Earnings Call Transcript - SPXC Q3 2024

Operator, Operator

Good afternoon, and welcome to the SPX Technologies Q3 2024 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Paul Clegg, Vice President, Investor Relations and Communications. Please go ahead.

Paul Clegg, Vice President, Investor Relations and Communications

Thank you, operator, and good afternoon, everyone. Thanks for joining us. With me on the call today are Gene Lowe, our President and Chief Executive Officer; and Mark Carano, our Chief Financial Officer. A press release containing our third quarter results was issued today after market close. You can find the release and our earnings 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 and discussion of GAAP results in the press release and to follow along with the slide presentation during our prepared remarks. A replay of the webcast will be available on our website. 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 largely focus on adjusted financial results and comparisons will be to the results of continuing operations only. You can find detailed reconciliations of historical adjusted figures from the respective GAAP measures in the appendix to today's presentation. Our adjusted earnings per share exclude acquisition-related costs, nonservice pension items, mark-to-market changes, amortization expense and other items. Finally, we will be meeting with investors in various events during the fourth quarter, including at the Baird Global Industrial Conference on November 13, the Wolfe Research Conference on December 4 and the Sidoti's Small Cap Conference on December 5. And with that, I'll turn the call over to Gene.

Gene Lowe, President and CEO

Thanks, Paul. Good afternoon, everyone, and thank you for joining us. On the call today, we'll provide you with an update on our consolidated and segment results for the third quarter of 2024 and discuss our outlook for the remainder of the year. Our Q3 results reflect solid revenue growth and substantial increases in our key profit measures. Our margin performance was strong across both segments and we continue to execute on our key value creation initiatives, including sustainability and continuous improvement. We are well positioned to achieve our full year guidance, which reflects a year-on-year increase in adjusted EBITDA of approximately 35% and an increase in adjusted EPS of 28%. Turning to our high-level results. For the third quarter, we grew revenue by 7.8%, driven by strength in HVAC cooling. Adjusted EBITDA increased approximately 27% year-on-year with 320 basis points of margin expansion. As always, I'd like to update you on our value creation efforts during the quarter. On the sustainability front, we recently published our annual sustainability report reflecting another year of progress across our key initiatives. In particular, we achieved a 30% reduction in carbon intensity well ahead of schedule, and introduced several new climate-conscious solutions that help to reduce our customers' power usage, emissions, and water usage. We also continue to see progress in our continuous improvement initiatives, including benefits from significant capital investments in equipment and processes that add to production capacity by improving throughput. We've continued to see incremental margin gains as a result of investments to improve efficiency. And now I'll turn the call over to Mark to review our financial results.

Mark Carano, Chief Financial Officer

Thanks, Gene. Our third quarter results were strong. Year-on-year, adjusted EPS grew 31% to $1.39. For the quarter, total company revenue increased 7.8% year-on-year. Organically, revenue grew 3%, while acquisitions drove an increase of 4.4%, with FX as a modest tailwind. Consolidated segment income grew by $22.2 million or 24.2% to $113.8 million, while segment margin increased 310 basis points. For the quarter, in our HVAC segment, revenues grew 15.9% year-on-year. On an organic basis, revenues increased 9%, driven by continued strength in cooling demand, while heating was similar to the prior year. The acquisition of Ingenia and our cooling platform contributed growth of 6.8%, while the FX impact was nominal. Segment income grew by $21.7 million or 37.2% while segment margin increased 370 basis points. The increases in segment income and margin were due to operating leverage on higher organic cooling sales and the Ingenia acquisition. Segment backlog at quarter end was $438 million, up modestly from Q3. For the quarter in the Detection & Measurement segment, revenues decreased 7% year-on-year. FX was a 0.8% tailwind. The decrease in revenue was driven largely by lower contract sales associated with the large pass-through project delivered during 2023 and into the first quarter of 2024. Excluding the pass-through project, revenue grew approximately 3%, driven by transportation and AtoN project sales. Year-on-year segment income grew $0.5 million and margin increased 190 basis points, driven by a more favorable project mix. Segment income margin also continued to benefit from our efforts to enhance the efficiency of our segment structure. Segment backlog at quarter end was $193 million, down 5.8% sequentially from Q3, reflecting the timing of certain project deliveries and awards. Turning now to our financial position at the end of the quarter. In Q3, we had cash of $129 million and total debt of $738 million. Our leverage ratio, calculated under our bank credit agreement, was 1.4x. We now anticipate our leverage ratio declining to 1.2x or lower by year-end, below our target range of 1.5 to 2.5x, assuming no additional capital deployment. Adjusted free cash flow for the quarter was approximately $61 million. During the quarter, we amended our credit agreement to double the size of our revolving credit facility to $1 billion in order to better match our increased size and growth opportunities. Moving on to our guidance, we are maintaining our full year guidance for adjusted EBITDA and adjusted EPS. We are narrowing the range of our HVAC revenue guidance to $1.365 billion to $1.385 billion, reflecting year-on-year growth of 22.5% at the midpoint. We are also slightly narrowing our range for HVAC margin guidance while maintaining the midpoint of 23.5%, a 260 basis point increase year-on-year. In D&M, based on our year-to-date performance and outlook, we are increasing our margin guidance to a range of 21.25% to 22%, raising the midpoint to approximately 21.6%. This represents a year-on-year increase of approximately 240 basis points compared to a year-on-year increase of 210 basis points previously. In total, consolidated midpoint segment income for the company remains unchanged as a result of these adjustments. As always, you'll find modeling considerations in the appendix to our presentation. I'll now turn the call back over to Gene for a review of our end markets and his closing comments.

Gene Lowe, President and CEO

Thanks, Mark. Current market conditions continue to support our outlook. Within our HVAC cooling platform, we continue to see strong demand for our products across several key end markets, including data centers, healthcare, and institutional. In our HVAC heating platform, winter temperatures are a key driver of year-end demand as is typical. In our Detection & Measurement segment, we continue to experience flat global demand in our short-cycle business with regional variations, while project orders remain healthy. Looking ahead, we anticipate ending the year with a solid backlog position, giving us well positioned for growth in 2025. In summary, I'm pleased with SPX's Q3 results, including significant margin expansion in both segments. We're well positioned to achieve our updated full year guidance, which implies 35% growth in adjusted EBITDA and 28% growth in adjusted EPS. We see multiple opportunities to continue growing our businesses both organically and through our attractive acquisition pipeline. Looking ahead, I remain excited about our future. With the right strategy and a highly capable, experienced team, I see significant opportunity to continue driving value for years to come. And with that, I'll turn the call back to Paul.

Paul Clegg, Vice President, Investor Relations and Communications

Thanks, Gene. Operator, we will now go to questions.

Operator, Operator

Our first question will come from Ross Sparenblek with William Blair.

Ross Riley, Analyst

Strong HVAC order growth during the quarter with the Dodge index continuing to climb, and all the work you guys have done to streamline the sales process. How should we think about the sustainability of the 2024 growth rates into 2025? Is it a fair base case to underwrite mid-teens for cooling and still double digits for the overall business?

Paul Clegg, Vice President, Investor Relations and Communications

First of all, I want to be careful. We don’t get into a discussion about 2025 too early. I think we've had a strong year here with respect so far with respect to organic growth on the cooling side. We benefited from some of the acquisitions that we've done as well. Obviously, we've also done some significant throughput improvements that expanded our capacity. Yes, I'd say largely, as we look into next year, we feel good about the strength of those markets that have benefited us this year. We’re looking at data centers, healthcare, and institutional. From the cooling side, I'd say we still feel pretty good about where we stand.

Ross Riley, Analyst

I understand in 2025. Maybe I'm just trying to understand the timing of when we should expect order flow from the recovering Dodge index to hit your books if it hasn't already. Is more to come? Or is this already starting to bleed through to the numbers?

Paul Clegg, Vice President, Investor Relations and Communications

I'm not sure the Dodge is a perfect proxy for all of our HVAC business. About 70% of it is replacement, which is not really linked to the Dodge index exactly. So you really need to be thinking about both the replacement dynamic as well as the new build. And then you think about some of these markets that Paul just mentioned, like datacenters, healthcare, institutional, and some of the reshoring we're seeing. The thematic trends there really haven't changed. They continue to be strong markets. And we see those continuing through the fourth quarter and in the next year.

Ross Riley, Analyst

Fair enough. And maybe just on the boiler side, it was a little surprising to see flat growth just kind of given the new product launches and share gains you guys have seen there, and some of the intra-quarter read-throughs we've seen from at least the commercial side. Is there anything we should read into the fourth quarter as we look at seasonally low comp for residential?

Gene Lowe, President and CEO

I think it was a slower start to the heating season this year than we had initially anticipated. This, in conjunction with the fact that really the lead times in our business and our boiler business have kind of normalized. Last year, they were still at longer than normal lead times. We're seeing distributors manage their inventory levels a little more prudently than perhaps they have in the past. So really, at the end of the day, it's largely driven by the weather dynamics, and we just haven't seen the heating season kick in yet. As you know, once it does, it can concern quickly. This is an 80% replacement business. So that business will really start to ramp up once you see the weather dynamics shift. With respect to our guidance, we've adjusted it to take into account the delayed start to the heating season.

Paul Clegg, Vice President, Investor Relations and Communications

You do mention the residential versus commercial. I think we are stronger on the commercial side. I think residential, which is a much more replacement market is where we are seeing all the flatness.

Bryan Blair, Analyst

I'd like to dig in on Detection & Measurement, starting with your run rate business. Just your team's perspective on sustainability of demand and perhaps near-term inflection. The commentary on the slides, I may simply be reading into this too much, but flattish, you actually said in the script, flattish global demand in terms of run rate? Is there anything that we should read into there? And in terms of regional variation, what is your team seeing currently? Looking forward in terms of project business, you've been very consistent in citing healthy underlying demand, infrastructure spending being on the horizon? How should we think about the setup for project activity and perhaps catalysts going into 2025?

Gene Lowe, President and CEO

I wouldn't read too much into that word. I think that in general, the run rate has been flattish with very, very modest growth. There’s regional variation. At a company level, we're approximately 85% North America and about 15% equally split in Europe and Asia. I'd say the two areas that appear to be soft would be China and Continental Europe. But our relative revenue there is fairly small. In North America, the U.K., Southeast Asia, and some other regions, I would say the U.S. is holding pretty steady. Overall, we're cautiously optimistic looking into 2025. We want to be careful about not giving 2025 guidance. However, the project activity is healthy. There are a lot of large projects we are bidding on. The big thing to keep an eye on is when those will actually come to fruition. We have some very large projects that could start in '25 and others that could start in '26.

Bryan Blair, Analyst

Appreciate the color. Maybe for a quick update on your M&A pipeline. Can you frame your team's confidence in executing a deal over the coming quarters? Speak to the composition of your pipeline. With your leverage moving below the targeted range, having expanded your credit facility to $1 billion, are there potential deals that would utilize that capacity? Or is it simply flexing to the scale of current operations?

Gene Lowe, President and CEO

You're spot on. Our business generates a significant amount of cash. I do think one thing is our EBITDA has expanded somewhat. When we got our revolver in place, EBITDA was almost well below half of what it is today. So part of it is just getting the appropriate size of the revolver with our strategy. We feel very good about that. But having said that, we actually feel optimistic about our pipeline. The activity level is very strong on the M&A side, both on the D&M side and the HVAC side. There’s a good level of activity. I feel optimistic about what we're seeing over the next 12 months in terms of the ability to keep building out our platforms. We see intriguing opportunities on the location and inspection side, on the content side, on the transportation side, and in HVAC, we see good opportunities in engineered air movement and cooling in those segments. It feels like there's a lot going on. With our new revolver and our relatively low debt-to-EBITDA ratio, we do have the dry powder to grow.

Damian Karas, Analyst

It's been a long few weeks. Maybe just a couple of follow-up questions on D&M here. I just want to make sure, first, I heard correctly that you had a single project that had a 10-point impact on the quarter and otherwise, D&M would have been up 3% organically. Did I hear correctly?

Paul Clegg, Vice President, Investor Relations and Communications

Yes, you did. We're giving you the math without the pass-through projects that delivered in the prior year. In our communication technologies business, we had a large pass-through project with lower than typical margin associated with it, and that delivered through last year and into the first quarter of this year. That's tended to skew our results all year. As we do the year-over-year comparisons, we just gave that math.

Damian Karas, Analyst

The margin seems pretty strong, considering sales were off 7% versus last year. Could you give us a sense of the mix impacts related to that stronger margin? How much would that have been versus just kind of the operating initiatives that you've been working on?

Paul Clegg, Vice President, Investor Relations and Communications

It's really a mix of both. We have been very intentional around the segment as we pulled it together and looked for operational efficiencies and opportunities to drive margin, whether that's across sourcing or IT, all sorts of initiatives related to bringing all these businesses together under one roof or segment. We also had a favorable mix of projects in the quarter from a margin perspective. These projects execute and have a variety of margin profiles. In Q3, we had a slightly higher margin profile than we initially anticipated.

Gene Lowe, President and CEO

The team has done a nice job driving margins. If you look at last year versus this year, the actions they’ve taken on productivity, pricing, and some different synergy areas have been very beneficial. It's really nice to see the progress they're making.

Paul Clegg, Vice President, Investor Relations and Communications

We obviously raised our midpoint guidance for D&M for the year as well, reflecting many of those activities. The midpoint is now 21.6%, which is up from 1.5%.

Damian Karas, Analyst

I wanted to ask about the updated guide for the year. Just the range seemed pretty wide for just one quarter left. Anything to read into that?

Paul Clegg, Vice President, Investor Relations and Communications

It's just the timing of projects. We've had a fair number of chunky projects this year. As we look at the timing of those, that's caused us to revisit which ones fall into which quarter during the year. On average, we feel really good about where we are going into the fourth quarter. The midpoint implies revenue in the mid-150s and a healthy margin.

Walter Liptak, Analyst

I wanted to ask about HVAC, just the cadence of orders. It sounds like some of the data center and health care is doing fine. I wonder if you could talk about the order cadence there. With the boilers, the weather has clearly been a lot warmer this year, and you don't have supply chain issues from last year. What is normal for boilers? When do you usually start seeing your distributors take up boiler inventory?

Paul Clegg, Vice President, Investor Relations and Communications

Typically, we were expecting to see some of that start in September. We did not see much of that. Distributors held off as the lead times have come down to just-in-time levels. With warm weather, they can save a little on their inventory management. You should start to see that in the winter months. At this point, it's still warm in October, and we've accounted for that in our guidance for the fourth quarter. We're forecasting one of the lowest levels we've seen in close to the last decade, with the exception of last year, which was particularly weak. We’re still expecting some year-over-year growth in the fourth quarter in heating. Last year was particularly weak due to both the warm weather and destocking in a post-COVID environment.

Walter Liptak, Analyst

Great. And then the cadence of orders for data centers and health care?

Gene Lowe, President and CEO

Overall, we're feeling very good about what we're seeing there. In healthcare, the biggest opportunities are Ingenia and customary handling, which are receiving some nice awards, even booking into '26 with very long lead times. Data centers remain strong across all three regions. In the U.S., we have nice projects in Europe and Asia as well. The progression is good, with institutional markets like schools, governments, and universities showing a good amount of replacement activity that seems very healthy as we look ahead to '25.

Bryan Blair, Analyst

Switching over to D&M, you guys called out AtoN. I can't remember if that was in a good trend in the second quarter too. I wonder if you could just talk about AtoN and what you're seeing there, any kind of order funnel or project visibility you might have.

Gene Lowe, President and CEO

AtoN has had a very good year. We're pleased with the progression this year, both in top-line growth and margin growth. The majority of that is run rate. We have a very global business serving many regions and we believe we're the global leader. We're very pleased, and there's nothing that signals any follow-up.

Steve Ferazani, Analyst

I just wanted to check in on capacity additions. I know the plan was to expand with Ingenia. Where is that progress in terms of your ability to grow that business beyond the current market it serves?

Gene Lowe, President and CEO

It's very positive. One way to look at it is how much we're getting out each quarter. We've had nice expansion in Q4 and expect more growth next year. It’s a good situation to be in with a high level of demand, and we’re getting the product out through automation and robotics. It's a smaller business than our cooling products, but it’s seeing nice growth, and we expect year-over-year growth from '24 to '25.

Steve Ferazani, Analyst

Are you where you need to be with Marley now? Is that expansion completed? Do you have plenty of room to run on that side?

Gene Lowe, President and CEO

That’s gone exceptionally well. It's driven more margin and throughput, which has been very positive. We've brought our lead times back to very competitive levels and we believe we're at or below our two primary competitors. We feel good about those investments with more runway going into '25.

Steve Ferazani, Analyst

You mentioned industrial reshoring again. Do you have any sense of where we are with that? Are you still seeing demand coming from additional reshoring?

Gene Lowe, President and CEO

There are projects there. Once something reshores, it's not necessarily a one-time thing. If you bring a car plant or semiconductor plant here, you get cooling towers and those need to be maintained. It’s not a one-time project; it expands the TAM and aftermarket services. There are still projects we're working on. A few have slowed down, particularly with electric vehicles, but those represent a small percentage of our overall revenue.

Steve Ferazani, Analyst

Obviously, another very strong cash flow quarter. Is the intention to pay down debt in the near term until some deals come up?

Paul Clegg, Vice President, Investor Relations and Communications

Yes, that would be our intention in the near term to continue reducing outstanding debt until we have a transaction.

Operator, Operator

Our next question will be a follow-up from Damian Karas with UBS.

Damian Karas, Analyst

I wanted to ask you, I didn't hear the word hurricane mentioned. Obviously, you guys are headquartered in the Carolinas and have facilities in the Southeast U.S. here. Were there any impacts in the quarter from the two hurricanes we've had recently? Considering your solutions, particularly in D&M, do you see any potential uplift activity from some of the rebuild and restoration post-storm?

Paul Clegg, Vice President, Investor Relations and Communications

We did not get impacted by the hurricanes directly. None of our facilities were affected. One was in line in Florida with our business, but it wasn't impacted. Fortunately, we didn’t face any issues. Regarding your second question, we haven’t seen meaningful activity with respect to damage caused by the hurricanes for replacement activity, but it's early days.

Gene Lowe, President and CEO

We sometimes have weather events where we see more industrial area activity for cooling towers and fan stacks. We're working to identify how we can support, but so far, we haven’t seen anything materially significant.

Damian Karas, Analyst

I wanted to ask you about nuclear, which has become quite topical all of a sudden in the investor world. I know your business has a solid position in some areas of nuclear power generation. Could you speak to the potential opportunity there for SPX?

Gene Lowe, President and CEO

It’s a net benefit for our power business, with our process cooling. The majority of the cooling towers in nuclear facilities are provided by our services. We do service work and provide OEM parts. Whether upgrading cooling towers to increase output is beneficial against the growth of data centers will increase grid pressure. New capacity takes time to come online. While you may see some activity on new plants, larger projects, such as modular nuclear reactors, typically reach out to us for cooling towers. This is an emerging opportunity, but material impact may take a couple of years.

Operator, Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Paul Clegg for any closing remarks.

Paul Clegg, Vice President, Investor Relations and Communications

Thank you all for joining us. We look forward to updating you again next quarter and seeing many of you at conferences and one-on-ones throughout the quarter.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.