The Daily Magic Formula Stock for 11/24/2008 is SPX Corp. According to the Magic Formula Investing Web Site, the ebit yield is 19% and the EBIT ROIC is 25-50 %.
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We were incorporated in Muskegon, Michigan in 1912 as the Piston Ring Company and adopted our current name in 1988. Since 1968, we have been incorporated under the laws of Delaware and we have been listed on the New York Stock Exchange since 1972.
We are a global multi-industry manufacturing company with operations in over 35 countries and sales in over 150 countries around the world. The majority of our revenues, approximately 59% in 2007, are driven by global infrastructure development. Our infrastructure-related products and services include wet and dry cooling systems, thermal service and repair work, heat exchangers and power transformers into the global power market. We also provide pumps, metering systems and valves into the global oil and gas, chemical and petrochemical exploration, refinement and distribution markets. Our infrastructure-related products also include packaged cooling towers, boilers, heating and ventilation equipment and filters. We continue to focus on developing and acquiring products and services to serve global infrastructure development, as we believe that future investments in these end markets in both emerging and developed economies around the world provide significant opportunities for growth.
The other major component of our revenues in 2007 was test and measurement products and services, representing 24.3% of our 2007 revenues. In this area, we provide, among other things, electronic diagnostic systems, specialty service tools, service equipment and technical information services with a primary focus on the global transportation market. Our strategy includes partnering with manufacturers of automobiles, agricultural and construction equipment and recreational vehicles, among others, to provide solutions for maintaining and servicing these vehicles after sale. With the expanding global population and demand for vehicles, we believe there are significant future growth opportunities in this market.
Our operating strategy is focused on an integrated leadership process that aligns performance measurement, decision support, compensation and communication. This process includes:
a demanding set of leadership standards to drive achievement of results with integrity;
expanding our technological leadership and service offerings with a market focus on providing innovative, critical solutions to our customers;
growing through internal development and strategic, financially compelling acquisitions;
increased globalization with a focus on emerging economies and markets;
right-sizing our businesses to market and economic conditions to protect against economic downturns and take advantage of strong economic cycles;
focusing on continuous improvements to drive results and create shareholder value; and
strategically analyzing our businesses to determine their long-term fit.
Unless otherwise indicated, amounts provided throughout this Annual Report on Form 10-K relate to continuing operations only.
Our strategy is to have a centralized approach to continuous improvement, including lean manufacturing, supply chain management, organizational development and global expansion, with the intent of capturing synergies that exist within our businesses and, ultimately, on driving revenue, profit margin and cash flow growth. We believe that our businesses are well positioned for growth in these metrics based on our current continuous improvement initiatives, the potential within the current markets they serve and the potential for expansion into additional markets.
We aggregate our operating segments into four reportable segments in accordance with the criteria defined in Statements of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related Information". The segments are Flow Technology, Test and Measurement, Thermal Equipment and Services and Industrial Products and Services. The factors considered in determining our aggregated segments are the economic similarity of the businesses, the nature of products sold or services provided, production processes, types of customers and distribution methods. In determining our segments, we apply the threshold criteria of SFAS No. 131 to operating income or loss of each segment before considering impairment and special charges, pensions and postretirement expense, stock-based compensation and other indirect corporate expense. This is consistent with the way our chief operating decision maker evaluates the results of each segment. For more information on the results of our segments, including revenues by geographic area, see Note 5 to our consolidated financial statements.
Our Flow Technology segment had revenues of $1,121.3, $865.7 and $775.8 in 2007, 2006 and 2005, respectively. APV, a global manufacturer of process equipment and engineering solutions primarily for the sanitary market, had revenues of approximately $876.0, $753.0 and $700.0 in 2007, 2006 and 2005, respectively, which have not been included in our results of operations as we acquired APV on December 31, 2007. The Flow Technology segment designs, manufactures and markets products and solutions that are used to process or transport fluids, as well as solutions and products that are used in heat transfer applications. Our focus is on innovative, highly-engineered new product introductions and expansion from products to systems and services in order to create total customer solutions. Our primary products include high-integrity pumps, valves, heat exchangers, fluid mixers, agitators, metering systems, filters and dehydration equipment. Our primary global end markets, in order of size, are sanitary food, beverage and pharmaceutical processing, general industrial, chemical processing, oil and gas processing, power generation and mining. We sell to these end markets under the brand names of Waukesha Cherry-Burrell, DeZurik, Lightnin, Copes-Vulcan, M&J Valves, Bran & Luebbe, APV, APV Gaulin and APV Rannie. Competitors in these fragmented markets include Alfa Laval, GEA, Fisher, Haywood, Chemineer, EKATO, Lewa, Fristam and Sudmo. The segment continues to focus on initiatives such as a global enterprise resource planning ("ERP") system implementation and lean manufacturing improvements. The primary distribution channels for the Flow Technology segment are independent manufacturing representatives and direct to customers.
Test and Measurement
Our Test and Measurement segment had revenues of $1,174.1, $1,137.5 and $1,059.6 in 2007, 2006 and 2005, respectively. This segment engineers and manufactures branded, technologically advanced test and measurement products used on a global basis across the transportation, defense, telecommunications and utility industries. Our technology supports the introduction of new systems, expanded services and sophisticated testing and validation. Products for the segment include specialty diagnostic service tools, fare-collection systems, portable cable and pipe locators and vibration testing equipment. Our diagnostic service tools product line includes diagnostic systems and service equipment as well as specialty tools. We sell diagnostic systems and service equipment to the franchised vehicle dealers of original equipment manufacturers ("OEM"s), aftermarket national accounts and independent repair facilities. We sell diagnostic systems under the OTC, Actron, AutoXray, Tecnotest and Robinair brand names. These products compete with brands such as Snap-on and ESP. We intend to grow this business by developing new service capabilities, strengthening alliances in diagnostic platforms and through acquisitions. We sell our specialty tools to franchised vehicle dealers, aftermarket national accounts and independent repair facilities. We are a primary global provider of specialty tools for motor vehicle manufacturers' dealership networks to General Motors, Ford, Chrysler, BMW, Harley Davidson and John Deere, and a primary domestic provider to Toyota and Nissan. Sales of specialty service tools essential to dealerships tend to vary with changes in vehicle systems design and the number of dealerships and are not directly correlated with the volume of vehicles produced by the motor vehicle manufacturers. The segment sells automated fare-collection systems to municipal bus and rail transit systems, as well as postal vending systems, primarily within the North American market. Our portable cable and pipe locator line is composed of electronic testing, monitoring and inspection equipment for locating and identifying metallic sheathed fiber optic cable, horizontal boring guidance systems and inspection cameras. The segment sells this product line to a wide customer base, including utility and construction companies, municipalities and telecommunication companies. We sell our vibration testing equipment primarily to the aerospace, automotive and electronics industries, with our main competitors being IMV and Upholtz Dickie. The segment continues to focus on initiatives such as lean manufacturing and expanding its commercialization of the European and Chinese markets. The primary distribution channels for the Test and Measurement segment are direct to OEMs and OEM dealers, aftermarket tool and equipment providers and retailers.
Thermal Equipment and Services
Our Thermal Equipment and Services segment had revenues of $1,560.5, $1,327.7 and $1,178.4 in 2007, 2006 and 2005, respectively. This segment engineers, manufactures and services cooling, heating and ventilation products for markets throughout the world. Products for the segment include dry, wet and hybrid cooling systems for the power generation, refrigeration, HVAC and industrial markets, as well as hydronic and heating and ventilation products for the commercial and residential markets. This segment also provides thermal components for power and steam generation plants and engineered services to maintain, refurbish, upgrade and modernize power stations. We sell our cooling products and services under the brand names of Marley, Balcke-Duerr, Ceramic and Hamon Dry Cooling, with the major competitors to these product and service lines being Baltimore Aircoil, Evapco and GEA. Our hydronic products include a complete line of gas and oil fired cast iron boilers for space heating in residential and commercial applications, as well as ancillary equipment. The segment's hydronic products compete mainly with Burnham and Buderus. Our heating and ventilation product line includes i) baseboard, wall unit and portable heaters, ii) commercial cabinet and infrared heaters, iii) thermostats and controls, iv) air curtains and v) circulating fans. The segment sells heating and ventilation products under the Berko, Qmark, Farenheat, Aztec, Patton and Leading Edge brand names, with the principal competitors being TPI, Quellet, King, Cadet and Dimplex for heating products and Lenexa, TPI, Broan-NuTone and Air Master for ventilation products. The segment continues to focus on expanding its global reach, including expanding its dry cooling, heating and manufacturing capacity in China, as well as increasing thermal components and service offerings, particularly in China, Europe and South Africa. The primary distribution channels for the Thermal Equipment and Services segment are direct to customers, independent manufacturing representatives, third party distributors and retailers.
Industrial Products and Services
Our Industrial Products and Services segment had revenues of $966.4, $836.7 and $716.0 in 2007, 2006 and 2005, respectively. Of the segment's 2007 revenue, approximately 44% was from the sale of power transformers into the US transmission and distribution market. We are a leading provider of medium sized transformers (MVA between 10 and 60 mega-watts) in the United States. Our transformers are sold under the Waukesha Electric brand name. This brand is recognized for quality and reliability by our customers. Typical customers for this product line are public and privately held utilities. Our key competitors in this market include ABB, Kuhlman and GE Prolec.
Additionally, this segment includes operating units that design and manufacture industrial tools and hydraulic units, precision machine components for the aerospace industry, crystal growing machines for the solar power market, automatic transmission filters and television and radio broadcast antenna systems. The primary distribution channels for the Industrial Products and Services segment are direct to customers, independent manufacturing representatives and third party distributors.
We regularly review and negotiate potential acquisitions in the ordinary course of business, some of which are or may be material. We will continue to pursue acquisitions and we may consider acquisitions of businesses with more than $1,000.0 in annual revenues.
In August 2007, we completed the acquisition of the European diagnostics division of Johnson Controls ("JCD") within our Test and Measurement segment for a purchase price of $40.3. The acquired business had revenues of approximately $93.0 in the twelve months prior to acquisition.
In October 2007, we completed the acquisition of Matra-Werke GmbH ("Matra") within our Test and Measurement segment for a purchase price of $36.6. The acquired business had revenues of approximately $26.0 in the twelve months prior to acquisition.
In December 2007, we completed the acquisition of APV within our Flow Technology segment for a purchase price of $524.2. The acquired business had revenues of approximately $876.0 in the twelve months prior to acquisition.
As part of our operating strategy, we regularly review and negotiate potential divestitures in the ordinary course of business, some of which are or may be material. As a result of this continuous review, we determined that certain of our businesses would be better strategic fits with other companies or investors. In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," we report businesses or asset groups as discontinued operations when the operations and cash flows of the business or asset group have been or are expected to be eliminated, when we do not expect to have any continuing involvement with the business or asset group after the disposal transaction, and when we have met these additional six criteria:
management has approved a plan to sell the business or asset group;
the business or asset group is available for immediate sale;
an active program to sell the business or asset group has been initiated;
the sale of the business or asset group is probable within one year;
the marketed sales value of the business or asset group is reasonable in relation to its current fair value; and
it is unlikely that the plan to divest the business or asset group will be significantly altered or withdrawn.
During the third quarter of 2007, we committed to a plan to divest our Air Filtration business within our Flow Technology segment. We are actively pursuing the sale of this business and anticipate that the sale will be completed in the first half of 2008. Accordingly, we have reported, for all periods presented, the financial condition, results of operations and cash flows of this business as a discontinued operation in our consolidated financial statements. As a result of this planned divestiture, we recorded a net charge of $11.0 during 2007 to "Gain (loss) on disposition of discontinued operations, net of tax" in order to reduce the carrying value of the net assets to be sold to their estimated net realizable value.
We have one significant joint venture, EGS Electrical Group, LLC and Subsidiaries ("EGS"), with Emerson Electric Co., in which we hold a 44.5% interest. Emerson Electric Co. controls and operates the joint venture. EGS operates primarily in the United States, Canada and France and is engaged in the manufacture of electrical fittings, hazardous location lighting and power conditioning products. We account for our investment under the equity method of accounting, on a three-month lag basis. We typically receive our share of this joint venture's earnings in cash dividends.
See Note 9 to our consolidated financials statements for more information on EGS.
We are a multinational corporation with operations in over 35 countries. Our international operations are subject to the risks of possible currency devaluation and blockage, nationalization or restrictive legislation regulating foreign investments, as well as other risks attendant to the countries in which they are located. Our export sales from the United States were $339.7 in 2007, $335.2 in 2006 and $290.2 in 2005.
See Note 5 to our consolidated financial statements for more information on our international operations.
Research and Development
We are actively engaged in research and development programs designed to improve existing products and manufacturing methods and to develop new products to better serve our current and future customers. These efforts encompass all our products with divisional engineering teams coordinating their resources. We place particular emphasis on the development of new products that are compatible with, and build upon, our manufacturing and marketing capabilities.
We spent $70.3 on research activities relating to the development and improvement of our products in 2007, $61.4 in 2006 and $56.3 in 2005. In addition, we expensed purchased in-process research and development of $0.9 related to the APV acquisition as technological feasibility had not been established for the related projects.
We own over 700 domestic patents and 200 foreign patents, including approximately 50 patents that were issued in 2007, covering a variety of our products and manufacturing methods. We also own a number of registered trademarks. Although in the aggregate our patents and trademarks are of considerable importance in the operation of our business, we do not consider any single patent or trademark to be of such importance that its absence would adversely affect our ability to conduct business as presently constituted to a significant extent. We are both a licensor and licensee of patents. For more information, please refer to "Risk Factors."
Outsourcing and Raw Materials
We manufacture many of the components used in our products; however, our strategy includes outsourcing some components and sub-assemblies to other companies where strategically and economically feasible. In instances where we depend on third-party suppliers for outsourced products or components, we are subject to the risk of customer dissatisfaction with the quality or performance of the products we sell due to supplier failure. In addition, business difficulties experienced by a third-party supplier can lead to the interruption of our ability to obtain the outsourced product and ultimately to our inability to supply products to our customers. We believe that we generally will be able to continue to obtain adequate supplies of major items or appropriate substitutes at reasonable costs.
In the last four years we have faced significant increases in the prices of many of our key raw materials, including petroleum-based products, steel and copper. Over the past three years we have been able to generally offset increases in raw material costs across our segments mainly through effective price increases.
Because of our diverse products and services, as well as the wide geographic dispersion of our production facilities, we use numerous sources for the raw materials needed in our operations. We are not significantly dependent on any one or a limited number of suppliers, and we have been able to obtain suitable quantities of necessary raw materials at competitive prices.
Although our businesses are in highly competitive markets, our competitive position cannot be determined accurately in the aggregate or by segment since our competitors do not offer all of the same product lines or serve all of the same markets as we do. In addition, specific reliable comparative figures are not available for many of our competitors. In most product groups, competition comes from numerous concerns, both large and small. The principal methods of competition are price, service, product performance and technical innovation. These methods vary with the type of product sold. We believe that we can compete effectively on the basis of each of these factors as they apply to the various products offered. See "Segments" above for a discussion of our competitors.
See "MD&A β Critical Accounting Policies and Use of Estimates β Contingent Liabilities," "Risk Factors" and Note 14 to our consolidated financial statements for information regarding environmental matters.
At December 31, 2007, we had approximately 17,800 employees associated with businesses that have been classified in our consolidated financial statements as continuing operations. Additionally, we had approximately 700 employees associated with a business that we intend to sell in 2008 and have classified in our consolidated financial statements as a discontinued operation. Twelve domestic collective bargaining agreements cover approximately 1,275 employees, none of which relate to the business classified in our consolidated financial statements as a discontinued operation. We also have various collective labor arrangements covering certain non-U.S. employee groups. While we generally have experienced satisfactory labor relations, we are subject to potential union campaigns, work stoppages, union negotiations and other potential labor disputes.
J. Kermit Campbell , 69, is the former Chairman, President and Chief Executive Officer of Herman Miller, Inc., a designer and manufacturer of office furniture. Since leaving Herman Miller, Inc. in 1995, Mr. Campbell has invested in a number of ventures, including Bering Truck Corporation, Black Star Farms, United Power Line Contractors, United Shield International, PassAlong Networks and CORE Energy Co. He is a director of Irwin Union Bank Pacific and PassAlong Networks. Mr. Campbell is an honorary Trustee and past Chairman of the Board of Hope College, a Trustee of Eagle Village, a Trustee of Traverse Symphony Orchestra and a trustee of NorthWest Michigan College Foundation. Mr. Campbell has been a director of SPX since 1993.
Emerson U. Fullwood , 60, was named Corporate Vice President of Xerox Corporation in 1996. In 2004 he assumed the role and responsibilities of Executive Chief of Staff and Marketing Officer for Xerox North America. He is planning on retiring from Xerox in July, 2008. Prior to his current role he was President of the Xerox Worldwide Channels Group, President of Latin America, Executive Chief Staff Officer of Developing Markets and President of Worldwide Customer Services. Previously, Mr. Fullwood held several executive and general management leadership positions with Xerox. Mr. Fullwood serves as a director of the Vanguard Group and the Vanguard Funds, the United Way of Rochester, the Rochester Boy Scouts of America, the Xerox Foundation, Monroe Community College Foundation, the Urban League and Colgate Rochester Crozier Divinity School. He was formerly a director of General Signal Corporation. Mr. Fullwood has been a director of SPX since 1998.
Michael J. Mancuso , 65, is the retired Senior Vice President and Chief Financial Officer of General Dynamics Corporation, a market leader in mission-critical information systems and technologies; land and expeditionary combat systems; armaments and munitions; shipbuilding and marine systems; and business aviation. He joined General Dynamics in 1993 as Vice President and Chief Financial Officer for General Dynamics Land Systems, Inc., and was promoted to Vice President and Chief Financial Officer in 1994. Before joining General Dynamics, Mr. Mancuso spent seven years with United Technologies. His background also includes 21 years with General Electric. Mr. Mancuso is a director of CACI International Inc., LSI Logic Corporation and the Shaw Group Inc. Mr. Mancuso has been a director of SPX since 2005.
J. Michael Fitzpatrick , 61, has been an Executive Advisory Partner of Wind Point Partners, a middle market private equity firm since 2005, and has been Chairman and CEO of Citadel Plastics Holdings, Inc., a portfolio company of Wind Point Partners, since March 2007. Citadel Plastics acquires and manages companies in the plastics compounding industry. Dr. Fitzpatrick was Vice-Chairman, an executive position, of Carpenter Technology from February 2006 to October 2006. He was President & Chief Operating Officer of Rohm and Haas Company, an industry-leading specialty materials company, which invents, develops, and manufactures products for the personal care, grocery, automotive, building and construction and electronics industries, from 1999 until his retirement in 2005. He joined Rohm and Haas Company in 1975, and served in various research and development and management positions until his appointment as President and Chief Operating Officer. Dr. Fitzpatrick is a director of McCormick and Company, Inc. and was formerly a director of Rohm and Haas Company and Carpenter Technology Corporation. Dr. Fitzpatrick has been a director of SPX since 2007.
Albert A. Koch , 65, is President and CEO of Handleman Company. He is also a Vice Chairman and Managing Director with AlixPartners, LLP, an international corporate turnaround and financial advisory firm. Mr. Koch joined AlixPartners in 1995 as Managing Principal. Mr. Koch has been Chairman of Polar Corporation, a privately owned company, since 2004, and was its CEO from 2004 until 2007. In 2004 and 2005, Mr. Koch was the Chairman, interim President and CEO at Champion Enterprises, Inc. In 2002 and 2003, Mr. Koch served as interim CFO of the Kmart Corporation. Mr. Koch also was a partner with Ernst & Young for 14 years, including 7 years as Managing Partner of the firm's Detroit office. Mr. Koch has been a director of SPX since 2007.
Sarah R. Coffin , 55, is President, Performance Products Division, Hexion Specialty Chemicals, Inc., a supplier of thermoset and other high performance resins. Ms. Coffin worked from 2004 to 2005 as Vice President Sales and Marketing for Seaman Corporation, a private firm serving the industrial coated fabric market. She served as Senior Vice President Global Sourcing, Human Resources and Information Technology of Noveon, Inc., a global producer of performance polymer systems and adhesives from 2002 to 2003. From 1998 to 2002, she was Group President Specialty Plastics and Polymer Additives, Senior Vice President and General Manager Performance Coatings with BF Goodrich Performance Materials Company/Noveon, Inc., a manufacturer of performance polymer systems and additives. She has been a director of SPX since 1995.
Christopher J. Kearney , 52, is Chairman, President and Chief Executive Officer of SPX. He was named President and Chief Executive Officer in December 2004, and added the title of Chairman in May 2007. He joined the company in February 1997 as Vice President, Secretary and General Counsel and an officer of the company. Prior to joining SPX he was Senior Vice President and General Counsel of Grimes Aerospace Company, a leading manufacturer of aircraft lighting equipment, engine system components and electronic systems. His business experience also includes positions at Borg-Warner Chemicals as Senior Attorney and Senior Counsel at General Electric's global materials business. Mr. Kearney holds an undergraduate degree from the University of Notre Dame and a law degree from DePaul University Law School. Mr. Kearney is a Member of the Advisory Council for University Libraries, University of Notre Dame. Mr. Kearney has been a director of SPX since 2004.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overall, 2007 was a successful year for SPX as we experienced our third consecutive year of improvement in revenues and operating income. Specifically, revenues and operating income for 2007 were higher than 2006 by 15.7% and 32.6%, respectively. In addition, net operating cash flows from continuing operations were $404.2 in 2007 compared to $48.6 in 2006. We also continued our progress on our six key operating initiatives (emerging markets, new product development, lean processes, supply chain management, information technology centralization and organizational development). A brief summary of our efforts to date on our operating initiatives is as follows:
Emerging Markets β Our primary emerging markets' efforts have been on China. During 2007, revenues from sales into China totaled approximately $344.0, including approximately $244.0 relating to our Thermal Equipment and Services segment, with the primary driver being cooling systems in support of power plant construction. The developing infrastructure in China also provides opportunities for a number of our other businesses. For example, the number of vehicles throughout China continues to increase, which we expect to drive demand for our Test and Measurement segment's electronic diagnostic equipment, specialty tools and dealer services. In addition, our Flow Technology segment is expanding its presence in China, as it was recently awarded two contracts valued at $13.0 to design and provide squib valves to various nuclear power plants in China and to provide training and technical expertise for these plants, and we expect additional orders in the near-term. As part of our expansion into China, we recently rolled out plans for a shared service center in Shanghai, which will initially focus on finance and will eventually service all of our businesses in Asia Pacific. Our Shanghai service center will likely serve as a blueprint for other shared service centers around the globe, with the next likely candidate being our businesses in Europe. The expected benefits from this shared service approach are (i) our ability to capitalize on scale and synergies, (ii) an intensified market and customer focus, and (iii) an improved internal control environment. Our global expansion has not been limited to China, as other parts of the world, including Africa, the Middle East and Russia, are contributing to our organic revenue growth. In particular, our Thermal Equipment and Services segment recently obtained a $235.0 multi-year contract in South Africa to supply filters, air preheaters and pressure parts for boilers within a power generation facility. The acquisition of APV also expands our reach into emerging markets, as approximately 37% of APV's annual revenues are associated with sales into Asia Pacific, Africa and South America. In 2008, over 50% of our consolidated revenues are expected to be from sales outside of the U.S., with over 20% outside of North America and Western Europe.
New Product Development β We are committed to developing new, innovative solutions to meet our customers' needs and, in some cases, regulatory standards. Within our Test and Measurement segment, new product development is critical to keeping pace with increasing vehicle complexity and new model launches. During 2007, the segment launched a new air conditioner servicing unit that has received two awards from the U.S. Environmental Protection Agency for its ability to protect the climate and ozone. The segment also recently launched the DT-500, a diagnostic tool that operates in Mandarin and is currently being sold in the Chinese aftermarket. Within our Thermal Equipment and Services segment, we have over 250 patents relating to our cooling systems. The segment recently introduced a new hybrid cooling application called Air-2-Air. This technology can reduce water consumption within a power plant by up to 20%. As noted above, our Flow Technology segment has developed a new squib valve technology for use in nuclear power plants.
Lean Processes β Our businesses are implementing lean principles throughout all their functions, with an ultimate objective of achieving operational excellence. Our lean efforts focus on making each task more efficient through, among other things, the elimination of waste and bottlenecks. Businesses within our Flow Technology segment as well as our power transformer business have experienced significant improvements in their manufacturing processes as a result of implementing lean principles, resulting in increased capacity and through-put and ultimately in improved profitability. Many of our other businesses are beginning to experience similar progress with their lean efforts, which should have a favorable impact on future operating results.
Supply Chain Management β Our supply chain initiative is focused on driving cost reductions and working capital improvement, along with quality and on-time delivery through partnering with a strategic global supply base. Across all our businesses, we are effectively managing challenging material markets (e.g., steel and copper) by (i) making strategic material purchases, (ii) consolidating our vendor base, and (iii) implementing hedging strategies where market opportunities exist.
Information Technology ("IT") Centralization β We continue to invest in and make progress on the IT front, including the planned global expansion of SAP, with an initial focus in our Flow Technology and Thermal Equipment and Services segments. During 2007, 15 business locations implemented SAP and another 10 are scheduled for 2008. The success of many of our other key operating initiatives is highly dependent upon continued investment in a global IT structure.
Organizational Development β Our employees are the backbone of the company. We are providing leadership and managerial training to further develop the skills of our employees. We have development programs for engineering, finance and human resources that are focused on recruiting and developing high-talent individuals. In addition, we recently implemented a business leadership development program for a select group of high potential managers. The program focuses on further developing leadership and problem solving skills, with the problem solving activities generally focused on our own key operating initiatives.
During 2007, our focus on these initiatives contributed to improvement in revenues and operating income and margins as described in "Results of Continuing Operations" and "Segments Results of Operations." In 2008, we will continue to focus on and anticipate continued progress across all these key initiatives, which we expect will result in additional improvement in revenue and operating income and margins. In addition, during 2008 we also will be looking to expand our low-cost country engineering and manufacturing presence. APV, which we acquired on December 31, 2007, already maintains a 32,000 square foot manufacturing facility in Bydgoszcz, Poland and is constructing an additional 113,000 square foot facility at the same location. We will to look to leverage what is already in place for APV and will consider other alternatives where there is an available skilled workforce, possible tax incentives and a modernized infrastructure. We believe that expanding our low-cost country engineering and manufacturing presence can favorably impact our cost structure as well as our ability to expand our customer base.
Other Significant 2007 Items
There were a number of other significant items that impacted our 2007 operating results, including:
We entered into new senior credit facilities, with total capacity of $2,300.0, which replaced our then-existing senior credit facilities.
We issued, in a private placement, $500.0 aggregate principal amount of 7.625% senior unsecured notes due in 2014.
In August 2007, we completed the acquisition of JCD within our Test and Measurement segment for a purchase price of $40.3.
In October 2007, we completed the acquisition of Matra within our Test and Measurement segment for a purchase price of $36.6, including cash acquired of $2.9.
On December 31, 2007 we completed the acquisition of APV within our Flow Technology segment for a purchase price of $524.2, including cash acquired of $41.7.
Dispositions and Discontinued Operations:
In April 2007, we sold Contech, our automotive components business, for net cash proceeds of $134.3. We recorded a net loss on the sale of $13.6 to "Gain (loss) on disposition of discontinued operations, net of tax."
During the third quarter of 2007, we committed to a plan to divest our Air Filtration business within the Flow Technology segment. As a result of the planned divestiture, we recorded a net charge of $11.0 during 2007 to "Gain (loss) on disposition of discontinued operations, net of tax."
During the third quarter of 2007, we recognized an income tax benefit of $13.5 to "Gain (loss) on disposition of discontinued operations, net of tax" relating to the reversal of certain deferred tax liabilities associated with businesses previously disposed of and reported as discontinued operations, primarily in 2005.
In December 2007, we sold BD Austria for cash proceeds of $11.6, exclusive of cash balances assumed by the buyer of $30.0. We recorded a gain on sale of $17.2 to "Gain (loss) on disposition of discontinued operations, net of tax."
In December 2007, we sold Nema for cash proceeds of $6.8, net of cash assumed by the buyer of $0.4. We recorded a net loss on the sale of $2.3 to "Gain (loss) on disposition of discontinued operations, net of tax."
Common Stock Repurchases β We repurchased 9.0 shares of our common stock for total cash consideration of $715.9.
As a result of our adoption of FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109" ("FIN 48"), we reduced our income tax liabilities for unrecognized tax benefits by $52.5, with a corresponding increase to retained earnings.
We reached an agreement with the Internal Revenue Service ("IRS") regarding certain matters related to our Federal income tax returns for the years 1995 through 2002 after the agreement was approved by the Joint Committee on Taxation of the U.S. Congress. In connection with the resolution of these matters, we reduced our income tax liabilities by $35.6, which resulted in a continuing operations tax benefit of $16.8 and a decrease in goodwill of $18.8.
We recorded an income tax benefit of $11.5 associated with a reduction in the statutory tax rates in Germany and the United Kingdom.
We recorded an aggregate income tax benefit of $15.9 associated with the settlement of various state matters and certain matters in the United Kingdom, an expected refund in China related to an earnings reinvestment plan, and the reversal of income taxes that were provided prior to 2007.
An internal audit of an operation in Japan uncovered employee misconduct and improper accounting entries. Correction of these matters resulted in a charge of $7.4 during the third quarter of 2007, which included $2.4 of inventory write-downs, $2.0 of accounts receivable write-offs and $3.0 of other adjustments. See Note 1 to our consolidated financial statements for further information.
We recorded a benefit of $5.0 within our Thermal Equipment and Services segment as a result of cost improvements associated with a state-approved environmental remediation plan at a site in California during the second quarter of 2007.
We recorded net charges of $8.5 related to the settlement of a legacy product liability matter within our Industrial Products and Services segment during the first, second and fourth quarters of 2007.
We recorded charges of $5.0 related to legacy legal matters, with $4.8 recorded during the fourth quarter of 2007.
Results of Continuing Operations
Seasonality and Competition β Many of our businesses follow changes in the industries and end markets that they serve. In addition, certain businesses have seasonal fluctuations. Our heating and ventilation products businesses tend to be stronger during the third and fourth quarters, as customer-buying habits are driven largely by seasonal weather patterns. Demand for cooling towers and related services is highly correlated to contract timing on large construction contracts, which may cause significant fluctuations from period to period. Revenues for our Service Solutions business typically follow program launch timing for diagnostic systems and service equipment. In aggregate, our businesses generally tend to be stronger in the second half of the year.
Although our businesses operate in highly competitive markets, our competitive position cannot be determined accurately in the aggregate or by segment since our competitors do not offer all the same product lines or serve all the same markets. In addition, specific reliable comparative figures are not available for many of our competitors. In most product groups, competition comes from numerous concerns, both large and small. The principal methods of competition are price, service, product performance and technical innovations. These methods vary with the type of product sold. We believe we can compete effectively on the basis of each of these factors as they apply to the various products we offer. See "Segments" for a discussion of our competitors.
Non-GAAP Measures β Organic revenue growth (decline) presented herein is defined as revenue growth (decline) excluding the effects of foreign currency fluctuations and acquisitions and divestitures. We believe that this metric is a useful financial measure for investors in evaluating our operating performance for the periods presented, as when read in conjunction with our revenues, it presents a useful tool to evaluate our ongoing operations and provides investors with a tool they can use to evaluate our management of assets held from period to period. In addition, organic revenue growth (decline) is one of the factors we use in internal evaluations of the overall performance of our business. This metric, however, is not a measure of financial performance under accounting principles generally accepted in the United States ("GAAP") and should not be considered a substitute for revenue growth (decline) as determined in accordance with GAAP and may not be comparable to similarly titled measures reported by other companies.
Revenues β For 2007, the increase in revenues was driven primarily by organic revenue growth. We continued to experience strong demand in the power, chemical, mining, oil and gas, sanitary and dehydration markets serviced by businesses in our Flow Technology segment, as well as for cooling systems and products and thermal services within our Thermal Equipment and Services segment. Growth in our Industrial Products and Services segment has been led by strong demand for power transformers. Revenues for 2007 also benefited from the fourth quarter 2006 acquisition of Aktiebolaget Custos ("Custos") within our Flow Technology segment, the 2007 acquisitions of JCD and Matra within our Test and Measurement segment, and the favorable impact of foreign currencies (i.e., weakening of the U.S. dollar against most other currencies).
For 2006, the increase in revenues was driven primarily by organic revenue growth. We experienced strong demand for thermal services and repairs in Europe and dry cooling products in China within our Thermal Equipment and Services segment, as well as within the power, chemical, mining and oil and gas markets serviced by businesses in our Flow Technology segment. Growth in our Industrial Products and Services segment was led by strong demand for power transformers, crystal growing and laboratory equipment, machined components for aircrafts, and industrial and hydraulic tools. Revenues also benefited from the fourth quarter 2005 acquisition of CarTool GmbH ("CarTool") in our Test and Measurement segment.
Gross profit β The increase in gross profit in 2007 was due primarily to the revenue performance described above. The following items favorably impacted gross profit as a percentage of revenues in 2007 when compared to 2006:
Improved pricing, favorable product mix and productivity associated with the power transformer business within our Industrial Products and Services segment.
Improved pricing and lean manufacturing initiatives within the Flow Technology segment.
Improved execution and favorable project mix within our cooling systems and products business.
The following items partially offset the 2007 increases in gross profit described above:
A significant decline in OEM program launches due to difficult conditions within the domestic automotive market led to reduced revenues and margins in our Test and Measurement segment.
An internal audit of an operation in Japan uncovered employee misconduct and improper accounting entries. Correction of these matters resulted in a total charge of $7.4 during third quarter of 2007, with a reduction of $2.3 of revenues, $4.5 recorded to cost of products sold and $0.6 recorded to selling, general and administrative expense. See Note 1 to our consolidated financial statements for further information.
Charges of $8.5 within our Industrial Products and Services segment related to the settlement of a legacy product liability matter.
The increase in gross profit in 2006, when compared to 2005, was due primarily to the revenue performance described above. The following items favorably impacted gross profit as a percentage of revenues in 2006 when compared to 2005:
Improved pricing and lean manufacturing initiatives within the Flow Technology segment.
New product introductions, improved pricing and favorable product mix associated with the specialty tools and portable cable and pipe locator product lines of our Test and Measurement segment.
Improved pricing, favorable product mix and productivity associated with the power transformer and industrial and hydraulic tools businesses within our Industrial Products and Services segment.
The following items partially offset the 2006 increases in gross profit described above:
Higher pension and postretirement costs, relating primarily to our domestic pension plans.
Lower profit margins for our boiler products business within our Thermal Equipment and Services segment as a result of lower overall demand in the domestic heating markets, unfavorable product mix and higher manufacturing costs in 2006.
Selling, general and administrative ("SG&A") expense β For 2007, the increase in SG&A expense of $107.0 was due primarily to incremental costs associated with the acquisitions of Custos, JCD and Matra, as well as increases in headcount and associated costs to support the organic revenue growth within our segments. Additionally, 2007 SG&A expense was higher due to the following:
Higher salaries and incentive compensation relating to the impact of headcount increases in support of certain key operating initiatives.
Higher stock-based compensation expense of $3.8 primarily as a result of an increase in the fair value of our 2007 restricted stock and restricted stock unit awards due to an increase in the market value of our common stock.
In addition, SG&A for 2007 included charges of $5.0 relating to legacy legal matters and a benefit of $5.0 within our Thermal Equipment and Services segment as a result of cost improvements associated with a state approved environmental remediation plan at a site in California.
For 2006, the increase in SG&A expense of $88.2 was due primarily to increases in headcount and associated costs to support the organic revenue growth within our segments. Additionally, 2006 SG&A expense was higher due to the following:
Higher pension and postretirement costs, relating primarily to our domestic pension plans.
Higher stock-based compensation expense of $9.3, resulting primarily from 2006 being the third year of our restricted stock/restricted stock unit awards (i.e., three years of awards being amortized to earnings in 2006 compared to two years of awards in 2005).
Charges of $4.1 in 2006 relating to the agreement in principle to settle both the Securities Class Action and the tag-along ERISA action. See Note 14 to our consolidated financial statements for the details associated with this matter.
Net charges of $6.7 relating to legal matters.
Higher incentive compensation costs as a result of improved operating results in 2006.
Incremental costs associated with the CarTool and Custos acquisitions.
Intangible Amortization β The increase in intangible amortization in 2007, as compared to 2006, was due primarily to the impact of amortization of intangibles associated with the acquisitions of Custos, JCD and Matra. The increase in intangible amortization in 2006, as compared to 2005, was due primarily to the impact of amortization of intangibles associated with the acquisitions of CarTool and Custos.
Impairment of Intangible Assets β In connection with our annual impairment testing of indefinite-lived intangibles under SFAS 142, we determined that other intangible assets held by a business within our Thermal Equipment and Services segment were impaired. Accordingly, we recorded an impairment charge of $4.0 in the fourth quarter of 2007 related to this matter. See Note 8 to our consolidated financial statements for further discussion.
Special charges, net β Special charges related primarily to restructuring initiatives to consolidate manufacturing, sales and administrative facilities, reduce workforce and rationalize certain product lines. See Note 6 to our consolidated financial statements for the details of actions taken in 2007, 2006 and 2005.
Other expense, net β For 2007, other expense, net, was composed primarily of foreign currency transaction losses of $3.0 and minority interest charges of $2.0, partially offset by $1.1 of life insurance death benefits that were received during 2007, while 2006 other expense, net, was composed primarily of $20.0 in costs to settle the litigation with VSI (see Note 14 to our consolidated financial statements) and $7.1 of foreign currency transaction losses.
For 2005, other expense, net, was composed primarily of foreign currency transaction losses of $15.6 and legal charges of $6.7, partially offset by a $2.8 gain associated with a reduction of liabilities related to an environmental remediation site and gains of $1.7 associated with the sale of assets.
Interest expense, net β The increase in interest expense, net during 2007, as compared to 2006, was the result of higher average debt balances during 2007 due to additional borrowings on our trade receivables financing arrangement and our domestic revolving loan facility to facilitate the repurchase of our common stock. In addition, in December 2007 we issued $500.0 of 7.625% senior notes.
During 2006, interest expense, net was impacted negatively by the fact that during the first half of 2006 we redeemed the Liquid Yield Option Notes ("LYONs"), which carried an interest rate of 2.75%, and simultaneously became a borrower under our delayed draw term facility, which carried a higher interest rate than the LYONs. In addition, interest income for 2006 was $4.5 lower as a result of lower average cash balances during the year. These increases to interest expense, net in 2006 were more than offset by the impact of the debt retirement activity in 2005. See "Liquidity and Financial Condition" and Note 12 to our consolidated financial statements for details pertaining to our 2005 debt retirement activity.
Loss on early extinguishment of debt β During 2007, we incurred $3.3 of costs in connection with the termination of our then-existing senior credit facilities (see Note 12 to our consolidated financial statements), including $2.3 for the write-off of deferred financing costs, $0.2 for an early termination fee and $0.8 for costs associated with the early termination of our then-existing interest rate protection agreements (see Note 13 to our consolidated financial statements).
During 2005, we incurred $85.4 of charges associated with the redemption of 93% of the outstanding 6.25% and 7.50% senior notes, with such charges related to premiums and fees paid to redeem the notes and the write-off of deferred financing costs related to the notes. In addition, we incurred charges of $28.2 associated with the repayment of $1,073.4 on the term loans of our then-existing senior credit facilities, with such charges related to the write-off of deferred financing costs and the termination of the remaining interest rate protection agreements related to the term loans.
Equity earnings in joint ventures β Our equity earnings in joint ventures are attributable primarily to our investment in EGS, as earnings from this investment totaled $39.3, $40.2 and $22.4 in 2007, 2006 and 2005, respectively. For 2006, the equity earnings associated with EGS included a benefit of $2.2 representing our portion of the income recorded by EGS in connection with the change in fair value of their commodity contracts. Additionally, in 2005, we recognized a charge of $7.5 representing our portion of the estimated costs of a legal settlement at EGS.
Income taxes β For 2007, we recorded an income tax provision of $89.5 on $389.8 of pre-tax income, resulting in an effective tax rate of 23.0%. The effective tax rate for 2007 was favorably impacted by: 1) a decrease in the interest charge associated with the liability for unrecognized tax benefits; 2) income tax benefits of $16.8 and 3.8, respectively, associated with the settlement of certain matters related to our a) 1995 to 2002 Federal income tax returns and b) various state income tax matters; 3) an income tax benefit of $11.5 associated with a reduction in the statutory tax rates in Germany and the United Kingdom; 4) a decrease in our state income tax provision due to a reduction in the valuation allowance for certain states resulting from current and projected taxable income for such states; 5) an income tax benefit of $3.5 associated with the settlement of certain matters relating to income tax returns in the United Kingdom; 6) an expected refund of $3.7 associated with an earnings reinvestment plan in China; and 7) an income tax benefit of $4.9 associated with the reversal of income taxes that were provided prior to 2007. The lower interest charge was the result of the reduction of our liability for unrecognized tax benefits associated with the adoption of FIN 48 in the amount of $52.5 and payments made against this liability of $66.6 and $37.5 in December 2006 and January 2007, respectively.
For 2006, we recorded an income tax provision of $57.8 on $283.5 of pre-tax income, resulting in an effective tax rate of 20.4%. The effective tax rate for 2006 was impacted favorably by income tax benefits of $34.7 and $8.3, associated principally with the settlement of certain matters relating to our 1998 to 2002 Federal income tax returns and various state income tax returns, respectively.
For 2005, we recorded an income tax provision of $71.4 on $106.1 of pre-tax income, resulting in an effective tax rate of 67.3%. The high effective tax rate in 2005 was primarily the result of approximately $44.5 in income taxes that had been provided for the repatriation of foreign earnings. This increase in the 2005 income tax provision was offset partially by the closure of certain domestic and international tax matters, resulting in a reduction to the 2005 tax provision of $15.1.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
RESULTS OF CONTINUING OPERATIONS
The unaudited information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements contained in our 2007 Annual Report on Form 10-K. Interim results are not necessarily indicative of results for a full year. It is our practice to establish actual interim closing dates using a βfiscalβ calendar, which requires our businesses to close their books on the Saturday closest to the end of the calendar quarter. The interim closing dates for the first, second and third quarters of 2008 are March 29, June 28 and September 27, respectively, and March 31, June 30 and September 29 for 2007, respectively. This practice only impacts the quarterly reporting periods and not the annual reporting period. We had one fewer day in the first quarter of 2008 and will have two additional days in the fourth quarter of 2008 when compared to the respective 2007 periods.
Seasonality and Competition β Many of our businesses closely follow changes in the industries and end markets they serve. In addition, certain businesses have seasonal fluctuations. Our heating and ventilation products businesses tend to be stronger during the third and fourth quarters, as customer buying habits are driven largely by seasonal weather patterns. Demand for cooling towers and related services is highly correlated to timing on large construction contracts, which may cause significant fluctuations from period to period. Revenues for our service solutions business typically follow program launch timing for diagnostic systems and service equipment. In aggregate, our businesses tend to be stronger in the second half of the year.
Although our businesses operate in highly competitive markets, our competitive position cannot be determined accurately in the aggregate or by segment since our competitors do not offer all the same product lines or serve all of the same markets. In addition, specific reliable comparative figures are not available for many of our competitors. In most product groups, competition comes from numerous concerns, both large and small. The principal methods of competition are price, service, product performance and technical innovations. These methods vary with the type of product sold. We believe we can compete effectively on the basis of each of these factors as they apply to the various products and services we offer.
Non-GAAP Measures β Organic revenue growth (decline) presented herein is defined as revenue growth (decline) excluding the effects of foreign currency fluctuations, acquisitions and divestitures. We believe that this metric is a useful financial measure for investors in evaluating our operating performance for the periods presented, as when read in conjunction with our revenues, it presents a useful tool to evaluate our ongoing operations and provides investors with a tool they can use to evaluate our management of assets held from period to period. In addition, organic revenue growth (decline) is one of the factors we use in internal evaluations of the overall performance of our business. This metric, however, is not a measure of financial performance under accounting principles generally accepted in the United States (βGAAPβ) and should not be considered a substitute for revenue growth (decline) as determined in accordance with GAAP and may not be comparable to similarly titled measures reported by other companies.
Revenues β For the three and nine months ended September 27, 2008, the increase in revenues compared to the respective 2007 periods was driven primarily by the fourth quarter 2007 acquisition of APV by our Flow Technology segment and the acquisitions of a division of Johnson Controls (βJCDβ) and MatraβWerke GmbH (βMatraβ) by our Test and Measurement segment during the third and fourth quarters of 2007, respectively. Additionally, we have experienced strong sales of power transformers, crystal growing machines for the solar power market, and television and radio broadcast antenna systems within our Industrial Products and Services segment, as well as products in the power, oil and gas, dehydration and sanitary markets serviced by business within our Flow Technology segment. Revenues for the three and nine months ended September 27, 2008 also benefited from the favorable impact of foreign currencies ( i.e. , relative weakening of the U.S. dollar against many foreign currencies, primarily the Euro), partially offset by declines in organic revenue in our Test and Measurement segment due to lower revenues associated with the difficult conditions within the domestic automotive market.
Gross profit β The increase in gross profit for the three months ended September 27, 2008 compared to the respective 2007 periods was due primarily to the revenue performance described above. Gross profit as a percentage of revenues for the three months ended September 27, 2008 as compared to the respective 2007 period was impacted favorably by improved pricing, favorable product mix and improved productivity associated with the power transformer business within our Industrial Products and Service segment, as well as leverage on the organic growth noted above. These favorable items were offset partially by lower margins at APV, as APV generated lower margins than the rest of our businesses. In addition, gross profit for the three months ended September 29, 2007 was impacted unfavorably by charges of $6.8 associated with employee misconduct and improper accounting entries at an operation in Japan.
The increase in gross profit for the nine months ended September 27, 2008 compared to the respective 2007 periods was due primarily to the revenue performance described above. Gross profit as a percentage of revenue for the nine months ended September 27, 2008 was impacted by the items noted above, as well as improved execution and favorable project mix within our cooling systems and products business, partially offset by an incremental charge of $7.5 at APV, representing the excess fair value (over historical cost) of inventory acquired in the APV transaction that was subsequently sold during the first quarter of 2008. Gross profit for the nine months ended September 29, 2007 was impacted unfavorably by the $6.8 of charges noted above relating to an operation in Japan and charges related to the settlement of a legacy product liability matter of $9.6.
Selling, general and administrative (βSG&Aβ) expenses β For the three and nine months ended September 27, 2008, the increase in SG&A expense was due primarily to the acquisitions of APV, JCD and Matra, as well as additional costs in support of organic revenue growth and increased corporate expenses during the periods as compared to the respective periods in 2007. The impact of the change in the exchange rate of foreign currencies to the U.S. dollar also resulted in an increase in SG&A during the three and nine months ended September 27, 2008 of approximately $4.5 and $18.5, respectively. SG&A for the nine months ended September 29, 2007 included a benefit of $5.0 within our Thermal Equipment and Services segment for cost improvements associated with a state-approved environmental remediation plan at a site in California.
Intangible amortization β For the three and nine months ended September 27, 2008, the increase in intangible amortization was due to amortization expense associated with intangible assets acquired in connection with the APV, JCD and Matra transactions.
Special charges, net β Special charges related primarily to restructuring initiatives to consolidate manufacturing, distribution, and administrative facilities and functions. See Note 5 to the condensed consolidated financial statements for the details of actions taken in 2008 and 2007.
Other income (expense), net β Other expense, net, for the three months ended September 27, 2008 was composed primarily of a charge of $9.5 relating to the settlement of a lawsuit arising out of a 1997 business disposition, minority interest charges of $1.3 and foreign currency transaction losses of $0.9. Other expense, net for the three months ended September 29, 2007 was composed primarily of foreign currency transaction losses of $1.4 and minority interest charges of $0.6, partially offset by $1.1 of life insurance death benefits that were received during the quarter.
Other expense, net for the nine months ended September 27, 2008 was composed primarily of the charge of $9.5 mentioned above, minority interest charges of $4.4, partially offset by foreign currency transaction gains of $0.4 and gains on sales of assets of $0.9. For the nine months ended September 29, 2007, other expense, net was composed primarily of minority interest charges of $1.5 and foreign currency transaction losses of $1.8, partially offset by the $1.1 of life insurance death benefits noted above.
Interest expense, net β Interest expense, net includes both interest expense and interest income. The increase in interest expense, net, was the result of higher average debt balances during the three and nine months ended September 27, 2008 as compared to the respective periods in 2007. The average debt balance for the three and nine months ended September 27, 2008 was higher than the average debt balance for the respective periods in 2007 primarily as a result of the issuance of the $500.0 of senior unsecured notes in December 2007 (see Note 10). Refer to the discussion of Liquidity and Financial Condition in our 2007 Annual Report on Form 10-K for details pertaining to our 2007 debt activity.
Equity earnings in joint ventures β The increase in equity earnings in joint ventures for the three and nine months ended September 27, 2008 was attributable primarily to strong operational performance at our EGS Electrical Group, LLC and Subsidiaries joint venture.
Income tax provision β For the three months ended September 27, 2008, we recorded an income tax provision of $18.2 on $128.7 of pre-tax income from continuing operations, resulting in an effective tax rate of 14.1%. This compares to an income tax provision for the three months ended September 29, 2007 of $12.9 on $107.8 of pre-tax income from continuing operations, resulting in an effective tax rate of 12.0%. The effective tax rate for the three months ended September 27, 2008 was impacted favorably by a tax benefit of $25.6 that was recorded in connection with the finalization of the audits of our 2003 through 2005 Federal income tax returns. The effective rate for the three months ended September 29, 2007 was impacted favorably by an income tax benefit of $11.0 associated with the settlement of certain matters related to our 1995 through 2002 Federal income tax returns and an income tax benefit of $8.1 associated with a reduction in the statutory rates in Germany and the United Kingdom.
For the nine months ended September 27, 2008, we recorded an income tax provision of $99.0 on $363.6 of pre-tax income from continuing operations, resulting in an effective tax rate of 27.2%. This compares to an income tax provision for the nine months ended September 29, 2007 of $59.0 on $255.4 of pre-tax income from continuing operations, resulting in an effective tax rate of 23.1%. The effective tax rate for the nine months ended September 27, 2008 was impacted favorably by the tax benefit of $25.6 noted above. The effective tax rate for the nine months ended September 29, 2007 was impacted favorably by the items noted above for the three months ended September 29, 2007, as well as by a reduction in the state
income tax provision due to a reduction in the valuation allowance for certain states and an income tax benefit of $3.5 associated with the settlement of certain matters relating to income tax returns in the United Kingdom.
Jeremy W. Smeltser - Investor Relations
Thank you, Shauna. Good morning everyone. Thanks for joining us. With me on the call this morning, as always, are Chris Kearney, Chairman, President and CEO of SPX; and Patrick O'Leary, our Chief Financial Officer.
This morning's call is being webcast with a slide presentation which can be accessed on our website at www.spx.com in the Investor Relations section. This webcast will be available until November 12.
You may wish to follow along with the webcast as we reference the detailed information on the slides. Please note that this slide presentation also includes supplemental schedules, which provide reconciliations for all non-GAAP financial measures referenced today.
Our earnings press release was issued earlier this morning and can also be found on our website.
Before we continue, I would like to point out that portions of our presentation and comments are forward-looking and subject to Safe Harbor provisions. I would also refer you to the risk factors in our most recent SEC filings.
With that, I'll turn the call over to Chris.
Christopher J. Kearney - Chairman of the Board, President, Chief Executive Officer
Thanks, Jeremy and good morning everyone. Thanks for joining us as we report our third quarter earnings. As you know there have been a lot of changes in the global economy since we reported Q2. I'll address these changes and what we currently know about their impact on Spx. I will also update you on our key end market developments and recent strategic actions.
Patrick will take you through a detailed analysis of the third quarter results, our expectations for Q4 and our revised full year guidance. He will also review our balance sheet and liquidity. I'll close with a brief summary before we take your questions.
Recently there have been many changes in global economic landscape. The value of the euro, British pound and South African rand have each declined significantly versus the US dollar. In this call we will discuss how these foreign currency fluctuations impacted our Q3 results, Q4 outlook and reported backlog.
Additionally, the banking failures and consolidations have stirred an unprecedented global credit crisis. Availability of capital is uncertain for many companies and it is unclear at this time how that impacts our customer's capital budgets as we move into 2009.
We do expect that customers will generally be more cautious over the coming months. We also recognize that in today's global economic climate there are increased risks of potential changes in the behavior of our customers. We are carefully monitoring those risks and stand prepared to take additional restructuring or other actions if they become necessary.
Most importantly we remained confident that our long term strategy and solid balance sheet have us well positioned to manage through the world's evolving economic changes.
Looking specifically at Q3, let me highlight our key financial metrics for the quarter. Q3 earnings per share were just over $2 per share. On an adjusted basis, EPS for the quarter was a $1.66, up 19% year-over-year. Adjusted EPS excludes a $0.47 tax benefit and a $0.11 legal charge both related to recent settlements,
Patrick will provide more detail on these two items latter in the call. The topline grew 29% in the quarter driven largely by the APV acquisition. Organic revenue was 6.5%, up from 4% in Q2. Segment income margin was 13.8%, down 40 points from Q3 last year due to the diluted impact of ATV but ahead of our expectations. Excluding APV, third quarter segment margins were up 120 points over last year.
Free cash flow in the quarter was $71 million much stronger than the prior year quarter. We pleased by our financial results throughout the first nine months of the year. Our topline grew more than 30%, including 6% organic growth. Improved operating execution and strong leverage on the organic growth increased segment income a $162 million or 39%. Segment margins expanded 70 points to 13.1%.
Excluding the dilution from the APV acquisition, margins in the base business improved 240 points year-to-date. The growth and improvement were reflected in the bottom line and adjusted earnings per share grew 45% in the first nine months.
Moving into Q4; we are targeting organic growth for the quarter to be between 8% and 10%. We have good visibility in our backlog, the power and energy equipment orders that we expect to deliver in the fourth quarter. Outside of this end market our forward look is more limited. About 60% of our business is short cycle with visibility at around three months. This is particularly true for tools and diagnostics which has a significant daily tools business.
We experienced softness in U.S. tools and diagnostics market through the first nine months of this year. In Q3, organic revenue into this market was less than we had anticipated and our outlook for Q4 has come down as well. We are now expecting a double digit organic decline in Q4 in our Test and Measurement segment. We've also seen some reduced activity in parts of our Industrial segment. But we are still targeting double digit organic growth in this segment for Q4.
The other change of note on this chart is the sanitary market. Our recent bookings and order rates have been steady but not growing at the same pace we were seeing through the second quarter. This is true primarily with shorter cycle sanitary orders in the U.S and Europe. Asia and the large project backlog continued to grow.
It's important to note we exclude the impact of foreign exchange fluctuations in our reported organic growth. With more than 50% of our business generated from sales outside the United States, changes in FX rates can impact our reported revenue and operating profits significantly. The translation of the euro and British pound have the most impact on our financial results. Each of these rates has declined nearly 20% since the end of June.
These declines reduced reported revenue in Q3 by about $30 million as compared to the revenue target we gave on July 30 and also reduced our outlook for Q4. We have updated our full year guidance range primarily as a result of these currency changes.
Additionally, declines in the value of the euro, pound and also the South African rand have reduced the dollar value of our backlog. At the end of Q3 our backlog was $3.6 billion, down $120 million from Q2. $108 million of that was decline was due to foreign currency fluctuations.
Order growth in our Thermal backlog for instance was offset by approximately $75 million of decline related to currency fluctuations. The order pipeline at thermal is strong. Quoting and bidding activities for cooling systems and heat exchanges remained steady, particularly for large projects.
Yesterday we announced that we have signed a $124 million contract with Hitachi, to provide key thermal equipment for the new Kusile power station in South Africa. This power station was previously referred to as Project Bravo. This contract is not reflected in the backlog we just presented today, which are as of the end of September.
Our foreign backlog at the excuse me our Flow backlog at the end of Q3 was down $19 million. Foreign currency fluctuations reduced the backlog by $33 million, offset partially by growth from orders of $14 million.
Overall orders remain steady and the majority of our slow end markets. However we have experienced a few delays of larger sanitary projects from Q4 into the first half of 2009. Backlog in our Industrial segment declined 10%, which was partially due to a 28% organic growth in the period.
However orders have slowed to some of our industrial products including distribution transformers. The settlement underlying this recent behavior by our U.S based transformer customers appears to be driven in the short term by uncertainty regarding the availability of capital in the current economic environment and uncertainty as to what affect the slowing economy could have on electricity demand in the near term. If the settlement persists it could have an impact on the transformer business in the next year.
Looking at our entire business at this point it's too early to judge what impact the changing economic conditions and various responses to those conditions will ultimately have on our customers and their actual behavior in 2009. To date we have not had any major contract cancellations.
Our planning process for next year is underway and we expect to issue 2009 guidance in January as we normally do. We're proceeding cautiously in the short term and are closely monitoring the potential impact on our business. We're confident in our long-term strategy to focus growth around power and energy infrastructure, process equipments and diagnostic tools.
The fundamental global driver of these end markets remain positive; including population growth, increasing demand for electricity and the advancement of developing countries. And we continue to execute the strategy which includes divesting of non-core businesses and product lines and developing our core platforms.
During the quarter, we committed to divest two non-core product lines with combined annual revenue of about $70 million. The financial results for these businesses are now classified as discontinued operations. They were previously reported in our Flow and Test and Measurement segments.
Additionally, we signed a definitive agreement to sell our vibration test business for about a $100 million. We expect to complete this sale by the end of the year. While this is an attractive niche business, we did not have the critical mass needed to grow the business and we believe we have found a more natural owner for it. We continue to focus on globalizing the Tools and Diagnostics platform with acquisitions to expand our geographic customer base and technology capabilities.
During the quarter, we acquired AUTOBOSS, an Asian manufacturer of aftermarket diagnostic tools. This business has annual revenues of about $10 million. Although, this business is small, it gives us access to the core systems used in the electronics of most Chinese manufactured vehicles.
This significantly increases our ability to serve the evolving Asian markets and also provide distribution opportunities to local customers. AUTOBOSS is the first acquisition we've completed since acquiring APV at the end of last year. The integration of APV is well under way, and it's initially focused on rationalizing operations in high cost regions including Europe and the United States.
We are executing on several facility closures and consolidations that are expected to reduce headcount by approximately 500 employees. As a reminder, we expect that total cost of the integration to be between $60 million and $80 million. We expect the entire integration to be completed sometime in 2010. Our projected annualized savings are between $40 million and $60 million after the integration is finalized.
Lastly in September we announced that we have entered into a new 10b5-1 plan to repurchase up to 3 million shares of SPX stock. This represents about 6% of the outstanding shares. The plan becomes active on November 3rd. We expect the APV integration and the share repurchase program to benefit earnings per share in 2009.
Moving onto our financial position; as of the end of the third quarter our balance sheet continued to improve. At the end of the quarter we have $466 million of cash on hand. Net debt was reduced to just over a $1 billion and net leverage was down to 1.4 times. Gross leverage was 1.9 times, within our target range of 1.5 to 2.0 times. Patrick will give you more details on our debt structure and liquidity later in the call.
So we believe our financial position is solid and it gives us significant flexibility in the current economic environment and with that I will turn the call over to Patrick.
Patrick J. O'Leary - Executive Vice President, Treasurer and Chief Financial Officer
Thanks, Chris. Good morning everyone. Beginning with EPS, we reported earnings per share for the quarter of $2.01. During the quarter we recorded a $0.47 tax benefit as a result of a favorable outcome of IRS tax audits for the years 2003 through 2005, details are not closed [ph]. Additionally we recorded $0.11 charge related to the settlement of a lawsuit associated with the business disposition that took place in 1997.
This charge was recorded on the other expense line of our income statement in Q3. Excluding these two items, Q3 EPS was a $1.66, that's up 19% over the last year's adjusted EPS and $0.01 above the top end of the guidance range we gave you on July 30.
Increased segment income contributed $0.53 of improvement; this more than offset headwinds from interest, pension expense and a higher effective tax rate. The effective tax rate on the adjusted earnings for the quarter was 34.3%, that's up from 30% in Q3 last year.
Looking at our consolidated operating results for the quarter, the year-over-year performance was solid. However, compared to the targets we communicated on July 30, reported revenue was less than we anticipated, though the margin performance was much stronger than we expected.
Reported revenue for the quarter was $1.5 billion, up 29% year-over-year. Acquisitions contributed 20% growth with APV reporting $211 million of revenue. Organic growth was 6.5%, highlighted by 28% from Industrial and 8% from Flow. We had expected modest organic growth at Thermal and Test and Measurement. However, these two segments reported organic declines for the quarter. Thermal had a tough comparison to last year due to project timing delays and lower sales into China. And Test and Measurement as a result of increasing softness in the U.S market.
Foreign currency fluctuations increased revenues $30 million or 2.6%, and compared to our target model on July 30 foreign currency translation impact in the quarter resulted in about $30 million less revenue than we had anticipated. Additionally, the two product lines reported as discontinued operations in the quarter, reduced our reported revenue by about $16 million.
Obviously the reduced revenue from currency translation and discontinued operations also negatively impacted segment income. Despite these headwinds our operating execution was solid. Segment income was $209 million, that's up 25% over Q3 last year and in line with our target.
Segment margins were 15.8%, 70 points better than the high end of our target range. Reported margins were down 40 points year-over-year in Q3 reflecting 160 points of dilution from the APV acquisition. Excluding APV our segment margins were up 120 points year-over-year.
Moving on to the segments; beginning with Flow. Please not the result of Flow now excludes the discontinued product lines for all periods presented. For the quarter, Flow reported revenue of $493 million, up 92% from Q3 last year. As I mentioned APV reported revenue of $211 million accounting for 83% of the growth. Organic growth was 8%, driven by strong sales of our Engineered products in power, oil and gas and dehydration markets.
Segment margins were 11.3%, down from 17.2% in Q3 last year. The APV acquisition accounted for the majority of the decline diluting margins 550 points. Margins were also impacted due to shipping delays of higher margin products at our Houston facility, caught by Hurricane Ike. Excluding the dilution from APV and the hurricane impact, margins in the base business were essentially flat year-over-year.
For Q4, we are targeting total revenue growth of about 60%, with organic growth in the mid single digits. We expect Q4 cost reduction actions to improve Ape's margins into the high single digits by year-end. For the segment, we are targeting margins between 14.2 and 14.5%. Our Thermal segment reported revenue of $437 million, up 3.5% over last year.
Foreign currency fluctuations benefited revenues 5%, offsetting a 2% organic decline. In Q3 last year, Thermal reported 28% organic growth making this quarter's comparison challenging just as it was in Q2. Additionally, some revenue on projects, we had anticipated booking in Q3, was delayed due to construction timing and are now expected to be booked in the fourth quarter.
Q3 margins were 12%, down from 13.4% in the prior year. The year-over-year margin decline was caused by a lower margin mix of project business. The uneven nature of project timing in this segment is likely to continue to cause quarterly fluctuations in revenue growth and margin performance.
In Q4, we are targeting total revenue growth of about 20% with strong organic growth. Margins are expected to increase year-over-year approaching 13%. And for the year, we are now targeting margins to be just under 12% within the long-term margin target range for this segment.
2008 margins have benefited from the $100 million dry cooling project in Qatar that we expect to be near completion by the end of the year. Moving on to Test and Measurement, again please note, the results for this segment exclude the product line that was discontinued during the quarter. Revenue for the quarter was up 6 to $260 million.
The European businesses acquired in 2007 contributed 7% growth and foreign currency benefited revenue by 2%. Organically revenues declined 3%, primarily due to continued softness in the U.S. market for Tools and Diagnostics. Segment margins were 11.7% in the quarter, up from 9% last year. However it should be noted that there was a one time charge of $7 million recorded in this segment in Q3 last year.
On a comparable Q3, 2008 margins were modestly lower than last year. We anticipate Q4 to be another challenging quarter for this segment. We have reported revenue roughly flat sequentially to Q3 but down significantly year-over-year. The total revenue decline is expected to be between 13% and 18%, including a double-digit organic decline driven by the weakness in the U.S. markets and fewer OE programs globally.
Foreign currency fluctuations are expected to decrease revenue about 5% as compared to Q4 last year. Q4 margins are targeted between 10.2% and 10.5%. Our long term strategy for Test and Measurement is focused on partnering with global OEMs. We recently took another important step in that strategy, partnering with Honda to develop Honda's third generation diagnostic system. This is another good example of our successful growth with non U.S. OEMs.
Lastly our industrial segment, which turned in another very strong quarter. Our revenue in the period was $320 million, up 29% year-over-year. Organic revenue growth of 28% was driven by strong sales of power transformers into the U.S. market and crystal growers supporting growth in the global solar power market.
Organic revenue also benefited from transformer shipments that were delayed in Q2 due to the flux in the Midwest. Those units were delivered to customers at the beginning of Q3.
Segment income was $70 million, up 60% year-over-year and margins for the quarter were 22%, up 430 points from Q3 last year. The margin improvement was driven primarily by leverage on the organic growth and improved pricing in power transformers.
For Q4, we are targeting revenue growth in the mid-teens with margins just under 20%. Looking at our Q4 target on a consolidated basis, we expect total revenue growth of about 20% with organic growth between 8% and 10%, and acquisition growth of about 15%. Foreign currency fluctuations are expected to reduce revenue year-over-year by 5% to 6%
This represents a significant change in our outlook driven by the recent declines in foreign exchange rates. Segment income is targeted at about $225 million or about 15% greater than Q4 last year. Segment margins are expected to be just over 14%. Excluding APV, we are targeting margins to be flat versus last year and earnings per share are targeted to grow 14% to 20% and be between $1.90 and $2 per share.
For the full year we have updated our segment revenue, growth and operating margin targets. Most notably, we have reduced our revenue targets by about $120 million. We think the average segment margins for the year of about 13%, this equates to about $15 million of segment income.
In addition the product line discontinued in the third quarter, reduced revenue and segment income by about $70 million and $4 million respectively. From an organic point of view we have reduced both the revenue growth and the margin targets at Test and Measurement due the increasing challenges in the U.S. Tools and Diagnostics markets.
This decline has been partially offset by an increase in our expectations for Thermal's full year margin. We raised the Thermal margin target about 80 points to 11.7% to 11.9%. This reflects the Q3 margin performance and represents an increase of about a 140 point over 2007. Based on these and other smaller changes we have revised our EPS guidance range to $6.40 to $6.50 per share. This reduces the midpoint of our EPS guidance $0.05 to $6.45 per share.
A complete model for the EPS midpoint is provided in the appendix of the presentation. On a consolidated basis we are targeting full-year revenue growth of 28% to 29%. Organic growth is expected to be between 7% and 8%, consistent with our July 30th model and segment margins are expected to be about 13.3%, up 20 points over the last year, this includes dilutive impact of APV.
Excluding APV, the base business is expected to increase margins more than a 150 points. Effective tax rate on our updated model is just under 34%. And free cash flow guidance remains at $300 million to $320 million. The most significant fact is that we believe it could cause us to report 2008 EPS outside of our revised guidance range are additional foreign currency fluctuation, changes in the market for our short-cycle businesses, project timing on larger orders, execution of the APV integration and the change up or down in our effective tax rate.
I'll finish with a brief update on our cash flow, financial position and liquidity before I turn in the call back to Chris. Through nine months, we have generated $68 million of free cash flow. We have invested nearly $80 million of CapEx to support growth in the business. This is more than $30 million greater than last year at the same time.
Consistent with prior years, we expect to generate the majority of this year's free cash flow in the fourth quarter. We are targeting Q4 free cash flow of about $240 million. Our full year free cash guidance of $300 million to $320 million represent between 85% and 90% conversion of net income. As a reminder our free cash flow guidance includes $30 million to $50 million of cash restructurings for APV and capital spending of about $145 million.
During 2007, we refinanced the majority of our capital structure to give us increased flexibility to grow the business. We also issued Senior Notes in December last year to finance the APV acquisition. This has positioned us well given the current credit market. At the end of the third quarter, we have $1.5 billion of debt outstanding and $400 million of available credit lines.
With our current debt structure, we have minimal repayment requirements in the near term. Over the next two years we are only required to pay $75 million annually on the term loan. In 2012, our credit facilities mature and in 2014, the Senior Notes become due.
Looking at our liquidity, at the end of September, we had $466 million of cash on hand plus the $400 million of available credit lines. In Q4 we are targeting free cash flow generation as I mentioned of about $240 million and we expect to complete the sale of LDF before the end of the year, which would add approximately $100 million of cash.
We require... Q4 uses of cash include $19 million of principle payments on our debt and our quarterly dividend payment of $15 million. Reserving about $200 million for working capital needs that give us total projected liquidity of about $975 million by year-end.
We have already announced the plan to repurchase up to $3 million of SPX stock, assuming yesterday's closing price, the total cost of repurchasing 3 million shares is approximately $130 million.
If we complete the share repurchases at that price we would still have projected liquidity of nearly $850 million. We believe this amount of liquidity gives us significant flexibility in making strategic capital allocation decisions in the future. In summary we are very comfortable with our capital structure and liquidity going into 2009.
With that I will turn the call back to Chris.
Christopher J. Kearney - Chairman of the Board, President, Chief Executive Officer
Thanks Patrick. In 2005 we communicated a plan to investors focused on repositioning SPX for the long term. Over the past four years, we successfully recapitalized our balance sheet and strategically reshaped SPX around three global end markets. We defined a disciplined approach to capital allocation and we've shown consistency in balance with our investment decisions.
And we focused growth and improvement around core operating initiatives that have been embraced by our employees, and are driving a culture of continuous improvement at SPX. We believe these actions will have SPX well positioned to manage through an uncertain economic environment. And we are pleased to report Q3 earnings per share above our guidance range, and we are targeting double-digit revenue and earnings growth for the fourth quarter.
Our financial position is strong, and we believe that we have ample liquidity to remain flexible in our investment decisions for acquisitions and share repurchases. The integration of APV is progressing, and we expect the cost reduction actions we are taking to benefit earnings in 2009. And we expect to begin executing our most recent share repurchase program next week.
We are carefully evaluating our plan for next year, and expect to present our 2009 guidance in January. As I said in my opening remarks, we are seeing some changing trends in certain end markets and we recognize that in today's global economic climate, there are increased risks or further changes in the behavior of our customers.
We are carefully monitoring those risks, and we stand prepared to take additional restructuring or other actions if they become necessary. We are confident in our long-term strategy, and we remain committed to executing it. Thanks again for joining us for the call. And at this time we are happy to take your questions.