SPX Technologies, Inc. (SPXC) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the SPX Strategic Update Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Paul Clegg, VP, Investor Relations and Communications for SPX. Please go ahead.

Thank you, operator, and good afternoon, everyone. Thank you for joining us. With me on the call today are Gene Lowe, our President and Chief Executive Officer; and Jamie Harris, our Chief Financial Officer. This morning, we issued a press release announcing a material agreement and an update to our guidance. You can find the release and a slide presentation as well as a link to a live webcast of this call in the Investor Relations section of our website at spx.com. I encourage you to review our disclosure in the press release and to follow along with the slide presentation during our prepared remarks. A replay of this webcast will be available on our website for approximately 30 days. As a reminder, portions of our presentation and comments are forward-looking and subject to safe harbor provisions, please also note the risk factors in our most recent SEC filings. Our comments today will include references to prospective adjusted financial results, including updates to our guidance. And with that, I'll turn the call over to Gene.

Thanks, Paul. I'm very pleased to announce today that we signed an agreement for the sale of SPX Transformer solutions to Prolec GE, a leading manufacturer of small and large-sized transformers for the Americas region. We are very excited about this transaction, which we believe has significant benefits for both Prolec GE and SPX and marks a watershed moment in SPX's growth journey. Before getting into the transaction details, I would like to address the strategic logic and timing of the sale. Since the spin in 2015, we have focused on simplifying and strengthening our portfolio. We reduced our exposure to power generation related businesses and focused our investments in our HVAC and Detection & Measurement segments. This transaction is another key step along the journey of concentrating our strategy on these higher margin, higher growth businesses. It also allows us to focus on adding value through product management, innovation and digital solutions. I'm very proud of the hard work and great results of the SPX Transformers Solutions team over the last several years. They help to reshape that business and strengthen its financial performance while adding substantial value for customers. We'll miss our friends and colleagues at Transformers Solutions but are very excited about their future as they become part of a dynamic global business that is focused specifically on solutions for the electricity transmission market. This transaction creates incremental or increased opportunities for SPX and our customers by enabling an acceleration of growth in our remaining businesses. By freeing up additional human capital and financial resources, SPX becomes a more streamlined and focused company that is well positioned to further develop our key strategic platforms within our HVAC and Detection & Measurement segments. Since 2015, SPX has added dozens of new products and technologies, multiple new sales channels and several value-added digital solutions while making significant progress on our continuous improvement and talent goals. In the past 3 years, we have completed 8 strategic acquisitions, helping to transform highly successful niche businesses into broader value-added solutions platforms that extend our scale and growth potential. Now I'll turn the call to Jamie for a transaction overview.

Thanks, Gene. This is a transaction for $645 million, reflecting a multiple -- a 10.5x last 12 months EBITDA of approximately $62 million. We expect net proceeds of approximately $540 million after-tax and other deal costs. The transaction is structured as a stock deal with normal reps and warranties and expected to close in the second half of 2021, subject to typical closing conditions, including regulatory approval. As part of the transaction, we have signed a transition services agreement, or TSA, to facilitate the transition. We expect the TSA to cover a majority of our corporate costs previously associated with this business during the transition period. We anticipate the primary use of proceeds to be strategic investments in both organic and inorganic growth opportunities. In the short term, we will use a portion of the proceeds to reduce all current borrowings on our revolver and securitization loan, which is approximately $140 million. We will have a significant amount of capital available, both in the form of cash and borrowing capacity to deploy towards growth initiatives. We believe we have many avenues to invest in the highly productive and strategic manner and within a reasonable timeframe. With regards to capital deployment, growth investments are our focus, but as a reminder, we do continue to have a share repurchase authorization of $100 million in place. Following the close of the transaction, on a pro forma basis, we expect our cash on hand to exceed our outstanding debt by approximately $170 million. Including cash and borrowing capacity on our remaining businesses and giving credit for assumed pro forma acquired EBITDA, we will estimate capital available to deploy of approximately $650 million at a leverage ratio of 2x and up to $930 million at a leverage ratio of 3x. As we focus our strategy and capital on our HVAC and Detection & Measurement segments, the financial profile of SPX has a significant increase in our growth rate and margin structure. Post transaction, we would expect our long-term organic revenue growth rate to be approximately 2% to 5% on average or 1% to 2% higher than previously communicated. We would also anticipate gross margin to increase by approximately 450 basis points to 37%. From a financial reporting perspective, the following will be applicable beginning with our Q2 earnings report. Our Transformers results will be reported as discontinued operations and therefore, excluded from our reported adjusted operating results. Our Process Cooling business, which was previously reported as part of our Engineered Solutions segment will be reported in our HVAC segment. We will eliminate our Engineered Solutions segment. As a result of the transformer sale, we are providing updated 2021 guidance for adjusted revenue of approximately $1.25 billion and segment income margin of approximately 17%, up approximately 150 basis points compared to prior guidance. We believe there is significant opportunity to continue creating value in our higher-margin, higher growth core platforms. Together with our continuous improvement in digital initiatives and capital deployment opportunities, we see an attractive growth and margin trajectory. In 2025, on an adjusted basis, we are targeting run rate revenue of $2 billion with gross margin of 40%, segment margin of 20% and operating income margin of approximately 16%. We believe that these targets are reasonable and achievable and supported by our track record, current momentum on organic initiatives, cash generation, significant capital available and active pipeline of acquisition prospects. I will now turn the call back to Gene for an update of our strategic focus.

Thanks, Jamie. We believe that focusing on our Detection & Measurement and HVAC segments simplifies our business, and enables us to better leverage our management resources and business system to drive value creation. Our segment platform share several attractive characteristics, including their focus on niche engineered products, technology and innovation. They are less capital-intensive overall, helping to support high-return profiles. Most of our businesses have leading market positions and diverse end market exposure. They have high levels of replacement revenues that are often government-mandated or spec-driven, leading to less cyclical variation in results. In our HVAC segment, our cooling and heating platforms provide a solid base from which to invest for future growth. In Cooling, we have a leading position in packaged cooling and field directed towers as well as key expertise in heat exchange and air movement technologies. Our proprietary channels are a significant asset that can support incremental new products and services. In Heating, we offer a broad array of residential and nonresidential boilers as well as a strong lineup of electrical heating products. We have a large installed base and many positions where our products are specked in and a leading distribution network, all of which are significant advantages to support our growth initiatives. With this foundation, we see several avenues to accelerate growth in HVAC. Our organic initiatives in our cooling platform include extending our product presence in fluid coolers, and refrigeration solutions where we are a smaller player today but have technological expertise and see opportunities for profitable growth. We are also focused on extending our geographic footprint and continuing to introduce new product innovations, such as with our Everest cooling tower line, which offers the highest cooling capacity of any factory assembled single cell cooling tower. We also see several attractive inorganic opportunities to grow through investments in adjacent product segments and end markets. We believe our significant expertise in air movement and handling provides a strong base for expansion. In our Heating platform, we are very pleased with our progress extending our high-efficiency and commercial boiler product lines and see additional room to grow our footprint. The success of our contractor conversion programs, digital engagement and efforts to increase our penetration rate with top distributors continues to see momentum. In Electrical Heating, we see a significant opportunity to grow inorganically through the consolidation of high-value niche applications in a fragmented space as well as through select product add-ons. In our Detection & Measurement segment, we have built upon our successful niche technology-focused businesses to develop platforms that provide end-to-end solutions in location and inspection and age to navigation or ATON. We see similar opportunities with our market-leading COMTECH and fare collection businesses. In Location and Inspection with a global distribution network and established channels we are very well positioned to continue executing on our growth initiatives. Our business model increasingly brings to bear integrated hardware and software solutions as well as leading-edge technologies and development capabilities. These include data analytics, robotics and AI, which provides significant value and reinforce loyalty among customers. Additionally, our geographic and product breadth in the ATON market provides us with significant advantages such as a large installed base and high replacement sales. In this market, sales are often driven by mandates and regulations and require sophisticated network monitoring capabilities to identify potential safety concerns. With high-technology and incumbency barriers, our COMTECH and transportation platforms also provide a number of attractive expansion paths. We have several ongoing successful organic growth initiatives in our Detection & Measurement platforms. Over the last few years, these initiatives, along with our acquisitions, has significantly expanded our cross-selling opportunities across different geographies, enhanced our product portfolio and development capabilities and added new sources of revenue. Embedded software continues to create new avenues for growth while providing customers with valuable insights and efficiencies. As we look across these platforms, we continue to see room to increase our market presence by consolidating our position around our core offerings, adding innovative leading technologies and product niches and expanding into new verticals and closely adjacent end markets. We have a proven track record of successfully developing our platforms. Over the last 3 years, we have deployed approximately $525 million in capital for 8 acquisitions, representing approximately $260 million in annualized revenue with pre-synergy EBITDA margins of 20%. In our Location and Inspection platform, we have transformed $100 million locators business into a $260 million full life cycle solutions provider. In ATON, we have grown from a $40 million to $50 million obstruction lighting business into the global leader of highly engineered ATON solutions with roughly $110 million in annualized sales. In our HVAC segment, we have significantly accelerated our offering of high-efficiency commercial boilers and bolstered our technology and market presence within commercial and industrial Refrigeration. I'm very confident in our model for sustaining this flywheel effect of reinvesting for growth and creating value. We have a disciplined business system that enables us to methodically drive organic growth through product innovation and thoughtful product and channel management. We have been instilling continuous improvement into our culture through tools such as lean and 80/20. We are also investing heavily in our people with leadership and development programs, training, and educational resources. Our digital initiative has become an important value creation tool that permeates all aspects of our customer experience and drives more efficient outcomes. The SPX approach to acquisitions is highly disciplined and always emphasizes strategy first. We are pleased with the overall results of our acquisitions and see numerous opportunities to continue our momentum. Our average multiple for the 8 acquisitions we have completed is approximately 10.5x EBITDA pre-synergy and 8.5x on a post-synergy basis. We believe this process for driving sustainable growth will result in superior performance across all major financial categories including revenue growth, margin expansion and cash generation. At this point, I'll turn the call back to Jamie to review our long-term targets in more detail.

Thanks, Gene. We believe that with the combination of our disciplined organic and inorganic initiatives, we can reach our target of approximately $2 billion in revenue in 2025. Taking into account our growth rates over the last 5 years, our momentum in several initiatives and significant capital available, we believe these targets are achievable in a very reasonable time frame. Post-sale of Transformers, we anticipate an increase in both gross margin by approximately 450 basis points and segment income margin by approximately 150 basis points. We are confident that we have further upside through our growth in our top line revenue, the scaling of our corporate cost structure and our continuous improvement culture and initiatives. In addition, we believe our focus on high-margin acquisition targets will yield margin expansion on a post-synergy basis. We are targeting another 300 basis points increase in both gross margin and adjusted segment margin by 2025. We believe this will also significantly scale our corporate costs, which are more semi fixed in nature, resulting in an increase in operating income margins. Turning to an update of our guidance for 2021 and we are making no changes to the guidance we provided in May, other than those resulting from the divestiture of Transformers. Comparisons with prior guidance are available in the appendix to this presentation. Due to the change in our segment structure, we are providing you with updated metrics for HVAC and the full company, for consistency, we have also translated our qualitative guidance for the Texan measurement into numerical gates. While you will note that the inclusion of process cooling into our HVAC segment dilutes the segment margin somewhat, we see real margins and opportunities in both segments as we continue to grow. Adjusted revenue is now expected to be $1.25 billion. Adjusted EPS now anticipated to be in the range of $2.17 to $2.37 at the midpoint of $2.27. We see the sale of our Transformer business is one more step along the journey to a more strategically focused business. There will be a reduction in our earnings per share profile over the short to intermediate-term, but we see this as an investment along the path to higher long-term growth and therefore, earnings. I'll now turn the call back over to Gene for his closing comments.

Thanks, Jamie. In summary, we believe this transaction is a significant positive milestone in our growth journey. It is a natural next step in creating a more strategically focused business with a higher growth rate higher margins and a less cyclical profile. We see great opportunities to accelerate our growth, including through the redeployment of the proceeds. Now I will turn the call back to Paul.

Thanks, Gene. Operator, we are ready to go to questions.

[Operator Instructions] Our first question comes from the line of Bryan Blair Oppenheimer.

Exciting announcement this morning. I was curious just to level set, if your team contemplated revising your baseline HVAC guide alongside the update today? Gene, you noted good momentum in R&D and innovation. And it seems like underlying market trends are improving at a pretty good clip there.

Yes. On the update for HVAC, there is no update in terms of our guidance that we presented on the last call, it's just merely the combination of process cooling becoming a part of the HVAC segment. And while that is modestly dilutive to margins, we actually see some nice paths to bring that up, and you actually have a number of actions and initiatives underway that we feel very good about.

Okay. Understood. And how should we think about longer-term growth as you've framed in your 2025 outlook and the margin profile, by your growth platforms of HVAC and then D&M.

So I think let's start with the organic. If you look at the historical organic growth rate, and I'll make a few comments, and I'll put it over to Jamie. If you look at -- since we've had the businesses and spend '15 to '19, let's take out the COVID year, HVAC organically has been around 3.6% organic, which is above our targets of 3%. Detection and measurement, we've targeted at 4%. We've been ahead of that. We've been at 4.4%. And we would expect that to be somewhat consistent with our organic growth rate going forward. We do see more opportunity to accelerate our inorganic growth rate. We've brought in approximately $80 million of revenue over the past 3 years, $80 million a year. If you think about our path to go from $1.250 billion to $2 billion, we see about 1/3 of that being organic, about $250 million and about 2/3 of that being inorganic. And that would be a modest increase in inorganic growth, but we actually feel very comfortable with the traction and the success that we've had to be able to go from, let's say, $80 million a year or 2, I think, in our model, it would be a little over $100 million a year. Jamie, you'd like to add any comment?

Yes, it's a good summary. I'd say the only thing I would add is a couple of things because Gene talked top line, as we look at the margin expansion from organic, we expect to get some -- we've got a lot of CI initiatives going on. It's becoming a centerpiece of our corporate business value system and really our culture. We do believe there's good opportunities to grow the segment margin through things like operational, CI, digital, just managing cost well. And then it's also -- we are going to be very focused as we deploy capital -- to deploy capital, not only in businesses and our segments or platforms that have high growth but also in segments that have good margin profiles. And I think if you look back at the history of the discipline that the company is utilized to buy good and small companies, medium-sized companies, we're able to buy them at a good multiple and then synergize them into a place that increases our margin profile. And that is how we've kind of constructed our 2025 outlook, but we have the balance sheet to do that well. So if you kind of think through all the pieces of the puzzle that are necessary, to hit that 2025 outlook, and we think we've got them in place and can execute against them.

Helpful detail. And one last one, in terms of your inorganic capacity, I mean, you're not going to be constrained in any sense there going forward, following the transaction. Any color you can offer on the current deal funnel and the likelihood of further M&A acceleration this year? Jamie, you mentioned a little over $100 million deployed in the model on a normalized basis going forward. Could we see a higher figure over the near-term post-transaction? How should we think of the weighting by segment in terms of priorities or near-term actionability? And then looking beyond the financial consideration, where again, we can't imagine you'd be constrained at all. Operationally, would there be any restrictions to really accelerate the flywheel '21 into '22?

Yes, Bryan, it's a good question. And what I would say is I actually feel better about our strategy and our pipeline than I ever have. We have very clear road maps in all of our areas in our Cooling business, in our Heating business and our Location and Inspection platform within Detection & Measurement, within our ATON platform in Detection & Measurement, within COMTECH within Detection & Measurement. And what I would say is the 8 acquisitions that we've done have been, I would argue, very strategic and I think they're very aligned with our strategy. And we're really looking for engineered niches with high-technology innovation focus, typically market leadership, a lot of replacement revenue. And I think that the 8 bolt-ons that we've done are indicative in terms of being very aligned with our strategy. As we look forward, we do see a very attractive pipeline to be able to build out both HVAC and detection and measurement. And as we pointed to in our last earnings call, we would draw out how we've done that, location and inspection being an example where we had a $95 million location business. Now we have a $260 million Location and Inspection platform that has a very strong strategic position. Similarly with ATON, where we had a $40 million, $50 million obstruction lighting business. Now we believe we're the global leader in engineered lighting Solutions. And we see some very attractive growth avenues in a lot of different areas. Having said that, obviously, with acquisitions, timing is predicting timing can be hard, but what I would say is we feel good about our -- I actually feel very good about being able to achieve our inorganic goals. And I think we have a lot of momentum. And to put it simply, I think our flywheel is working. We have a really good front end machine on the business development and the strategy side and how we're going to market, but then our SPX business system, how we integrate. We're on our eighth one right now. And the team, we have a really good team in how we do it is it's very structured, very methodical and we feel like we've gotten a strong competence on how to extract value and how to capture the synergies, and we've been achieving our targets across our acquisitions. So yes, I would say, overall, I feel more optimistic than I ever have about our growth trajectory. In terms of timing this year, next year, it is always a little bit hard to be completely predictive there, but I actually feel good that we have some good levers for growth there. And I would anticipate us -- I would anticipate you'll be seeing some activity over the next 12 months various activities going on.

It's great to hear.

Our next question comes from the line of Steve Ferazani with Sidoti.

Any color you can provide on how this deal came together? And whether you thought maybe there would have been other buyers out there? I don't think it's a business you've really shopped, right?

So, Steve, this is one that, as we've talked about our strategy over the past several years, we very clearly said our focus is on building our HVAC and our Detection & Measurement business. And that is really where our our focus and our growth efforts have been. As you know, our 8 acquisitions have all been in building out our HVAC and Detection & Measurement. At the end of the day, we work for our shareholders, and we look for how do we invest and build the highest return, highest growth business and we've always said that Transformers is a very good business. It is a very different type of business than our HVAC and our Detection & Measurement. And as you know, at the time of spin, we divested all of our power generation businesses. We thought that was very value-creating for both our core businesses and our trajectory. We feel this will be very value-creating for our enterprise going forward. And I think it's very value-creating for the Transformers business. They will be joining Prolec GE and this will be their core business and their core focus and their core effort. And I think businesses enjoy that, and they want to be a part of that, so yes. So I'd say we're very pleased with the outcome here. And we think it's going to deliver a lot of value for us going forward.

Yes. So again, did you think there would be another buyer out there that you might have pursued? Or how did you settle on this before more actively shopping?

Yes. And we have in our press release, you'll see, JPMorgan was our adviser. We did have a process going on here and we did talk to a lot of people here, both in terms of strategics and private equity buyers during this process.

Okay. And any thoughts on the regulatory process for approval?

We feel good. I think it's subject to regulatory approval, like all deals, but we have done a lot of work on that, and both teams feel comfortable with where we are. We do have to go through that process. And it's a normal part of the process, but yes, we feel comfortable with where we are.

Okay. And then just from a modeling perspective, any idea how much this takes out of your annual Capex?

Approximately $5 million.

[Operator Instructions] Our next question comes from the line of Walter Liptak with Seaport Global.

Congratulations on the transaction. So just a similar question to the last one. I wondered about corporate expenses. Does this divestiture change anything in that line?

Walt, this is Jamie. I'll take that one. Obviously, by the math, our operating margins are flattish, down ever so slightly in the short term. That's something we're going to manage very closely. We're always going to look to optimize those costs. If you go back to the strategic framework of why we did this, we sold this business in order to grow. And so in the short term, there will be some descaling that occurs while we reinvest, while we actively reinvest, we think in the intermediate and especially the longer term, the use of that capital as well as the balance sheet capital we already had. We think we have a lot of opportunity. And with that opportunity, at the top line or the segment income line comes the opportunity to scale. And so as you look at our 2025 outlook numbers, you see a fairly significant scaling that takes place at the operating income margin line that is the very specific goal we have. And as a management team is an accountability that we have to manage for the company and for the shareholders. And so in the short term, there is some descaling. And in the intermediate and long term, we expect that to be scaled very nicely to produce some good bottom line results.

Okay. Got it. And I wanted to ask too about the -- you called out the buyback that there's a buyback in place, but it wasn't increased. So I guess a question could be in that new guidance of $2.17 to $2.37 are yet assuming execution on part or all of the existing share repurchase?

Yes, great question. And we included that really as a reminder, you think are the exact words we used. And we did wanted to remind the audience in the market that was there. We don't have specific plans to execute that. There's no numbers included in the guidance that says we're going to execute a certain amount. But from a management team, we're trying to deploy capital in the most effective way. It is something that will be on the table for us to watch closely. We don't have a specific plan today, but it is a reminder for ourselves and reminder for the market that it is there. And if the circumstances warranted, we could execute against that.

Okay. Great. And the divestiture changes, the business mix, and I guess there should be some sort of a revaluation. I wondered if you could help us think about other diversified industrial companies that you guys admire or that you think of now as peers that we could use for our public valuation purpose.

Yes. Walt, I'll -- again, I think we're not -- I think even has to come over here on assertation of how they value companies, but what I would say what we most commonly hear from investors or other people. Our HVAC segment is pretty clear. There is a pretty good group of benchmarks there in the HVAC segment. If you look at the classic guys that compete in there, the carriers, the Otis's, the JCIs, there is a population of HVAC companies that we typically get compared against. On the other side, our Detection & Measurement, I would say, that is a somewhat unique business, but it has very similar characteristics to a number of businesses that we've been compared to. I do know a number of our investors think of that very much as an AMETEK or an IDEXX or a Nordson type of business where you have niche leadership positions in engineered markets. And so there are some similarities there. So I would say most commonly it would be the detection and measurement. There's a population there and then an HVAC, there's a population there. Jamie, you'd like to add or Paul, anything you'd like to add in terms of how people see us through this lens.

No, I think that's right, seen that people tend to look at us on many investors and many analysts that we talk to look at us on more of a sum of the parts basis and do use a wide range of tiers. It is a little bit harder to narrow it down for D&M, obviously, than it is for HVAC just given the diversity of the businesses there.

There are no further questions in the queue at this time. I would now turn the call back to Paul Clegg for closing remarks.

Okay. Thank you, everybody, for joining us. Appreciate your participation and look forward to catching over to you again very soon.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.