SPX Corp. Q2 2008 Earnings Call

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SPX Corporation (SPW) Q2 FY08 Earnings Call July 30, 2008 8:30 AM ET

Executives

Jeremy W. Smeltser - IR

Christopher J. Kearney - Chairman, President and CEO

Patrick J. O'Leary - EVP and CFO

Analysts

Jeffrey Sprague - Citigroup

John Inch - Merrill Lynch

John Baliotti - FTN Midwest Securities Corp

Shannon O'Callahan - Lehman Brothers

Deane Dray - Goldman Sachs

Nigel Coe - Deutsche Bank

Operator

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

Jeremy W. Smeltser - Investor Relations

Thanks, Felicia. Good morning, everyone. Thank you for joining us. With me on the call this morning, as always, 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 August 13. 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 issued earlier this morning can also be found on our website.

Before we continue, I would like to point out that portion 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'll turn the call over to Chris to begin.

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

Thanks, Jeremy and good morning everyone. Thanks for joining us as we report our second quarter earnings. Q2 marks another period of growth for SPX, with nearly all key financial metrics improving over last year's second quarter.

The integration of APV remains on track and we continued to focus on our operating initiatives to drive growth and improvement throughout the business. Demand for our engineered products remained strong. This was highlighted in Q2, when we were awarded more than $500 million of orders to supply thermal equipment, supporting the energy infrastructure build in South Africa. I'll discuss this and other wins in more detail later during this call.

We're also raising our full year earnings guidance today. Patrick will update you on our revised 2008 targets along with a detailed analysis of our segment results for Q2. After we conclude, we'll take your questions.

Let's begin with the key financial highlights for Q2. EPS for the quarter was $1.70 up 37% year-over-year. Revenue grew 29% in the quarter, including 4% organic growth. Segment income margins increased 100 points to 13.4%. Free cash flow in the quarter was $22 million, and we're on track operationally to hit our target for the full year.

Based on the strength of our second quarter and the continued strong order trends in our key businesses, we're raising our 2008, EPS guidance range $0.20 to $6.40 to $6.60 per share. Additionally, we're raising our full year free cash flow guidance to a range of $300 to $320 million.

Taking a closer look at the consolidated results for the quarter, revenue was $1.6 billion, up 29% or $348 million over last year. Businesses acquired in 2007, accounted for 21% of the revenue growth, primarily driven by APV.

Organic growth was 4%, highlighted by 14% organic growth from our Flow segment. And foreign exchange fluctuations benefited revenue by about 5%.

Segment income increased $60 million, up 40% over Q2 in 2007. The increase was driven by strength in the power and energy markets, 2007 acquisitions, and success with the operating initiatives. Despite significant margin headwind from consolidating APV and rising raw material costs, segment income margins expanded 100 points to 13.4%.

The increase with segment income was a primary driver of earnings growth in the quarter. In total, segment income accounted for $0.74 of improvement over Q2 last year, including about $0.19 from acquisitions. This more than offset increased interest expense and a higher effective tax rate.

A lower share account, driven by 2007 share repurchases contributed $0.08 of earnings which was largely offset by higher restructuring and other charges.

Our Financial division remains strong, Cash on hand increased to $420 million at the end of the quarter. Net debt was $1.2 billion and our net leverage ratio was 1.5 times.

Our growth leverage ratio was at the top end of our target leverage range of 1.5 to 2 times. Both gross and net debt ratio declined from the year end numbers. Looking at our end markets, over 50% of our revenue is generated from sales supporting global infrastructure. Demand for power and energy continue to be robust around the world. We are expecting double-digit growth from this market in 2008.

Overall trends in Sanitary markets, primarily processed food and beverage manufacturing have also been positive. And our Other, Infrastructure and Industrial markets are providing solid growth as well.

In our Tool and Diagnostic end markets, we are experiencing modest growth outside the United States. However the U.S. markets, particularly the daily tool aftermarket, remains challenging.

During the first half of 2008, our revenue and earnings have grown significantly over last year. Total revenue increased 33% and segment margins expanded 120 points versus the first half of 2007. This improvement contributed to 65% EPS growth year-over-year. The key drivers have been strong market demand, acquisition growth and our continued focus on operating initiatives.

As we look at the second half of the year, executing on strong demand is our primary focused, specifically driving organic growth and free cash flow conversion. Consistent with the plan we laid out the end of last year, we will continue our efforts to integrate APV.

And with a leverage ratio of two times, we expect to be in a position to consider investing capital on strategic acquisition or share repurchases during the second half.

Our updated EPS guidance range is now $6.40 to $6.50 per share, an increase of about 34% over last year's adjusted earnings. In addition, we're raising our free cash flow guidance to between $300 million and $320 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'll provide you with more details on our updated guidance in a moment. First, I'll walk you through the segment results for Q2.

Beginning with Flow, for the quarter, Flow reported revenue of $547 million or at nearly double the revenue from Q2 of last year. APV accounted for about 80% of the segment top line growth, reporting $217 million of revenue. Strong global demand in our core power, oil and gas and sanitary end markets grew at 14% organic growth in the period. Demand for SPX valves and pumps, due to final trends for oil and gas was strong globally.

Sanitary demand was stronger for mixes and was particularly robust in the U.S. and Europe. Foreign currency fluctuations benefited revenues by 4%. Q2 segment income was $70 million, that's up 58% over last year and 12.8% of revenue. Operating margins are in the quarter, that's continued to strengthen, improving 140 points to 17.4%. This was driven by leverage on the organic growth and improvement from the operating initiatives.

Dilution from APV was 460 points in the quarter. APV reported operating margins at 6%, significantly better than Q1 and its pre-acquisition performance. The integration of APV remains on track, through six months of the business has contributed $445 million of revenue, with about 3% operating margins, including the $7.5 million purchase accounting charge taken in Q1. APV is on pace to meet its full year target of $885 million to $900 million of the revenue, that was 5% operating margins.

We have further integration actions planned for the second half of this year, that are expected drive margin expansion over the balance of 2008 and into 2009.

The base Flow business has had solid growth through the first two quarters this year and all trends continue to be strong globally across many of our key Flow end markets. Accordingly we are raising the full year revenue growth target for the segment to between 91% and 93%. And we are raising the margin target 30 points to 11.8% to 12.3%. This includes the organic growth target of 7% to 8% for the segment in 2008.

Moving on the Thermal segment, our revenue for the quarter was $409 million, that's up 6% from Q2 last year. Foreign currency fluctuations benefited revenue by 7% year-over-year. This was offset by organic decline of 1.6%, driven by increased local competition in China and the uneven nature of large infrastructure projects. Overall the [ph] year-over-year revenue change... it should be noted that in Q2 last year, this segment reported a record 30% organic growth.

During the period, the backlog for the segment increased 43% up to $2 billion. We continue to view this business as a strong growth driver for SPX in the near term.

For the second consecutive quarter, year-over-year operating margins expanded substantially. Q2 margins increased by 140 points over last year to 11.1%. Margins were favorably impacted by improved project execution and better operating performance across the product lines.

Our order trends and quoting activity remains strong globally for this segment. For the year we're increasing the target revenue growth to a range of 11% to 13%. Based on the Q2 operation performance, we're also raising full year target margins, 20 points to a range of 10.6% to 11.1%. We now expect 2008 Thermal margins to approach the low end of our long term target range of 11% to 13%.

On to Test and Measurements, our total revenue for the quarter was $324 million, up 12% from last year. The European acquisitions completed in the second half of 2007 were the primary revenue drivers contributing 11% of growth. Foreign currency increased revenue by 5%. Organically revenues declined 3%, driven primarily by surplus months in the North American aftermarket for tools and diagnostics. The restructuring actions we've taken in the segment as well as growth in Europe, are partially offsetting the revenues softness in the U.S.

Q2 segment income increased 13% over the last year and margins improved modestly in the quarter to 11.4%. For the balance of the year we expect the North American aftermarket to remain challenging. We are holding our revenue growth target of 9% to 11% and adjusting our margin target to 10.5% to 11%.

For the longer, term we are positioning our diagnostics tool segments for global expansion. We are getting solid traction in Europe from the acquisitions and expect this to continue. We believe Asia is an important region for future growth.

Looking at Q2 result for our Industrial segment, total revenue for the quarter was $276 million above 9% over last year. Organic growth was 8% and foreign currency fluctuations added 1%. The organic growth was driven by strong demand, primarily to broadcast and solar equipment as well as hydraulic tools. Flooding during June in the Midwest caused timing delays on rail shipments of transformers, negatively impacting organic growth in the second quarter.

Segment income increased 65% to $57 million, this growth was driven by improved pricing, operating leverage and efficiencies from the operating improvements. Margins expanded to 20.5%, that's up 700 points from Q2 last year.

At the end of May, we held an investor open house at our Transformer facility in Waukesha, Wisconsin that highlighted the industrial segment and our transformer business in particular. The slide presentation for this event is still available in the Investor Relations section of our website. It includes a detail analysis of our controlled business as well as a look into the positive developments on our Solar and hydraulic tools businesses.

We are very pleased with the job Lee Powell and his team has done to drive improvement throughout the product lines in our industrial segments. For the year we are expecting positive revenue growth in all the industrial market, this segment serves.

All the trends for the business in this segment have been strong. Looking at the full year we're raising our revenue target to be between 18% and 20% and maintaining the full year margin target which is just about 20%.

Moving on to cash flow. Consistent with the marginal performance, all eight businesses have reported solid operating cash flow improvement during first half of the year. Other catches [ph] have however offset this improvement. We have invested $46 million year-to-date to June. This is about $20 million more than last year and as supporting improvements in our IT infrastructure, lean and capacity expansions. Through the first half we had invested over $30 million into the integration of APV. Interest payments are also up year-over-year due to the debt issue to fund the APV acquisition.

Interest payments were higher as a first half driven by the higher earnings. The net results through the six months towards our cash flow usage of $3 million. This was all was positively impacted by the reclassification of $25 million of cash outflows, from operating to financing activities, thereby increasing cash flow.

$23 million of this charge related to Q1. The change was made for employee income tax withholdings or invested restricted stock awards. As we determine, during the quarter, the classification in financing was the most appropriate accounting treatment, this change is ultimately reflected in the 2007 cash flows break up in press release, the amount reclassified for the first half of 2007 was $18 million.

We've had strong second half free cash flow performance in each of allowed two years and we're expecting a similar performance this year.

And compared to the first half, we are expecting higher organic growth, over the balance of the year to be a key driver of free cash flow in 2008. Based on the first half performance, we have raised the full year cash flow guidance to be between $300 and $320 million. This represents 85% to 90% conversion of net income and includes $30 to $50 million of cash restructuring for APV and capital spending of about $145 million.

Looking at our ability to deploy available capital, this year, in addition to the $420 million of cash on the balance sheet at the end of June, we are expecting to generate over $300 million of free cash flow, during the balance of the year. The sale of the air filtration businesses was completed earlier this month and the sale of the vibration test equipment product is on track. We anticipate the proceeds of this sale to also be available for use during the second half for the year.

With our gross leverage ratio at two times we are within our target range and expect to be in the position to consider additional strategic acquisitions and share repurchases. As a reminder, to meet our criteria, acquisitions must be strategic to our core end markets. EPS accretive within 12 months must exceed our cost to capital in the short-term.

Before I send the callback over to Chris, I'm going to quickly go over the updated full year model and our Q3 targets.

Looking at Q3, we are expecting strong top and bottom-line growth to continue, we expect total revenue growth in the range of 34% to 36%, with organic growth in the high single-digits.

Segment income was targeted at about $210 million or about 25% greater than Q3 last year. Segment margins are expected to be between 12.9% and 13.1%, down from last year. The expected margin decline is primarily driven by dilution from APV.

Earnings per share added to growth 15% to 20% and be between $1.58 and a $1.55 per share. And the updated full year model, the mid-point of our EPS guidance is up $0.20, to $6.50 per share. This equates to earnings growth of about 34% over our 2007 adjusted EPS.

Revenue growth is targeted between 30% and 33%, driven largely by acquisitions, with organic growth between 7% and 8%. Segment margins are expected to be around 13%, roughly flat to last year, and this includes the full year diluted impact of APV.

Excluding APV, the base business is expected to increase margins 19 to 140 points.

In our updated target model, we have reduced the effective tax rate for the year to 34%. Additionally we've increased our expected special charge expense by $5 million, to a total of $20 million for the year.

The net of these two changes is neutral to our 2008 earnings. As I mentioned earlier, our free cash flow guidance is 300 to $320 million. There are several items that potentially could impact our 2008 guidance, these item include the change in the order trends of our short-cycle businesses. The speed in cost of the APV integration, additional acquisitions or disposals, take significant changes in the cost of raw materials, at any change in our effective tax rate.

With that I'll turn the callback over to Chris, for brief wrap up.

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

Thanks, Patrick. We are very pleased with our second quarter results and the continued improvement at SPX. Along with solid financial performance, our backlog increased 20% during the quarter. From June 2007, through June 2008, reported backlog is grown 62% to $3.7 billion, an all time high.

As the backlog is grown, the size and length of the project has increased. We now have multiple contracts greater than a hundred million dollars expected to be realized over several years. Global demand for power and energy infrastructure has been the primary growth driver, particularly in our Thermal equipment and service business which now has a back log of $2 billion.

As governments approved plans for two new large coal-fired power plants. The Medupi Power Station and project Bravo which has not yet been formally named are expected to add about 4.8 gigawatts of additional capacity each. Grossly 25% of South Africa's total plant expansion.

During the quarter our Thermal business received more than $500 million of orders from Alstom to support Ascom power generation build out in South Africa. SPX has been contracted by Alstom to provide dry cooling systems for the six turbine islands on Project Bravo and feed water heaters on both Medupi Power Station and Project Bravo.

In 2007 we were also contracted to provide over $200 million of critical thermal equipment to the Boiler Island on the Medupi Power Station. SPX now has more than $700 million of projects in the backlog to provide equipment in South Africa.

Another big win during the quarter came in Europe, where we agreed to provide a $100 million cold end solution for five new geo-thermal plants to be built in Iceland. For this project our thermal group will engineer, design, manufacture and install steam condensing systems, utilizing multiple SPX heat exchangers.

Just last week we announced another notable win. Our Tools & Diagnostic business was awarded a five year contract from John Deere, to provide all of the special service prepared tools used through out John Deere's complete global viewer network.

This contract demonstrates our ability to provide dealer-service readiness for our global platform. It also deepens our relationship with John Deere and increases our non-automotive OEM presence.

In closing we're very pleased with our second quarter results and the first half performance of our organization this year. We raised our financial target for 2008 and we are in a position to consider investing in strategic acquisitions and share repurchases during the second half of the year.

SPX strategically focused on serving three global end markets that we believe have positive long term growth characteristics. Our back log has increased significantly, and we're expanding our capacity and adding resources to execute on this growth.

Driven by strong end market demand, focus on operating improvement and disciplined capital allocation, we've steadily grown earnings in each of the past three years. And we're on target to achieve earnings growth of more than 30% in 2008. And with that we will be happy to take your questions.

Question And Answer

Operator

The question-and-answer session will be conducted electronically. [Operator Instructions]. And our first question from Jeff Sprague with Citi investment.

Jeffrey Sprague - Citigroup

Thanks good morning everyone.

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

Hi, good morning Jeff.

Jeffrey Sprague - Citigroup

Quite impressive. Just a couple of questions, first on raw material obviously judging by the margin you are doing a great job staying ahead of the curve but you did call out a little bit as friction point. I am just wondering on the roll forward if you can give us some thoughts of where you stand and I guess most particularly you know Chris here mentioned a lot of these projects are now multi-year in nature and what you are doing or what you have been able to, to kind of protect yourselves there in those out years is you actually deliver on this big projects.

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

Sure. Well consistent with our recent experience Jeff, in Q2, we again we were able to offset inflation and commodity cost throughout all four segments. And our efforts in managing our supply chain and the discipline in structuring contracts continued to help us offset inflation and we expect that discipline in our process will continue going forward.

Having said that continued inflation does remain a key risk as we as people or consistently the earnings estimates for the year, particularly in our short cycle flow business. In our Oriental raw material spend is about 60% of our total cost of sales. And our largest raw material spend annually is on steel. Copper is our second largest raw material spend in terms of total annual spend, but, we are pleased with how we handled it thus far this year which is consistent with the improvement we seen in our each of the last three years. And I think that focus, that discipline, that organization has begun to mature, it's going to help us as we go forward in time.

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

And the proper [ph] technique that we're using for these longer-term contracts and obviously in particular some fixed price contract is... cash payments from the customers, that we're passing on to the vendor network, and passing on those cash flows enable us to hold the line with the vendors to the extent possible, but in other parts of the business, we are being surcharged by the vendors with some of the raw materials, from that you can tell from the margins, we're passing those on directly to customers.

Jeffrey Sprague - Citigroup

Okay, great. Could you elaborate a little bit on the competition in China obviously, there is a nice shift to the left, I guess to South Africa from China, but you guys have been talking about this for a while, has it intensified? Are you reorienting, what you go after in China and maybe a little color on how much backlog in business you still have ongoing in China?

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

Yes. Sure Jeff. There are local competitors online now in China until the competitive landscape as we've discussed before, has changed recently, it hasn't changed significantly or measurably from the last time, we talked. I might think it's just... it is a natural development that is expected frankly, and something that we're dealing with. I think the important thing to understand is that the global demand in power and energy and in broader global infrastructure for the products and services, we provide, is pretty dramatic and it's dramatic particularly in developing parts to the world, not only China where we still continued to be a significant player in that market, but you're absolutely right, South Africa, its huge. For us the Middle East is a strong developing market.

And I think also important to note is that in the developed parts of the world, we're still seeing positive trends, particularly in replacement applications but with respect to China, I think its important to understand that we still are a significant player in that market.

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

Yes, we still have a big backlog in the Chinese market. We're in total, use that contracts over 40 profile [ph] launches and we're still winning orders in that market and we're exploring other ways to collaborate with Chinese suppliers.

Jeffrey Sprague - Citigroup

That was 40, Patrick?

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

Yes. We've done over 40% of them at this point. And the rest is kind a split between in progress and yet to be started. But if you look at the numbers in the aggregate, over the next 12 to 24 months, obviously there will be a shift in geography, away from Asia towards Africa.

Jeffrey Sprague - Citigroup

Just a quick housekeeping line I'll pass it on, it looks like industrial backlog was restated or something for Q1. What was going on there?

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

Really, Jeff, we just had a wrong number on our presentation, so we restated it for purposes of Q1, and the Q2 filing and that number should be adjusted in your filing as well.

Jeffrey Sprague - Citigroup

Great. Thank you.

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

Thanks, Jeff.

Operator

Our next question comes from John Inch with Merrill Lynch.

John Inch - Merrill Lynch

Thank you. Good morning.

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

Hi, good morning John.

John Inch - Merrill Lynch

Morning, Just to pickup on Jeff's point. The first quarter industrial backlog, that had nothing to do with disk copying, the vibration or filtration businesses that what.--

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

No, it did not John.

John Inch - Merrill Lynch

Okay. Do you guys... its interesting, you called out transformer delays but in the industrial margins, were still seven points above last year. Now, if... my question is a mix shift that rich on stuff like broadcast and solar, and that suggest even though you are on such a higher base, you're going to continue to see sort of an acceleration in margins in the second half '08, in that segment, where you've seen another years. Is that still delay to think about this business?

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

Well, with respect to transformers, transformers was still, the biggest driver of margin improvements. So we're still benefiting from the mix up and the rise in prices on those products reflecting dramatic increase in raw material cost there. So, what we're trying to bring out on the total and the fuller guidance is that, is the all of the other industrial businesses are doing well, and are showing for the full year, our revenue growth and margin improvement, in this particular strength in some of the businesses I called in the remarks, solar obviously which we discussed in the last call, hydraulic tools and then broadcast equipment are particularly strong. So you will see our stronger organic growth as the next few months progress along with the impact of the timing difference from the transformers we were unable to ship at the end of Q2.

John Inch - Merrill Lynch

But if anything your mix should still be helped in the back half as transformers improve, right.

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

It should.

John Inch - Merrill Lynch

Flow, Patrick, up 14% yet you have some pretty tough comps, was there any kind of demand put forward in that business or may be what actually happens as the quarter progress that you mention...

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

No, really, it really is just this timing and shipment. If you actually look at the overall Flow business, one, it is our fourth of lets say double digit organic growth. So we are building on a very large base and so that organic growth rate is not indicative of the growth rate for the year. We are still looking at organic growth in Flow 9% to 10%, for the year. So it's simply timing of the way certain projects came out and

John Inch - Merrill Lynch

Fine that pulls a little forward from the third quarter, Patrick?

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

Basically you are not going to see the same sort of forcing the same organic growth over the whole period.

Jeremy W. Smeltser - Investor Relations

Yes, John this is Jeremy, we did have some good, some heavy big project shipments in Q2, that could have kind of fall on each quarter. So actually what you saw [indiscernible] is that we raised the full year organic, with Flow to 7% to 8%, which will be below the Q2 run-rate, Patrick's explained. So what we are saying is, we should be modeling the Q2 run-rate to continue, throughout each quarter.

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

And you can see that with the field packed with such a high organic growth quarter on the back log.

John Inch - Merrill Lynch

May be just lastly, with the weakening U.S. auto environment, I mean you guys have done a fantastic job of keeping your profits up, but you did... I see you tweaked it down a little bit, are there additional cost actions you can take in that business to domestically, are we sort of add up pretty lean run rate. I think we closed the plants, just give us may be a sense of other additional actions you could take to preserve profitability?

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

We have taken additional actions in Japan there and note the actions are manifesting themselves. It's a little poignant. The margin run-rate in that business. There is a combination of things here. We have taken significant actions in terms of restructuring our footprint in United States. And that started at end of last year and moved into the first half of this year and we are seeing that benefits roll through.

But as that business expands its global foot print particularly with greater emphasis on the Asian market, I think that will help the cost addition as well. I think the important thing to remember about this segment as I said in the past is that it is an evolving global business and you can see just by the nature of kind of contracts that we're developing in that business like the one we announced today with or discussed again today with John Deere, we are becoming a much bigger global provider. And as we establish those relationships to support those global OEMs around the world, both automotive and non-automotive, we will continue to structure our business appropriately to support those customers in cost defective way. Which I think we will continue to emphasize shift to lower cost countries for manufacturing to support them.

John Inch - Merrill Lynch

Thanks very much.

Operator

Our next question from John Baliotti with FTN Midwest Securities.

John Baliotti - FTN Midwest Securities Corp

Hi, good morning.

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

Hey, good morning, John.

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

Hey, John.

John Baliotti - FTN Midwest Securities Corp

Hi guys. Its interesting you said that the China as a competitor in terms of affecting organic growth, but you are, but thermal margins continue to go up and I guess can we infer that, that's obviously, price is not a leverage that you are using there, that you are sticking your guns in terms of higher competing?

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

It is John, I think I would restate a couple of important things to remember, because I think, first of all we are proud of progress that we made in that segment. We're having full year margin targets for thermal by 30 points, between 10.6% and 11.1%, which those reflected its significant improvement made in Q2. Drew [ph] and his team have just done a terrific job, improving both the contract structure and execution against those contracts which again reflects our commitments to lean and they have also done a nice job managing rising material costs.

We've made some specific improvements throughout... through the lean initiative, and we think importantly that there is still a lot more opportunity on that front. The large projects in this market are typically awarded through an open bid process, it does remain competitive, the large project nature of the business does create some lumpiness, as we've seen in terms of organic growth quarter-to-quarter. But we are confident that over the next two to three years, we'll be able to accomplish our long-term target margins of 11% to 13%. We've made terrific progress not only in getting closer to that long-term target margin, but seeing better consistency, quarter-over-quarter. So, it's a result of the combination of all those things.

John Baliotti - FTN Midwest Securities Corp

Right, and I'm not sure if you pointed this out, but obviously ratio for your core and second quarter was little bit low than the first quarter, but I don't know if you... I maybe missed it that, your second quarter last year was the significantly harder, comparison like the 2.5 times harder than the first quarter of last year?

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

That's exactly.

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

It was very high.

John Baliotti - FTN Midwest Securities Corp

Right.

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

Exactly right.

John Baliotti - FTN Midwest Securities Corp

In terms of APV, it's sounds like it's progressing nicely and in sometimes when you see, its also set a good growth in sanitary, I know APV is predominantly sanitary and sometimes when you're seeing growth, sometimes that's maybe a little bit harder to do some integration stuff, that you don't want to disrupt, but, how is that, how do you kind of balance all that. Is that obviously you take the growth, but it doesn't seem to be an impediment to improving that business?

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

No, it doesn't and I guess I would describe it this way John, it's no different in the way we treat, our view in the rest of our business is probably a little more intense, because there is some work to do there, what I would tell you about APV is that... all the reasons that underscored our divide on that business have proven to be true, and we are very pleased with the acquisition. We're particularly pleased with the presence on the opportunity that, that business, gives us for the same kind of sanitary process equipment, demand in growing, and developing markets that we see in other developed parts of the world, where we previously had an established presence.

So we're in a consistently and in tandem with approaching those growth opportunities, consistently focus on lean improvement opportunities, right size and structure that organization, so that we can get at the margin improvement that we believe is their. And what I would tell you is to date; one, there are no surprises; two, we are very pleased with what that brings to those segment and we are excited about the prospects of that business going forward, particularly the opportunity it brings us in developing market.

John Baliotti - FTN Midwest Securities Corp

Thanks very much.

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

Thanks, John.

Operator

Our next question comes from Shannon O'Callahan with Lehman Brothers.

Shannon O'Callahan - Lehman Brothers

Morning guys.

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

Good morning, Shannon.

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

Hi, Shannon. How are you?

Shannon O'Callahan - Lehman Brothers

Good. So, on the... can you fill out what you're seeing in the developed markets a little bit, more for thermal in terms of this replacement demand and I mean guess I'm assuming its mainly on the wet side, that you're seeing. Are you seeing more of the conversion to dry or any other solutions and is that something picking up or it's sort of remaining as strong as it's been?

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

I would say the pace has probably picked up somewhat, we're seeing good quoting activity, across the Board, it's not only wet, Shannon its wet and dry. And as we talked about in the past, there is a very aged infrastructure and there is increasing demand on that structure, both in Europe and in the United States and so... logic will tell you that, that needs to happen and I think we are seeing it happen.

Customers continued to look for way to improve efficiency in their power generation capacity, we think we have the technology and the product we help them do that and so lot of the cooling activity that we're seeing, is related to just that.

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

We've got some interesting bids out for rebuilds in the U.S. market and historically generally speaking, rebuild is somewhat more profitable for us than new construction.

Shannon O'Callahan - Lehman Brothers

Okay great. And then on the Flow business, can you just give a little more flavor I guess by I mean you mentioned sanitary I mean, can you give a little more flavor by vertical. What you're seeing over the strongest areas and maybe geographically as well?

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

Oil and gas very strong, mining very strong and strong at the U.S. strong in Europe, we got demand in Asia, South Africa obviously we are participating more directly in the local Asian Market with APV and it is a period of time where we are strong pretty much in all of the product lines and all of the geography. Then you can see that in strong developed margin in the core business and a lot of progress by the team, it's not taken their eye off the ball on the core business, not withstanding the challenges of APV integration.

Shannon O'Callahan - Lehman Brothers

Okay, and I mean I guess you say your expectations for the core business in terms of the market potential that business has taken a notch up from what you used to think?

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

We're obviously operating you know on some quarters above the high ends, of our previous target range of 15% to 17%. On annualized basis we kind of at the top end. But I think that as we get to the end of the year and go into '09 we will reevaluate that.

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

Yes, I mean our long term revenue growth target for this mix of businesses in Flow is still 3% to 5%. So operating an elevated revenue level after three years of decent organic growth. So don't forget that the size of the business also is now substantially larger than it was.

Shannon O'Callahan - Lehman Brothers

Right, okay. And then just one more, I guess from the leverage point, getting back into the target range here, what's the global acquisition pipe line working like? Or do you think this is more over time to do another decent sized acquisition or is the pricing still probably more likely to maintain share rate [ph]?

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

Well I think... on the acquisition side Shannon, I think clearly that there will continue to be attractive opportunity to supplement the growth in our three core growth platforms. But we are going to continue to apply the same disciplined capital allocation process that we have done over 3.5 years. And that same process applies whether its acquisition opportunities or share repurchases, but yes I think there are certainly other opportunities to expand our businesses, particularly Flow, in Test and Measurement that will give us a better geographic presence in some of the attractive growth markets and particularly some of the attractive developing markets.

And in terms of filling out product offerings as those were certainly there as well. So we are going to... we have very discipline processors around the capital allocation methodology, that will continue. It's an ongoing process, it's dynamic and we will see where we are in second half of the year.

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

Yes obviously strategic fit is more important than size. We found some relatively small businesses, that have been super fits with our core activities. I think that will continue to be the case and frankly first, particularly to some of the smaller to medium sized businesses, prices are more larger [ph] than they were, lets say again in a half ago, with the absence of small players [ph] in the market. And so we will leap into [ph] in there now. We'll compare the benefit to our shareholders, of acquisitions versus share repurchases and make the decision accordingly.

Shannon O'Callahan - Lehman Brothers

Okay, great. Thanks a lot, guys. Great, job.

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

Okay, thanks, Shannon, we appreciate it.

Operator

[Operator Instructions] And we'll take our next question Deane Dray with Goldman Sachs.

Deane Dray - Goldman Sachs

Thank you. Just following up on that last point. You managed the buy back program and as you resumed buy backs, just a sense of how opportunistic you expect... I mean you got a sizeable cash position today? And what's your attitude towards putting up to work?

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

It's just as I said in response to the last question, Deane, we will look at that opportunity relative to other attractive acquisition opportunities and we will make the best decision.

Deane Dray - Goldman Sachs

And the size of the program?

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

That will be communicated at the appropriate time.

Deane Dray - Goldman Sachs

The existing program in place?

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

Basically revolves around our leverage strategy that we described. So we are not describing a program size. What we have been doing effectively is following a buy-back strategy in accordance with the leverage of 1.5 to 2 times above that range, we are paying down debt within that range. We're committed under our credit agreements to buy equity. And we have been announcing our 10(b)5-1 plans for the company, to enable the company to consistently execute on the buy-back and so I would expect going forward and as we make decisions with respect to the available capital... we would do as we've done in the past which is communicate that clearly to the market.

Deane Dray - Goldman Sachs

And that's.--

Jeremy W. Smeltser - Investor Relations

As a reminder, for the broader audience from a technical perspective, our Board authorization is inline with our credit facility, which provides for unlimited repurchases, when we're below 2.5 times growth. And so really to Patrick and Chris has pointed its really based on our management's capital allocation methodology.

Deane Dray - Goldman Sachs

Right. That's helpful, clarification Jeremy. And Patrick, the tax rate at 34% is there still room to go there?

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

I think with respect to 2008, that's the rate we're using the model right now, I think in the longer-term, I think there is room for the rate to come down. We need to get through the APV integration and organizational restructuring overtime; I do think that you'll see some improvements in the tax rate.

Deane Dray - Goldman Sachs

Great and then just a last question on backlog, I mean you see backlog at thermal up to $2 billion and Flow continues to build backlog as well. What's happening at the margin, I mean there are couple of dynamics, one is customer's less apt to give orders if their backlog is going to get pushed out or the deliveries kind of be pushed out further, and they are less apt to actually give you an order. So you'll see that tailing down, there were any push-outs cancellation, changes in lead time and so forth, just color at the margin of what you expect?

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

Yes, what I've seen that dynamic at all being, it's point to remember that a large part of that backlog about $2 billion of it is in thermal those are projects that's are spaced that over several years. Lean has really helped us improve lead times and to meet the demand on customers. So I think that has certainly helped us alleviate any kind of stress that you alluded to.

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

And with respect the competitors, you can say that our backlog development, is actually very consistent with the way the backlog of our competitors is developing as well.

Deane Dray - Goldman Sachs

Great. Thank you.

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

Yes. Thank you.

Operator

Our next question comes from Nigel Coe with 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

Hey, just to follow up on Deane's question on the backlog, but through the feeling backlog to be in the dollars. You mentioned this amortization over several years. Can you give some sense on, when you expect the ship that between... maybe '09, 2010, 2011?

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

I think it depend to this different geography. If you look at the South Africa backlog that's building, and that will space out over several years in the 2011, and beyond the some cases, but the other dynamics that's going on here Nigel, as I mentioned in my comments is that we're seeing more large contracts, $100 million are over as part of that backlog, which represent by themselves, some pretty large project. So that's a different dynamic than we've seen in the years past in the business.

Nigel Coe - Deutsche Bank

Sure. And based on what you can see right now, I mean, are there any sort of... similar size contracts coming up that could popping the backlog, maybe this side is 2000, 2008?

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

Well we think those markets that are supporting growth are robust, there is more activity as I again alluded to you in my comments. We expect continued growth in those developing markets around the world and we don't see any evidence of that changing.

Nigel Coe - Deutsche Bank

Okay and then on APV, obviously the margins very good, running ahead of your full year target. Where do you think that goes by the end of the year?

Unidentified Company Representative

At this point, is really not going to change our guidance for the year, which is really sort of 5%, which gets us on by $900 million of revenue to be, somewhere around five times accretive to our overall model, obviously we get a little further into the year, we'll have a better idea of exit markings [ph], we have other integrations actions to take place and we'll give you much more specific guidance on the impacts for the overall flow although we get the '09 guidance in January.

Nigel Coe - Deutsche Bank

And just to clarify that 5% that includes the 1Q accounting adjustments?

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

Yes, exactly.

Nigel Coe - Deutsche Bank

Okay. And then look to the 3Q guidance. I think you're looking for margins to be down 20 to 40 bits in the 3Q. Can you just talk about that what's driving that decline in special lines of the encouraging trends, before this quarter?

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

Well, obviously in the thermal segment, it's a very much about project mix and the development of revenue and margins is not linear and then APV as the overwriting margin impact for Q3, I think a better way to look at the second half for the year is, we are running the first half at the segment level at about 12.6 margins and we are running the second half for the year at about 13.6.

So obviously within each segment there are puts and takes based on the project nature of some of these businesses. And we have got a different organic growth profile quarter-by-quarter, as you can see. So the expectation in aggregate for earnings are obviously higher than the last time we talked and we are quite comfortable with the way we have got, the second half expectations set.

Nigel Coe - Deutsche Bank

Okay and then just one final one, quick one. Special charges, you moved that up from $15 million to $20 million for the full year, would they be head count reductions?

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

Basically, what they are doing in helping us make further progress on shared services and lien and it's a mix we are closing a number of areas that we have accounting activity. We are migrating within the segments much more towards shared service and we starting to look at shared service activities across the segments for the company. So that's a primary driver that increased of $5 million of restructuring charge.

Nigel Coe - Deutsche Bank

Okay and what sort of pay back do you expect in that activity?

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

We have used the same pay back criteria as we do for any investment, we used our EBA tools and typically we see a pay back somewhere in the twelve months range.

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

And the other thing that I would mention that part of that additional restructuring charge is we're relocating some of the segment team here to Charlotte to be co-located with corporate management team and that is a part of it too, Nigel.

Nigel Coe - Deutsche Bank

Okay, that's helpful, thanks.

Operator

And we have a follow question from Jeff Sprague with Citi Investment.

Jeffrey Sprague - Citigroup

Yes thanks. Just a couple little minor things. Can you give us just a little bit more color on what's going on in solar in the quarter, how much it grew and if there is kind of a back log forming in that piece of the business?

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

It continues to grow at a pretty rapid pace. I mean its up double-digit margins in the quarter, Jeff, I don't have exact numbers... somebody will get that to you... but the back log is up as well. So the demand continues and we continue to add capacity and to look for additional capacity to meet those demand both here and in Asia. And it's a pretty high growth little business. They did book another large solar contract in this quarter. So the momentum continues there, its double digit, we will give you exact growth rate on. Try and follow up with [indiscernible]

Jeffrey Sprague - Citigroup

Okay, great and also just on transformers, obviously ABB is buying Coleman, I just wonder if you guys had interest in that, if you think it shifts the competitive landscape at all. May be it's good news for consolidation, but is that something you had some interest in?

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

Yes, I can't really comment on that Jeff, and nor can I comment on what it does to change the competitive landscape. We are going to continue to be a premier provider in the market and compete effectively as we have in the past, just based on the product quality and reputation we have in the markets. So what we are, we are not going to concern ourselves with that.

Jeffrey Sprague - Citigroup

And just one final on kind of this whole share repurchase question, as minimum place holders should we kind of assume you offset the share creep on a go forward basis even if there is some deal activity going on?

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

It's obviously not appropriate for us to comment in about specific share repurchase activity at this point. But you can tell that we have a fairly significant capacity developing with the cash flow, we expect in the second half and we really do need to compare the acquisition growth opportunities with the share repurchase to see what is in fact the best economic returns.

Jeffrey Sprague - Citigroup

Great. Thanks a lot.

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

Great. Thanks, Jeff.

Operator

And we have another follow up question from John Inch with Merrill Lynch.

John Inch - Merrill Lynch

Thanks. Just a quick follow up, Chris or Patrick shared services initiatives, I know it's too early in the process but have you seen any kind of a net benefit from that in the quarter. So, how much and then Chris or Patrick I mean what ultimately, do you think its going to be the potential margin opportunity from these sorts of opportunities for these initiatives, I mean overall for the company?

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

It's really too early in the process, John. I think we clearly believe that we will see margin improvement overtime, we think this is probably a three year process to really get to get where we need to be. And a lot of is just driven around... it certainly improving margins in the company but creating a... to create a less complicated smoother structure in the company, with greater critical mass around things like back office support and manufacturing for the business. And so I think the theory makes a lot of sense too, but I think it's way too early to predict the impact, but we're pretty locked in and convinced it's the right thing to do.

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

Yes, we've not changed our view that 50 points of margin improvements for the whole company is a realistic goal for the continued implementation of the lean and migration toward shift services. So we see this as evolutionary to our existing targets and the individual margin targets for the segments are still 14 to 16 at Flow, 11 to 13 at Thermal, 13 to 15 at Test and over 20 at Industrial. And so we are enjoying more than the 50 points of margin improvement in the core now from... probably from the benefit of strong top line growth. We need these initiatives to be implied so we can sustain other margin improvement that we've been achieving on the core business.

John Inch - Merrill Lynch

And then otherwise, recently I've been on South Africa but it's the Middle East still a significant emerging opportunity are call it by one contract maybe a little bit of color I mean. Could Middle East be as biggest not bigger than South Africa, and maybe just a little kind of color in the timing?

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

It can give certainly been significant for us. We believe one of the additional collateral benefits that we got, with the APV acquisition is the much greater presence in the Middle East and we can hopefully leverage that sales channel in presence for the rest of our process business and likewise with our thermal equipment and services segment, we think there will continue to be attractive opportunities for us in the Middle East, not only in power and energy, but in Test, chemical as well. So yes, we think it will be important and we also think South America will continue to be an important market for us in the sanitary and process business.

John Inch - Merrill Lynch

Thanks, Chris.

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

Okay, thanks. John.

Jeremy W. Smeltser - Investor Relations

Thanks, John and thanks Felicia. I believe that's the last question in our queue and we're out of time. So thanks, everybody for joining us today and for your questions. Ryan and I will be in the office all day today for any follow ups. Have a great day.

Operator

And that concludes today's teleconference. Thank you for your participation. Have a good day.

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