SPX Corp. Q1 2008 Earnings Call Transcript

Apr.30.08 | About: SPX Corporation (SPXC)

SPX Corporation (SPW) Q1 FY08 Earnings Call April 30, 2008 8:00 AM ET

Executives

Jeremy Smeltser - VP of Finance

Christopher J. Kearney - Chairman, President and CEO

Patrick J. O'Leary - EVP and CFO

Analysts

Jeff Sprague - Citigroup

John Inch - Merrill Lynch

John Baliotti - FTN Midwest Securities Corp.

Deane Dray - Goldman Sachs Research

Shannon O'Callaghan - Lehman Brothers Equity Research

Nigel Coe - Deutsche Bank

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Operator

Good day everyone, and welcome to SPX Corporation First Quarter 2008 Results Conference Call. This call is being recorded. At this time I'd like to turn the conference call over to the Vice President of Finance, Mr. Jeremy Smeltser. Please go ahead, sir.

Jeremy Smeltser - Vice President of Finance

Thanks, Felicia. Good morning everyone, and thank you for joining us today. With me on the call this morning are Chris Kearney, 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 can be accessed on our website at www.spx.com in the Investor Relations section. This webcast will be available until May 14. You may wish to follow along with the webcast as we reference the detailed information on the slides. Please note that this slide presentation also includes supplemental schedules, which provide reconciliations for all non-GAAP financial measures referenced today. Our earnings press release was also issued earlier this morning and can be found on our website.

Before we continue, I would like to point out that portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. I would also refer you to the risk factors in our most recent SEC filings.

With that, I will turn the call over to Chris.

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

Thanks, Jeremy, and good morning everyone. Thanks for joining us as we report our Q1 earnings. As many of you know, over the past three years we've strategically positioned our business around three global end markets: Infrastructure, Process Equipment, and Diagnostic Tools. We've invested capital in these areas and disposed of businesses that do not fit with our long-term growth strategy. Over 50% of our revenue is from international sales, and about a third of our revenue comes from supporting power and energy demand. Internally, we continue to shape a culture of continuous improvement, focusing on our core operating initiatives. This strategy continues to yield strong financial results.

In Q1, we more than doubled earnings per share. EPS was $1.14, up 115% over last year. Our top line grew 37% in the quarter, including 7% organic growth. Segment income margin increased 140 points to 11.6%. Based on the strength of our first quarter and strong order trends in our key businesses, we're raising our EPS guidance range $0.20, to $6.20 to $6.40 per share.

Looking at the Q1 consolidated results in more detail, revenue was $1.4 billion, up 378 million over last year. The growth was driven largely by strategic acquisitions, primarily APV. Organic growth was 7%, highlighted by 25% organic growth from our industrial segment. With more than 50% of our revenue generated outside the United States, changes in foreign exchange rates are having a greater impact on our financial results.

In Q1 foreign exchange fluctuations benefited revenue by over $40 million, or 5%. Segment income was $161 million, up 56% over Q1 2007. The increase was driven by our strength in the power and energy markets, and focus on lean and supply chain initiatives. Despite significant market headwind from consolidating APV and rising raw material costs, segment income margins expanded 140 points to 11.6%.

Our improved operating performance in the quarter was far and away the biggest driver of earnings growth. Increased segment income contributed $0.63 of earnings. Additional debt used upon acquisitions and share repurchases in 2007 resulted in $0.17 of additional interest expense in the quarter. This was largely offset by the reduced share count from 2007 share repurchases, which contributed $0.13 to EPS. Net of associated interest expense, ATV was about $0.11 dilutive in the quarter, including $0.09 of charges related to purchase accounting.

Benefits from planned integration actions have not yet had a material impact. We expect to see positive results from the integration materialize over the balance of the year. For the full year, we continue to expect the acquisition to be neutral to slightly accretive to earnings.

Our financial position remains strong. The balance sheet at March 31st is generally in line with where we ended 2007. At the end of Q1, we had a little more than $385 million of cash on hand. Net debt remained at $1.2 billion, and our net leverage ratio was 1.7 times. Our growth leverage ratio was 2.2 times, modestly above our target range of 1.5 to 2.

Our capital allocation expectations for the year remain the same. We expect to focus on debt reduction until we're back within the target range. We anticipate that this will occur before the end of the year.

There have been no significant changes in our key end-markets. Demand for infrastructure remains robust globally. The North American tools and diagnostics market remains soft, as we anticipated. Outside of this market, growth in North America is strong in most of our key businesses. Positive order trends across all our power and energy product lines drove a significant increase in our backlog during Q1.

Our total backlog as of March 31st increased $400 million or 15% since the end of 2007. The backlog in our thermal segment increased 12% to $1.4 billion. Global power and energy demand for cooling systems and thermal equipment continue to be robust.

power and energy demand also drove a 90% increase in our industrial segment backlog. Demand for replacement transformers in the aged domestic electrical grid remains strong.

Additionally, we were awarded two large contracts to supply crystal-growing equipment into the solar power market. Flows backlog grew 9%, driven by demand for pumps and valves supporting oil and gas, mining, and power generation markets.

The growth in our backlog underscores the demand for our products and services in global infrastructure and process industries. Part of our long-term strategy is to increase our focus on these attractive markets. In doing so we've disposed of businesses that were not core to our growth strategy.

The pending sale of air filtration is expected to be completed in Q2. During the first quarter we committed to divest the vibration testing business, previously reported in our test and measurement segment. This business has annual revenue of approximately $75 million and is a market leader in vibration test systems. While it's an attractive niche business, end-market applications for these products are more discrete than the products in our core tools and diagnostics platform. After strategic review, we concluded that it was not part of our long-term growth strategy. The financial results for this business are now classified as discontinued operations for all periods presented. We expect to complete the sale of this business by the end of the year.

Our EPS guidance is based on earnings from continuing operations. As such, we've excluded a net $0.10 of expected earnings from the vibration testing business in our updated 2008 guidance. We also increased our expected restructuring expense by $0.06, to accommodate identified actions relating to shared service initiatives and Flow integration plans. These declines are more than offset by increased expectations on operating performance. Based on our strong first quarter results, the weakened U.S. dollar, and current order trends, we're expecting $0.36 of additional earnings from segment income.

On a net basis we are increasing our 2008 earnings guidance by $0.20. Our updated EPS range, again, is now $6.20 to $6.40 per share, an increase of about 30% over last year's adjusted earnings. Our free cash flow guidance remains between $260 million and $300 million.

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

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

Thanks Chris. Good morning everyone. I'm going to begin with our segment results for the quarter. Starting with Flow Technology, now our largest segment. For the quarter Flow reported revenue of $504 million, that's up 101% year-over-year. APV delivered $227 million of revenue in the quarter, in line with our run-rate expectations for the year. The base business reported 5% organic growth, driven by global demand for process equipment in power, oil and gas, and sanitary markets. Foreign currency benefited revenues by 5%.

Segment income was $46 million in the quarter, up $8 million or 22% in Q1 2007, leveraging the revenue growth. APV's Q1 operating profit was $8 million. This was offset by a $7.5 million charge required by purchase accounting to step up APV's inventory at the point of acquisition. Reported Q1 operating margins were 9%, down from 15% a year ago.

Dilution from APV was 730 points during the quarter, and margins in the base business increased 140 points year-over-year to 16.4%. We are extremely pleased with the Q1 results. Don Canterna and his team are making solid progress integrating APV while simultaneously continuing to improve the base business.

As a result of the solid Q1 from the base business, we are raising our full-year revenue and margin targets for the Flow segment. With a backlog growth of 9% and order trends in our short-cycle business steady, we're increasing the full year organic growth target to between 5% and 7%.

Flow margins excluding APV are now expected to improve 50 to 100 points over last year. Including APV, we are targeting total 2008 revenue growth of about 90%, with margins between 11.5% and 12%.

Implementation of our restructuring plans for APV are under way and the integration is on track. As Chris mentioned, we expect to see financial benefits from the integration actions over the balance of the year.

Moving on to the thermal segment, revenue for the quarter was $347 million, up 11% over Q1 last year. Foreign currency fluctuations, particularly the strength in the euro versus the U.S. dollar, increased revenue 6% year-over-year. Organic growth was 5% in Q1, up sequentially from Q4, however not as strong as we had expected. Strength in the Middle East, including the Linde petrochemical contract, was the primary organic growth driver.

Schedule changes on a number of power projects have pushed revenue out to the latter part of 2008. It's important to know that, unlike our other three segments, most of the revenue in thermal is related to large construction projects. Our average projects range between $30 million and $50 million in revenue, but they can be as large as a few hundred million dollars. We are booking revenue on these large projects under percentage-of-completion accounting. Project timing and schedule changes can have a significant impact on quarterly revenue, both positively and negatively, and the timing of workforce, unevenly quarter-to-quarter. This dynamic has caused large fluctuations in organic revenue growth over the past four quarters.

We are very encouraged by the backlog growth of $150 million or 12% during Q1. Quote and bid activity is still strong, and we anticipate enormous opportunities for new orders will continue.

During the quarter we visited our key customers in South Africa to confirm our support for the growth of energy infrastructure in that region. We met with our South African employees in Nigel, and dedicated an expansion of their 220,000 square foot campus. The additional capacity is expected to be completed by November this year. We also recently approved capital to expand our manufacturing capabilities for thermal equipment, primarily stationary heat exchangers in Germany. These capacity additions reflect our expectation for future growth in this segment, particularly in South Africa and in Europe.

As we previously stated, with strong top line demand expected over the near and long term, our primary focus in this segment has been on profitability improvement. We continued the significant progress towards this goal in Q1. Segment income was $36 million in the quarter, up 126% over last year.

Reported Q1 margins more than doubled, increasing 540 points over last year to 10.5%. This is a clear indicator of better discipline in structuring contracts and improved execution against those contracts. Additionally, margins are benefiting from our focus on lean and supply-chain. We are extremely pleased with the increase in profitability in the thermal segment. For the year, we have increased our margin target range for thermal by 30 points, to be between 10.3% and 10.8%.

Revenue growth for the year is now targeted between 9 and 11%. This is up slightly from our previous target, primarily due to foreign currency expectations for the year.

On to test and measurement; as a reminder, these results have been adjusted to exclude the vibration testing business, now classified as a discontinued operation. The first quarter results for test and measurement were better than we had expected. Revenue was $275 million in the quarter. That's up 14% from last year. Last year's European acquisitions contributed 13% growth. Foreign currency fluctuations increased revenue about 5%. This growth was partially offset by 3% organic decline, due primarily to reduced volumes in the North American aftermarket.

The restructuring actions we completed last year in the U.S. helped to limit the impact of the soft North American market. However, these volume declines did reduce margins about 100 points. Q1 segment margins came in at 8.9% versus 9.9% last year. It should be noted that we also incurred costs related to investments we are making in Asia-Pacific to expand our presence in that region. We believe margins for test and measurement will continue to stabilize over the balance of the year.

We remain committed to globalizing this segment and investing in new product development. For the full year we're raising our target revenue growth to be between 9% and 11%, and our margin target remains 10.8% to 11.3%, modestly up from 2007.

Moving on to industrial products, our revenue grew 26% in the quarter. The growth was nearly all organic with a small benefit from currency. Demand for our power transformers was the most significant driver. However, we experienced strong growth across the segment, most notably in our broadcast, solar equipment, and aerospace components businesses.

Segment income more than doubled, increasing 108% to $54 million. Margins increased 800 points to just over 20%. Pricing strength, operating leverage, and focus on our lean and supply-chain initiatives continue to drive tremendous improvement in this segment. For the year, we are increasing the revenue growth target for the industrial segment to be between 14 and 16%.

In addition, we are raising our margin target range 20 points, to between 20.2 and 20.7%. Replacement demand in the U.S. for distribution transformers continues to be robust. To meet this demand, we have been investing in new machinery and lean initiatives to improve throughput and cycle times. From 2004 to 2007, we increased the combined capacity of our two transformer plants by 28%. This year we are on track to add about another 10%.

Each year we showcase at least one of our operations to allow analysts and investors the opportunity to see our facilities first-hand. On May 29, we are planning to highlight our transformer facility in Waukesha, Wisconsin. Details of the agenda and logistics for this event will be available later this week.

Moving on to cash flow, we have a net investment of $48 million into the operations during the period. This is relatively consistent with prior years' first quarter performance and the seasonal nature of our businesses. Working capital increased $153 million, driven by the APV integration and organic growth.

Accounts receivable grew $91 million during the quarter, and we invested $43 million building inventory. Additionally we spent $21 million on CapEx in the period, nearly double Q1 last year. Historically our free cash flow performance has improved throughout the year with the majority of our annual cash flow generated during the second half. We expect 2008 to follow the same historical pattern, and we are on track to meet our full-year free cash flow target of between $260 million and $300 million.

Our capital allocation methodology remains unchanged: our target range for gross debt to EBITDA is 1.5 to 2 times. As Chris mentioned, this ratio was 2.2 times as of March 31, modestly above the target range. When levered above two times, we focus available capital on debt reduction; when levered within our target range we expect to invest in strategic acquisitions and/or return capital to shareholders.

With the level of free cash flow targeted for the balance of the year, combined with proceeds from asset sales and EBITDA expansions, we are expecting to be back within our target leverage range before the end of the year.

As Chris mentioned, we are increasing our 2008 guidance and financial targets today. I am going to quickly go over the updated targets. The full-year earnings model to the midpoint of our EPS guidance range is provided in the appendix of the presentation. We have raised our 2008 midpoint EPS guidance $0.20, to $6.30 per share. This equates to 30% earnings growth over 2007 adjusted EPS. In our updated model we are now targeting about 30% revenue growth for the year, with segment margins at approximately 13%. Excluding the diluted impact of APV, we're expecting 80 to 130 points of segment margin improvement.

We are using a tax rate of 35% and weighted average share count of 55 million. Free cash flow, as I said, is targeted between 260 and $300 million. This includes $30 million to $50 million of cash restructuring for APV, and capital spending of about $145 million, supporting lean, capacity expansion, and IT investments.

For the second quarter, we expect consolidated revenue to grow between 28% and 30%. Excluding APV, target revenue growth is 9% to 11%. Segment income is targeted at $189 million to $195 million, compared to $149 million a year ago, that's up about 30%. We expect segment margins in the range of 12.2% to 12.6%, about flat for last year. This includes the dilution from APV.

We are expecting about 150 points of margin expansion from the base business. Our Q2 EPS range is $1.50 to $1.57 per share, that's up more than 20% from last year. Several items could potentially impact our 2008 guidance. These events include asset or business disposals, the speed and cost of integrating APV, foreign currency fluctuations, increases in raw material costs, changes in the order trends of our short-cycle businesses, and any change in our effective tax rate.

With that, I will turn the call back over to Chris for a brief wrap-up.

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

Thanks Patrick. We are indeed off to a very good start in 2008. Q1 was highlighted by a 37% revenue growth, 140 points of margin expansion, and 115% earnings growth. Our backlog grew $400 million or 15% from the end of 2007, and the APV integration is on track... both solid signs of future growth.

We have reshaped SPX around three attractive growth markets and are executing successfully against strong demand for our products and services. Lean and supply-chain initiatives are yielding margin expansion, and I believe we have a long runway in front of us to continue driving improvement in these areas. The increase in our segment income is indicative of the steady, continuous improvement culture at SPX. In 2008 we are expecting segment income of around $800 million, up more than 50% from 2006. Our employees are engaged and are working hard each day to improve SPX. We're very pleased with our start to this year and remain focused on the challenges ahead of us. And with that, we will be happy to take your questions.

Question And Answer

Operator

Thank you. [Operator Instructions] We'll go to Jeff Sprague of Citi Investment.

Jeff Sprague - Citigroup

Thank you. Good morning everyone.

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

Good morning, Jeff.

Jeff Sprague - Citigroup

First, Patrick, could you elaborate a little bit on what you're seeing on the project timing in power and thermal in particular? Is there a region, a market or something to call out? Is it resource limitations? Is it just customer schedules, just a little more color there?

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

Yes, Jeff. It's more customer scheduled, and it's really related to large power, petrochemical projects that affect, obviously, mostly the thermal segment. And as you know, the nature of that business is that it is large construction projects. And so, quarter-by-quarter organic growth comparisons can be difficult. What's important to remember, and important to note here today, is the backlog in that segment is growing significantly, up 15% or $150 million year-over-year. And also we're really pleased with the steady and consistent margin improvement we've seen in that segment.

Jeff Sprague - Citigroup

Not any apparent issue of the EMCs just having problems executing and getting things done, or is that the root of it or...?

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

No, not really. It's just... it's not really unusual from things that we've seen in the past. Sometimes it tends to be more concentrated in a particular quarter. But there is no pattern outside of that that's different that we what we've seen, Jeff.

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

We've not changed our revenue expectations for the year. As you saw it's simply a question of timing. And the quoting activity is very strong, and actually the diversity of project is quite interesting, from coal to geothermal to solar operations. So, a very broad spectrum and obviously as you gather, from the comments on the call, a significant potential activity in South Africa.

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

And what I would describe, Jeff, is a developing, nice steady rhythm in terms of the order process in that business. And again, to Patrick's point, that's not isolated to just developing parts of the world. We are seeing robust quoting activity in other developed markets. As we hoped and expected that we would, but we're pretty happy with what we see developing there.

Jeff Sprague - Citigroup

And could you give us a... maybe on APV, did the business actually grow in the quarter? Are you are trying to grow it, or is there a little bit of a shrinkage going on with some of the more engineered systems?

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

We're not as focused on revenue growth as we are on profit improvement, for obvious reasons. Q1 was significantly impacted by the purchase accounting. The component orders are positive. We are in the process of putting our own quoting discipline in place for the larger orders. Frankly, I don't have good comparisons to how foreign currency impacted the reported results within their ownership of Invensys. And at close to $230 million, what we expected for the run rate.

Jeff Sprague - Citigroup

Yes, no surprises. And then, just one more and I will pass it on. Patrick, the tax rate was lower than you thought but you still think it's 35? What's...

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

A fair question. The core rate is still 35. Every quarter it's going to be impacted by one or two small, discrete items. We're still modeling actually each of the quarters for the rest of the year, with 35%, and I will update you as we go through the year.

Jeff Sprague - Citigroup

Okay. Thank you.

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

Thanks, Jeff.

Operator

We'll go next to John Inch of Merrill Lynch.

John Inch - Merrill Lynch

Thank you. Good morning.

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

Good morning John.

John Inch - Merrill Lynch

Good morning. This vibration business, this disc-op, how much would that have contributed to EPS in the quarter, which I assume was part of your original guidance?

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

It was fairly insignificant. Less than $0.02, I think, John.

John Inch - Merrill Lynch

So, it's less than 2. So, basically it has more of a back half waiting. Is that the idea?

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

Yes, it's more profitable in the latter part of the year.

John Inch - Merrill Lynch

I see how you've raised some of the segment top-line results. But, and obviously currency, I am assuming, is having a little bit of an impact on that. Have you guys... I am assuming Waukesha gets raised as part of industrial. Can you talk about segments where on a core or organic basis, you actually think results are going to be stronger in 2008 versus what you had originally anticipated?

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

I think, you can tell from the comments on the call that we can see slightly better than expected improvement in the core business, Flow. Obviously, we are getting no net benefit from APV in the first quarter, as I mentioned. So we have raised the margins in Flow from 11.3 or 11.8, up to 11.5 to 12. You will gather it from my comments that we're fairly happy with the start to Test. We've actually left the margins the same. We have a significant new product rollout towards the end of this quarter, so we'll see how that actually develops for the rest of the year but leaving it flat for now. And then, obviously the largest business in industrial, transformers, helping drive our outlook margin there up from the top end that we gave before, about 20.5 to 20.7. But to be fair, we are having a very strong start with the other businesses as well.

In fact I'd really say, across the industrial segment we are expecting nice improvement. And then, thermal had a very strong profit start to the year, improving our confidence in margin delivery. Our long-term target there is, has a threshold of 11%, and we've raised the top end of our margin expectations from 10.5 to 10.8. So, in many respects I would say we are getting slightly better margin performance across the company than we initially expected, and you can see that in the $0.36 improvement in EPS from ops.

John Inch - Merrill Lynch

I mean, I guess because of the U.S. consumer recession. I mean, did any of your businesses, Patrick or Chris, I mean, is the outlook lower on an organic basis versus where we started the year? Of significance?

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

No, it's... across the board... sorry, I think missed the point to your question John. Across-the-board organic growth is slightly better than we initially expected.

John Inch - Merrill Lynch

Okay. Then just lastly, the Flow margin is ex-APV, north of 16%. Can you remind us, is there any reason that over time APV could not be at the Flow segment average, if not even a little bit better over time?

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

I think, over the long term it's certainly theoretically possible that APV would achieve the average margins of the segment. We are not at this point changing our guidance for APV, which is neutral to slightly accretive for this year and at least $0.25 accretive for the 2009 model.

John Inch - Merrill Lynch

But there is nothing as you've gotten into the business that suggests that this can't be as profitable?

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

No.

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

No.

John Inch - Merrill Lynch

Thanks very much.

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

Thanks John.

Operator

We'll go next to John Baliotti of FTN Midwest.

John Baliotti - FTN Midwest Securities Corp.

Hi, good morning guys.

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

Hey, good morning John.

John Baliotti - FTN Midwest Securities Corp.

Hey Chris or Patrick, it's interesting if you look at the two segments that had your strongest margin improvement, thermal and industrial. Those are two segments that you talked about continuing to add capacity. And I would have imagined that that naturally is an offset to... because of the cost and the timing of it. How do you... how are you looking at that through, I guess the balance year and sort of longer term? Is it... can you still have a good mix of just efficiency improvements versus organic, or sort of new capacity? How do you look at that scheduled out?

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

Yes, sure John. I think it was a thing which is a little bit... I think if you look at capacity expansion at Waukesha, for instance, that has come primarily through focus on efficiency improvement led by lean initiatives. But also some added new equipment into the facilities in Waukesha and Gold Pearl [ph]. But that is primarily improving throughput for a... with a very intense focus on lean. If you look at the anticipated demand coming from the power industry as it relates to our thermal segment, a lot of that is coming from developing markets. South Africa is a perfect example, and in that case the investment there is in building facilities or adding to existing facilities in South Africa. And adding to facilities that are adding equipment in, to some of our facilities in Germany as well. But the... as we've talked about now for the last several quarters, the next wave of significant demand for that segment is expected to come from South Africa, and we don't see any change in that expectation. But we are adding physical capacity there.

John Baliotti - FTN Midwest Securities Corp.

So is it part of the nature of the fact that this is physically... the equipment, it just makes more sense to be local on the...?

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

There is a requirement that a percentage of it be local.

John Baliotti - FTN Midwest Securities Corp.

Okay, and so obviously that, without, I'm sure you don't want to talk about underlying it, but I'm sure that that had some offset to the core margin?

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

Not yet. In the future of course it may. But we've just begun the expansion process. In fact, part of what Patrick and I did, along with Drew and Bob Foreman... we were down there several weeks ago... was dedicate some of the new capacity that was going up. And it's just beginning.

John Baliotti - FTN Midwest Securities Corp.

Okay. Because I know in the beginning of first half '06 and the first half of '07 you had impact from capacity that you've obviously... that's behind you. You've obviously shown nice improvement beyond that point.

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

That's right. And it's important to remember John that, like these contracts in South Africa, I mean these are multi-year projects, and... like the contract that we were awarded in December for $235 million. That project will go up over a period of several years. And so we're talking about long range, big project, multi-year construction.

John Baliotti - FTN Midwest Securities Corp.

Okay, great. Thanks Chris.

Operator

We'll go next to Deane Dray of Goldman Sachs.

Deane Dray - Goldman Sachs Research

Thank you, good morning; just a follow-up on that point on industrial. Can you take us through some of the dynamics at Waukesha in particular, but the mix and what price and volume played in the quarter?

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

Obviously price has had a positive impact on the margin development. If you look at the margins for the quarter, really it's more of a pricing impact that occurred in the market last year. And it's rolling on. It's a combination of volume. We are putting more units through both factories, and core product demand is actually up, and that's still reflected in the current order trend. The mix of products is interestingly still primarily distribution transformers. We have not yet seen an elevation in demand for transmission transformers at the point of generation, although we do expect that to take place over time. The overall market remains, I would describe as, stably strong.

Deane Dray - Goldman Sachs Research

How about the idea as you add capacity, just remind us how far your backlog takes you out into 2009 at Waukesha for the transformers. But as you add capacity, your customers can take deliveries earlier. Will that be a dynamic there?

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

The key... if you come to the open house at the plant, you'll see that one of the keys is throughput and one of the competitive advantage is that we're looking for is shortening the time to respond to customer order. Obviously each one of these is individually engineered. So it's not just a question of being able to produce them fast. It's actually being able to respond to an individual customer. We're actually taking orders about 12 months out, although for our key customers, we typically have agreements where we exchange information about their likely demand, and we give them slots in the forward manufacturing schedule. And so we are really... right now, as is typical for the peak of this business, in terms of peak of the cycle, we are about 12 months' visibility. At the bottom of the cycle, it shrinks down to about three months' visibility. But right now, very high level of confidence in our expectations for 2008, and obviously starting to fill out the 2009 manufacturing schedule.

Deane Dray - Goldman Sachs Research

Great. And just a last question if could. I know there was a lot of focus here on the transformer side, but you did touch on some of the other products within industrial. Could you just give us some further color on what was going on in the contribution in broadcast, in aero, and solar?

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

Sure, I'll be happy to. In broadcast we are seeing a surge in that business as we complete the conversion from analog to digital. In our TPS business, a new market area for us that we've talked about before, is providing crystal growing equipment into the solar equipment industry, so that has surged as well. And our aerospace business, Deane, has a good strong order flow there as well. So those are the three standout businesses, in addition to Waukesha, that are helping drive growth in that segment.

Deane Dray - Goldman Sachs Research

And just so I have it sized right, Waukesha versus all others, what's the percent of earnings within that segment?

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

Waukesha for the year is about...

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

About half.

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

About half of it.

Deane Dray - Goldman Sachs Research

Great, thank you.

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

Thanks, Deane.

Operator

We'll go next to Shannon O'Callaghan of Lehman Brothers.

Shannon O'Callaghan - Lehman Brothers Equity Research

Good morning guys.

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

Hey, good morning, Shannon.

Shannon O'Callaghan - Lehman Brothers Equity Research

So the thermal margin was really strong in the quarter. I mean can you go into a little bit there, the mix of the pieces? I mean in terms of what got so much better, was it dry versus wet services, heating [ph]? Can you fill that out a little bit?

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

Sure.

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

Yes, it's actually across the board. The lean initiative has had a positive impact on the wet business, it continues to do well. Dry, I would say the backdrop overall is contract terms and conditions are better than they have been historically, meaning that we generally have more ability to flex pricing in response to material changes over the period of the contract. So, better team execution in quoting activity, including contractual terms and conditions, and then better execution of the projects. Mix changes quite a bit quarter-to-quarter, as I try to allude to. In thermal, from... it might be a petrochemical project. It might be a power project that is the driver. It's truly a global business, and executing these projects in many different parts of the world, in many different terrains, so a number of positive factors driving the margin improvement.

Although when you look at the margins, the execution in Q1 is not significantly different than the execution that we saw in the latter part of last year. And the margins are now finally trending towards the 11 to 13% target range. So we're getting much better execution across the board, and we're very happy with the margin development. Frankly, we expect to just come close to touching the bottom end of our long-term range this year.

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

I think the short-term takeaway, Shannon, is better contract structure, better execution against that, and a good job managing the supply chain and raw material cost.

Shannon O'Callaghan - Lehman Brothers Equity Research

Okay, so I mean is there anything that you expect to swing the other way? Or does getting to this 11 to 13, obviously you are almost at the low end. But maybe your confidence is a little better of getting to the middle or high end in a reasonable timeframe, unless there is some issue that you thought benefited you more than normal in the quarter?

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

If you look at the contract developers, the margin development in that business over the last several quarters, we certainly have to feel confident about the way we're heading, and our confidence in trending towards our long -term margins in that business. I think like any of our other businesses, I think we are always mindful of pressure from raw material cost increases, particularly steel. And the contract structure, and again, focus on management of the supply chain have helped us manage against that. That's not going away. I mean that's going to be something that we are going to have deal with. But I think the process and the discipline that Drew and his team have put in place across the various product lines in their business give us great confidence that they will continue to make good progress on the margin side.

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

Yes, and we are expecting less margin percentage volatility quarter-to-quarter; however, with the caveat but this is unlike the other segments. This is a project oriented business, and revenue and profit development is not going to be linear going forward.

Shannon O'Callaghan - Lehman Brothers Equity Research

Okay. And then just, you mentioned raw materials as part of this discussion and once before. I mean, can you talk about the things... I mean you guys have done a lot of work in terms of the supply chain, and also I think just how you think about prices in the organization relative to what it was a few years ago. How do you think about the ability to keep up with the raws in terms of price increases? Do you expect any gaps or any problems, keeping the ball going in the right direction here?

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

What I expect is that we continue to get better at it. We've got a supply chain council and it's headed by Jim Peters' team here at corporate. They meet on a weekly, and then in person on a quarterly basis with all the key supply chain folks within the businesses. And so, what we've tried to do is, we've restructured our organization over the last three years, Shannon, as you know is to create a central focus so that we can be leveraging across the company with all of our key material spend. And I think we've made progress certainly, and I think it's demonstrated in the results that we're seeing, and particularly in the improvement in margins that we are seeing in businesses like our thermal segment. I think that process will continue to develop and we will continue to get better at that, but it is something that we are very, very mindful of, and that we are very focused on, on a daily basis.

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

In the first quarter generally speaking, we kept with material inflation. As you're aware, material inflation in currently perhaps one of the biggest issues in the industrial world. But in terms of our process, both our sourcing initiatives and pass-through pricing to the market, we are clearly holding our own.

Shannon O'Callaghan - Lehman Brothers Equity Research

Okay, great. Thanks a lot, guys.

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

Thanks, Shannon.

Operator

[Operator Instructions] We'll go next to Nigel Coe of Deutsche Bank.

Nigel Coe - Deutsche Bank

Thanks. Good morning.

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

Hey, good morning, Nigel.

Nigel Coe - Deutsche Bank

Chris, you talked about your crystal business and I know this is quite a small area for you, but it seems like a nice niche business with good growth opportunities, and you called out two big orders during the quarter. Could you just talk about what the growth opportunities are in that business, please?

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

Yes, the growth opportunities, Nigel, are fairly significant relative to the size of that business. The solar market in Europe particularly is very attractive to us, and that's where a lot of the growth is coming from. But globally, the entire market is booming, and so I think it's another example of us trying to steer our core growth platforms that support power and energy, global infrastructure more broadly across the world, and seizing those opportunities. We've got a nice management team in place in that business and they aggressively went after these opportunities over the past several years, and they've been successful getting these contracts. So yes, I mean we think it's a nice place to be. Relative to the entire company, it's not a large percentage of total revenue; but we certainly like the trend in terms of how that business is developing, and we think it's a pretty attractive business from a margin standpoint.

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

And interestingly, we're also quoting on some opportunities to provide cooling for these solar panels themselves in service.

Nigel Coe - Deutsche Bank

Oh, great. And what was the size of the orders you took during the quarter for that business?

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

I think probably... we're looking at about $40 million probably.

Nigel Coe - Deutsche Bank

And this is a $100 million business right now, for you.

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

That looks right.

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

Yes.

Nigel Coe - Deutsche Bank

Okay, great. And secondly within thermal, I know that HVAC is a relatively meaningful size of that segment. What do you have baked in for second half of the year because we're seeing a pretty significant slowdown from the HVAC OEMs? What have you baked in, and what impact does low HVAC have on the margin mix?

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

First of all, as you know we're not in residential HVAC. And actually if you look at our organic growth expectations for the whole thermal segment, I don't really see... we're expecting the second half to be stronger organically than the first half. And so really if you just look at the things that are sensitive to the domestic market, it really is MEP and Weil-McLain. And what we are really seeing there is performance at expectation, with decent margin improvement. So in terms of what we are expecting for the year, we are not expecting to see a downturn in the second half of the year from the market dynamics that you're describing.

Nigel Coe - Deutsche Bank

Okay, great. And then finally, Patrick, it sounds like... when you answered Jeff's question on the tax rate, it sounded almost like you were implying that maybe 35% was a bit too conservative. Would you need just one more quarter before you can make that call?

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

I think as we look at the year... obviously, for the full model for the year right now, we've got a significant headwind from taxes. And the drivers of that are primarily tax law changes that took in Germany at the beginning of the year. As a company that's now more than 50% international, our tax rate is going to be sensitive to jurisdictional OP, where it comes in the world, when it comes, and what impact that has on our U.S. tax calculation. So I think... and then we are still going to have some small or potentially some larger discrete tax items from closure of historical years that are under audit at the moment. So I think if I go out beyond this year, I'm fairly confident that we are going to see a declining tax rate. Right now, for this year, I think 35% is the rate that we should be using. And as I said in the risk analysis, obviously a change in the tax rate is an area that could impact our earnings per share going forward.

Nigel Coe - Deutsche Bank

Great, thanks a lot.

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

Thanks, Nigel.

Operator

We'll go next to Ned Armstrong of Friedman Billings Ramsey.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Yes, thank you. Good morning. I noted that the units that you're discontinuing, and was curious as to what you're thinking is about more of that coming in the future, given where your areas of focuses are and how we can think about that in terms of potential timing?

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

Yes, we have said consistently, Ned, that we continue to evaluate the portfolio from a strategic perspective on regular basis. And clearly if look back over the last three years, we have marched down that path to refine the company and focus it around our core growth segments. And everything we do going forward will be to further effect that strategy. And so we have now got one additional non-core but good business lined up for disposition, we'll continue that evaluation process, and as opportunities develop we'll disclose them. But clearly nothing to say on that at this point.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Is it fair to assume that proceeds from these divestures when they are completed would be use to pay down debt?

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

In the short term... as I mentioned, by the second half of the year we'll be back within the target range. Obviously in the case of the business that we discontinue in Q1, our timing estimate is such that there's not much mitigation on the earnings model due to proceeds. It will be significantly less dilutive to our 2009 model than it is to the 2008 model, where we are simply taking the earnings out and moving them into discontinued operations.

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

And let me, broadly speaking Ned, you can assume that we'll reallocate the proceeds from the sale of these non-core businesses one way or another back into our core growth platforms.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay. And then in the aerospace business, was the majority of that business that you did weighted towards commercial, or was it more evenly split towards commercial and military?

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

It's more towards military.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay.

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

I think there is a shortage of capacity in the whole aerospace components business. We have been approached by a number of historical customers about whether or not we can provide new products. Demand is strong domestically, and of course some of that, there is some replacement work from the conflict in Iraq.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay. What's the approximate proportion towards military?

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

It's almost all military right now. But to Patrick's point though, Ned, I think there is an opportunity to develop that business beyond military, going forward.

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

Primarily critical helicopter components.

Ned Armstrong - Friedman, Billings, Ramsey & Co., Inc.

Okay, good. Thank you.

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

Thank you, Ned.

Jeremy Smeltser - Vice President of Finance

Thanks Felicia. I believe that was the last person on our queue. Thanks everybody for joining us this morning. We appreciate your time. Ryan and I will be available all day in the office for any further questions. Have a great day.

Operator

That concludes today's conference. We thank you for participation. You may disconnect at this time.

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