SPX Technologies, Inc.
Q3 2015 Earnings Call Transcript

Published: 7 Nov 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the SPX Corporation Third Quarter 2015 Earnings Call. At this time all participants are in listen-only mode. Later we'll conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's program is being recorded. I would now like to introduce your host for today's program, Paul Clegg, VP of Finance and Investor Relations. Please go ahead.

[Paul Clegg:]

Thank you, Jonathan and good afternoon everyone. Thanks for joining us. With me on the call today are Gene Lowe, our President and Chief Executive Officer, and Scott Sproule, our Chief Financial Officer. Our third-quarter results press release was issued just after market close. You can find the release, as well as a link to a live webcast and slide presentation of this call, in the investor relations section of our website at SPX.com. I encourage you to follow along with the slide presentation during our prepared remarks. A replay of the webcast will be available on our Web site until November 13. As a reminder, portions of our presentation and comments are forward looking and subject to Safe Harbor provisions. Please also note the risk factors in our most recent SEC filings. Due to multiple complexities related to the spinoff of SPX FLOW, Inc., charges associated with our South African projects, and other items, our comments today will largely focus on pro forma financial results. Specifically, we will focus on pro forma core operating results, which exclude the results of the South African projects and we will separately provide an update on those projects. This is the way we manage the business and we believe this provides the best transparency to investors about our ability to drive value across the portfolio. You can find reconciliations of all pro forma figures to their respective GAAP measures in an appendix to today's presentation. Finally, we plan to present at the Credit Suisse Global Industries Conference on December 3, and we plan to be on the road meeting with investors during the week of November 9. And with that, I will turn the call over to Gene.

[Gene Lowe:]

Thanks, Paul. Good afternoon, everyone. Thanks for joining us on our first earnings call following the spinoff of SPX FLOW, Incorporate. Before I begin with comments around the business, I would like to thank our employees for their hard work in completing this long spinoff process, which I believe results in two even more focused companies that can create greater opportunities for employees and customers, as well as drive additional value for shareholders. We appreciate your commitment and dedication. As discussed at our investor day in September, there are many complexities in the presentation of our GAAP results in the third quarter. On September 26, we completed the spinoff of our FLOW business, our hydraulic technologies business, and certain other corporate entities into SPX FLOW, Inc. the results of SPX FLOW are reported as discontinued operations this quarter. We're also reporting under our new segment structure for the first time. In addition, our results contain several nonrecurring and unusual items that affect comparability with other quarters, including a significant charge related to our South African projects, which we will discuss in greater detail later in the presentation. As such, our comments today focus on pro forma results that assume the spinoff of SPX FLOW happened at the beginning of 2015 and the resulting cost structure and capital structure of the new SPX was in effect for the full year. We will also discuss the results of our core businesses separately from the results of the South African projects. And with that, let's discuss our Q3 results. For the third quarter, excluding the impact of the South African projects, core revenues were $411 million or below our target range. Our HVAC segment continued to perform well. Detection and measurement delivered solid profitability. However, the timing of certain orders has pushed into subsequent quarters in the project-oriented part of the segment. In our power segment, our transformer business remained on track for an improving full-year performance, while in power generation we continued to experience weaker customer demands. As a reminder, most of our segment income comes from our HVAC and detection and measurement segments and overall we would expect these segments to continue their solid contribution to earnings. Before I turn over the call to Scott to go through the numbers in more detail, I want to revisit our value creation roadmap and talk about some of the actions that we are currently undertaking. At our investor day in September, we laid out initiatives to drive significant increases in core EBITDA over the next three years, equating to yearly double-digit earnings growth. We plan to accomplish this through operational efficiencies by expanding our growth platforms and reducing our exposure to lower return markets. Our three year targets reflect organic growth in HVAC and detection and measurement, two growth segments where we generate more than 85% of our core segment income. Additionally, we also intend to grow these platforms through bolt-on acquisitions. We also have a solid power transformer business where we see a long runway of replacement opportunity in the U.S market and where we are focused on margin expansion through value engineering and productivity initiatives. In the power generation component of our power segment, we will continue to be focused on reducing our costs to be aligned with market demand, as well as repositioning our business towards more profitable market segments. To be clear, all of our businesses must have a path to attractive returns; otherwise, we will evaluate all strategic alternatives to drive shareholder value. Now I will move into a brief update on initiatives in our segments. In HVAC, in addition to our solid performance this quarter, we remain on track with our plans for several new product launches and expanding and optimizing our channels to market. We recently re-launched our flagship package cooling product and have entered an adjacent new market with evaporative condensers. In detection and measurement, we're seeing some of the lumpiness you can experience in project based end markets where the timing of order approvals, particularly by government entities, can be difficult to predict. Having said that, there is a healthy front-log across these businesses and we continue to see customer interest in our new products and our development roadmap, both of which support our continued growth outlook over the coming years. As a reminder, a substantial portion of our business in our HVAC and detection and measurement segments is replacement revenue, which generally provides more stable and predictable demand profile. Within our power segment, our transformer backlog is up sequentially and the business is on track to meet our margin targets. Pricing is comparable with the year-ago period and we're seeing our order book go out to the middle of next year. We also see a strong replacement cycle ahead for transformers, with a large number of transformers having been installed in the 70s in the U.S. market that are coming to the end of their useful lives. Recent press has been filled with stories about a weaker macroeconomic environment, particularly for larger energy equipment, and we've seen this in the results of our power generation products in our power segment. We are addressing this head-on by taking aggressive action to reduce complexity, risk, and cost. First, we have become more selective in our order process, which may reduce our revenues in this business, but it avoids us using capital for projects that have returns that do not meet our targets. We have also consolidated operations in Europe in the third quarter to reduce our future cost structure there, for which you saw a charge this quarter, and we are increasing our full-year targets for restructuring costs in order to further align our costs with challenging market conditions. In short, we are taking action to make the power generation business smaller, but more profitable. Turning to the South African projects, a lot has changed since last quarter. There have been a lot of discussions about the challenges of the South Africa projects in previous quarters. Recall that these are two mega power projects owned by the state owned South African utility Eskom, power projects that have unfortunately seen continual delays through their lifecycle. We are a contractor for various components at each of the sites, with a scope that can include engineering, manufacturing, construction, and commissioning, depending on the specific contract and clients. We've reported challenges with project delays, subcontractor performance, subcontractor solvency, construction activities, and even certain manufacturing challenges over the projects' life, all of which have led to an environment that creates uncertainty, despite our efforts to focus on the items we have control over. We remain committed to meeting our obligations on these projects and supporting our customers and the owner of the plants, as well as help bring a much needed new power supply to the country of South Africa. While there continue to be many challenges in the completion of these projects, several recent changes have provided significantly more clarity on certain options previously under consideration than we had even a few months ago. But first, let me talk about some of the progress we made during the quarter. First, the initial unit of the Medupi Power Station went online in August of this year. This is a very important milestone for the owner, Eskom, our customers, and SPX as well, signifying another step forward in the process. Secondly, we've added a seasoned global executive, Randy Data, to help lead us through the completion of these projects. Randy is the former President and Chief Operating Officer of Babcock & Wilcox's power generation group. He brings very strong competencies to our Company in large project execution in the global power industry. Randy and his team have worked to further develop strategies to more effectively execute the backlog, whether it be leveraging other internal SPX resources, utilizing external resources, addressing process issues, or resolving ongoing customer or subcontractor related issues. I am confident that we are addressing the project challenges head on, making the changes necessary to reduce longer-term risk, while continuing to support our customers in completing the work. Now I would like to make a few comments around the $95 million charge we recorded in Q3. First, we need to reiterate that these are complex power projects that have had continue delays for many reasons, delays measured not by, measured by years, not months. When there are delays like this, costs continue to escalate, while pressure to recover the schedule increases and typical work processes get modified. This creates a situation of suboptimal execution, as well as complex negotiations with customers and suppliers over additional costs. Late in the third quarter, the discussions we have been having with our customers to understand the impact of delays on all parties progressed significantly. We have reached the point where the situation became much clear with respect to the likely outcome around cost recovery options, as well as decisions on how to move forward in the best interest of meeting contractual obligations while also mitigating longer-term risk. All of this is a material, although this is a material adjustment to the projects, it is our opinion that the outcome of the discussions we are having will reduce the overall project risks, and the charge we have taken in the third quarter represents these significant portion of potential risk. That said, given the complexities of these projects and the overall situation in South Africa, further risks remain and we'll keep you updated as we execute the remaining scope of the work. In summary, I believe we have the right team and the right strategy for moving the projects to completion and meeting our contractual obligations, while minimizing our risk. I also believe that the actions we have taken have materially reduced our risk profile going forward. Now, I'll turn the call over to Scott.

[Scott Sproule:]

Thanks, Gene and good afternoon everyone. My comments today will focus on pro forma results. There are a number of adjustments we need to make to our reported results to provide a better representation of our ongoing business. Also, as Paul noted, we'll separate the discussion of our results between our core operations and those from the South African projects. This is how we look at our business and it allows us to provide clear insight into the portion of our business we are focused on for long-term strategic developments and to discuss the progress we are making to mitigate risk associated with South Africa. This will be the way we discuss the Company going forward. Specifically, we're making adjustments to our reported Q3 results, which were an operating loss of $113.6 million and a loss of $2.58 per share on a GAAP basis. For revenue and segment income, we are removing the results of our South African projects, which include the $95 million charge that Gene just mentioned. And I will go into more detail on that in a moment. Certain costs below segment income need to be normalized to align with the post-spin SPX. Corporate expense includes costs for individuals and other expenditures that are part of corporate during the quarter, but post-spin are either direct costs of SPX FLOW or have been otherwise eliminated from our cost structure, so these amounts are being adjusted out. The adjustments shown for pension, stock-based compensation, and restructuring are all attributable to the spins, so have also been adjusted out. On a pro forma basis, we had $14.2 million of core operating income, which is more indicative of the ongoing results for the post-spin SPX. Our core revenues of $411 million declined $51 million compared with the prior year period. This reflects an organic year-over-year decline of 7.4% and a 3.6% currency headwind, which is predominantly attributable to our power generation businesses. Core segment income margin was 8.2%, only slightly below the prior year period, but there was a significant decline in profitability in our power generation and we had lower margins in detection and measurement, which were mostly offset by stronger margins in HVAC. Now I'll walk through the details of our results by segment, starting with HVAC. Revenues increased 3.9%, driven by 4.6% organic growth. Currency headwinds were modest for this segment. The revenue growth was driven by sales of cooling products, including the shipment of the largest order ever for this business. This was partially offset by a decline in heating products, where we saw certain channel partners reduce their inventory levels in the quarter. Segment income margin improved 330 basis points to 16.5%, due to the increase in volume of cooling products with higher-than-normal margins. Additionally, we have a number of operational improvement and strategic sourcing initiatives underway in this segment that favorably impacted our results. With respect to order trends within HVAC, as a reminder we have a fair amount of book and turn and shorter-cycle products in this segment. In the first half of the year, we saw mid single-digit order growth, and entering the quarter, we expected this growth trend to continue. However, late in the third quarter customer behavior grew more cautious across the board and we saw some of the channel inventory adjustments I just referred to. As a result, Q3 orders ended up low single-digit percentages above the year-ago period. Moving on to detection and measurement, revenues were essentially flat on an organic basis as higher sales of pipe and cable detection products and bus fare collection products were offset by lower sales of communication technology products. Including the effect of currency, revenues declined 2.4% year over year. Our communication technology business benefited from an industry transition to LED lighting in prior years. The business revenues began to normalize late in 2014, but Q3 still had a tough year-over-year comparable. Segment income and margins declined year-over-year are primarily due to the favorable operational leverage in 2014 associated with the industry's conversion to LEDs. Additionally, changes in overall business mix in the segment and the impact of the stronger U.S dollar contributed to the margin decline. We continue to introduce new products that are gaining customer acceptance in the end markets we serve from this segment and we see a strong front-log, which gives us confidence in the future growth potential. In our power segment, excluding the results of the South African projects, revenues declined 20.6% year-over-year, including a 5.4% currency headwind and a 15.2% organic decline primarily from lower sales of power generation equipment. Demand for power generation equipment remained at low levels and we are being selective in the projects we choose to bid on. Both are contributing factors to the year-over-year revenue decline. Segment income margin declined 280 basis points due to the revenue reduction, as well as significant declines in profitability in our European based operations. Bookings for power generation equipment remained at low levels and backlog declined sequentially from Q2. As power generation markets remain weak, we are intensely focused on reducing costs and risk in this business. We have executed $13 million of restructuring actions so far this year, including about $8 million for actions announced in Q3 that are currently underway. Our focus is to right-size this business to align with our long-term views of the market and improve profitability. As we not foresee any near-term market improvement, we are increasing our restructuring targets for 2015. As a reminder, our transformer business is also part of the power segment and we remain positive on the outlook for this business. We are seeing good results this year from our margin improvement actions we remain on track to achieve our target for margin expansion. Turning now to the South African projects, as I noted earlier we recorded a $95 million charge for the projects in the third quarter. As you can see on this slide, this further complicates the presentation of results as the part of the charge was accounted for as a reduction in revenue. As a reminder, we have a 25% minority partner in South Africa, so the net effect from the $95 million charge on our bottom line is $71.2 million. During the third quarter, we gained considerably more insight into what it is going to take to complete these projects. The commercial operation of the first unit at the Medupi site was part of that. Additionally, based on further experience around the erection scope of work for the cooling towers and filter products and productivity levels at our Nigel manufacturing facility, we concluded that our prior cost estimates needed to be revised. The progression of discussions we are having with our customers, the project owner, and our subcontractors around responsibility for costs associated with delays and the likely level of recoverability we will receive are also very significant factors in the quarter. These discussions have progressed to a point where we now better understand our cost responsibilities between parties and can more accurately estimate our costs. As a result of this, we have also reduced our expectations around the recoverability of these costs from either subcontractors or customers. As a result of this charge, the projects are now in a cumulative loss positions and prospectively we will not recognize profit on future revenues. We will continue to have an overhead support structure in South Africa that will naturally decline as we complete phases of the projects, but will represent an ongoing headwind to earnings until then. We are currently working through our 2016 financial planning process and will update you on those efforts and what to expect from the ongoing operations when we provide our 2016 guidance in February. There is still a long way to go to complete these projects. Given the complexity of the projects and the overall operating environment in South Africa, there remains risk of additional material charges in the future. However, it is our opinion that the third-quarter charge represents the significant portion of our potential risks on the project and properly accounts for everything we know of today. Moving on to our financial position and modeling targets, overall we exited the spin in a solid financial position. We had $83 million of cash and our net debt position is slightly better than our expectations. Our new credit facility includes a five-year, $350 million term loan that does not have significant mandatory repayments for several years. We also have a $350 million revolver. The revolver and our projected cash generation are expected to be our primary sources of liquidity. Excluding outstanding letters of credit, we had availability under our revolver of $300 million at the end of the third quarter. Our post-spin gross debt to EBITDA leverage of 2.9 was higher than our target range of 1.5 to 2.5 times and slightly higher than our expectations. Due to the seasonal nature of our HVAC segment and the timing of projects in our detection and measurement segment, our EBITDA and cash flows are concentrated in Q4. Based on this and with a focus to pay down short-term debt in Q4, we expect to be back within our target range by the end of the year. Now turning to our 2015 modeling targets, based on the significant change in the accounting estimates around the South African projects, we're restating our 2015 targets on a core basis. We believe this gives the best visibility into the organic changes in our targets. At the midpoint, we are reducing our full-year 2015 core revenue targets by approximately 3% and our core segment income targets by approximately 6% or $10 million. Also, we are increasing our full-year target for additional restructuring actions in Q4 to better align the cost structure in our power generation business with market demand. As a reminder, restructuring charges are below the segment income line and are also an add back under our bank credit facility calculation of EBITDA. With respect to revised full year segment targets, for our HVAC segment we now expect full year revenue to be similar to last year, but given recent caution in customer orders, but we still expect full year segment income margins of about 15% or 200 basis points higher than 2014. For our detection and measurement segment, revenue is expected to be flat to modestly down compared with 2014, due to the project timing issues we discussed. We expect sales mix to reduce full year margins in 2015 to about 20%, but with particularly strong year-on-year and sequential growth in the fourth quarter. As a result of the revenue pressures from weak power generation markets, base power is expected to represent the largest component of the decline in overall core revenues and segment income year-over-year. As a reminder, at our September 2, investor day we put a plan forward to deliver significant EBITDA growth and generate incremental financial flexibility to deploy excess capital in most appropriate way to further increase shareholder value. Specifically, we stated that we expected to grow core EBITDA to $180 million to $200 million by 2018. A substantial portion of the increase we projected is dependent on internal operational improvement initiatives, rather than organic growth. Amidst weaker macroeconomic data, we continue to view these targets as reasonable, based on the progress we are seeing in our operational initiatives, the strength of the front-log in our detection and measurement segment, and continued replacement demand for our HVAC products. If we see a prolonged downturn, we'd need to revisit our assumptions, but we would also likely get more aggressive on cost actions. From a capital allocation perspective, we have stated that we would have the flexibility to deploy a minimum of $200 million to actions that deliver incremental shareholder value. In developing that target, given the significant uncertainty around the South African projects we discussed that day, we were conservative on our modeling assumptions around South Africa. Based on that, the charge we announced and the future cash losses that will result do not materially differ from our assumptions over the three year planning horizon. So, we are comfortable reaffirming this target based on everything we know today. And with that, I will turn the call back over to Gene.

[Gene Lowe:]

Thanks, Scott. In September, we spoke about SPX's value creation roadmap being focused on growing EBITDA. The current macro environment is creating stronger headwinds in power generation where we are taking aggressive actions to reduce our exposure to risk. Throughout our other businesses, we continue to see considerable earnings growth opportunities over the coming years, many of which are more dependent on driving efficiencies and expanding into new products and new markets than they are on underlying market growth. The majority of our businesses has attractive cash flow profiles and are not capital intensive. This is particularly true of the businesses within our HVAC and detection and measurement segments, which generate more than 85% of our core segment income, while representing a minority of our sales. These businesses have healthy front-logs and we continue to execute on our plans to introduce innovative new products, enter new markets, and drive further efficiencies. In our power segment, our transformers improvement plan remains on track and we continue to take costs out of our power generation business to align with market demand. Our South African projects have a highly focused and effective new leader who is actively engaged in risk mitigation and moving the projects forward towards completion. Overall, we are targeting core EBITDA to reach $180 million to $200 million annually over the coming few years. And we, as Scott had mentioned, we expect to generate at least $200 million of liquidity. Over time, we expect to be in a position to evaluate and execute disciplined capital allocation and strategic actions, which could drive additional value creation above and beyond the growth we are targeting in our core EBITDA model. We intend to invest in the highest return opportunities available to us, including strategic bolt-on acquisitions into our growth platforms. We are also actively assessing our portfolio on a return basis and all of our businesses will need to have a path to attractive returns or we will look at all other options to create value. In summary, we have a solid plan to drive growth and create shareholder value and we expect to have optionality to drive additional value through our capital allocation decisions. At this point, I will turn the call back over to Paul.

[Paul Clegg:]

Thanks, Gene. Jonathan, I think at this point we are ready to go to questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Shannon O'Callaghan from UBS. Your question please.

[Shannon O'Callaghan:]

So, obviously, the $71 million charge is big in the context of one event, but not really in the context of the length of the what people might have thought over the time of the contract. So, can you fill out more this clarity point and what really gives you confidence that this significantly de-risks future years? And is there enough clarity at this point where you can actually put some kind of a range around what future losses might be after this?

[Gene Lowe:]

Okay, I'll take that. Thanks, Shannon. You know, as we've stated over previous quarters, we have focused on being very proactive in taking actions that can do a couple things. One, we want to improve our control over our direct scope of work. We want to improve our execution on these projects and ultimately mitigate our potential risk. We are committed to our obligations on these projects and supporting our customers, the owners, and getting this very important power to the country of South Africa. Now there have been a lot of changes in the third quarter and a lot of these are the results of our direct actions that have significantly reduced our cost, our risk profile going forward. Some of those we talked about in our prepared remarks, the fact that the Medupi 6 Power Station is now in commercial operation, the fact that we brought in a very experienced leader to oversee and manage this project to completion, the fact that we've added additional resources to execute these projects and reduce risk going forward, and also the fact that we have a lot more clarity about the likely outcomes based on the recoverability of the costs in our discussions with various parties. What I would say, Shannon is we really do believe the actions we are taking are significantly reducing our overall risk on these projects. As Scott and I both said, we believe this charge represents the significant portion of our potential risk. Having said that, there is still several years of execution ahead of us here. I do believe we have the right team, I do believe we have the right strategy, and we are very focused on managing this very tightly. But at this point in time, I don't think -- I think that's what we can say at this point in time unless, Scott, you have any additional commentary here.

[Scott Sproule:]

No, what we have talked about before, Shannon, this is obviously, a lot has happened in this quarter for us to get to the position we are in today versus where we were just a couple months ago. And we do feel better that we have accounted for everything we know of. But there is still five years to go to execute these projects. There is a lot of volatility in South Africa, so we can't sit here today and say there is not risk. There is a chance for risk, but we feel good that we have accounted for everything we do know.

[Shannon O'Callaghan:]

Okay. And then on the transformer business, it is making nice positive progress, as you said. It is just unfortunately tough to see because the base power business, ex South Africa, looks like it is losing money now again at this point. So, what is the, you talked about the additional restructuring. What is the broader pathway to profitability for that business? How long does it take to get there and what is the scenario where this becomes an acceptable margin business?

[Gene Lowe:]

I'll make a few comments on that. Just, Shannon, on transformers, I will highlight a couple of points just to give a little more flavor of what we are seeing there. Pricing we are seeing in the markets is pretty steady. I would say lead times are relatively consistent with last quarter. What we're seeing is medium power, 20 to 30 weeks, and in the large power and in the EHP units, 45 week to 55 week lead times. We have a very strong backlog position. This is up sequentially, and right now we're really filling up Q2 and Q3 of next year. And then, basically, what we have talked about in terms of our improvement initiatives are starting to take hold. I think the team there has done a nice job. We have outlined 400 basis points of margin improvement that we are targeting in our planning horizon and the team is doing a real nice job. So we feel like that's going in the right direction. I think we see a very different story in the power generation business where we have seen less demand. We have seen the way I'd break it down is in the developed markets, let's say U.S and EMEA, we're seeing continued low levels of new power build. Asia, I would say we are seeing slowing growth, and additionally what has traditionally been pretty steady for us, the service business, we are seeing some lower service demands in our developed markets. This, of course, leads to more challenging pricing dynamics because there is less opportunities on the market and we're just being very realistic about our power generation business. We have had a very significant restructuring in Q3 and we're putting in place targets for a very significant restructuring in Q4. We don't see any positive changes on the horizon for this business, so really we have to take it into our own hands and get it to the point where it's healthy. And as I said before, Shannon, all of our businesses have to meet a threshold. All of our businesses are going to have to add value for shareholders. Our focus is getting our businesses healthy, but ultimately we're going to have to evaluate all of our businesses to ensure they are driving value for shareholders. If they are not and we don't see a path to get them there, we will evaluate all options that we have at hand, and Scott, do you have any other comments on the just transformers or power gen?

[Scott Sproule:]

Yes, so I will just add a couple things to what Gene just said, and one is you are right in your observation as far as the contributors of profitability of this segment. It is all transformers. The additional restructuring that we are talking about here, we are going after structural change in the business. As such, that's going to take longer to implement and it is going to have a bit longer of a payback cycle, probably in the two year type of a time frame, and so it's kind of an action that we are doing now that we're moving forward on that we really don't expect to see much in the way of benefit in 2016. It will be beyond that. But as you said, there is a long way to go with this business to get back to our expectations of return profile, so we are continuously looking at just strategically what are we going to do, but right now we think our best intent is to additional restructure this business to get at the overall structure.

[Operator:]

Thank you. Our next question comes from the line of Julian Mitchell from Credit Suisse. Your question please.

[Julian Mitchell:]

Just a question around the cash flow, the operating cash outflow was almost $170 million in the nine months period. I guess a bunch of that is charges and so on, but you still had a sort of $80 million plus outflow for working capital, even though revenues were down over the period. So maybe talk a little bit about the cash flow and how quickly you think that working capital move can reverse.

[Scott Sproule:]

Sure, this is Scott, Julian. So, first off, for, I will say that we're pleased with the level of cash that we had on a post-spin basis and where our net debt position ended up being. We are seasonally levered towards the fourth quarter. That's the traditional profile of this business, in particular because of the seasonality of our HVAC segment, and in this year, a number of our project-oriented businesses within the detection and measurement segment are weighted towards the fourth quarter. So, we're getting all of our cash generation essentially in the fourth quarter from our business units, and between that and the amount of cash that we have on hand will allow us to get ourselves back into our leverage position, leverage target range of 1.5 to 2.5 times gross leverage by the end of the year. And as you said, when you look at the reported cash flows for the nine months, that is similar to what I was saying on earnings is not a fair representation of what the post-spin SPX looks like. That has a lot of cost structure items in there that are not part of our ongoing operations, so the numbers are a bit distorted when you look at it from what does this mean on a go forward cash flow capabilities of the business. That said, we would still, as you adjust out items, still be a user of cash in the first three quarters, part of that due to some of the working capital items you mentioned and a lot of that coming from some of these large power projects that we are executing that will come back in the following years, starting in 2016. The other aspect of it is obviously in South Africa, and just to clarify some of the charge, so the $95 million charge did include a change in our assumptions around recoverability of certain working capital that we had talked previously about building in South Africa and coming back. So it's about $25 million that we no longer believe will be recoverable and the rest will be future cash charges.

[Julian Mitchell:]

And then just a quick follow-up on detection and measurement, you talked about the decline in comm tech product and how that gave you sort of a very heavy margin decline in the quarter. Beyond just Q4 or Q3, just wondered how you are thinking about that comm tech piece specifically for the next 12 months, how much of that is in backlog today, and just what your broad assumptions are for it.

[Scott Sproule:]

Sure. So the LED industry transition that I referred to, that really abates in Q4 of last year, so those comps become more normalized starting next quarter. We're sitting, we previously talked about we're sitting going to be in about 20% margins in D&M overall, and we have targets to getting to 22% to 24%. A lot of that is based on the front-log. We're seeing continued strong demand in our cable and pipe location products and that's been a real nice contributor to the business overall. Where we're seeing the headwinds right now from a margin perspective, beyond just the LED side, is the timing of projects in our bus fare location and in the signal monitoring. And that is part of the difficulties in this business and one of the reasons why we are not going on a quarterly guidance approach, because the timing of predicting those orders is difficult. But the front-logs remains robust. We're adding new products and new technologies in the business that gives us even more confidence in it. So it is really going to be a volume play on a go-forward basis and they are at fairly healthy margins, so you get a nice incremental drop down to the bottom line.

[Operator:]

Thank you. Our next question comes from the line of Brett Linzey from Vertical Research. Your question please.

[Brett Linzey:]

I just wanted to come back to HVAC. You posted some good margins in the quarter. You're going to see a nice lift this year versus last. I guess my question is how much of the improvement in the quarter was a function of mix and some of these larger projects versus underlying operational improvements? And then as you look at '16 and Q4, how does that mix look and what do you see in terms of operational leverage to maybe grow margins next year?

[Gene Lowe:]

So, let me start off there. I will say that we did have, we have seen some real nice performance out of our HVAC business and as a reminder there's really two components to that business. There is the cooling business, which is mostly commercial, maybe 80% commercial and approximately 20% more industrial, and then we have the heating side, which is much more replacement demand. This is boilers and other heating products. I would say overall we are seeing nice improvement in our business on the margin side. We do think that the large project did inflate our margins, so I think as we were modeling out when we look at 2015, we think there is significant improvement in margins, probably 100 basis points plus, but for that one large project, that is raising where we are for 2015 a little bit higher than where we would be in a normal run rate environment.

[Scott Sproule:]

Yes, so I would say, this is Scott. I would say in the quarter, about half of the margin improvement was from the higher margin products that we were able to deliver and including products and the rest are operational initiatives across the segment. And those are ongoing. We're actually anticipating some tailwinds on those operational initiatives because some of those started earlier in this year, so we haven't gotten the full year benefit of it. So going into 2016, we obviously have a bit of a headwind there on margins, given this very large order that we had, but we feel good about both the impact of the operational initiatives that we have ongoing and getting full year effect on those, as well as some of the strength in, I will say, not as large of order, but there are a number of medium size orders out there, more so than what we were able to deliver in this year.

[Gene Lowe:]

And a lot of those initiatives have already fallen through to the bottom line in different areas of the business, so we're feeling good about that.

[Brett Linzey:]

And then back to transformers, could you just talk about where some volumes are relative to prior peak? Last cycle you had some help from price, given the push in commodities, but I guess just in terms of volumes, where are you at versus prior peak and how much cycle do you see here going forward?

[Scott Sproule:]

Yes, so volume wise we're near our peak levels in volume across the business. It is the pricing dynamic that has not changed and that's staying, that hasn't changed this quarter and is staying kind of flat. So, again, we talked about this at our investor day. We're planning the business based on same type of volume level, same pricing environment, so we are focusing very much on operational initiatives to improve our margins.

[Brett Linzey:]

Okay. Great, thanks, guys.

[Operator:]

[Operator Instructions] Our next question comes from the line of Robert Barry from Susquehanna. Your question please.

[Robert Barry:]

Just a quick follow-up on the HVAC, can you also break out what the impact was of that project on the revenue?

[Scott Sproule:]

It was about $7 million.

[Robert Barry:]

Okay. And then, I wanted to circle back to South Africa, so this $95 million charge is essentially your share of historic cost overruns and costs related to delays. Is that right? Yes, that's the first question, I guess.

[Scott Sproule:]

I would characterize it is a composition of numerous things. Through the course of the discussions that have been ongoing and, as Gene and I both said, had accelerated late near the end of the quarter, we have got a better visibility of the direction that things are going to go. There have been historical cost overruns and delays that have been the subject of discussion around who is going to have responsibility for those. So depending on paths that were being discussed, there were a lot of options or variability into where that was going to go. During the quarter, it became clear which options we were going to be going, which gave us that improved visibility around the cost structure, as well as the state of discussions amongst the multiple parties gave us a better understanding about what our expectations around recoverability would be. Again, that’s around multiple scopes of work, multiple levels of negotiation or ongoing discussions in South Africa, so it's multiple things there. And as I previously said, part of that included us saying that reassessing our expectations around recoverability of working capital we had invested. The remainder is around the future execution of the projects.

[Robert Barry:]

Right, I mean, I guess I am trying to figure out to what extent it de-risks the future. I get the management changed and I get Medupi being up and running, but does the charge in any way pay for, if you will, reduced share of future cost overruns or delays? Is it anticipatory in any way or is it really just paying for a share that you have decided on of things that have happened already?

[Scott Sproule:]

I would characterize it as it is based on everything we know and the direction we see things going, it's our best estimate of the outcomes. So, discussions are ongoing. As I said, they're with multiple parties, so getting into any details really would not be appropriate at this time because the risk is it could prejudice the outcomes.

[Robert Barry:]

Got you, okay, and maybe just a follow-up on the cash flow question, is it possible to break out what the working capital impact is just from South Africa this year or the cash flow impacts from it, and what the swing is expected to be now next year in cash flow just for South Africa so we can look at core versus South Africa on the cash flow front?

[Scott Sproule:]

Yes, what I would tell you, through the first nine months we have invested, we've used about $60 million of cash in South Africa, a little more than about three-quarters of that would have been working capital, so much of that, I'm saying, is it is not going to come back. We're not anticipating it to come back. The others are just tied to the natural progression of long projects that have progress versus billing milestones. We've also had about $40 million or so of working capital on these other power generation projects, most in Asia, that we do anticipate getting those and again, it's a very similar situation where you take a down payment. You execute the work. You ship the product, and then we trigger our billing milestones, so we'll be getting those recoveries over the next two years.

[Robert Barry:]

Got you, and maybe just finally a quick question on the restructuring, so the $23 million, just, was the message that there is no benefit from that until 2017 or what is the cadence?

[Scott Sproule:]

No, no, my comment was specific to the amount we're increasing in Q4, the amount that we're recognized and executing in Q3. No, we should get three-quarters of that benefit in 2016. It's the amount that we're executing and increasing our targets for Q4 is going to take longer to implement and have a longer payback.

[Robert Barry:]

Got you, so three-quarters of the $16 million in '16 and then the rest of that in '17, and then all the incremental from 16 to 23 is in '17 and beyond?

[Scott Sproule:]

I'm trying to do that math in my head real quick. You said three quarters of the first 16 and the rest going forward. That's probably a fair estimate.

[Operator:]

Thank you. And thank you ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.