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SPX Corporation (NYSE:SPW)

Q4 2008 Earnings Call

February 25, 2009, 8:30 am ET

Executives

Jeremy Smeltser - IR

Chris Kearney - Chairman, President and CEO

Patrick O'Leary - EVP and CFO

Analysts

Jeff Sprague - Citi Investment Research

John Inch - Merrill Lynch

Shannon O'Callahan - Barclays Capital

John Baliotti - FTN Equity Capital Markets

Nicole Parent - Deutsche Bank

Steve Tusa - JPMorgan

Operator

Good day everyone and welcome to the SPX Corporation Fourth Quarter and Full Year 2008 Results Conference Call. Today's call is being recorded. At this time, I would like to turn the conference over to Jeremy Smeltser. Please go ahead, sir.

Jeremy Smeltser

Thanks, [Soma]. Good morning everyone. Thank you for joining us. With me on the call this morning, are Chris Kearney our Chairman, President and CEO 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 March 11.

You may wish to follow along with the webcast as we reference the detailed information on the slide presentation. Please note that this slide presentation also includes supplemental schedules, which provide reconciliations for all non-GAAP financial measures we reference today.

Our earnings press release was issued earlier this morning it 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. The 2009 guidance and targets we discuss today are on a GAAP basis from continuing operations. I would also refer you to the risk factors in our most recent SEC filings.

With that, I will turn the call over to Chris.

Chris Kearney

Thanks Jeremy, and good morning everyone, thanks for joining us. We are pleased to present our fourth quarter and full year 2008 results today. I will begin this morning with key highlights from the quarter and the year. Patrick will then take you through a detailed analysis of our 2008 financial results and review our 2009 targets. I will conclude with a brief overview of the current economic environment and its impact on SPX before we take your questions.

2008 was our fourth consecutive year of solid revenue and earnings growth. Despite a challenging economic environment in Q4, we finished the year with strong operating results.

Our Q4 and full year EPS has been adjusted to exclude a non-cash goodwill impairment charge taken in the quarter, that Patrick will cover in more detail. On this basis Q4 adjusted earnings per share were $2.06, up 21% over the prior year and $0.06 above the top end of our guidance range.

Total revenue for the period increased 17% year-over-year to $1.5 billion. Organic growth was 7%. Segment margins were 15% in the quarter excluding the dilutive impact of APV margins expanded 90 points from Q4 2007. Free cash flow was $214 million. This included $40 million of capital spending and $14 million cash restructuring.

Looking at the full year, adjusted EPS increased 35% to $6.53 per share. Total revenue was up 28% year-over-year, to nearly $6 billion.

Acquisitions accounted for 20% of the revenue growth primarily from APV, organic growth was 6% following two consecutive years of 10% organic growth. Operating leverage on the revenue growth, pricing strength and continued focus on our operating initiatives drove margin expansion of 50 points to 13.7%.

Excluding the dilution from APV segment margins increased 200 points. Free cash flow for the year was $288 million and it included $116 million of capital investments.

Last year we continued to make strides in executing our long-term strategy to focus on three core end markets. We made solid progress integrating APV, and are on track with our three-year integration plan. We expect the targeted cost reduction action to significantly benefit earnings this year. Over the past 12 months, we completed four disposals for about $165 million of gross proceeds. Currently, we are in the process of selling a product line, previously reported in our Industrial segment.

Since 2005, we have been consistent sellers of non-core assets. The proceeds from these sales have been used to fund debt reduction, share repurchases and strategic acquisitions.

During 2008, we reduced our total debt by $223 million, which is nearly half the cost of the APV acquisition. This debt reduction combined with the increase in our EBITDA last year, reduced our gross leverage to 1.6 times as of December 31st.

When levered between 1.5 times and 2 times, we focused our capital allocation on share repurchases and strategic acquisitions. Recently, we have been buying back our stock. In December, we completed the repurchase of 3 million shares under 10b5-1 trading plan.

We subsequently announced an additional 3 million shares repurchase plan that is nearly complete. Through yesterday, we have repurchased 2.5 million shares under this plan of which 1.9 million were completed year-to-date. Our financial position at December 31 was solid. We had $476 million of cash on hand. Net debt was $870 million, and our net leverage ratio was down to 1.1 times.

As I mentioned, our gross leverage ratio was 1.6 times at the low end of our target range. Our required debt repayments in 2009 are $75 million and we project available liquidity at the end of the year to be more than $1 billion.

We believe this level of liquidity and our solid balance sheet have us well-positioned for the challenges we face in the current economic environment. Once we complete the current share repurchase plan, we intend to focus on maintaining our liquidity given the current macroeconomic trends. We will continue to update you on our capital deployment expectations as we report our quarterly financial results.

Today, we are reaffirming guidance we issued on January 21st. Our EPS guidance for 2009 is $5.40 to $5.80 per share, a decrease of about 14% from our adjusted 2008 EPS. This includes $0.85 of restructuring actions and assumes the current share repurchase plan is completed during the first half of 2009.

With the reduced share count, the sensitivity of our EPS calculation has increased significantly. In our 2009 model, $750,000 of operating profit is equal to one penny of earnings per share.

Our free cash flow guidance range for the year is $230 million to $270 million. Certain events could have an impact on our guidance, including changes in macroeconomic trends that influence our organic revenue, foreign currency translation and raw material costs, the timing and execution of restructuring actions, capital allocation decision that could result in additional share repurchases, acquisitions or disposals and a change in our effective tax rate.

And with that, I will turn the call over to Patrick.

Patrick O'Leary

Thanks, Chris. Good morning, everyone. I will begin with a look at earnings per share. For the quarter, we reported a loss from continuing operations of $0.20 per share in connection with the preparation of our 2008 year-end financial statements, and our annual impairment testing on goodwill for all of our operating units.

We determine that the fair market value of our boiler subsidiary was less than its carrying value at year-end. The profitability of this business actually increased year-over-year in 2008.

However, the significant declines in macroeconomic market conditions during Q4 caused the impairment, specifically the increase in corporate borrowing rate, declines in the US economy and housing market and decreases in M&A activity were all contributing factors. Accordingly, we wrote down the value of goodwill and intangibles for this reporting unit as required by US GAAP.

The net non-cash charge was a $119 million, or $2.26 per share. $90 million of this charge is related to intangible assets such as customer relationships and technology that must be valued for impairment testing, but cannot be recognized in our historical financial statements.

On an adjusted basis, Q4 EPS was $2.06, that's up 21% as compared to the prior year. Increased segment income contributed $0.41 of the improvement. This was offset slightly by $0.08 of increased special charges related to restructuring actions taken in the quarter.

There were also puts and takes below the line that netted to a $0.03 earnings benefit. The reported Q4 EPS modestly exceeded the top-end of the target range we communicated on October, primarily due to the additional share repurchases.

Looking at fourth quarter operations on a consolidated basis, our reported revenue was modestly less than our October 30th target. This was partially due to the discontinued business during the quarter, which we had expected to contribute about $25 million in sales. Revenue from continuing operations was up 17% to $1.5 billion.

Organic growth was 7%. As expected, the Industrial and Thermal segments reported strong double-digit organic growth during the quarter. However, Test and Measurement had a larger revenue decline than we expected, causing consolidated organic growth to come in slightly below our target.

Acquisition growth primarily from APV was 15% in the quarter, and foreign currency translation resulted in a 4% year-over-year decline in reported revenue. Q4 segment income increased $33 million, or 17%. At $227 million, we met the midpoint of our target range. Segment margins for the quarter were 15%, flat to last year, excluding a bit dilutive impact of APV, margins were 15.9%, up 90 points.

For the full year, adjusted earnings per share were $6.53, that's up 35% over 2007. The increase was predominantly driven by improved operating performance, which increased segment income by $2.35 per share. This offset a net headwind of $0.67 from below the line items, primarily due to increased interest expense related to the APV financing.

Looking at revenue and segment income on a consolidated basis, 2008 revenue increased 28% to $5.9 billion. The APV acquisition was the primary driver. In total, acquisitions contributed 20% year-over-year revenue growth. As Chris mentioned, we reported 6% organic growth driven by our power and energy end markets.

For the year, foreign exchange benefited revenue by 2%. Segment income for the year increased to $195 million, or 32% to $802 million. Leveraging the revenue growth, our segment launches improved 50 points to 13.7%. Excluding APV, segment margins expanded 200 points to 15.2%. Our improved operating performance was driven by operating leverage, improved pricing and our continued focus on operational excellence.

Moving on to the segments, I will begin with the fourth quarter results for Flow. For the quarter, Flow reported revenue of $479 million, that's up 54% from last year. The APV acquisition was the primary driver contributing 59% growth. Strong sales into oil and gas and power generation markets offset softness and dehydration and industrial markets. In aggregate, the segment reported 3% organic growth.

Foreign currency reduced revenue by 8%. Segment income increased 40% to $71 million in Q4. Reported margins were 14.9%, down from 16.4% in Q4 2007 due to the dilutive impact of APV. Excluding APV, margins increased 220 points to 18.6% driven by higher margin oil and gas sales as well as lien and supply chain improvements across the operations.

The integration of APV is on track after the first 12 months. In Q4, APV reported 9% operating margins. For the full year, APV met the 5% margin target we set at the outset of 2008, more than doubling its 2007 margin performance.

For the full year, Flow reported revenue of $2 billion, up 87% over 2007. APV acquisition contributed 79% of the revenue growth. Organic growth was 8%, a solid increase following double digit organic growth in 2007.

Segment income for the year was $243 million, up $68 million or 39% over 2007, reported margins were 12.2% for the full year, the dilution from APV was 550 points. Excluding APV, margins increased 130 points to 17.7%. Flow ended the year with a backlog of $646 million, down 15% from September due primarily to foreign currency fluctuations; the organic backlog declined 6%.

This level of backlog gives us visibility to revenue for much of the first half of 2009; however our line of sight for the remainder of the year is limited and could be impacted by changes in the global economy. For this year, we are targeting Flow revenue slightly less than $2 billion with operating margins between 13.7% and 14.7%.

Moving on to Thermal, as a reminder a large portion of the revenue in this segment is from large long-term projects. Accordingly, the quarterly results in this segment tend to fluctuate significantly.

In Q4 Thermal reported total revenue growth of 14%, increased sales of heat exchangers and cooling systems particularly into power generation applications drove organic growth of 17%. Foreign currency fluctuations reduced revenue in the quarter by 3%.

Q4 segment income was up $18 million or 34% over the prior year. Thermal reported segment income margins of 14.1%. Contract discipline, solid project execution and a higher margin project mix drove 210 points of margin expansion.

On an annual basis, Thermal's comparisons tend to be less volatile. In 2008, Thermal reported revenue of $1.7 billion, up 8% from the prior year. Increased power and energy sales grow 5% organic growth and foreign currency fluctuations benefited year-over-year revenue by 3.5%.

We continued to show improved performance on contract structure and execution. In addition, profitability in this segment is very sensitive to project mix, which was favorable last year.

For the year, Thermal reported $204 million of segment income, up 26% from 2007. Margins were 12.1%, up 170 points from the prior year and in the middle of our long-term target range for the segment.

Demand for our thermal equipment continued to drive backlog growth in Q4. The ending 2008 backlog was more than $2 billion. That's up 4% from Q3, despite a 6% headwind in currency fluctuations. For 2009, we are targeting mid single digit organic growth with margins between 10.4% and 11.4%.

As expected, Test and Measurement had a very challenging fourth quarter, due to difficulties in the US automotive market. I mentioned earlier that the revenue decline was worst than we had anticipated for the period. Test and Measurement revenues were down 21% year-over-year to $250 million. Organic revenues were down 17% and foreign currency fluctuations were a negative 4%. In the US aftermarket, tool and equipment sales were down significantly in Q4. Historically these two markets tend to show growth when new vehicle sales are down however we are not seeing that. The decline in volume had a significant impact on profitability. Segment income was $18 million in the quarter, a 7.2% margin.

For the year, reported revenue was $1.1 billion, up 2% from the prior year, revenue from the European based acquisitions made in 2007 contributed 8% growth offsetting a 7% organic decline. Foreign currency fluctuations were a 1% benefit to revenue.

We began restructuring this business in 2007. Over the past two years, we have reduced the US footprint to one manufacturing plant and one distribution center. Additionally, we reduced headcount by about 225 employees last year. These actions helped sustain a reasonable level of profitability in 2008 with full year margins just shy of 10%.

The 2009 outlook remains challenging and we have additional restructuring actions planned. And this year, we are now planning over 500 headcount reductions. We are targeting revenue between $920 million and $980 million with margins in the high single digits.

Our fourth segment, Industrial Products and Services delivered an outstanding performance in the fourth quarter. As Chris mentioned, during Q4 we discontinued a product line on this segment, its financial results are now reported as discontinued operations and the results you see today have been restated for all the periods presented.

Q4 revenue was $281 million, up 24% from the prior year, increased sales of transformers and crystal growing equipment drove 25% organic growth in the period. Segment income was $67 million, up 35% from Q4 2007.

Improved pricing and leverage on the strong organic revenue growth yielded segment income margins of about 24%. For the year, revenue was up 23% to $1.1 billion. All the growth was organic. Each reporting unit reported positive organic growth for the year led by the transformer, crystal growing and broadcast businesses. Segments income for the year was $245 million, it's up $95 million or 64% from 2007.

Improved pricing in operating initiatives drove 570 points of margin expansion. Full year industrial margins were 23%. The outstanding 2008 performance is going to be followed by a much more difficult 2009. The credit crisis is impacting the order trends in this segment substantially.

In Q4, the backlog in this segment decreased 14% with transformer orders down 27%. As we have described on recent investor calls, we believe this trend is being driven by the uncertain availability and higher cost of capital as opposed to a change in customer need. We can not predict how long this trend will last. Our 2009 targets for this segment assume order trends consistent with the Q4 run rate.

For the year, we are targeting total revenues to be between $790 million and $850 million. This is more than the 20% decline for the year, and we expect second half comparisons will be much more negative than the first half.

We have a 44.5% interest in the joint venture with Emerson Electric or EGS which reported about $500 million of revenue in 2008. We record our portion of the EGS income on the equity earnings line in our income statement, it accounts for the majority of our equity earnings.

In Q4, we reported $12 million of equity earnings, up 15% from 2007. For the year, equity earnings were $46 million, roughly 9% of our pre-tax income excluding the impairment charge. Trends in industrial end markets are impacting EGS this year and we expect equity earnings to decline to around $40 million.

Moving on to cash flow, we have historically generated the majority of our free cash flow in the fourth quarter, last year was no different. In Q4 2008 we generated $214 million of free cash. This was slightly less than we had targeted primarily due to foreign exchange impact. Increased accounts receivable during the quarter also drove a higher year-over-year change in working capital. We invested $40 million in capital projects and $14 million in restructuring actions, the combined investment was $18 million more than Q4 2007.

For the year, free cash flow was $288 million, all in accounting for the APV working capital investment and capital spending, $34 million above depreciation. We are pleased with the operating conversion performance. With the discipline in our use of capital in 2008, our primary use of capital was debt reduction. We reduced our outstanding debt by $223 million or 14%. We invested $116 million in capital improvements including our IT infrastructure and lean initiatives. And we allocated a $115 million to share repurchases in 2008.

We continue to withdraw capital through the disposal of non-core assets totaling $248 million in the last two years. We currently pay an annual of $1 per share which is just over $50 million per year.

As Chris mentioned, we are reaffirming our 2009 guidance this morning.,Let me briefly review our targets with you. In the appendix of this presentation, we have provided a full model to the midpoint of our EPS guidance range. Looking at our consolidated 2009 midpoint guidance, we are targeting total revenue of about $5.4 billion, that's down about 7% from last year.

We expect foreign currency fluctuations to decrease reported revenue by about 5%, and organic revenue to be flat-to-down about 5%. Segment margins are targeted at around 13%. Our 2009 midpoint EPS guidance is $5.60 per share, a decrease of about 14% year-over-year, and we are targeting free cash flow between $230 million and $270 million. This includes $60 million to $80 million of cash restructuring, and about a $100 million of capital spending.

Looking at the first quarter, as compared to our January 21st targets, we have lowered our revenue expectations, primarily due to currency fluctuations and the timing of thermal projects. We are now expecting year-over-year revenue to be down about 10%, driven mostly by foreign exchange impacts, but we are also forecasting a low single-digit organic decline. Based on the lower revenue target, segment income is now expected to be between a $126 million and a $131 million with margins at about 10.5%.

The net change in our forecast for below the line items is a benefit to EPS offsetting the decline in segment income. For the quarter, we are holding our EPS guidance range at $0.75 to $0.85 per share, that's down about 30% year-over-year due mostly to currency fluctuations and increased restructuring charges.

With that, I will turn the call back over to Chris for a brief summary.

Chris Kearney

Thanks, Patrick. We are obviously very pleased with our 2008 financial performance. It was an outstanding year for SPX and we have recognized the great effort our employees put forth to improve the performance of the company.

That said, we are focused on the challenges that lie ahead of us. We began 2009 with a backlog of $3.4 billion, about two-thirds, or $2.2 billion is scheduled to be converted into revenue this year. That gives us good visibility to about 40% of our targeted revenue for this year.

Although we are experiencing slowdown in the order rates for many of our shorter cycle businesses, we continue to see steady order activity for larger infrastructure projects, particularly for power generation. We received four large scale cooling systems orders in China over the past three months, totaling just under $100 million.

And yesterday, we announced an award of more than $100 million to supply squib valves for the nuclear plants Westinghouse is planning to construct. This order was not in our backlog at the end of the 2008, and is not in the guidance we discussed today. We don't expect it to have significant impact on our 2009 financial results as the majority of the revenue will be booked in 2010 and beyond.

In our current guidance, we are targeting organic revenue to be flat-to-down 5%. In power and energy, we expect a year-over-year revenue change between 1% increase and a 3% decline. As I mentioned, we continue to have strong order activity for our power generation equipment. However, this is being offset by significant declines in power transformer orders.

Based on recent trends, we are expecting a large decline in our transformer shipments in the second half of 2009. We are expecting the North American market for vehicle repair tools to weaken further this year driving a decline of approximately 10% in our tools and diagnostics business.

Food and beverage spending is historically less cyclical than our other end markets. In 2009, we are expecting revenue into this market to be flat-to-up 4%. And in aggregate, we believe our other infrastructure and general industrial businesses will be down on average as much as 5%.

The macroeconomic trends in January were not favorable and industrial production decline began. In response to the current state of the global economy, many of our businesses are planning restructuring actions this year.

As I mentioned earlier, we have $0.85, or $65 million of restructuring actions currently projected in our guidance. These actions are expected to mitigate to some degree the current end market pressures we are experiencing. They are also focused on increasing the efficiency and flexibility of our operations over the long-term.

In total, we expect to reduce global headcount by 10% to 11% based on the 2008 restructuring and 2009 targeted actions. We expect this will position us to better leverage future revenue growth.

If the economy continues to decline, we are prepared to take additional restructuring actions as necessary. Our financial position is strong and we believe we have ample liquidity.

We intend to maintain our liquidity given the uncertainty in the global economy. And although current environment is challenging, we do remain confident in our long-term strategy and committed to executing it.

Thanks again for joining us. And at this time, we are ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will take our first question from Jeff Sprague with Citi Investment Research.

Jeff Sprague - Citi Investment Research

Thank you, good morning.

Chris Kearney

Hi, good morning, Jeff.

Patrick O'Leary

Hi, Jeff.

Jeff Sprague - Citi Investment Research

Just a couple of things, first on transformers, the 27% decline, is that a sequential decline versus Q3 or is that year-over-year, and can you give us the other one, the other side of that equation?

Patrick O'Leary

It's sequential.

Chris Kearney

It's sequential. Q3 had declined 10% from the prior quarter, and Q4 was 27% sequential decline from there, so the year-over-year, Jeff it would be a little bit worse than that 27%.

Jeff Sprague - Citi Investment Research

And can you give us an update on what's going on with price on transformers, any change, any pushback relative to product in the backlog or any significant change by some new orders?

Chris Kearney

Yeah. Where we are right now Jeff, is that we are still experiencing a reasonable level of pricing in that business. However prices have come down since the middle of last year. The decline in the input cost of copper and oil have impacted pricing and the contribution margin has come down off the peak that we saw in the third quarter of last year, and of course those things are factored into the 2009 guidance that we have out there.

Jeff Sprague - Citi Investment Research

And can you give us a sense of how much broadcast falls in '09 coming off this digital conversion?

Patrick O'Leary

It really isn't significant based on the mix of revenue and the new products that they are introducing.

Chris Kearney

I would say the segment, we are targeting, Jeff, around probably 20% organic decline give or take, and the business isn't too far after that I would suggest.

Jeff Sprague - Citi Investment Research

Okay. And Patrick, there's just a few things sequentially moving around on the balance sheet, deferred tax liabilities and other long-term liabilities. What's that related to?

Patrick O'Leary

Some of that relates to the acquisition of APV and the finalization of purchase accounting. Again, settlements of legacy matters occurring expiry of statues and outside of that, no other significant fundamental change in the business.

Jeff Sprague - Citi Investment Research

And then finally for me, just thinking about Test and Measurement, how the year plays out, obviously it would be difficult. But when you try to look at kind of to pass-through this period of weakness, what can you gleam from looking at dealer consolidations or inventory in the channel, or other factors to give you a sense of what inning we might be in this downward grinding process?

Patrick O'Leary

Yeah, in that business, Jeff, as you know, we have seen a steady decline really going back to the second quarter of '07, and we have, as we've talked about now consistently over the last several quarters and our guidance shows a net again today, taking some pretty significant restructuring actions, starting last year and carrying through to this year.

So, a lot of people are coming out of that business. We've consolidated our operations in the United States down to one manufacturing location, one distribution center. And while we have been doing that in concert with declining revenues in United States, both OE and aftermarket, we have done some really good strategic acquisitions in Europe and now most recently in China.

If you look forward into 2009, as we said in the call today, we anticipate another 10% decline in that business. And again continuing restructuring in recognition of that change. But if you look forward overtime, and where the growth markets are, the strategy in that business is to position ourselves in terms of where our people are manufacturing our R&D and where cost generally is to support growth in areas, but I think over the long-term, still look attractive. And also help position us better with some of the key foreign OEs that we have developed good relationships with over the past several years both as a result of the acquisitions we have done in Europe and as a result of us broadening our relationship with them with existing products and services that we have.

So, it’s a rapidly changing environment, I think the future will look very different in the industry, we recognize that. I think the strategic actions and the restructuring plays that we have made recognize that change and I think it will better position us to be in the right places over time.

Patrick O'Leary

And we do think that there will be a significant dealer rationalization in the United States, but it's important to realize that we are getting half of our profit in this segment now, outside the United States. And that’s true, even of our relationship with GM, we are approaching 50% of our revenue with GM, is actually outside the United States as well.

And, I sort of hinted on the call in the prepared remarks that the aftermarket is particularly weak and historically the aftermarket should get better as we go through this period and that’s not happening and the feedback we are getting from the channel partners there is that items which saw our ticket prices of less than a $1000 are passing through the channel, but those above a $1000 are very slow, and that is again sort of consistent with lack of availability of financing, cost of financing and reluctance to assume credit risk on the part of end customers.

Jeff Sprague - Citi Investment Research

Just a little additional tweak on the question, the US Big Three portion of revenues is down to what now at year-end?

Chris Kearney

It's down about 16% of the total revenue in terms of revenue with Big Three inside the United States.

Jeff Sprague - Citi Investment Research

That’s 16%.

Patrick O'Leary

Yes, I mean our typical receivables exposure to the Big Three US combined at a point in time is between $15 million and $25 million, so not very significant.

Jeff Sprague - Citi Investment Research

Thank you very much.

Chris Kearney

Thanks, Jeff.

Operator

We will take our next question from John Inch with Merrill Lynch.

John Inch - Merrill Lynch

Thank you. Good morning.

Chris Kearney

Good morning, John.

John Inch - Merrill Lynch

Good morning, guys. So, it looks like in the first quarter, the sort of lower revised number slightly about $0.05 lower EPS impact than what you thought recently. And I think Patrick you said that, that would be made up with below the line items. What are those items again?

Patrick O'Leary

Basically it's a mix of slightly lower interest expense. What's happened to the share count based on the way the 10b5-1, the second 10b5-1 is trading out which you can tell from our margins, it's trading out fairly quickly, a little tweak to restructuring. And broadly speaking, neutralizing the small decline in segment income.

John Inch - Merrill Lynch

I mean intuitively what we are seeing sort of in the first quarter is going to spill into the second quarter. As you kind of look at the year, do you expect say impact of lower share count and some of the other things you just called out, does that help to sort of stabilize the earnings trend as the year progresses even if the fundamentals on the top line are going to be worse. I mean, how should we think about that?

Patrick O'Leary

Well, first of all, I would say historically Q1 is by far and away historically our weakest quarter, and so you kind of have to say the subsequent quarters in the context of that. Obviously, the drivers of the annual model are pretty much still the same, the reduction in segment income from revenue on margin declines that we have talked about. This FX headwind effecting both revenue and OP, and then the benefit from some of the below the line items, where corporate costs are down, interest is down obviously from the debt reduction that we have had. And frankly the rates continue to be extraordinarily low levels relative to LIBOR. So, in terms of the change to the Q1 mix of earnings, it really isn’t significant at this point for our expectations for the rest of the year.

John Inch - Merrill Lynch

I am thinking past again, I mean, I guess the organic sequential backlog was down about 6% right. And so obviously the trends seems to be getting worse, that’s about 40% of the company but you think the company still does kind of down 0 to 5.

Patrick O'Leary

I mean the backlog can be a little misleading. From Chris's comments, there clearly is a downturn in the short cycle parts of our business, particularly those exposed to what I will describe as more industrial markets or markets where credit is being used to acquire tools and ticket items in the certain range.

So, I think, you really have to look at it in terms of larger projects for Thermal and Flow are still coming in, but those things tend to be lumpy and so if you look at the backlog while it clearly is an indicator of organic revenue, there are different things happening with the larger orders. We are still taking nice orders in Thermal at a fairly high level, order of about $25 million. There are still a lot of quoting activity and we are taking orders for project business particularly in the sanitary part of Flow, these would typically be more like $10 million to $20 million orders, most of them are outside of the United States, a lot of activity in Russia at the moment. And then obviously contracts like the Westinghouse contract that we announced yesterday. And so we will update you quarterly on what the backlog and the order trends are.

John Inch - Merrill Lynch

Thank you again. Can I just wrap with service solutions, I mean the down 17% was inline with what we are thinking, but how much was service solutions in the US down and perhaps how much of this dynamic you think is a function of vehicle service base, maybe closing or consolidation within the dealer. Now that trends continue, doesn’t that business have to begin to start to improve in the aftermarket side at some point? What are you thinking there?

Chris Kearney

Yes, the US actually was down clearly more than international, so most of that decline, John, reflects softness in the OE, but significantly in the aftermarket part of the market. And yes your logic is right, I mean as people hold on to vehicles longer logically that aftermarket has to improve at some point in time, but as Patrick pointed out, a lot of the tension that we are seeing in the aftermarket in that business is consistent with some of our other businesses and it relates directly to credit availability and the opportunity that our dealers have to finance new inventory.

So again, to get back to my earlier answer, we think that the actions that we have taken recognize the shifting nature and the developing nature of that business. And I think as we move forward in time, the actions that we are taking in that business in reaction to a very difficult economic environment will really help better position us and make us more flexible as we expand into those markets that I think have promise going forward. We have a much greater presence in China now. We are focused on opportunities in Eastern Europe and opportunities not only in China but throughout the rest of Asia.

So, Dave and his team have been very proactive in recognition of the very challenging market and have managed to hang in there and do as well as they possibly can in spite of those conditions. But I think the long-term strategy is the right one.

Patrick O'Leary

And the driver for the business is still the same, I mean dealer count has been declining for over a decade. I mean, the drivers of the business are really primarily new platform introductions and electronic complexity of vehicles. And so even though the number of dealers has been declining, the number of high quality dealers with multiple service base has actually been rising in a more professional level of service. So, we don’t attribute what's happened in that business in the last six months to be related to dealer rationalization.

John Inch - Merrill Lynch

Yes, they just need to get a bank loan. Thank you.

Operator

We will take our next question from Shannon O'Callahan with Barclays Capital.

Shannon O'Callahan - Barclays Capital

Good morning guys.

Chris Kearney

Hi Shannon, How are you doing?

Shannon O'Callahan - Barclays Capital

Good. On the Thermal business; you mentioned you have some good project orders still coming through, how about kind of the basic replacement upgrade business in some of the developed markets. Is there any change of behavior there?

Chris Kearney

No, I wouldn’t say there is much change at all. I guess I would describe it as still good solid quoting activity, but the growth in that business we anticipate will come from the places, that it has come from over the last several years and you can clearly see that from the orders we have got in over the last three months with China still being very productive for us and other developing markets being attractive as well.

Like everything else and it sort of sounds like a broken record on this, but like everything else financing really still is an issue for the timing of projects for our customers in some cases in this market as well.

Patrick O'Leary

We are still getting hit demand for the bulk of their products which are primarily heat exchangers and environmental management products. We are happy we made the expansion in the plant in Germany last year. And so we are still optimistic about the replacement market in the developed world and still seeing quoting activity for some larger projects and still believe that aged infrastructure, fatigue towers could be an opportunity in the next two years.

Shannon O'Callahan - Barclays Capital

Okay. On transformers, you mentioned there are no real changes in the order environment. I mean as you are talking to customers, is there any change you are telling there and when you think about this 4Q run rate up against the state of the grid, I mean does that seem like a unsustainably low level, that's a temporary pause or you think it could go lower, how do you think about that in terms of the need to upgrade these transformers?

Chris Kearney

Well, there is some significant stress on the power producers and they are facing the reliability standards in a grid that is not getting any younger. But what we are still seeing and I think what we anticipate seeing in the foreseeable future is that difficulty that they started to face in the fourth quarter of last year around the ability to get affordable financing, long term debt financing for these projects. So the stress they face is the risk of failure versus the burden of long-term high interest debt to support the growth of the infrastructure. But what we have said consistently in the past, Shannon, is the difference in this cycle and the business that we have seen in the past is primarily the reliability standard sort of creating a floor for that demand. And as we know, the cost of failure apply pretty significant.

Shannon O'Callahan - Barclays Capital

In terms of the stimulus, I know it's still not defined, but we have moved forward a little bit. I guess what are you hearing, you are having conversations with DC and where the things stand?

Patrick O'Leary

We've reviewed the details of the stimulus plan and many of those initiatives are attractive and frankly right in our sweet spot, particularly in terms of power infrastructure, research and development. The smart grid technology is going to get about $11 billion for that research, there is $3 billion earmarked for clean coal research. The tax credits that are going to be granted for companies developing renewable energy sources helps us in some of our initiatives.

So these items in particular have the potential to help drive future sales for our thermal equipment and our transformer business and our solar equipment business. And so internally what we have done is we put together a task force with representatives from these businesses to work closely with representatives of NAM to try and identify opportunities for the company and we think there are many.

So right now it's really too early for us to quantify the opportunity, and certain we have not factored any stimulus benefits into our guidance for 2009. But we certainly believe that it will provide good opportunities for the business overtime.

Shannon O'Callahan - Barclays Capital

Okay last one I just when you look at where the thermal margins at 14, Flow ex APV at 18.6, industrial 23.9. I mean these are all well above what you guys used to target for those businesses. I mean can you talk about what aside from the lift in the end markets helping you out, I mean as we look into a tougher world, can you talk about what provides you support, you did much better on the up cycle than we thought you would. How do you think you could support those margins as things get a little tougher?

Patrick O'Leary

Well I mean you have to talk about this segment by segment, but if you look at Flow, currently our long-term targets are 14 to 16 and we lowered that at the point of the APV acquisition and you can tell that the core business performing at sort of record levels as we exit last year. And we think, 14 to 16 is realistic, for this year we are looking at 13.7 to 14.7, a big driver of that is obviously the improvement that we are achieving at APV.

With respect to Thermal, our long-term margins are 11% to 13%, we will prove that with the Q4 performance obviously, but this is a project mix of business and based on the mix we see right now, we are expecting margins this year, so a 10.4% to 11.4% sort of chipping into that range.

And than tax, obviously the recent performance and what's happening with not just the organic decline but that segment is facing sort of a 5% foreign exchange headwind also this year. We actually lowered our long-term margin target in the guidance meeting, down to 11% to 13% and that’s obviously dependent on some level of recovery in the sales, but represents a realistic margin rate relative to its history and frankly the manufacturer of electronic diagnostic products.

And then industrial, we still believe the long-term margins for this segment should be somewhere around 20%, obviously we have been pruning some lower margin non-strategic businesses in the segment and that the 800 pound gorilla there is and will continue to be in the transformer business, and so as the transformer business goes so goes the margins in the segment.

Shannon O'Callahan - Barclays Capital

Okay. Alright thanks guys, I leave with that.

Chris Kearney

Hey thanks Shannon.

Operator

We will take our next question from John Baliotti with FTN Equity Capital Markets.

John Baliotti - FTN Equity Capital Markets

Hi good morning.

Chris Kearney

Hey John.

Patrick O'Leary

Hey John.

John Baliotti - FTN Equity Capital Markets

Hey guys, Chris or Patrick how do we look at the, I mean I know it's not smaller by any means, but the squib order from last night, does that tell you anything about maybe credit markets or just the stability of those particular end markets in terms of power markets?

Chris Kearney

Yeah when you look at that John in connection with the continuing flow of orders in China, the massive orders that have come out of South Africa over the last 6 to 8 months, it really underscores what we have been talking about for some time and that is despite the difficult economic environment, there is a fundamental underlying need for power generation capacity in these parts of the world that just have to be dealt with. And so what we are seeing is that governments supporting that developments are finding ways to finance. In South Africa, we've seen it with the World Bank stand behind that project with a $5 billion loan. In Iceland, seeing financing coming through to solidify the approach there. And the same has been true in China. And even though in China, with the more competitive environment that we have seen develop over the last couple of years, 2008 developed into a very nice year for us in the cooling equipment business, and that has continued on into the first quarter of this year.

And so, that same recognition is in the larger order with Westinghouse where much of that will be applied to nuclear power generation facility to be built in China, but in the United States as well. So, I think if anything what those recent large order do is validate our growth assumptions that we have made over the past several years when we directed this company into these three key end markets.

John Baliotti - FTN Equity Capital Markets

I mean it just seems that the order rate, I believe I have the numbers right is for delivery through 2013, and it just seems they are consistent with some of the market I think that 2010 power just rolls over and it's just gone. I would think a company like Westinghouse would -- thinking to put order like this out, feel pretty good about. I mean the long-term growth rates may have modified somewhat, but it doesn’t seem like at least at this point that they have changed dramatically.

Patrick O'Leary

No, that’s true and with these orders as you know, eventually come some pretty significant upfront deposits to secure those and to secure the commencement of the detailed engineering work that has to go with that.

Chris Kearney

And for that order in particular, it relates to 12 new nuclear power plants, six in the United States, four in China, and two where the location has not yet been determined. So it does support our thesis for medium-term investment in global power infrastructure.

John Baliotti - FTN Equity Capital Markets

Okay, great, thank you.

Patrick O'Leary

Thanks, John.

Operator

We will take our next question from Nigel Coe with Deutsche Bank.

Nicole Parent - Deutsche Bank

Yeah, hi guys, this is actually Nicole asking questions on Nigel's behalf.

Chris Kearney

Hey, Nicole.

Nicole Parent - Deutsche Bank

Hey, good morning, a couple of questions for you. First of all, on deferred taxes, was there any cash impact this quarter and then will that impact taxes going forward?

Patrick O'Leary

No, there is no significant cash consequence to the changes there. There are some tax cash benefits that we will have in the first part of the year. We will have a refund in Q1 of about $23 million, and we will have a capital launch carry back refund in Q2 of about $18 million. So you will see some cash benefits over and above normal tax payments in the first half of 2009.

Christopher Kearney

But just as a reminder, the deferred tax line item you see on the cash flow statement really just represents the difference between the book rate in the quarter and the cash taxes paid in the quarter.

Nicole Parent - Deutsche Bank

Got it, thanks. And then on the 2009 revenue guidance, you guys kept the midpoint intact despite the industrial discontinuation, how do we think about that?

Patrick O'Leary

When we went into the guidance making in January, we actually first announced that discontinued business. So it was contemplated in our original guidance presentation.

Nicole Parent - Deutsche Bank

Okay. Got it, that make sense, and then on the reduction in your equity earnings guidance for next year, what drove the decline there?

Chris Kearney

Actually the same impacts that we are seeing in the other industrial markets on that joint-venture. We just account for the income, we actually account for on a quarterly lag basis.

Nicole Parent - Deutsche Bank

Okay, got it. And then lastly on the thermal mix, the benefit from the large dry cooling contract, is that completed now, and then what's the impact on 2009?

Chris Kearney

The majority of it has been completed, so a little bit carryover throughout 2009. It's not a lot.

Nicole Parent - Deutsche Bank

Okay, got it. Thank you.

Chris Kearney

Thanks. We have I think time to sneak one more quick question in before we close.

Operator

We'll take our next question from Steve Tusa with JPMorgan

Steve Tusa - JPMorgan

Hi, good morning.

Chris Kearney

Good morning, Steve.

Steve Tusa - JPMorgan

Just a question on industrial, you guys really blew away the margin there relative to your guidance, how much price was actually in the quarter in industrial?

Patrick O'Leary

We don't actually breakout price versus volume. Remember that the discontinued business that we had with lower margin in this segment and that impacted the actual Q4 reported results versus the guidance we gave at the end of Q3 of last year.

Steve Tusa - JPMorgan

What I mean is your January presentation?

Patrick O'Leary

We didn't update guidance at the January presentation for Q4.

Steve Tusa - JPMorgan

But just the annual numbers you gave so that backing into the Q4, am I missing something?

Patrick O'Leary

I think so, because there was a difference between the 2008 guidance for industrial and the 2009 guidance, the '08 still included that business and the 09 did not.

Steve Tusa - JPMorgan

Okay. So that's a major difference. And then just one more quick question on industrial. In the earnings presentation you have a long-term growth target of 3% to 5%, but in the January presentation you had 5% plus, is that just rounding air, or is there something a little more going on there?

Patrick O'Leary

There might be a cycle there, it could also be the difference between, in one area you are talking about this segment and other we are talking about the end-market chart. But for the industrial segment, we still are thinking 3% to 5% long-term.

Chris Kearney

Yeah. And we've not changed that over the last couple of years.

Steve Tusa - JPMorgan

Okay, got you. That's it. Thanks.

Chris Kearney

Thanks Steve.

Jeremy Smeltser

That will conclude the call today, thank you everybody for joining us. Any further calls, Ryan and I are both in the office today and will be happy to spend some time with you on the phone. Thanks and have a great day.

Operator

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

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