looking now at our Industrial segment. This segment is made up of niche businesses that are among the leaders in their respective markets and very focused on innovation. As such, they have attractive profitability and cash flow characteristics. Most of the business in this segment are domestic with a few offering global capabilities. For 2012, this segment reported $927 million of revenue with close to 80% from sales into the Americas.

Our U.S.-based power transformer business contributed about 1/3 of the segment's total revenue. This business is highly cyclical and is a key driver of this segment's financial performance from year-to-year, and I'll talk more about transformers in a moment.

Taking a brief look at the other businesses reported in this segment. Hydraulic technologies is a global supplier of high-pressure pumps, torque wrenches and railway track systems. These products are used primarily for infrastructure-related construction, including bridges and rail systems as well as mining and oil and gas exploration.

Our communications technology business includes solutions for spectrum monitoring, communications intelligence, specialty obstruction lighting and broadcast antenna. Radiodetection is a leading global supplier of underground cable and pipe locators. This business is based in the U.K. and sells into telecommunications and construction markets.

Precision components is a U.S.-based business, primarily serving the aerospace industry by providing precision machine components that are part of flight critical assemblies. Thermal product solutions supply industrial ovens that are used in a wide range of testing and processing applications. And Genfare, based in Chicago, is a leading U.S. supplier of fare collection systems. You can see Genfare's fareboxes on buses in many cities across North America.

In the fourth quarter, Industrial reported 8% organic revenue growth. Power transformer sales were up 24% versus the prior year, driven by increased volume of both medium and large power units. This more than offset lower year-over-year sales of higher-margin communication technologies and fare collection systems.

Segment income increased 4% to $32 million. Margins were 12.3%, down 50 points. This was due primarily to the higher volume of Transformer revenue, which came at lower margins than the segment average, as well as the revenue declines in our communication technologies and fare collection businesses.

Looking now at the sequential performance. As we expected, sales of farebox collection systems increased quarter-to-quarter, reflecting increased spending by our customers as a result of the transportation bill that was signed in the middle of last year. Revenue from transformer sales also increased sequentially. In total, Industrial's revenue increased $42 million or 19% from Q3 to Q4.

The ending 2012 backlog was $453 million, down $25 million quarter-to-quarter. Our power transformer backlog was down sequentially. This was due in part to strong revenue conversion in the quarter, and we also continue to be patient with respect to new orders. This has impacted our lead times for medium power units, which have come down a bit to between 6 and 8 months, in line with the current industry average.

There has been no significant change in demand or pricing in the U.S. power transformer market. We continue to see a steady volume of order activity with a stable pricing environment.

In the near term, we believe the decline in U.S. electricity demand during 2011 and 2012 has impacted the pace of price recovery. That said, the U.S. Energy Information Administration is forecasting increased electricity demand in the second half of this year, driven by higher industrial utilization. We are encouraged by this estimate and the stronger U.S. housing data we've seen recently, and we remain confident that the underlying fundamentals for replacement demand will ultimately drive continued recovery in the cycle.

Taking a brief look now at the key market dynamics. The need to replace aged transformers is the primary driver for investment in the U.S. market. The International Energy Agency estimates that about 2/3 of the future investment in the U.S. P&D market will address replacement needs, the majority of which are projected to be in distribution. The reliability standards implemented by FERC in 2007 have encouraged our customers to replace aged transformers in advance of failures. Penalties for interruption and failure of service can result in financial penalties that exceed the cost of a transformer. In addition, last year, the U.S. Department of Commerce issued a ruling in favor of an antidumping petition filed against Korean transformer manufacturers. As a result, tariffs were imposed on Korean imports in the range of 15% to 29%.

We continue to view the U.S. power transformer market as a very attractive opportunity for our business in the medium to long term, primarily due to the need to replace aged transformers.

Our transformer sales increased 30% in 2012 and we are targeting an additional 20% to 30% growth in 2013. This assumes pricing on shipments remains flat year-over-year. We expect this year's sales growth to be driven about equally by increased volume in our medium power shipments and the continued ramp-up of large power transformer production in our expanded facility.

Now moving back to the segment results. The full year, Industrial reported $927 million of revenue, up 8% over the prior year. Segment income increased 4% to $114 million and full year margins were 12.3%, down 50 points versus 2011.

As a reminder, in 2012, we had a $10 million headwind to segment income from the under-absorption of the startup costs at our expanded transformer facility. We expect to neutralize these costs with the increased production in 2013.

For this year, we are targeting 6% to 11% revenue growth, driven largely by the increased transformer volume. Although we expect margins in the transformer business to improve in 2013, we expect them to remain in the single digits. We are targeting segment income margins between 13.3% and 13.8%, up 100 to 150 points over last year.

So now moving on to our consolidated results, beginning with Q4 earnings per share. For the quarter, we reported net earnings per share of $2.83. This included 2 items that significantly impacted EPS. In earnings from discontinued operations, we recorded a $6.32 per share gain on the sale of Service Solutions. And in earnings from continuing operations, as a result of our annual impairment testing of goodwill, intangibles, we recorded $5.19 noncash impairment charge. This was related primarily to the goodwill, trademarks and other long-term assets of our cooling equipment and services reporting unit and was largely due to the challenging conditions we continue to experience in the global power generation market.

Excluding the impairment charge, our adjusted EPS from continuing operations was $1.57 in Q4.

On an adjusted basis, the effective tax rate for Q4 was 24.2%, a little lower than the full year tax rate of 25%.

On a consolidated basis, we reported $1.4 billion of revenue in Q4, up 14% versus last year. Acquisitions contributed 13% growth, organic revenue grew 2% and currency was a modest headwind. Segment income increased 8% to $174 million or 12.1% of revenue. Segment margins declined 70 points over the prior year, including 20 points of dilution from ClydeUnion.

For the full year, revenue was up $563 million or 12% to $5.1 billion. Acquisitions increased revenue by 12.6% and organic revenue grew 2.5%. Currency was a 2.7% headwind.

As reported, segment income margins were 9.9%, down 160 points from the prior year. ClydeUnion accounted for 90 points of dilution, including 20 points related to purchase accounting adjustments.

The decline in the Thermal segment's profitability contributed 40 points of dilution.

Looking at 2013 now. We are targeting revenue to be flat to up 5%, driven by organic revenue growth. We expect a small benefit from the Seital acquisition to be offset by a modest currency headwind. At the midpoint, segment income is expected to increase approximately 11% with margins increasing about 100 points year-over-year.

Looking at the other items in our midpoint EPS model. Corporate expense is targeting at just over $100 million, that's $8 million lower than last year. Pension expense is expected to be $29 million, down $10 million, reflecting the benefit from the planned pension contribution. Stock compensation expense is $37 million.

And we are targeting restructuring expense between $25 million and $30 million. This includes a continued focus on cost reduction on our Thermal segment, continued integration actions and manufacturing localization efforts across the company.

Looking at equity earnings, we are targeting $41 million. As a reminder, nearly all of our equity earnings relate to our 44.5% interest in our EGS joint venture with Emerson Electric. We also modeled a modest contribution in 2013 from our JV with Shanghai Electric.

Interest expense is expected to be about $105 million.

We are using a 26% tax rate. This includes the R&D tax credit for both 2012 and 2013.

And we are estimating 46 million shares outstanding in 2013. This reflects the 5.1 million shares repurchased in last year's plan as well as a partial benefit from this year's planned repurchases.

Our full year EPS guidance range is $4.60 to $5.10 per share with a midpoint of $4.85.

Now looking at Q1. We expect the quarter to be consistent with our historical seasonality. Revenue is expected to grow 3% to 6%, including a 1% currency headwind. We are projecting $90 million to $95 million of segment income. This represents approximately 16% of our full year target similar to prior years.

Decline in segment income at Thermal and Industrial year-over-year are expected to partially offset increased profitability in our Flow segment. Our Q1 segment income margins are targeted to be between 7.4% and 7.9%.

There are some notable items below the line. About 60% of our full year stock compensation expense is expected to be recorded in the first quarter, consistent with past practice. We also expect to book a $3.3 million tax benefit to recognize the full year 2012 R&D credit. This will drive our tax rate quite a bit lower than our full year target. And we're using 47 million shares outstanding in our Q1 EPS model.

I should also point out that we don't expect any significant EPS benefit in Q1 from our 2013 capital allocation plans. Based on these assumptions, our Q1 EPS guidance range is $0.20 to $0.30 per share.

I'll finish with our thoughts on capital allocation before I turn the presentation back over to Chris. We obviously entered 2013 in a solid financial position. Cash on hand at the end of the year was $984 million, up 79% year-over-year. This reflects the $1.1 billion of divestiture proceeds, which were partially offset by a portion of the cash outflows related to the 2012 capital investments. Note that during the first 2 weeks of January, we settled $104 million of share repurchases from the 2012 10b5-1 plan.

We ended 2012 with $1.7 billion of total debt, down $309 million or 15% over the prior year. Our debt-to-capital was just over 40% and net debt-to-EBITDA was 1.4x.

As you can see on this chart, we don't have any significant required debt repayments until December 2014. Our debt structure includes $500 million of want at 7 5/8% that mature in Q4 next year and $600 million of bonds at 6 7/8% that mature in Q3 2017. Our bonds have make whole provisions that would require us to essentially prepay the interest on the notes if we choose to prepay the principal.

In addition to the bonds, we have a $475 million term loan that is part of our credit facility. The current interest rate on the term loan is about 2.3%. At this point, we don't view prepaying any of these debt obligations as an efficient use of capital. We are also very comfortable that our liquidity and future cash flows are sufficient to cover our 2014 maturities.

Having said that, gross leverage remains a key metric we use to evaluate our financial position and our capital allocation plans. We calculate this ratio based on the definitions of debt and EBITDA and our credit agreement. Our target gross leverage range is 1.5 to 2.5x EBITDA and we ended 2012 at 3.1x.

Our 2013 EPS midpoint model assumes approximately $615 million of EBITDA for this year, up from $536 million in 2012. At that level and assuming debt remains flat, we expect gross leverage to decline towards the target range during the year. In the past, we levered the company above the target range for short periods of time to facilitate transformative acquisitions. This approach has served us well in building the company and we expect to continue it in the future when compelling strategic acquisitions are available.

As we've done previously, we will assess operational, integration and financial risk and use our disciplined approach to make decisions that we view as being in the best interest of our shareholders.

As Chris mentioned, since 2005, we've allocated a total of $5.6 billion of capital. A little more than 50% has been returned to shareholders through stock repurchases and dividends. We are targeting an additional $200 million in share repurchases this year, but we are also mindful of our gross leverage remaining above the target range for a second year.

With regard to our pension, our underfunded obligation is clearly a future cash requirement, similar to our conventional debt obligations. The gain on the sale of Service Solutions and our current excess cash create a compelling opportunity to fund that pension obligation at an attractive after-tax cost. Combined with the share repurchases, we expect these actions to increase our 2013 earnings per share by about $0.30 and have an annualized impact of approximately $0.50. After executing these planned allocations, we still expect to have about $1.2 billion of liquidity.

Now quickly taking a closer look at our U.S. qualified pension plan. We discontinued offering pension plans to newly hired employees in 2001, and more than 91% of our current pension participants are inactive. At the end of 2012, our plan assets totaled $937 million and our projected benefit obligation was just over $1.2 billion.

We implemented a long-duration asset and liability matching strategy in 2006 to reduce the volatility in our underfunded position. This has served us very well, stabilizing the underfunded amount and generating a 5-year rate of return of about 7%. With this voluntary $250 million contribution, we will essentially be fully funded from a U.S. perspective and will position our plan to greatly reduce any potential future funding requirements. In addition to the EPS benefit, this should improve free cash flows going forward.

Looking at share repurchases. Since 2005, we've repurchased 43 million shares at an average purchase price of $63 per share. And this year, we're targeting an additional $200 million of repurchases beginning in late Q1. In our earnings model, we have assumed buying the shares back in the open market ratably throughout the year on trading days outside our quiet periods. We plan to provide progress updates on our share repurchases during our quarterly earnings calls. If at some point, we decide to enter into a formal share repurchase plan, we will announce that publicly.

Moving on to cash flow. For 2013, our reported free cash flow is expected to include a tax payment of approximately $115 million related to the gain on the sale of Service Solutions. It will also include the planned voluntary pension contribution, net of the tax benefit, of approximately $160 million. Excluding these items, we are targeting adjusted free cash flow of $260 million to $300 million. Compared to our midpoint earnings model, that equates to about 125% conversion of net income.

So to summarize the key 2013 cash outflows and inflows. We began the year with $984 million of cash on hand. As I mentioned earlier, we settled $104 million of share repurchases in the first part of January. In Q1, we plan to make the tax payment from the gain on Service Solutions, which will be partially offset by the $90 million cash tax benefit from our pension contribution. At the midpoint, we're targeting $280 million of adjusted free cash flow for the year. So after making our quarterly dividend payments and executing the $200 million of share repurchases and the voluntary pension contribution, we are projecting over $600 million of cash on hand at the end of 2013. Combined with $580 million of borrowing capacity from our existing facilities, this gives us an estimated $1.2 billion of additional liquidity. Based on these projections, we believe we will have sufficient financial flexibility to evaluate additional capital allocation actions as the year progresses.

That concludes my portion of the prepared remarks. And at this time, I'll turn the presentation back over to Chris.

Christopher J. Kearney

Thanks, Jeremy. So in summary, our fourth quarter was the strongest financial quarter of the year, highlighted by sequential revenue growth and margin improvement across all 3 segments. We completed the sale of Service Solutions, as well as our previously communicated share repurchase and debt reduction plans. Building on these capital allocation actions, we plan to invest an additional $450 million of capital into voluntary pension funding and share repurchases. We believe these actions will generate a solid return on investment and will increase earnings per share by $0.30 in 2013 and by $0.50 on an annualized basis. Our EPS guidance range for 2013, again, is $4.60 to $5.10 per share, and we believe our future earnings potential is stronger than it's ever been. We've significantly transformed SPX and expanded our business into higher-growth markets with attractive growth prospects and higher-return profiles. Our long-term strategy is centered on expanding our Flow platforms, and we believe there are attractive growth opportunities in all 3 of Flow's key end markets.

Going forward, we plan to continue to execute a strategy that has made us successful while maintaining the financial discipline that we have demonstrated in the past. And we have significant liquidity to continue building a stronger SPX and to add customer relevance in our strategic end markets.

So that concludes our presentation. At this time, we'll be happy to take your questions. And as a courtesy to our webcast listeners, we ask that you please wait for a microphone before asking the question.

Question-and-Answer Session

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Yes. Just on the year, the price in medium duty for transformers was basically 0, or is it still negative for the full year?

Christopher J. Kearney

I'm sorry, can you say again?

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Price in medium-duty transformers, was it still -- was it 0 for the year or was it still negative?

Jeremy W. Smeltser

It's basically flat, yes.

Christopher J. Kearney

Flat, yes.

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Okay, basically flat. And then the core margin in Flow continues to disappoint. You guys talked about the mix. I mean, when does that start to get better? And are you at a consistent run rate of mix, or can you start to see -- I mean, you're remodeling some pretty decent improvement in the core for next year. So what are the dynamics there?

Christopher J. Kearney

Yes. Well, we had a significant increase in -- significant growth in our systems businesses as we indicated in the presentation today, Steve. That has had a dilutive impact. I think there's opportunity for that to improve. We think the long-term target margins we have out there for our Flow segment are correct and we think that's where the business is heading. We're looking for another 250 points of margin improvement in ClydeUnion this year. So we think that as the business transforms, and it has transformed over the last 3 years for the larger system component in the business, that has been dilutive and will always be dilutive to the component part of our business, but I think there's an opportunity to improve those margins and we believe we will.

Jeremy W. Smeltser

And I think, Steve, if you look at the 130 to 180 points expected for 2013, about 1/2 of that is from the core and it's from exactly the things that Chris was talking about. In particular, in Europe where do you remember in the first half of 2012, we struggled with core margins. That's improved steadily in the second half of the year and we expect that to continue.

Charles Stephen Tusa - JP Morgan Chase & Co, Research Division

Okay. And then we haven't talked to you guys in a while, but you guys kind of went radio silent there. Why did you make the decision to shift from normal operating procedure like the last couple of years you've done an investor meeting then you get us down here, and it seems like this is basically -- we report the results, we do a little bit of investor day. There's also very, very little detail around Thermal and Industrial relative to prior presentations. So I'm just curious as to what the decision was behind the scenes as far as the significant changes here. And then if you could just talk to the future strategic merit of having those businesses where it doesn't really seem like you're going to building those out or invest in those.

Christopher J. Kearney

Yes, sure. With respect to the first question, in terms of merging the meetings, I think that's a result of our process improving, and we're closing the year and having that date move up. And we were getting to a point where the time between where we gave guidance and we actually reported results was compressing. It made sense to us, I think, and we think, frankly, easier for you to combine those meetings and put them all in one, so that we're not giving you guidance and then weeks later coming out and talking about last year results. So I think it makes sense to do that. Our goal is to continue to improve that process, so I think we can compress it even further, and that's a challenge we've got internally.

With respect to less focus on Thermal and Industrial, more than anything, Steve, I mean, that's just a reflection of where the portfolio has transformed. I mean, we've been very, very direct and transparent about our focus on growing the Flow business, and we've been consistent about that. So it now accounts for more than 1/2 the company's total revenue. And I think over time, regardless of what happens to the other businesses in the portfolio, Flow, I think you should assume, will continue to become a larger part. That is not a -- that's not some tacit commentary on the rest of our businesses. They're clearly important. We clearly continue to invest in those businesses. As we look at the total portfolio going forward, what I've told you guys in the past is that, that portfolio review is a dynamic process and we have made some key decisions in terms of assets that we've divested since I've been in this job as well as the acquisitions that we've done. We'll continue to be thoughtful about that process going forward and look at opportunities to divest businesses that we think makes sense to do it at that point in time. In the meantime, I think we continue to invest significantly in all of our businesses and to focus on how we improve their competitive position around the world to make them better. If you look at Thermal, for instance, recognizing a competitive change in the developing parts of the world, we formed our joint venture with Shanghai Electric because we think that will make us more competitive in that important Asia Pacific market and we believe it will. And we're seeing good results in terms of orders taken out of that. And then the rest of that business, we are -- that's a long-cycle business and it's a late-cycle power business. We have gone through a couple of challenging years and we have described ourselves as we think bottoming out in that cycle. And back to Jeremy's comments earlier on Thermal, if you look at where we are year-over-year, taking South Africa out of that, that would support our belief that we have bottomed in that business and it's kind of flat year-to-year. What has been noticeably missing from Thermal over the last 2 to 3 years is significant replacement and retrofit opportunities in Europe and the United States. That's impacted margins, as you know, significantly in that business. And that's, I think, a reflection of a number of things, I think lower energy consumption, confusion over energy policy and where utilities need to invest. Over time, though, the same dynamic applies to that business as it does, I believe, in the transformer business and that is there's a very aged infrastructure. There is a critical need to replace that infrastructure, and I think, as economies recover and there's going to be increased, I think, pressure on utilities and power providers to make those investments. So we think a long-term prospect for that business is good around the world and particularly in developed -- excuse me, and particularly in the developed markets of Europe and the United States, which we think is due to improve. And with respect to the businesses in Industrial, there's a lot of businesses to talk about in that segment. They're smaller, they're very attractive niche businesses. They are good producers of cash and OP. They're not terribly labor-intensive from a management standpoint. In the past 8 years, we've looked at opportunities to divest businesses that were noncore if it was -- if it made sense at the time. But they're all great businesses and they're contributing and we continue to invest and there's great innovation going on in those businesses. So we are in no rush and don't need to be anywhere -- in any rush to do anything with respect to those. I'll get back to you. Julian?

Julian Mitchell - Crédit Suisse AG, Research Division

The first question really just on transformer sort of margins. Because in the past, I think you've said that you think this cycle should play out similar to previous in terms of the slope and the absolute level of the margin recovery in that business. One interesting point in this cycle is, as you say, the that in mature economies, electricity consumption just doesn't grow anymore. So I wondered if that had -- the fact you've seen it now for 2 years consecutively, if that's maybe you think the slope of the margin growth is a lot less steep than perhaps you'd thought 2 years ago?

Christopher J. Kearney

I think the recovery slope, Julian, is still very similar. I think it's very difficult, obviously, for us to make an accurate prediction in terms of price infections in that business. I think the situation is quite similar. I think there's incrementally more capacity in the market because the few U.S. players in medium power that have traditionally played in that market, I think, have all added some capacity. But I don't believe that's so much the issue. I think it's the pace of recovery in electricity demand, which I think reflects the pace of recovery in the economy and particularly with respect to the housing market. So it's interesting, though, when you look back at the last recovery cycle, there is a bit of a -- there was a bit of a hitch in terms of that cycle returning as we did the same thing that we're doing now, and I think that is being disciplined about opportunities that we go after and I think we need to do that. But we're quite confident that the demand is there, the dynamics are strong. And with each passing year, the age dynamic gets even more critical. So we're happy that we made investment that we did when we made that investment. We think it's a great business. And we think going forward, we will see recovery in that business. And I think that's a medium-term issue. But it's just -- it's difficult to predict. We are encouraged in terms of the volume we've seen. Revenue was up 30% last year. For more than the last 1.5 years, we've seen a nice continued build in the orders. And so we know it's there. And the commentary we get out of the utilities would support that. So it's coming. It's -- and I think we're well positioned and probably better positioned this time around than we were last time to get more of that recovery when it comes.

Julian Mitchell - Crédit Suisse AG, Research Division

And just on the Thermal business, does the guidance reflect the fact that maybe exiting this year, these sales are maybe flat, or do you kind of assume that year-on-year sales are down every quarter this year?

Christopher J. Kearney

In Thermal?

Julian Mitchell - Crédit Suisse AG, Research Division


Christopher J. Kearney

No, with the exception of burning off the South Africa backlog, year-to-year we believe it is flat and essentially has been for the last 2 years.

Jeremy W. Smeltser

Yes, I think the range would assume for the core outside of South Africa, it's flat to slightly down from a revenue perspective in 2013.

Julian Mitchell - Crédit Suisse AG, Research Division

And just lastly within the Flow business. You talked about systems, and obviously you have a lot of strength on the equipment side. What are your thoughts on the control kind of layer within Flow overall, sort of control software, this sort of approach in addition to systems and the equipment you have and then you'd offer kind of everything to the customer?

Christopher J. Kearney

Look, I think the attractive thing about that platform broadly, and as I mentioned in my comments, particularly about the industrial flow end markets, is that there are many different directions you can take that business and many of them are attractive. And I think many of them are logical, either vertical extensions of where we are or logical vertical app -- excuse me, horizontal applications of where we are in terms of looking for adjacent applications for technologies that we have, that we can improve, that we can expand through innovation and through acquisitions. So our original investment thesis in that business going back to when I came in this job at the end of 2004 was we were quite excited about the opportunities to consolidate in that industry and to grow this into a world-class Flow business. And I think we've made great strides doing that, but I think there's a lot still to be done.

Unknown Analyst

I want to go back to Steve's second question related to what might be the dynamic process of the portfolio review and some of the radio silence we went through in December. So it was some pretty specific media speculation about an acquisition and maybe some comments around that. But more specifically, there seemed to be a disconnect between what the investors and analysts were expecting in terms of either growth by acquisition versus what look like -- would have been a large acquisition for SPX. So can you comment the extent on the thought process on the portfolio and specifically about what that disconnect was between what investors were thinking versus what the implications of that deal would have been?

Christopher J. Kearney

Well, there's no disconnect in our strategy. I mean, our strategy has been consistent and we reiterated that strategy again today. And so hopefully, what we've established over the last 8 years is a consistency -- a strategic consistency in terms of what we want to do and we've talked ad nauseam about that and the discipline around how we do it. I can't comment and won't comment with respect to any particular rumor that's out there. If you're a consolidator in the flow space and there are deals going on, it's almost a given that our name is going to get mentioned in the mix and we're never going to comment on that kind of speculation. I'll tell you what I've told you guys always: Believe it when you hear it from us, right? And I think -- and I hope that you know me and this team well enough that what we've done in the past should be a good roadmap to what we're going to do in the future in terms of consistently developing that strategy in Flow and exercising that same capital allocation discipline around how we do it. And I think as we grow, as we manage our liquidity, we are better able to continue that process going forward. So nothing at all has changed with respect to our strategy and discipline. And look, it's unfortunate when rumors are out there, but no reasonable person who stands in this position is going to comment on that and it just makes no sense to do that.

Unknown Analyst

Sure, I understand that entirely. And perhaps, you can never time these things exactly right, but had you had this meeting this morning, and given the kind of emphasis about the Flow opportunity, maybe that would have been less of a disconnect. All right, so a separate unrelated question, but on the Flow side, on the dairy contract in Shanghai. Very interesting, the comments about you want to do more of these systems projects and develop that installed base. The 28% that your content take us out the next several years, what's that right number? And if you get there just on white space with new products, but where do you optimize -- you're never going to go do the installations, but how do you optimize what that percentage content should be?

Christopher J. Kearney

Well, I think the percentage content will vary -- could vary materially depending on the actual application. And our strategy in terms of building out our systems capabilities has to be focused on the go-forward aftermarket and service opportunity. That's a large part of the strategy. And so whether it's 20%, 25%, 30% or greater, I think the more significant issue is what kind of an aftermarket service opportunity does that create for us as we go forward. I think as we mature in that business and as we extend our technical and engineering capabilities in that business, I think we'll be in a position to be very thoughtful about which of those opportunities that we go after, so that the OE or the system opportunity is consistent with the aftermarket strategy within that business. And so it's not so much about what the percentage is. I think it's more about what opportunity does that present going forward. I think theoretically, you could have a system designed and built by us that has a much higher percentage, but has perhaps a less attractive aftermarket down the road. So all those things have to be taken into consideration. We're a new player in that world. We've been very successful in terms of putting those pieces together so that we can successfully compete and get those opportunities around the world. I think as we mature in that business, I think you'll continue to see us be more thoughtful about those opportunities. And back to Steve's question, I think that'll have an impact on how profitable that platform gets. And so a lot of credit to Don and his team. They have grown very rapidly over the last 5 years in that business. They've done a spectacular job with all the challenges. We would all like the integration of those acquisition opportunities to be more linear. It involves people and customers and markets and challenges. And so it seldom plays out exactly like you would like to. But over time, I think we've got a pretty good track record of having those things play out pretty well, and I think we'll continue to get better at it. Nigel?

Nigel Coe - Morgan Stanley, Research Division

Chris, you've talked about this transformer cycle in [indiscernible] the last cycle. The contraction and lead time, is that normal? Did that happen last cycle? And has that pushed out the price recovery somewhat given that the market [indiscernible]?

Christopher J. Kearney

In answer to your first question, if you look closely at how that last cycle played out, as I described it, there was a hitch in the recovery cycle when we look at our business. And that, I think, reflected our discipline about not getting over our skis in terms of pacing the recovery. I think there's a similar dynamic going on now, but understand that times are not ever completely the same. But I think that the opportunity for this recovery to be extended, given one, the severe age of the infrastructure and given the reliability standards and fines that have been imposed, I think, will be significant. I mean, for whatever it's worth, my theory is that if you even see incrementally higher growth in economies, in the U.S. economy, which will pull more electricity demand, I think that incremental growth can be a significant catalyst to accelerating recovery in there, but I don't know that for sure. But I believe that when I look at the data in the industry and when I look at the age dynamics and when you put that all together with the utility commentary around the need to invest, it sort of makes sense.

Nigel Coe - Morgan Stanley, Research Division

Agreed. Moving to ClydeUnion. ClydeUnion had a big pickup in revenues from 3Q to 4Q. Is that normal? Is that normal seasonality for that business?

Christopher J. Kearney

There is seasonality in the ClydeUnion revenue profile. That was a terrific quarter that I think reflects the hard work and focus that Don and his people had put on that business in terms of improving throughput in the business. That said, there's still a lot of work to be done there, and it's -- but we clearly are on the right path. But I think as you look at that business going forward, the profile in terms of revenue quarter-by-quarter is not dissimilar than what you should expect going forward.

Jeremy W. Smeltser

Yes, and I think Q4 weighted to the year is probably what we should expect to see going forward. It is a heavier revenue quarter, and thus, as a reminder, you should expect to see a step-down from Q4 to Q1. Typically, that's driven in that business, if you look historically over the last 4 years, by an increase in aftermarket, which did happen this time. But we also had higher throughput on the OE. And so the mix didn't change dramatically. It was really just about the absolute volume of revenue driving the margin improvement.

Nigel Coe - Morgan Stanley, Research Division

Can I ask one more, maybe to Jeremy, on pension.

Jeremy W. Smeltser


Nigel Coe - Morgan Stanley, Research Division

So the 50/50 [ph] mix that makes sense. Has that condition already happened? Do you get the benefit as of 1 January 2013?

Jeremy W. Smeltser

We do not. That'll happen around the end of Q1, maybe the beginning of Q2.

Nigel Coe - Morgan Stanley, Research Division

But you get the benefit as of 1 January, can you back date that?

Jeremy W. Smeltser

No, we don't, no. That's why that's part of the -- as we've said, combined their $0.30 benefit to this year and the 50% benefit on annualized. That's coming both from the annualized benefit of share repurchases and the pension.

Nigel Coe - Morgan Stanley, Research Division

And that 50% fully funded, I think.

Jeremy W. Smeltser

Yes, basically fully funds the U.S. qualified plans, which is consistent with where we're at in the U.K. as well, the 2 primary kind of areas to fund.

Nigel Coe - Morgan Stanley, Research Division

Okay. And just one quick one on the share repurchase. Have you considered doing an ASR?

Jeremy W. Smeltser

All the potential vehicles for share repurchases are on the table. We've modeled it this way because we think this makes the most sense for now. If we changed our minds on that or come up with an approach where we want to split that, we'll announce it then we'll talk about the impact to that. The flexibility is nice as we think about where we are at in the beginning of the year as it relates to timing and volumes. So that's why we've announced it the way we have, but we'll evaluate as we go.

David L. Rose - Wedbush Securities Inc., Research Division

David Rose with Wedbush Securities. Quick question, a couple questions on ClydeUnion. Can you provide a little bit more granularity for us in terms of the margin improvement coming from your cost containment versus the backlog? And then in terms of the guidance, how that reflects -- have that backlog, the low-margin backlog working through is in the guidance. And then I have one more follow-up after that.

Jeremy W. Smeltser

Okay, sure. So first on the cost side, we've probably taken about $5 million of costs out of the business, so you think about Q4 compared to Q1, a little over $1 million of cost savings is a way I would think about it and the way I would model it going into next year, so kind of a half-year benefit of that $5 million likely falling in 2013. On the revenue side, there were about $140 million of loss and no margin contracts in the acquired backlog. We've recognized about $100 million of that revenue, so there's an additional $40 million to $50 million or so in 2013 that we expect to execute on.

David L. Rose - Wedbush Securities Inc., Research Division

Okay. And then going through the margin step-up. There's clearly seasonality in your business, but you have a big leap from your first quarter segment margins through the average for the year. So beyond the ClydeUnion benefit, can you also walk us through perhaps some other Lean initiatives, give us some specific examples of what you plan to execute on for 2013.

Jeremy W. Smeltser

Well, as it relates to 2012, to start, in differential as the year progressed, I mean, the key drivers there are our typical aftermarket seasonality and the legacy flow businesses is skewed to Q4, and that's budgetary for a lot of our customers. We also really struggled -- as I mentioned earlier, we struggled with margins in Europe in aggregate in the first half of the year, particularly Q1. We just improved as we've gone on. I think what I would expect to see is continued lumpiness in ClydeUnion's performance based on mix, which we'll talk about each quarter as we report it looking backwards. And then year-over-year, I would expect good improvement in the core businesses in the first half from the European challenges we experienced in the first half. So again back to the question I answered earlier, 130 to 180 points of margin improvement for the whole segment, about 1/2 from ClydeUnion, about 1/2 from the legacy businesses in total.

David L. Rose - Wedbush Securities Inc., Research Division

Just for the 1Q guidance, having a little bit of trouble reconciling that. I mean, you've got a lower tax rate. I mean, you've got a tax benefit as well in there. You've got lower share count. You did $0.15 last year. That stuff kind of gets you $0.12, $0.15 on its own. That gets you to $0.30. And then with the businesses, ClydeUnion was losing money last year. And I think you were absorbing some of the costs from the large transformers in your Industrial business. And I mean, Thermal did a 3% margin, which is hardly a barnburning. So what -- within the core business, you're already kind of $0.30 on a nonfundamental basis or I'm missing anything in nonfundamentals, what within the core business is deteriorating that much to get you to this $0.20 to $0.30 range for the first quarter?

Jeremy W. Smeltser

Yes. So I mean, Q1 EPS obviously last year was pretty noisy. So there's a lot of different numbers out there for it. I tend to focus on segment income as it relates to driving the earnings year-over-year. And it's flattish to up slightly, which is going to be, from what we expect today, Flow up and Thermal and Industrial actually down year-over-year despite the challenging Q1 margins last year in Thermal. And that's based on the mix that we currently expect to execute on in Q1. And then in Industrial, in the communications businesses, we had a great contract in Q1 last year that executed. It isn't repeating, so it's a bit of headwind for the quarter. Not so much for the year, but for the quarter.

David L. Rose - Wedbush Securities Inc., Research Division

Okay. So Thermal will lose money in the first quarter, you think?

Jeremy W. Smeltser

I don't expect that it will, no.

Christopher J. Kearney


Nigel Coe - Morgan Stanley, Research Division

Just a follow-up on Steve's question there. I mean what can you do to preserve profitability? And so I understand the competitive challenge in that market, pricing pressures and things like that. But what can you do to kind of control your [indiscernible]?

Christopher J. Kearney

Well, the business has changed pretty dramatically in the time that I've been in this job and perhaps even in the last 5 years. Mostly 2 major factors, Nigel. I mean, clearly the competitive dynamic and the developing market of Asia Pacific has changed pretty significantly. We had a long successful run, building out power-generating facilities, particularly in China, for more than a decade. And that market has become much more competitive as we know. And so we've taken actions and realization that in terms of repositioning ourselves in that market. In the developed markets again, in Europe and the United States, there has been a very low level of new build-out in those markets and a low level of activity in replacement and retrofit. As we move forward in time in that business, I think our ability to be successful and to see margins recover will be -- will rest largely on us repositioning ourselves in that business with costs clearly in mind, but also with innovation in mind that is directed to where we think the new opportunities are going to come from and what existing power producers are going to need to do to replace aged infrastructure. So I think as we look at that business going forward, we have to make sure that we have reduced costs to the extent we reasonably can, and that means looking at our global footprint in that business and where resources are and we have been doing that steadily. We'll continue to do that. But I think, importantly, just as importantly, it will mean -- it will require us to stay focused on our innovation opportunities so that particularly, as those replacement markets recover in Europe and the United States, we have attractive energy-efficient solutions for those providers who are willing to pay for that value proposition as opposed to just competing on old technology and costs.

Well, that being it, I want to thank you, guys, for coming here. Apologize again for the delay due to the technical difficulties, but thanks for getting that sorted out. And everybody who's traveling away from Charlotte, safe travels. And look forward to seeing all of you during the course of the year. Thanks for coming.

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