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Executives

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

Patrick J. O'Leary - Chief Financial Officer, Executive Vice President and Treasurer

Ryan Taylor - Director of Investor Relations

Analysts

Scott Gaffner - Barclays Capital, Research Division

C. Stephen Tusa - JP Morgan Chase & Co, Research Division

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Sheila Kahyaoglu - Crédit Suisse AG, Research Division

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Terry Darling - Goldman Sachs Group Inc., Research Division

Deane M. Dray - Citigroup Inc, Research Division

SPX, (SPW) Q2 2011 Earnings Call, Aug 03, 2011 August 3, 2011 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 SPX Corp Earnings Conference Call. My name is Deana and I'll be the operator for today. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the call over to your host, Mr. Ryan Taylor, Director of Investor Relations. Please proceed.

Ryan Taylor

Thank you, Deana, and good morning, everyone. Thank you for joining us this morning. With me on the call today are Chris Kearney, our Chairman, President and CEO of SPX; and Patrick O'Leary, our Chief Financial Officer.

This morning's call is being webcast with a slide presentation, which you can access in the Investor Relations section of our website, spx.com. The webcast will be available until August 17, and I encourage you to follow along with the webcast as we reference the detailed information on the slides.

We have also included supplemental schedules in the appendix of today's presentation, these provide reconciliations for all non-GAAP financial measures we discuss today. Our earnings press release was issued this morning and can also be found on our website.

I would like to point out that portions of our presentation and our comments are forward-looking and subject to Safe Harbor provisions. Please also note the risk factors in our most recent SEC filings. The financial data that we discuss today relates generally to continuing operations. And additionally, some of the earnings per share numbers that we discuss this morning are on an adjusted basis.

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

Christopher J. Kearney

Thanks, Ryan. Good morning, everyone. Thanks for joining us on the call. This morning, we released our financial results for the second quarter and first half of 2011. On a year-over-year basis, during the first half of the year, our revenue grew 14%, EPS increased modestly and our backlog increased 10%. This was driven primarily by strong growth in the early-cycle businesses in our Flow Technology and Test and Measurement segments.

First half earnings and margins were adversely affected by less favorable profitability in the reported results of our late-cycle power-related businesses. Going into the second half of the year, we're encouraged by the overall development of our backlog, particularly in our short-cycle businesses. And accordingly, we expect to see organic revenue growth accelerate.

We also expect to see improved sequential earnings and margin performance over the balance of the year, particularly in the fourth quarter. From a strategic perspective, we completed the final phase of our credit facility refinancing in Q2. This has improved our financial flexibility to support future growth, and we now have no material debt repayment obligations until 2014.

Looking specifically at the financial results for the second quarter. Adjusted EPS was $0.91, slightly better than our guidance. Reported revenue grew 16% over last year to $1.4 billion. This was modestly better than we had targeted. Our revenue growth was primarily driven by continued strengthening in demand for products in our Flow Technology and Test and Measurement segments. We also benefited from the recent acquisitions in the 2 segments.

On a consolidated basis, organic growth was 7%. Acquisitions contributed 3% growth, and currency added a 6% benefit over last year. With 16% total revenue growth, we were encouraged that our backlog also increased by 10% over last year, and remained flat on a sequential basis.

Our consolidated segment income margin was 9.6%, modestly lower than we had anticipated. Coming into the quarter, we had expected margin headwinds from continued weakness in our late-cycle power businesses. However, we also experienced margin headwinds in our Flow Technology segment.

Flow's Q2 margin performance was impacted by an unfavorable revenue mix as well as raw material price inflation. Through our recent acquisitions, we have expanded our food and beverage systems offering. This has driven very strong growth in our systems revenue that is generally not as profitable as component sales.

Growing our installed base of systems however, is a key towards increasing our customer relationships and growing our future replacement opportunities for short-cycle components. In Q2, Flow's Food and Beverage systems revenue doubled as compared to last year, accounting for 23% of Flow's total revenue versus 15% in the prior year. We also experienced margin pressure on short-cycle component sales due primarily to inflation in raw material pricing particularly in high-grade stainless steel.

Don Canterna and the broader Flow leadership team have already taken action to drive improved margins -- excuse me, improve margin performance for the second half including multiple pricing actions that we expect to take hold in Q3.

We expect Flow's margins to improve in the second half and remain committed to achieving our long-term margin target of 14% to 16% in this segment. While Flow's Q2 incremental margins was not as good as we expected, we are pleased with Flow's continued strong revenue growth and backlog development.

Flow Technology is our largest and fastest-growing segment. This year, Flow is projecting to deliver a record level of annual revenue and operating profit.

Looking at our consolidated revenue by region. Geographic revenue trends in Q2 were very similar to the first quarter. Sales into Europe increased 25% year-over-year. This growth was particularly strong in our Flow Technology and Test and Measurement segments.

In the Americas, revenue increased 18%, with all 4 segments reporting growth over last year. In Asia-Pacific, continued strong sales growth in our Flow and Test and Measurement segments was more than offset by a decline of power project revenue in our Thermal segment.

Sales into emerging markets increased 9% year-over-year and accounted for 25% of total revenue, consistent with Q1. Revenue in Africa and the Middle East grew 42%, largely driven by increased revenue related to the power projects in South Africa.

Moving onto backlog. As I mentioned, our ending Q2 backlog increased 10% year-over-year to just over $3 billion. It was flat sequentially. Flow's backlog increased $59 million or 7% sequentially. We continue to see strong order trends in most of our key Flow end markets and regions. Flow's backlog has now increased by $271 million or 43% over the past year. This is meaningful when you consider that Flow is predominantly a short-cycle business and has reported organic revenue growth in each of the last 4 quarters with strong double-digit growth in the first half of this year.

The Industrial segment backlog grew $92 million, up 23% from Q1. This was driven broadly across most of the key businesses in this segment.

Our U.S. Power Transformer business continues to see a positive development, as the backlog for both large and medium transformers increase. With respect to Transformer orders, we were more selective in Q2 as we have previously communicated. As a result, on average, we saw modestly higher pricing in the new orders booked in the period. Open market pricing however, remains stable.

Looking at our guidance for the full year. This morning, we are reaffirming our full year EPS guidance range of $4.25 to $4.55 per share. It is now on an adjusted basis. Our free cash flow guidance remains at $220 million to $260 million, representing over 100% conversion of net income at the mid-point. Later on the call, Patrick will provide more details on our consolidated guidance.

Looking at our balance sheet. There was no significant movement in our key balance sheet accounts from Q1 to Q2. We ended the quarter with nearly $400 million of cash on hand, up 6% sequentially.

Total debt remained at $1.2 billion. Our key debt ratios were stable quarter-to-quarter, with debt to capital at 35% and gross debt to EBITDA 2.1x. The new credit facilities have improved our financial flexibility to make strategic investments. We continue to actively monitor potential acquisitions and other strategic actions and believe there are attractive opportunities to advance our long-term strategy.

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

Patrick J. O'Leary

Thanks, Chris. Good morning, everyone. I'll begin this morning with earnings per share.

For the quarter, we reported earnings per share from continuing operations of $0.62. This included a $0.29 non-cash impairment charge related to our SPX Heat Transfer subsidiary. The near-term revenue profile for this business no longer supports the carrying value of its goodwill.

Last year, SPX Heat Transfer reported just over $90 million of revenue, and we are forecasting a decline in its revenue in 2011. Approximately 85% of the revenue for this business is generated from sales into the U.S. power market. While orders in this market have been below historical levels over the past several quarters, we still believe this business has good medium to long-term growth potential in the U.S. and globally.

On an adjusted basis, Q2 EPS was $0.91 per share, $0.01 above the top end of our guidance. Year-over-year EPS declined 9%. In aggregate, our segment income was $0.04 lower versus the prior year. The decline was primarily due to reduced earnings in the power-related businesses reported in our Thermal and Industrial segments. Combined, these 2 segments reported a $0.26 decrease in segment income.

This was largely offset by a $0.22 increase in segment income at our Flow and Test and Measurement segments. Increased special charges reduced Q2 earnings by $0.06. In total we recorded $0.13 of special charges including a $0.05 charge related to the integration of the Diagnostic Solutions acquisition.

Our effective tax rate for the quarter was 27% , resulting in a $0.09 benefit versus the prior year. The reduced tax rate was due primarily to the favorable completion of certain field examinations. Other items netted to an $0.08 decline in year-over-year earnings with the most notable headwind being higher interest expense.

On a consolidated basis, we reported $1.4 billion of revenue in Q2, up 16% from the prior year and modestly better than we had expected. Organic revenue grew 7%. Acquisitions contributed $39 million or 3% growth, and currency was a 6% benefit in the quarter. Segment income was $132 million, slightly less than we had targeted. Segment income margins were 9.6%. The reduced year-over-year profitability was primarily attributable to declines in our power-related businesses.

Moving on to the segment results, beginning with Flow. Flow's revenue for the quarter increased 29% year-over-year to $493 million. This was up 8% sequentially. Revenue increased in all major regions, the growth was strongest in Europe where sales increased 42% and in North America where sales increased 18%. Organic revenue grew 14%. Acquisitions contributed $23 million or 6% growth and currency was an 8% benefit.

The organic growth was driven broadly across each of our key markets including the food and beverage; power and energy; and industrial markets. Segment income increased 25% to $57 million. However, operating margins declined 30 points to 11.5%. As Chris pointed out, Flow experienced margin pressure due to a higher percentage of systems revenue and raw material inflation.

We implemented price increases during the second and third quarters to address the raw material inflation, and we expect this to benefit Flow's margin performance over the balance of this year. We are also continuing the integration of recent acquisitions into Flow Systems business to better leverage technologies and reduce our cost base.

We expect to incur restructuring charges in Q3 relating further integration actions. Over time, we expect to drive improved profitability in our Systems business. Last year, we reorganized Flow's management into a regional structure to operate more efficiently as a global business. This year, we are taking another step to aggregate our Food and Beverage Systems businesses into one global unit with a centralized management team. We expect this structure to provide many benefits including better alignment with our global customers and a stronger ability to leverage our global engineering and project management resources and drive margin improvement over time.

During the first half of this year, we completed an expansion to our food and beverage innovations center just outside Copenhagen. This facility is now equipped to leverage the wider spectrum of technologies from our leading process equipment brands. On September 28 and 29, we plan to showcase this facility and the broader development of our Flow Technology segment to analysts and investors. In the coming weeks, we will release additional details, with instructions on how you can register to attend this event.

Flow's backlog grew to $907 million at the end of Q2, up 7% sequentially. The backlog is now 35% system orders and 65% short-cycle component orders. Flow booked a record level of orders during the quarter, driven by continued strength in food and beverage markets. We saw an increased level of activity in food and beverage systems, particularly towards the end of the quarter.

In oil and gas markets, demand for our components was strong, particularly within oil and gas pipelines. And we also saw a sharp increase in demand for plate heat exchangers in the marine industry and other industrial markets.

We have significantly more visibility to the second half revenue than we had at this time last year. More than 60% of Flow's estimated revenue over the balance of the year is in ending Q2 backlog as compared to 44% last year.

Looking at our Thermal segment. Q2 revenue was $432 million, up 10% to the prior year. Organic revenue increased 3.5% and currency was about a 7% benefit. The organic revenue growth was driven by an increase in evaporative cooling revenue, aftermarket service revenue and continued execution on the power projects in South Africa. We also had increased sales of package cooling systems and high-efficiency boilers into the U.S. industrial and HVAC markets. The organic growth in these areas offset a sharp decline in dry cooling revenue.

Segment income was $36 million, down 27% from the prior year, and margins were 8.3%. The decline in profitability was primarily due to an unfavorable project mix. You may recall that Q2 2010 profitability benefited from a high concentration of dry cooling and large retrofit projects. Based on the project mix and our backlog and historical seasonal strength in the personal comfort heating businesses, we expect margins to improve in the second half of the year.

Thermal ended the quarter with a backlog of $1.4 billion, down 11% from Q1. As a reminder, quarterly changes in our Thermal backlog are influenced by the timing of large orders, and do not, in our experience, fully represent end market trends.

The decline in our Thermal backlog is partly due to organic revenue growth in the quarter. In addition, we have maintained discipline in project selection as large, long-cycle project activity has been competitive. Investment in the global power market remains at a low-level, although it has increased modestly from a year ago.

For the first half of the year, our Thermal orders have increased about 27% as compared to last year and our book-to-bill was 0.8x. We expect to convert about 43% of the backlog or $620 million to revenue over the balance of this year. This represents approximately 2/3 of our revenue forecast for the second half of 2011 consistent with last year.

Moving on to Test and Measurement. Revenue increased by $48 million or 20% to $288 million. Organic growth was 8% year-over-year. The acquisition of Teradyne's Diagnostic Solutions business added $16 million of revenue, a 7% increase to the prior year. And currency was a 6% benefit.

The organic revenue growth was driven by strong demand in the global aftermarket, as well as increased OEM program sales. The aftermarket sales were driven primarily by increased replacement sales of air conditioning recovery units. We recently introduced the next generation air conditioning recovery unit for vehicles using a new refrigerant. Over the next several quarters, we expect to see sales growth from this product as OEMs transition to this refrigerant in new vehicle models.

Segment income increased 22% in the quarter to $29 million. Margins increased 20 points to just over 10%. Operating margins in our Service Solutions business improved from leverage on the organic revenue growth, as well as accretion from the Diagnostic Solutions acquisition. However, this was partially offset by a decline and higher margin sales of farebox collection systems.

In our Industrial Products segment, Q2 revenue was $171 million or down 1% from the prior year. Organic revenue declined 2% and currency was about a 1% benefit. Organic decline was caused primarily by a decline in sales of precision aerospace components and solar crystal growers. Our Power Transformer business reported organic growth for the first time since Q2 2009. Segment income was $11 million and segment margin was 6.4%. The decline in profitability was due primarily to lower pricing on transformer shipments. We also incurred $3.5 million of costs associated with the expansion of our transformer facility in Wisconsin. The Q2 ending backlog for this segment was $494 million, up $92 million or 23% sequentially. The backlog is now up 34% on a year-over-year basis.

The increase in the backlog is partly due to a $27 million order for solar crystal growers. We also saw sharp increases in the backlogs of our Aerospace and Communication Technology businesses. Our Power Transformer backlog increased by 10% and positive trends continue to develop during the quarter.

As I mentioned, revenue in the Transformer business grew organically for the first time in 2 years. We expect to see organic revenue growth accelerate in the second half of this year, driven by increased volume. Looking at the transformer backlog, beginning with medium power transformers, the backlog for medium power transformers has increased 43% year-over-year. On a sequential basis, growth moderated as we're more selective on new orders. Our lead times for medium power transformers remained at 8 to 12 months, and still exceeds the broader market. We are now taking orders for Q2 and Q3 2012. We increased our pricing modestly for 2012 shipments. However, open-market pricing remains stable.

Our facility expansion for additional large power transformer capacity remains on track to be substantially completed by the end of this year. We expect to begin shipping units in the first half of next year. We now have orders for 9 large power units that we expect to manufacture in the expanded facility. Total cost this year associated with expansion, including additional headcount and outsourcing activities are expected to be around $10 million.

Moving on to free cash flow. We generated $18 million of free cash flow in the second quarter. Our primary investment was in working capital, particularly in our short cycle businesses that experienced strong organic growth in the first half.

We also invested $31 million in capital expenditures, a little more than 1/3 of our capital spend in the quarter related to the expansion of our transformer facility. Through the first 6 months, we reported a net cash use of $34 million. This is relatively in line with our experience in prior years. The majority of our annual cash flow is typically generated in the second half of the year. We expect 2011 to follow this historical trend. For the full year, we are targeting about $240 million of free cash flow. This is net of the elevated CapEx spending of $150 million.

During the quarter, we completed our credit facility refinancing. We now have no significant debt repayment obligations until 2014. The new credit facilities are in aggregate, $1.8 billion and have a 5-year maturity. These new facility significantly increased our financial flexibility. We have increased the size of the available performance bond facility. We also have a $1 billion accordion option to upsize this facility. This is a key advantage for us in terms of executing strategic investments. These new credit facilities provide SPX with an increased financial capacity to support continued organic growth in our core businesses, while also increasing our financial flexibility to support our global acquisition strategy.

Now I'll review our updated 2011 financial targets before I turn the call back to Chris. For the first half of 2011, our revenue increased 14% in total and 6% on an organic basis. EPS for the first 6 months was modestly better than last year. Strong growth in our early and mid-cycle businesses, as well as emerging market growth was largely offset by revenue and margin declines in our late cycle power-related businesses. We are encouraged, however, by our backlog development in the first half of this year, as well as significantly improved order trends in many of our key end markets.

We believe financial results will improve sequentially in the second half, with a particularly strong fourth quarter. In the second half of this year, we're targeting nearly $3 billion of revenue and approximately $3 of earnings per share.

We expect acceleration in our organic growth to be a key driver of improved margin performance and earnings per share in the second half of the year. We are forecasting year-over-year organic revenue growth in all 4 segments and increased profitability in 3 of the 4 segments in the second half of the year.

We expect sales volumes to remain strong in our Flow Technology and Test and Measurement segments, with the organic growth rate moderating to around 10% in the second half. However, as opposed to the first half, we expect our late-cycle businesses to also contribute year-over-year organic revenue growth.

We are forecasting double-digit organic growth in our Industrial and mid-single digit growth in our Thermal segment. In Q3, we expect consolidated revenue growth of 9% to 13% versus the prior year, driven by our Flow and Test and Measurement segments. We are targeting mid- single-digit organic growth with 2% growth from acquisitions. Currency is expected to be about a 4% benefit to the quarter.

We are projecting $142 million to $147 million of segment income, up about 10% sequentially. However, we expect segment income to decline 7% from the prior year, primarily due to declines at Thermal and Industrial. We expect Thermal segment income to decline about $0.24 per share year-over-year in Q3 due to fewer global power projects. Our Q3 EPS guidance range is $1 to $1.10 per share, that's down about 5% from last year at the midpoint.

Historically, our earnings have been concentrated in the fourth quarter. For example, at the start of the last economic recovery, we recorded more than 40% of our earnings in Q4 in both 2005 and 2006. This year, we are expecting approximately 45% of our EPS to be delivered in the fourth quarter. In Q4, we are targeting double-digit organic revenue growth on a consolidated basis with organic growth across all 4 segments. This is partly driven by historical seasonality in our Thermal and Test and Measurement segments. We also expect the timing of execution on several large projects to be concentrated in Q4.

We expect the organic growth to be a key driver of higher segment income and margin performance. We are targeting particularly strong Q4 segment income in our Flow and Thermal segments, which we expect to contribute about 17% of our total segment income.

Looking at the updated full year targets by segment. In general, we have tightened up the revenue growth and margin ranges to reflect the Q2 results and our updated expectations for the second half. We have increased the full year revenue targets for our Flow; Test and Measurement; and Industrial segments reflecting the stronger order trends and backlog development in Q2. The most significant changes in the margin expectations is at Flow, where we have reduced our expectations to reflect these Q2 results. We now expect full year margins at Flow to be between 12.8% and 13.1% .

On a consolidated basis for 2011, we are now targeting about $5.5 billion of revenue, with high single-digit organic growth. Acquisitions are expected to increase revenue by about 2%. Our updated guidance assumes exchange rates from early July and based on these rates, we project currency to benefit revenue by between 3% and 4%. We are targeting the segment margins to be about 11%. We are now using a full-year effective tax rate, slightly above 30%. Our adjusted EPS guidance range remains at $4.25 to $4.55 per share. This represents about a 22% year-over-year increase at the midpoint. We expect to convert approximately 107% of net income into free cash flow, even with the elevated CapEx.

Please note our adjusted EPS guidance range excludes the $0.29 impairment charge in Q2. I'd like to remind you that our EPS calculation is very sensitive because of the low share count, $1 million of net income equals about $0.02 of EPS. Certain factors could occur in the remainder of 2011 that may impact our EPS and free cash flow guidance. On this chart, we have listed what we believe to be the most likely potential impacts and uncertainties at this time.

With that, I'll turn the presentation back to Chris for closing remarks.

Christopher J. Kearney

Thanks, Patrick. In summary, we are encouraged with our revenue growth and backlog development in the first half of the year, and we're very focused on operational execution over the balance into this year. We expect organic revenue and earnings growth to improve sequentially, during the second half. We expect our financial performance in the fourth quarter this year to be particularly strong.

We are at an interesting point with respect to the market trends across our businesses. We are experiencing very strong growth in early cycle businesses. However, the pace of recovery in our late-cycle power businesses has been mixed. Because of the late and the long cycle nature of our power businesses, we don't expect them to contribute meaningful revenue or earnings growth until late 2012 or early 2013. Our new credit facilities give us more flexibly to execute strategic actions, as we continue to focus on opportunities that fit with our long-term growth plan.

So that concludes our prepared remarks this morning. And at this time, we'll be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And the first question will come from the line of Shannon O'Callaghan, Nomura.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Can you talk a little more about some of the dynamics playing out in the quarter, and also in the second half in the non-transformer parts of Industrial?

Christopher J. Kearney

Yes. We're seeing actually pretty decent performance in the businesses in the Industrial segment outside of Transformers, Shannon. We saw a really good, sizable crystal growing order that we talked about, worth about $27 million. Overall, we saw substantial double-digit growth in that segment year-over-year, for which transformers only account for part of that. So I think in terms of where we are in that segment, in terms of how we see the transformer recovery playing out, it's really not different than what we've been talking about consistently this year. And as we expected to see it going into this year. And with respect to the other businesses in that segment, we're actually very pleased with how they're performing.

Patrick J. O'Leary

Yes. You can tell from the backlog that we saw a significant improvement, overall, in the industrial backlog. And as the year goes on, in Q3 and Q4, we are seeing a really nice year-on-year leverage. In Q4, frankly, pretty much all of the businesses with some continued strength in hydraulic tools, which is very much a global business, and some very strong order dynamics in Communication Technology.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Okay. And then just -- can you give us a little more flavor I guess on the project timing, both -- I mean in Thermal and in Flow, in terms of the fourth quarter, how is that played out? I guess, relative to the way you guys might have thought it would play out yet a couple of months ago? And what drove the shift?

Christopher J. Kearney

Well, first of all, I think with respect to the backlog we have and the projects that support the second half of the year, particularly in Q4, we feel better about it than we probably ever have, just given the percentage of backlog that we have relative to projected revenues in that segment for the balance of the year. It's a strong as it's ever been. I think with respect to Q2, Shannon, there has been some movement of projects into the second half. Some of those are higher-margin projects and help support the view that we have margins improving sequentially, in Flow in the second half of the year. But as we look at it, in terms of what we're guiding, and what we're outlooking, we feel, I think, in terms of what we've got in the backlog that supports that is good as we ever felt.

Patrick J. O'Leary

And as I mentioned in the prepared remarks, Flow's orders were particularly strong. Those orders were developing very strongly towards the end of the quarter. The acquisitions that we made in systems are driving 2 things. One is that, we are getting the bid on projects that we would not have gotten to bid on before because we offer a broader range of technology specifically in the dairy market. We're now able to offer the dehydration products as well as the wet end of the plant. And so -- and then for other projects that we would have been able to bid on, we're now able to offer a broader content. And so, as I also said, the amount of revenue we have or visibility on Flow is substantially above the prior year. I mean, if you step back and look at it, in terms of our general expectations, there haven't really been any significant changes to our expectations on project planning.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Okay. It just seems like you have, I mean you say across all segments, large projects concentrated in Q4, I mean, sounds like some of that was winning some more systems business, new business, I don't know, are there any large things that you have in place?

Patrick J. O'Leary

Historically there is a seasonal tilt towards the execution of construction projects towards the end of the year. And in terms of what's going on in Thermal, obviously, we're executing on the South African projects, and I would say, those are the significant items for the large project.

Shannon O'Callaghan - Nomura Securities Co. Ltd., Research Division

Okay. Just last one for me, it's just on the margin issues there. The systems mix, given your success there, it sounds like it might -- even though it's a negative mix, might persist for a little while. When do you feel like you get back to a mix and a price cost standpoint where you're getting the margins you want in Flow in terms of incrementals?

Patrick J. O'Leary

Well I mean, 2 things going on in material pricing. One is inbound surcharging, and actually, I think, we did an okay job of outbound surcharging. So the issue on raw materials, other than that, it is -- we've taken the pricing actions. It will take a few months to come through fully, but we expect margins to be sequentially, much stronger in Flow in both Q3 and Q4. With respect to the broader systems mix issue, generally, this equipment is run flat out by the customers, and within a relatively short period of time, we start seeing a replacement demand and the components are significantly higher profit than the systems business, generally speaking. But there's also other activities going on within the Flow segment. We also have that integrating the recent acquisitions and reorganizing on a global basis. So I think you're going to see very nice margin development in the second half versus the first half, with much stronger incremental margins for the incremental volume between the first half and the second half, something more like 20% to 30% on an incremental basis.

Operator

[Operator Instructions] The next question will come from the line of Steve Tusa, JPMorgan.

C. Stephen Tusa - JP Morgan Chase & Co, Research Division

You said that you got 2/3 of your Thermal backlog booked. What was that last year at this point in time? The 2/3 of your second half revenue booked in backlog, what was that last year?

Patrick J. O'Leary

It was about the same.

C. Stephen Tusa - JP Morgan Chase & Co, Research Division

Okay. So when I kind of look at the timing of the backlog, and just maybe correct me on my math if I'm wrong here, but last year, you had about 51% of your second half revenues booked, this year you have about 58% of your revenues booked in backlog. That implies that your kind of book and ship business is down in the second half? Am I looking at that the right way? Is there anything unusual that's going on here that we have to worry about as far as declines into the second half?

Patrick J. O'Leary

No. I mean, as I mentioned on the guidance, the rate is moderating but volumes are increasing on an absolute base over year, on a year-over-year basis. So if you look at the early-cycle businesses, they've been moving up very strongly. So the closer to 20% and what we're expecting is more like 10% in the second half. But as you look at the absolute dollars coming in there, they are significantly higher in Q4 year-over-year.

C. Stephen Tusa - JP Morgan Chase & Co, Research Division

Right. And then -- and obviously, since your kind of visibility is stronger here, this really seems to be more like a timing issue between the third and fourth quarter. And then, the final question, on Thermal in the third quarter, what will that margin be? I mean, we can obviously do the math on the $0.24 of headwind, but what do you expect Thermal margin to be in the third quarter?

Patrick J. O'Leary

High single digits.

Operator

The next question will come from the line of Scott Gaffner, Barclays Capital.

Scott Gaffner - Barclays Capital, Research Division

I was wondering if maybe you can give us some commentary on some of your shortest-cycle businesses, what are you seeing there sort of in the order trends and the sales trends? Anything that you're seeing in those short-cycle businesses that would support some of the slowing macroeconomic commentary?

Christopher J. Kearney

No, actually not. I mean, if you look at our largest short-cycle businesses are Flow and Thermal, and you can see the rate of organic growth in both of those segments. And the backlog trend in those businesses, particularly in Flow, where it's very meaningful. We don't see that changing. And so we've seen nothing as we sit here today, that indicate that's changing. The order flow and the backlog build in Flow is really as good as we've seen it. And we've now had consecutive quarters of pretty attractive growth in Test and Measurement. And as we look at the profile of that business going out over this year and the medium-term, with the new platforms rolling out and the air-conditioning equipment that we mentioned in the call earlier, we think that the forward-look in that business is pretty encouraging. Now -- it's the same as really true, when we look at some of the other short-cycle businesses that make up the Industrial segment. And as I mentioned in response to Shannon's question earlier, across that entire segment with some of those businesses, hydraulic tools come to mind as another short-cycle business and a good lead indicator. We're not seeing anything materially different in that business that we've seen over recent quarters.

Patrick J. O'Leary

As you can infer from the comments that we made, that the order trends towards the end of the quarter were particularly strong. So right now, we don't see any signs in the early short-cycle businesses of a change in the overall market dynamic. And also, you can see that with the way the backlog developed, despite the 7% organic growth.

Scott Gaffner - Barclays Capital, Research Division

Right. That's helpful. And then, what gives you confidence that we don't see some of these projects that are due to be completed in the fourth quarter sort of shift into the first quarter of next year? I mean, it sounds like you are maybe being over conservative and that you've got a lot of projects supporting the revenue growth there, but maybe if you could just help us out with that a little bit.

Patrick J. O'Leary

Well, I mean, there's always risk with the larger projects that there will be all kinds of execution timing delays that are not within our control. But in terms of the projects that we're working on, in Thermal, obviously, the South African projects are amongst the largest that we're working on this year. And they have experienced some delays through the process. Some of that activity of course, is still manufactured activity, and therefore, you can have changes in the actual site that don't affect the way we're contractually executing to create the components to contribute to the plant. And in the business broadly, we are a late-cycle, and not only are we late cycle with respect to economic factors, we're late cycle within the projects, meaning that -- for example, on some of these power projects, a significant investment has already been made in the turbine and the boiler before we are installing a lot of the peripheral equipment. And so, the likelihood of some significant change in that is actually quite low at the point that we are executing the piece of the project that's our responsibility.

Operator

And the next question will come from the line of Sheila Kahyaoglu, Crédit Suisse.

Sheila Kahyaoglu - Crédit Suisse AG, Research Division

Two questions. On the selective efforts from the transformer orders, how's the overall industry competitive discipline? You saw a number of companies have filed formal complaints on large creative power transformers been dumped into the U.S. power market. Are you seeing any increased pricing intensity? And second question, on the non-large transformer orders in the backlog, what's the pricing like?

Christopher J. Kearney

Well I would say, with respect to the heart and soul of our business, which is medium-power transformer what we've described is that the pricing in the open market is stable. With respect to some of our customer relationships that are booked through this year and into next year, and when we look at our business in general in terms of how pricing is trending, it is as we've described modestly better. So, stable in the open market, we've seen some modest increase in some of the contracts that we've taken into next year. And with respect to the large power transformer market, we are aware of the dumping case that's been filed. We're neutral on that matter. We are instead focused on running our business and completing the expansion of our large power transformer facility in Waukesha. We expect that, that market will continue to be competitive as it has been. But we also expect that we're going to have a meaningful role to play in that market. We've now booked about half of our projected capacity for the new facility and large power transformers for 2012, with some pretty attractive projects and opportunities out there that we think we'll continue to be competitive with. So all in, I would tell you that this point in time in the year, with respect to how the recovery of that market is progressing, it's as I said before, not really different than we had anticipated coming into the year.

Sheila Kahyaoglu - Crédit Suisse AG, Research Division

Got it. And just one more question on Flow. The management has been to do a good job, the revenue numbers are pretty robust. I guess, when do you think the reorganization will be complete? And what could the teams be doing better with one point of criticism?

Christopher J. Kearney

Sure, sure. We've done a fair amount of reorganization in that business over the last several years, and particularly focused and intense reorganization through the recession, as we move actively to integrate the acquisitions that we've done. There will be a little bit more of that in the European businesses in the second of the year, as we indicated. And that business has done, historically, a terrific job in terms of affecting price increases and surcharges to offset raw material input costs. They're dealing with a pretty significant ramp up in the business right now on a regionally based global organization that is still fairly new. And so, I think there are some adjustments that they've seen in the first half of the year with a pretty new organization dealing with a significant runup in revenue. And I can tell you that Don and his team have been very focused on making process changes and organizational changes to get that back on track. And they've already made significant progress. I think they have affected price increases that we'll benefit from in the second half of the year. And our long-term -- our long-term look at that business and the expectation for where it should operate from a margin range perspective, has not changed at all. I would also tell you that the strategy, as it is has played out in Flow, with respect to the acquisitions that we've done in that business, has been absolutely terrific. I mean, we're thrilled with the acquisitions going back to APV and Gerstenberg and Hydro, they've been just -- they've come together very nicely and we've built a terrific global platform for food and beverage. So we're on the right track there, and we expect to see improvement the second half for sure.

Operator

And the next question will come from the line of Ajay Kejriwal, FBR & Co.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Just following up on Flow, so as you integrate those newer acquisitions and get more revenues from larger projects, so what would the expectation for the mix going forward, systems versus the components business?

Patrick J. O'Leary

Over time the mix will obviously vary - one of the dynamics we're dealing with there, which I think will continue to be factor is that, we are participating on some much larger systems orders in terms of quoting in the dairy market. And so, I would say, you could have a bias on the upside towards -- in various quarters towards some larger systems business. But during the recession, there was a hiatus of replacement and service activity that was necessary. So we are seeing really sharp increases in demand for the components business as well. In terms of an overall trend, what we've experienced over time is sort of an 80% components, 20% systems mix, it's likely to be more like 75% component, 25% systems over time, and may vary from that on a quarterly basis.

Ajay Kejriwal - FBR Capital Markets & Co., Research Division

Good. And then in the Transformers business, sounds like you're being more selective in your bid activity. I would imagine that as you pass on some of that business, it's filling up the backlog of your competitors. So any insight into what you are seeing with respected to that backlog? And at what point in time would -- as those backlogs get filled, would you expect pricing to improve?

Patrick J. O'Leary

Well, historically, a better pricing has coexisted with about a year's lead time, and we're getting close to that. We did step back from the public market bids, and we priced slightly above the market during the quarter. And so, we still feel that we probably have lead times somewhat above the market. We obviously don't see competitor backlogs, but we look at the open market activity that give us an indication. And so for this last quarter, demand continues to be very strong for release over the fourth quarter in a row. And I think what you're going to see here, in terms of what has happened so far, it is very similar to the historical development charts that we have -- that we published before. And I don't see any reason for that to be different this time. The trend looks very similar, and we've got modest increases in prices on the directly negotiated business in Q2. And I expect that, that will continue over 2012 and '13.

Operator

[Operator Instructions] The next question will come from the line of Deane Dray, Citi Investment Research.

Deane M. Dray - Citigroup Inc, Research Division

One of the topics we had last quarter was the impactive events in Japan. I was hoping you give us an update both -- have you seen the expected push outs in some of the nuclear projects? And then, maybe an assessment of the auto impact, I know production is not a swing factor for you, but would there -- any catch-up in new platform rollouts?

Christopher J. Kearney

Sure. Yes, with respect to the events in Japan, Deane, I would describe it that as mixed. We don't have, as a company, a lot of business directly in Japan, anyway. But certainly, we have seen an impact in Europe, specifically in Germany, where some projects that we would have been supporting have been delayed or pushed aside. So it's had an impact there. I think it's probably selective, region-to-region, in the projects that we're associated with, in China for instance, those are moving forward. So it has had some impact, not material certainly for the company, nor would I describe it as particularly significant. But I would also describe it as uncertain going forward, particularly as it relates to Europe and seeing where countries like Germany go. And I'm sorry, what was the second question?

Deane M. Dray - Citigroup Inc, Research Division

It was just, was there an impact on auto from Test and Measurement?

Christopher J. Kearney

No, not material. There may have been some minor component impacts, but it's nothing significant.

Deane M. Dray - Citigroup Inc, Research Division

And then, on the guidance, this is now the second quarter where you've called out potential divestitures as a swing factor. Are you any closer to any announcements on any divestitures?

Patrick J. O'Leary

I mean, we've had divestitures in there longer than that, Deane. I mean basically, acquisitions and divestitures are clearly 2 swing factors in the forward earnings per share. We've don't, for all the obvious reasons, preannounced divestitures, 85% of what we're doing is in the core. And so, while divestitures may occur in the future, they're likely to be a lot less significant to the overall dynamic around earnings per share.

Deane M. Dray - Citigroup Inc, Research Division

So don't interpret the fact you list that one first as making it more significant?

Christopher J. Kearney

Exactly.

Operator

The next question will come from the line of Terry Darling, Goldman Sachs.

Terry Darling - Goldman Sachs Group Inc., Research Division

Patrick, I wonder if you could true us up on some of the below-the-line items relative to -- on your guidance, relative to previous, if any, change equity earnings, tax rate, corporate on the full year basis?

Patrick J. O'Leary

Sure. I mean, with respect to the midpoint model from the last time with the guidance, obviously both modeled there at 440. There are some subtle changes below the line. The biggest is probably about $0.07 from the tax rate edging down from about 31.5% to 30.4%. And interest expense is slightly better, maybe $0.03 offset by about $0.04 down in equity earnings and joint ventures, which is primarily our joint venture with Emerson Electric. And with respect to corporate expense pension, stock-based comp and special charges, they really wash to nothing.

Terry Darling - Goldman Sachs Group Inc., Research Division

And that number on a full year basis, the corporate line, is that you're still thinking in the $220 million range? Is it all in? Is that -- that's still the right place to be?

Patrick J. O'Leary

Let me just go back, I'm looking at my 6-month model. I've got like $105 million.

Terry Darling - Goldman Sachs Group Inc., Research Division

Okay, that's the general corporate piece. And then, I guess, wondering, you mentioned some restructuring in Flow in the third quarter. Is that in the continuing guidance or is that thought of as a special off?

Patrick J. O'Leary

Absolutely, it's in the continuing guidance.

Christopher J. Kearney

In continuing guidance.

Terry Darling - Goldman Sachs Group Inc., Research Division

Okay. And then can we get an update on the potential for India orders within the Thermal business or just India broadly on the power side?

Christopher J. Kearney

Yes, in the past quarter, we took our first 2 big orders that came out of the Heat Transfer business that totaled around $27 million, about $27 million. And a lot of the other quoting activity going on there, we still think it's obviously going to be important to us, Terry, and so, those first couple of orders were a nice total for us, but focused on developing those in the second half as well.

Patrick J. O'Leary

We are seeing Asian EPC particularly interested in the India market, obviously we have good experience selling direct into China. And so, there are opportunities there for us to leverage that experience and those relationships in the Indian market going forward.

Terry Darling - Goldman Sachs Group Inc., Research Division

And I guess, here just making sure that I'm square on kind of the high-level tone on the power recovery, it sounds like you're a bit more encouraged by what you see in the Power Transformers side, and maybe the Thermal side, just on the Power piece there is not developing, maybe as quickly as you had hoped. Is that a net-net you're about where you thought you were? Is that the right way to characterize it at the high-level?

Christopher J. Kearney

I think so. I think that's fair. We're certainly pleased with it and pleased with what we see developing in the Transformer business, and it's really consistent with our expectations that we had coming into the year. So that's playing out pretty nicely. We're booking into the Q3 next year, 4 consecutive quarters of double-digit backlog growth there. We saw our first organic growth in the quarter, in the transformer business, in 2 years. With respect to Thermal, Terry, it's just the timing of that is difficult. It's a competitive field around the world, as we know. And I think the dynamic that you see there is probably pretty predictable for an industry struggling to come out of the recession, where you see a more intense competitive environment. What we tried to do, and what we'll continue to focus on in the second half of the year is be selective about those opportunities and find those opportunities that present a decent payback for us, in terms of the innovation and engineering investment and the impact that those projects can have. So we have probably been a little more selective about it, but I would also tell you that in the pipeline around the world, there's some attractive opportunities and we're going to compete for those.

Patrick J. O'Leary

And a lot of these projects are large projects, and so the outcome is obviously binary. We are frequently taking projects above $30 million to $50 million. And having said that, we do expect to see a higher order intake in dry cooling than we've experienced in the last couple of quarters.

Ryan Taylor

Unfortunately, we've ran out of time. We still got a few analysts in the queue, and I apologize that we didn't have a chance to get to your questions. We certainly appreciate everybody joining us this morning on the call. I'll be in the office most of the day today. Please feel free to follow-up with me directly, so I can answer any questions that we didn't get to in the allotted time. Talk to you soon. Thanks.

Operator

Ladies and gentlemen, that concludes today's presentation. Thank you for your participation. You may now disconnect, and have a great day.

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