SPX Technologies Inc (SPXC) 2007 Q3 法說會逐字稿

Good day, everyone. Welcome to the SPX Corporation third quarter 2007 performance conference call. Today's call is being recorded.

At this time for opening remarks and introductions, I'd like to turn the call over to Mr. Jeremy Smeltser. Please go ahead, sir.

Thanks, Melissa. Good morning, everyone. Thank you for joining us.

With me on the call this morning are Chris Kearney, Chairman, President and CEO of SPX, Patrick O'Leary, our Chief Financial Officer, and Don Canterna, President of our Flow Technology segment and an officer of SPX.

This morning's call is being webcast with a slide presentation which can be accessed on our Web site at www.spx.com in the Investor Relations section.

This webcast will be available until November 14th. 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. News releases for our Q3 earnings and the APV acquisition can also be found on our Web site, and we expect to file our Form 10-Q by November 9th.

Before we continue, I would like to point out that portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. I would also refer to you the risk factors in our SEC filings. Additionally, we will include proposed terms of the APV acquisition, expectations on the timing of closing and preliminary financial estimates.

Keep in mind that these statements are subject to a number of risks and uncertainties that could cause the actual results or events to differ materially from those suggested or indicated by such forward-looking statements. These risks include the impact of future market conditions, the uncertainty of regulatory approval of the acquisition, the party's ability to satisfy the merger agreement conditions and consummate the transaction, and SPX's ability to successfully integrate APV with our existing flow technology business.

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

Thanks Jeremy, and good morning, everyone. Thanks for joining us.

We're pleased to present our 2007 third quarter results today. In addition, we've reached an agreement to acquire APV, a division of Invensys, for a purchase price of 250 million British pounds, the equivalent of approximately 510 million U.S. dollars. We'll provide details of the proposed transaction later in the presentation.

I'll begin this morning with the key financial highlights of the quarter and an overview of the APV acquisition. Don will then present the strategic benefits of the acquisition and Patrick will provide you with a financial update. After we conclude we'll be happy to take your questions.

Our consolidated third quarter results were significantly stronger than Q3 last year. Reported earnings per share were $1.71. This included two large tax benefits that totaled $0.35. Excluding these tax benefits, earnings per share were $1.36, up 56% year-over-year.

Strong operating performance was the primary driver of the increased earnings. We reported organic revenue growth of 13% and consolidated segment margins expanded 20 points over last year.

During the quarter we completed our most recent 10b5-1 share repurchase plan. In total, we have repurchased 9 million shares of SPX stock year-to-date at an average price of just under $80 per share.

Additionally, we have committed to a plan to divest the air filtration product line in our Flow Technology segment. The results for this business have been classified as a discontinued operation in all periods presented.

Based primary on our Q3 performance and the completed share repurchases, we're raising our 2007 adjusted EPS guidance range to $4.70 to $4.80 per share.

Taking a closer look at the consolidated results, total revenue was $1.2 billion, up about $200 million, or 19% over Q3 last year. This excludes air filtration revenues of $25 million that were included in our previous targets.

Organic growth was 13%, primarily driven by global demand for power and energy infrastructure. Our Thermal segment reported 28% organic growth, and Industrial grew 20% primarily on the strength of the global power market. Acquisitions and foreign currency gains combined to contribute about 6% revenue growth.

Segment income increased $29 million to $166 million, 21% better than Q3 last year. This included a charge of $7 million recorded as a result of an internal audit at an operation in Japan. Patrick will discuss the details of this charge.

Similar to the second quarter, strong operating performance at our Flow, Thermal and Industrial segments offset a decline in our Test and Measurement segment. In total, margins were better than expected at 13.5%, a 20% increase over the third quarter last year and up 170 points from Q2.

As I mentioned, adjusted EPS was up 56% over Q3 last year. Increased segment income was the primary earnings driver, accounting for $0.30 of improvement.

Excluding the tax benefit of $0.35, the effective tax rate for the quarter was 31%, down significantly from last year's adjusted rate of 39%. This increased earnings by $0.16 over last year. The lower share count contributed $0.09 of earnings.

Free cash flow was $19 million for the quarter, down from last year. This decline was primarily due to the timing of increased investments in working capital to support the strong growth. We remain comfortable with our full-year free cash flow target range of 260 to $300 million.

On a consolidated basis, we exceeded all of our operating targets and are very pleased with the continued growth and improvement.

Through nine months the business has delivered solid top line growth and margin improvement. Total revenue increased 19% and segment margins expanded 80 points versus the first nine months of 2006. The key drivers have been strong market demand and our continued focus on the operating initiatives.

Earnings per share increased about 65% year-over-year. In addition to improved operating performance, the reduced share count and tax rate also contributed to the increased year-to-date earnings.

Looking at our end market environment, global investment and infrastructure, our largest end market, remained strong particularly in emerging and developing regions. Power and energy infrastructure and processed equipment demand are our largest growth drivers.

And as expected, the North American automotive service market remains challenging. Quoting and bidding activity for thermal equipment and services is strong despite a decline in the backlog.

The backlog at this segment was $1.1 billion at September 30th, down 7% from the end of June. The decline is due to the significant Q3 revenue growth at Thermal and the timing of signed contracts. Contracts for our thermal projects can be as large as 50 to 1$00 million causing some unevenness in the quarterly backlog development.

The backlog for our flow products increased $50 million, or 13% from the end of June. It is at $433 million, an all-time high.

We believe our core markets will continue to provide solid organic growth over longer-term. Additionally, we have a robust acquisition process focused on identifying opportunities to enhance our growth capabilities in these core areas. From 1997 to 2004 SPX grew rapidly through acquisitions.

When I became CEO at the end of 2004, we narrowed the focus in our approach. Our number one criteria for an acquisition is strategic fit with our core business and the long-term vision for SPX. In addition, we evaluate acquisitions based on our financial criteria which include being accretive to earnings and returning greater than our cost of capital.

Over the past three years we have demonstrated the patience to find the right transactions and the ability to execute on opportunities that meet these criteria. Recent acquisitions have been focused on expanding our Flow and Test and Measurement segments. Each acquisition has significantly increased our global presence.

APV will be the fifth and largest acquisition we've made since 2005. It meets our acquisition criteria, and we're excited about the strategic opportunities that it adds to our Flow business. We expect that over time it will exceed our financial hurdles.

For those of you who aren't familiar with APV, let me give you a brief overview. APV is a division of Invensys headquartered in the U.K. with about 3,000 employees worldwide.

It is a global manufacturer of processed equipment and engineered solutions primarily for the sanitary market. Key products it manufacturers include pumps, valves, homogenizers and heat exchangers. For the year ending March 2007 APV reported revenue of approximately $800 million and operating margins of about 4%.

We'll provide more detail for you on expected future performance when we give annual guidance in January.

APV is a strong strategic fit with our Flow business in many respects. It will add critical mass and expand our global presence. APV's product offering is very complimentary to our existing product base and has a strong brand name.

With the combination, we will significantly increase our presence in the global sanitary market. We do this as an attractive market for growth over the long-term. From a manufacturing perspective, the acquisition increases our local footprint in China and adds low-cost manufacturing in eastern Europe.

We believe the combination of APV with SPX's flow technology will unlock significant revenue and cost synergies. Nearly 75% of APV's revenue serves the sanitary market primarily for food, beverage, dairy and pharmaceutical processing. In addition, it adds 16% exposure to general industrial applications and 11% to the power and energy market.

From a geographic perspective, over 50% of APV's sales are into Europe and the Middle East and Africa. Nearly a quarter of its sales are into Asia Pacific and 20% into the Americas. APV's exposure to the sanitary market and its global presence are very attractive and complementary to our Flow business.

Looking at the combined end markets, the global sanitary market will be Flow Technology's largest served market at over 40% of revenue. Historically, the sanitary market has been our most stable growth market. We believe that will be the case over the long-term, particularly on a global basis.

Increased standards of living around the world, especially in emerging markets, leads to more processed food and beverage consumption.

Global Industry Analyst Incorporated issued a report last year on the food processing machinery and equipment business. They estimate the global investment for food processing equipment this year to be nearly $37 billion. They predict this market to expand at a 5% annual growth rate from 2007 to 2010.

This would increase the global market size to $43 billion. The highest growth region is expected to be Asia Pacific at 7%. Europe and the U.S. are predicted to grow at about 3.5% over the same time period.

In addition to the near-term growth potential, we also like this market because it's stable and typically regulated by government authorities. We also believe that heightened standards in developing markets will be a driver of future growth.

Looking briefly at APV's financial history, you can see that it has experienced strong revenue growth. Excluding the impact of foreign currency gains, revenue has grown between 8 and 9% over the past two years, similar to our own Flow segment. APV has operating margins significantly lower than the 16% we're targeting in our Flow segment this year.

With a strong track record that Don and his team have with integrating businesses and the underlying fundamentals of APV, we believe there is significant opportunity for operating margin improvement. Many of you have had the opportunity to meet Don and his team and see their accomplishments at our Flow open house investor events.

For those of you who haven't, here's a brief snapshot of his professional career. Don joined SPX with the acquisition of United Dominion in 2001. We have continued to increase his responsibilities since that time. His businesses continue to show improved operating performance and they are an internal benchmark for SPX in lean manufacturing.

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

Thanks, Chris. Good morning, everyone.

As Chris mentioned, we've successfully integrated businesses in our Flow segment over the last five years. When SPX acquired United Dominion in 2001, the main strategic overlap between the businesses was the Flow segment.

From 2002 through 2004 we integrated the legacy pump, mixer and valve product lines into what we refer to today as SPX process equipment. In 2005 we were given responsibility over all of Flow Technology which included the dehydration and filtration businesses.

At the end of last year we acquired Johnson Pump. The integration of Johnson Pump into processed equipment is moving faster than expected. Margins have improved sequentially each quarter, and the revenue synergies have been better than we originally anticipated.

Our financial performance has improved significantly over the last three years. Organic revenue growth has been between 8 and 10% and with expanded operating margins about 200 points to almost 16% while integrating two lower margin acquisitions. So as you see, we've been in this position before and have proven the ability to deliver positive results.

APV will be dilutive to margins in the near-term. We believe there is significant opportunity for improvement. The acquisition nearly doubles our revenue base to just under $2 billion.

In addition, you can see that the revenue base continues to expand overseas. Over 60% of sales from the combined businesses come from the outside the Americas. 44% of our revenue will be coming from sales in Europe, Africa, the Middle East, and 17% into Asia Pacific.

This continued global expansion positions us well to serve growing markets around the world. APV has localized manufacturing in a number of regions including emerging and developing markets. In fact, its manufacturing footprint is located in regions similar to our existing business.

In Europe it has plants in Germany, Denmark and Poland. It has a facility in Shanghai, China, and in the Americas it is located in Wisconsin, North Carolina, and Brazil.

The acquisition will provide a natural opportunity to optimize the global footprint of the combined business. Additionally, it increases our local presence in China and adds low-cost manufacturing in eastern Europe.

Moving on to APV's products, like our Flow business, the majority of APV offerings are engineered products. We expect the leverage combined R&D and engineering expertise to maximize the quality of the products and solutions we are providing to our customers. APV has a very strong brand name globally with a solid market reputation and its products are very complementary to our current flow offerings.

Chris has spoken in the past about our initiative to expand into adjacent space. This is a great example of that expansion. APV's products will fill in niches where we currently have little or no presence and enable us to offer a broader range of solutions to our customers.

We expect a significant top line opportunity from leveraging combined global distribution and marketing efforts. Similar to Johnson Pump acquisition, we plan to pull products through the combined distribution channels.

We should also benefit by combining the complementary areas of excellence between the two businesses. Our current confidence includes lean manufacturing and operational expertise, strong component engineering, and strength in North American distribution.

APV will add increased R&D strength, strong solutions in systems engineering and more mature global sales infrastructure in distribution network. We believe this is a great strategic fit with significant opportunity to improve operating efficiencies at APV facilities and expand our Flow business.

At this point, I'll turn the call over it Patrick to provide you details of the proposed transaction and expected financial impact.

Thanks, Don. Good morning, everyone.

I'm going to start out with the capital allocation impact of this transaction. We believe this acquisition makes sense economically and meets our financial criteria.

The total purchase price, as you heard, is 250 million pounds. This translates into approximately $510 million. This is about 10 times trailing EBITDA before synergies.

We anticipate this transaction will close late in the fourth quarter and are planning to fund it with cash and incremental borrowings. There will be no equity issuance.

The projected growth leverage is approximately 2.3 times gross debt to EBITDA. This is modestly above our target leverage of 1.5 to 2 times. As we said previously, when we are above two times leverage, we will focus on reducing debt.

With future free cash flow dedicated to debt reduction, along with projected EBITDA expansion, we expect to be back below two times leverage early in 2009. This transaction will have only a moderate impact on our balance sleet and we expect to maintain flexibility to grow in our other core areas of business.

We expect there to be a significant but gradual financial impact from the combined cost and revenue synergies and expect to reach our target annual synergies within two to three years. The primary synergies we expect to benefit from are streamlining global presence and leveraging localized manufacturing infrastructure, implementing lean manufacturing best practices, leveraging combined spend with suppliers, and leveraging the combined distribution channels.

On an annualized basis, we expect these synergies to yield between 40 and $60 million of benefit to operating income, achievable within the next three years. We estimate cash restructuring for the integration will be between 60 and $80 million over those three years, and by the end of year three, we expect to have the combined Flow segment margins back to the 14 to 16% range, up from a 2007 pro forma margin of around 11%.

In 2008 and 2009 we expect APV to be dilutive to the Flow segment and consolidated SPX reported operating margins. We anticipate roughly half of the 60 to $80 million of cash restructuring will be spent in 2008.

Looking at EPS, we expect no impact on 2007 and in 2008 we expect the acquisition to be neutral to slightly accretive to earnings per share. Keep in mind that the progress may vary on a quarterly basis as we roll out our integration plan.

In addition, GAAP requires us to record acquired inventory at fair market value at the date of closing. As a result the first two quarters of next year will likely yield a net dilution to EPS.

We will provide more details on 2008 in January when we host our annual guidance meeting, and in 2009 we expect the synergy impact from this transaction to yield at least $0.25 EPS accretion.

Looking at the revenue profile on a pro forma basis, the acquisition will increase SPX's 2007 targeted revenue by approximately 17%. This will put our total revenues in the $5.7 billion range with Flow, our largest segment, at about 33% of consolidated SPX. It will also increase our global presence, 50% of our sales will come from outside of North America.

From an end market perspective global infrastructure will remain our largest market at over 50% of the Company, and sanitary will make up about 16% of SPX. As Chris mentioned, we think this is an attractive growth market as well.

Moving onto the segment results for the quarter, I'm going to begin with Flow. As Chris mentioned, we have started a process to sell the air filtration product line after concluding in strategic review that it is not core to the rest of our engineered flow products.

We are treating this as a discontinued operation and plan to complete the sale during the first half of 2008. The results for flow now exclude air filtration for all periods presented.

For the quarter Flow reported revenue of $269 million. That's up 27% from Q3 last year. Strong demand in power, oil and gas, mining, sanitary and dehydration markets contributed to 11% organic growth. The acquisition of Johnson Pump grew revenue by nearly 14% and foreign currency gains were about 2% benefit to revenue in the quarter.

The operating execution in this segment continues to be strong. Segment margins improved 60 points to nearly 17% in the quarter. Orders remain robust and operating execution continues to be strong. Chris mentioned the record backlog going into this quarter.

In the fourth quarter we expect 23 to 24% total revenue growth including about 8 to 10% from both organic growth and the Johnson Pump acquisition. We expect margins to expand 80 to 110 points over last year and be between about 16 or 16.3%.

Our Thermal segment had another exceptional quarter. Revenue grew 32% including 28% organic growth. This is the second consecutive quarter of greater than 30% top line growth. Our global demand for our power equipment products and services was the main revenue driver.

Margins for the quarter were 11.9%. That's up 160 points from Q3 last year. The margin expansion was primarily due to improved operating execution and lean initiatives. We're extremely satisfied with the year-to-date improvement in this segment.

Through nine months our revenue is up $262 million, or about 28%, and segment margins have increased 240 points to almost 9%. We expect operating improvement at this segment to continue in the fourth quarter, and are targeting 11.8 to 12.1% segment margins, an increase of nearly 200 points over last year.

Following two significant growth periods, and in comparison to Q4 last year when we reported 23% organic growth, we are targeting a modest Q4 revenue increase of 1 to 2%. This is primarily due to timing of projects and we expect double-digit revenue growth in Q1 2008.

Moving onto Test and Measurement. As anticipated, it was another challenging quarter for this segment. Total revenue for the quarter was $268 million, down 3% from Q3 last year.

The decrease in revenue was caused primarily by reduced volume of OE and dealer business in North America where we have experienced a reduction of new platform launches and warranty tool sales.

During the quarter we recorded a $7 million charge as a result of an internal audit at an operation in Japan. The audit uncovered employee misconduct and improper accounting entries. The three senior managers of the operation have left the Company.

As a result of this charge, and a difficult North American market conditions, segment margins were down from 15.8% a year ago to 9%. In Q4 we are targeting 1 to 3% revenue growth, and margins between 11.5 and 12%.

We have been investing in European acquisitions to increase our global Test and Measurement presence. We recently acquired the diagnostics division of Johnson Controls based in France and Mantra based in Germany.

Additionally, we have increased our R&D efforts throughout the year. Earlier this year we launched a new vehicle diagnostic tool specifically designed for the Chinese market. We expect these investments to benefit the growth and profitability of the segment over the long-term.

The Q3 results for our Industrial segment continue to be very strong. Revenue grew 21% in the quarter. The growth was nearly all organic with a small benefit from currency.

Spending on power and energy infrastructure is the key theme in this segment. Demand for our power transformers driven by reinvestment in the U.S. power grid and increased reliability standards was the primary growth driver in the quarter.

Segment income increased to $44 million. That's up $20 million, or 80% over Q3 last year. Reported margins were 17.7% for the quarter, up 580 points from 11.9% last year.

Operating leverage from the organic growth and better year-over-year pricing are the main drivers of the margin expansion. Through nine months this segment has grown revenues 17% and has increased margins to 14.6%, an improvement of 380 points over last year. In the fourth quarter we are targeting 9 to 11% revenue growth with segment margins approaching 20%.

Now I'll give you an update on our free cash flow, financial position and capital structure. Through nine months we have generated $64 million of free cash flow. This is down $16 million from last year. During the quarter working capital investments, particularly in accounts receivable were made to support the strong revenue growth of our business.

For the year we continue to expect to deliver free cash flow in our guidance range of 260 to $300 million. This represents at least 100% conversion of net income into free cash flow and an increase of approximately 50% from 2006.

Our financial position remains strong. At September 30 we had $283 million of cash on hand. Net debt was $954 million, and gross debt had increased to just over $1.2 billion.

We have had recent borrowings on our existing revolver to support share repurchases in the short-term. Our debt ratios have increased slightly as a result of those borrowings.

On September 30th our debt to cap was 40%, and net leverage was 1.6 times. Total debt to EBITDA was 2 times going into our strongest cash flow quarter of the year.

From a capital structure perspective we recently entered into a new five-year credit facility totaling $2.3 billion. This is designed to support the Company's global growth and increase our financial flexibility.

The new facilities include a five-year term loan of $750 million, a $400 million domestic revolver, a $200 million global revolver, and a $950 million foreign trade facility. The previous credit facilities were terminated.

In the quarter we recorded a $3.3 million charge to interest expense for deferred financing costs, early termination fees and the unwind of related interest rate swaps. We also entered into new interest rate swap agreements covering $600 million of the variable rate term loan, fixing LIBOR at 4.8%. Our mandatory debt service requirement for 2008 is only $75 million.

Before I turn the call back over to Chris, I'm going to quickly go over the updated full-year model and our consolidated Q4 targets.

We are increasing our full-year 2007 EPS mid-point guidance $0.15 per share to $4.75 per share. We have provided a full model to the EPS mid-point in the appendix. Better than expected Q3 results four our Thermal, Flow and Industrial segments more than offset the impact of the charge taken at Test and Measurement and the discontinuance of air filtration.

On a net basis we expect operating income to contribute $0.05 more than previously targeted. There are also changes to items below the operating income line that you should note.

Our full-year tax rate is now estimated at 32% reflecting the lower Q3 tax rate. Our dilutive share count is now expected to be just over 56 million, and increased interest expense at $68 million for the year.

We are now guiding to adjusted earnings per share in the range of $4.70 to $4.80 per share. This represents over 50% earnings growth from last year.

In our updated model we are targeting revenue growth of approximately 15% driven by continued demand for our infrastructure products.

We are targeting segment margins between 12.4 and 12.6%. That's 60 to 80 points better than last year, and as I mentioned, free cash flow guidance remains at 260 to $300 million. We believe the greatest risk to our model is unforeseen declines in the markets for our short cycle businesses.

Looking at Q4, we expect total revenue growth in the range of 7 to 8%, segment income is targeted between 185 and $193 million. That's up at least 12% from last year.

Segment margins are expected to be between 14 and 14.5%. That's up 70 to 120 points over Q4 last year, and earnings per share are targeted to grow about 40% to a range of $1.60 to $1.70 per share.

With that, I'll turn the call back over to Chris for wrap-up.

Thanks, Patrick.

In summary, we're pleased with the progress we made in Q3 and year-to-date. For the year we're targeting 15% revenue growth, 60 to 80 points of margin expansion and adjusted earnings growth greater than 50%. Our financial strength and flexibility have allowed to us repurchase 9 million shares this year and also grow our core businesses through acquisitions.

We believe APV is a solid business with great technology and products. It is an excellent strategic and operational fit with our Flow Technology segment.

There will be a lot of integration work to be done in the near-term, and within the next two to three years we expect this acquisition will have a significant, positive financial impact for SPX. Additionally, we expect global demand for power and energy infrastructure to continue to be a key driver of future growth for our company.

And with that, we'll be happy to take your questions.

(OPERATOR INSTRUCTIONS) We'll go first to John Baliotti with FTN Midwest Securities.

Actually, this is a question for Don if he can address this.

I think the most recent time that we've gotten an update on Flow, Don, you talked about the fact that over the period of time that you've been running it, there hasn't been any increase in core -- any organic increase in physical capacity, but you've increased your output ability by about 50%.

And I'm just wondering, you said one of the things that's enabled you to increase your margins strongly in what might appear to be commodity products is the fact that your customers have outsourced their own engineering to you. And I'm wondering, with respect to APV, is that a dynamic that you think would be incremental to them, the way they think about their business?

APV, John, as we previously mentioned, our strength is in manufacturing and operational excellence. And as you've been through our operations, you've seen that. We have been able to increase our throughput through those initiatives. We still also continue to have a strong engineering base with our businesses.

What APV adds to us is their strong engineering and systems business. They have -- they're leaders in several markets they deal with. Their engineering expertise, their global infrastructure will combine with our operational excellence, and they have, I might also have had a strong initiative in putting products into low-cost manufacturing and improving upon their operational excellence.

So we'll be determining all of this further as we go through our evaluation and integration processes, but we have strong manufacturing, engineering base, and I think that their engineering will help us.

So you think longer term that your base business would, or maybe short-term will benefit from your experience with them as well as your ability to get their margins closer to segment average?

Absolutely.

Okay. Great. Thank you.

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

Good morning, guys.

Hey, Shannon, how are you doing?

Good.

On Thermal maybe you can just talk a little bit through the margin improvement there. I mean, came through nicely, better execution. Can you just flush it out in term of the pieces of the business and what drove the result?

The overall improvement, Shannon, is real a result of the things that we talked about consistently over the past several calls over the last two years. We have had a lot of change in that business starting with the management team and a lot of focus on lean improvements across the world.

The drive business globally is really the main driver of the higher margin. That's the growth engine in the Thermal segment. We expect that that will continue to be the story in this segment.

But I think the important thing to point out is that we have seen operational improvement across the entire business which is encouraging to us and really is a result of hard work that Drew and his team have done.

Okay. Great. Thanks.

And then on Flow, Patrick mentioned biggest risk to the outlook is sort of unforeseen changes in the short cycle businesses. Can you talk about the visibility you have in Flow right now? Obviously, the organic growth is really strong. How do you feel do you feel about the outlook there?

In terms of 2007, we feel very good. As you heard on the call, we're actually operating a record backlog, over $440 million, so at this point in the quarter we have very good visibility to the rest of the year, and it's about execution.

The reality is that the order rate is not showing a sign of changing even through the fairly quiet historical summer periods of July and August. We really have continued to see robust order taking, and frankly, just as important, the quoting activity is still strong, and it's remarkably strong across all of the end markets that we're in. So from the point of view of Flow, we've got a decent line of line of line of sight and positive expectations to achieve the numbers I described.

Okay. Great. Thanks a lot. I'll pass it along.

Thanks, Shannon.

We'll go in this case to Nigel Coe with Deutsche Bank.

Good morning.

Good morning, Nigel.

I understand that the under performance of the margins at APV are largely due to the under performance in their contracting business. I think (inaudible) lost seven large contracts. Is that the case and can you make talk a bit more about that and what gives you confidence that you can turn around that side of the business?

Well, if you look at APV's businesses, Nigel, what's really encouraging to us is that they've got great technology and great products out there. While the OP margins are lower at this time, in the majority of their businesses the gross margins are more in line with ours, which I think speaks well to the quality of the technology that they have in their products.

About a third of their business is systems based with somewhat lower margins, and we're going to need to make some structural and manufacturing process changes to the business which we clearly have demonstrated we're good at, Don's good at. You look at the work that his team has done with the Johnson Pump acquisition and the challenges they've had in integrating that business and the rapid success they've had in seamlessly integrating it and improving margin performance, we believe the same opportunity exists with respect to APV.

So we're going to continue to move the business towards the historical margins that we've tended to have in our process equipment business and we'll be able to discuss this in more detail in our January meeting.

Okay. Great. And just a quick follow-on.

You mentioned cash restructuring costs of, I think, between 60 and 80. Just want to make sure that these aren't P&L costs, that this will be wrapped up within the goodwill.

Currently my expectation under current U.S. GAAP is that the majority of that will in fact be treated as acquisition accounting. However, it's possible that during the integration process we will look at some rationalization of our own activities, and so at this point it's premature to say that it will all be included in purchase accounting.

Okay.

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

Thank you. Good morning.

Good morning, John.

So you've been articulating comfort with the portfolio now for a little while, and then we see, of course you selling your filtration. Has something changed, and what was maybe a little bit of the dynamic behind this a little bit more?

I mean, is it just not, does it not have critical mass? It obviously its profitability isn't very good. Maybe just comment a little bit more on that and then sort of how you're thinking about the rest of the portfolio?

Nothing has really changed, John. What we've said about all the businesses that we own is that we think they're all good businesses, and we think that all of them have improved as a result of our operational improvement focus. I think that's certainly true.

But what we've also said is that the strategic process that we go through in terms of looking at all of our businesses and making decisions with respect to those businesses is dynamic, and it's ongoing. It'll continue to be the case.

What we have done over the last three years is we have shaped this company around these core growth platforms and primarily those that serve the global infrastructure market. I think that strategy has proven to be very effective and has proven to be the right strategy for us.

As we move forward in time, I think you will continue to see us focus on growing those core platforms organically as we have and through the right opportunistic strategic acquisitions as we've demonstrated with Johnson Pump, with CarTool, now APV, with Matra, with JCI. All of those, I think, are very smart, strategic decisions that we think will benefit the growth of those global platforms going forward. But everything is always under review, and it's part of the ongoing strategy.

But, Chris, it sounds like you're saying this was a growth and exposure to infrastructure issue versus anything else with respect to divesting air filtration?

We think that air filtration is a good business, but it's not core to the global growth of our Flow segment.

Okay. That makes sense. I want to ask you about Thermal. You obviously have the refinancing with respect to funding.

Everything you read about and hear about is talking about explosive, it's just explosive growth in power markets in China, you're sorted of scratching the surface in the Middle East. Do you guys have enough capacity to support what could be a very long tail of organic growth in this business for a number of years or are we going to have to start to build things up or do some acquisitions here?

We have a pretty flexible manufacturing base in that business, John, as you know, that has allowed to us adapt quickly to the rapid growth in China, the rest of the Asian market and now the opportunities that we've been executing on in the Middle East. We can and are willing, certainly, to invest capital to support that growth because we agree with your fundamental premise.

I think that is going to continue to be a strong growth driver for our business as we move forward in time, and we can certainly continue to invest capital to support that growth, and I think it'll make sense to do that. But I think we have demonstrated an ability to do that in a very flexible and quickly responsive way that will make sense.

Chris, did Waukesha get better in the quarter and are we looking for prospectively based on the base Waukesha to see deceleration as you move into next year?

I think in terms of our expectation for this year, John, we're looking at about 30% growth in that business. We continue to show a sequential margin improvement as the year developed.

You obviously heard that I'm expecting the segment to be at about 20% return on sales and our backlog also continues to increase in that segment. At the end of September backlog in Industrial was about $632 million.

So I would say at this point we've got pretty good visibility into the transformer business revenue for 2008, and I will defer comments on profitability development until we give guidance in January.

Okay. Just last for me.

The share repo, the 10b5-1 plan now completed, no sort of follow-up commentary. How are you guys thinking about, considering you've done this large acquisition, now the future opportunities with respect to announcing another plan or share repurchase versus just digestion of APV?

I mean, basically I said on the call APV will put us slightly above the target leverage range at 2.3 times. Obviously, improving profitability we're in our biggest cash flow generation quarter.

The sale of air filtration, other cash generation products, we're confident that we will come down fairly quickly back into the target range at which point equity repurchase will be on the table again as a comparison to acquisitions, but for the immediate future our primary focus of our free cash flow will in fact be on bringing the leverage back into the target range of 1.5 to 2 times.

That's fair. I just want to make sure, Patrick, your appetite for share repurchase, these financial considerations short-term aside hasn't somehow diminished?

No, it's simply a question of being faithful to our capital allocation methodology and running the business in the manner that we have previously communicated to our shareholders. Thank you.

(OPERATOR INSTRUCTIONS) We'll go next to Deane Dray with Goldman Sachs.

Thank you. Good morning, gentlemen.

Hey, Dean.

A couple questions first on APV. The first is, and, Patrick, I may have missed this. But when you refer to the 40 to $60 million of annual synergies, did you split that between cost synergies and revenue?

No, I did not.

Could you take a crack at that, please?

I think it's premature for us to do that. I think, though, you can gather from the discussion that we've had that there are both revenue and cost synergies. And the reality is that, as Chris mentioned, their gross margins for most of the business are not, in fact, very much different than our gross margins.

We started in the low 30s and we've moved up closer to the mid-30s, and so you can tell from that that there's an SG&A play here. They've got a footprint across the world, actually, in many respects kind of matches the locations that we're in.

So as the team goes through the detailed integration plan, which we'll be putting together in the next 60 days before close, we will have more to say on synergy and breakout and the timing of synergies when we give detailed guidance for 2008 in January.

Okay. That's helpful.

And then I'm looking at the Invensys APV Web site and just to want make sure I'm clear. They list under products for APV automation products including applications of their Wonderwear process management systems. Is this included in the acquisition? I apologize if that's a dumb question.

They do have -- this is Don Canterna.

They do have an automation portion in their systems. The Wonderwear is licensed from APV, or Invensys, I'm sorry. It does not come with the acquisition.

Since they are heavily integrated, they do have a heavy portion of their business is in systems. Their automation, they gradually migrated to more automation, and so it was a good marriage in the top end portion of it with Invensys. But as you can see, their products also on the Web site show how they synergize with us so very closely, so that's where the positive is.

Okay. So the automation products are not included?

No, they are not.

Okay.

And then that also begs the question about the some of the overlap. Is there the customary antitrust review that we should be expecting?

They're customary regulatory reviews as in any transaction this size, Deane, yes, that's right.

And then, Chris, could you give us a sense of the timing of the transaction, how long you've been interested in the asset and I trust this was a negotiated transaction?

It was a negotiated transaction. Clearly, it has been a company that we knew was a fit with ours, and the time and the circumstances were right for this transaction, and we think it makes all the strategic sense in the world, and we're excited about it, and excited about the future prospects.

And you were able to get to the finish line on the day of earnings?

It was a horse race as it always is. The team has worked hard. The teams actually on both sides, and did a great job down to the wire, and worked out just great for us in terms of timing of this, but we're excited about telling the story.

That falls under the category of heroic (inaudible) on the day of earnings.

I think that's a fair description. I think the effort on the part of both teams in the transaction was in fact heroic.

And just a couple of couple quick questions and I'll pass it on.

On the quarter, and it relates to price. And I know I've asked this question before is, can you quantify how much price contributed to overall organic revenue growth? And then very specifically in the Thermal numbers how much you're getting in price?

In terms of the overall impact, there really isn't that significant. We're basically now operating in an environment of elevated raw material prices where we have effectively, as you can see from the margins, passed most of those along.

I would say the Thermal segment is the segment we've probably struggled with price the most because of competitive bidding process, and we've had a more difficult management process, and I think Drew and his team have done an excellent job moving that forward. We're not specifically publishing pricing by segment for obvious competitive reasons.

I made the comment on Industrial that pricing has, improved pricing has been a factor in improvement. For the rest of the segments I would say basically our pricing activity is in keeping with the price increases that we're getting and that the vast majority of the organic growth you see is actually coming from increased volume of shipments and not pricing and other factors, and obviously, we've broken out separately, completely separately, the impact of foreign exchange.

Patrick, that's very helpful.

In terms of having difficulty getting price in Thermal, would that help explain why the incremental margins at 17% in Thermal are just a little more under whelming than what you would expect given that kind of revenue volume?

No, I mean, I guess, partially, I mean the big factor there is that we're executing on large projects. They span 18 months to two years, and so it really is, price is determined up front. Most of the contracts are fixed price contracts.

And so it's very much about project management and managing vendor costs and setting up contractual vendor costs to match the time period that we will be executing. And so in terms of our improvement, the improvement in profitability, has been really driven by the operating initiatives, a significant improvement in lean and operating performance in the wet products, and then, obviously, the expanding demand for our most profitable dry cooling products.

Thank you.

We'll go next to Tony Boise with FAS Advisors.

Thanks.

Just wanted to clarify a couple of things or maybe get a little bit more color. For fourth quarter Thermal revenue expectations 1 to 2%, is that, just help me figure out whether this is almost kind of by design on your part to meet commitments or we're not experiencing any kind of slowdown because backlog did come down a little bit, too, so help me out with that a little bit.

Sure. As I mentioned in my, this is Chris, Tony. As I mentioned in my remarks, backlog did come down which reflects in part the huge revenue growth we had in the quarter. The one thing you have to continue to remember about this business is that the timing of these contracts can be very uneven.

These are large contracts and they can come and go in large clumps, and so when we look at what the future holds for this business, and particularly the infrastructure growth that is driving this business and has driven it over the last several years, that has not changed, and we believe that that will continue to be the driver in addition to adjacent market applications that we found for the business.

I think that in prospective quarters you'll see sort of the same pattern of unevenness in terms of how these contracts are awarded. But over time we expect growth in this business to be attractive.

And specifically in response to your question, this is not a tool by design. This is simply a reflection of the timing of customer demand and shipment of products.

And then just a question on APV. Clearly, there's margin expansion opportunity, but what's the, I guess, the most important method by which you're going to raise the margins at APV?

There are several opportunities for us. One, our ability to leverage the spend in both organizations. The material spend will be combined, and we'll get the leverage there.

Secondly, APV has a vast manufacturing footprint. We will go in with our manufacturing and lean initiatives which will help us with throughput. Combining the product lines will give us more opportunity in the volume base.

They have a strong initiative that they're in the infant stages of putting manufacturing into eastern Europe and into the Asian markets for low-cost manufacturing which we can piggyback which will help. Their sales infrastructure and our sales infrastructure will be looked at for its synergies.

This will be identifying more and more of these opportunities as we go through the integration process review, as Patrick identified, that's going to takes place in the next 60 to 90 days. Those are just a few of the things that we see as opportunities for us.

In many respects this will be like Johnson Pump which we acquired a year ago. When we acquired Johnson Pump, I mean, it's obviously a smaller company, only $100 million of revenue, but they had a single-digit operating margins in less than 12 months we have them close to the reported segment margin rate, and actually at an organic growth rate that is at or slightly above the organic growth rate of the segment.

And so we will be using many of the same processes, and frankly, some of the same people in the integration team deciding how to best achieve the synergies that are available to us in the APV transaction.

Great. Thank you.

Melissa, I think we have time for just one for more question.

Okay. We'll take our final question from Steve Tusa with JPMorgan.

Good morning.

Steve, good morning.

No real questions on the quarter, very good results. Just on the transaction, I'm just curious, this business hasn't really grown much, at least the numbers I have since 2002. Have there been divestitures in there or anything like that that I am missing? And I guess that's the question.

There have been small divestitures in recent years, the product lines, and as we mentioned on the call, their organic growth rate in the last two years has been 8 to 9%, just a shade below ours. And looking at the development of our product demands, they've got a very similar organic development in the recent 24 months to the kind of organic development that we are experiencing ourselves in the Flow segment.

What are the gross margins of this business?

The gross margins for the majority of the products are just above 30%.

Okay. Great. Thank you.

Thanks, Steve.

Thanks, everybody. Melissa, that'll be the end of the call. Ryan and I are available and in the office all day for any additional questions. We appreciate your time this morning and look toward to talking to you soon.

Thank you.

Once again, that does conclude today's call. We do appreciate your participation. You may disconnect at this time.