SPX Corporation Q4 2009 Earnings Call Transcript

Feb.25.10 | About: SPX Corporation (SPXC)

SPX Corporation (SPW) Q4 2009 Earnings Call February 25, 2010 8:30 AM ET

Executives

Ryan Taylor - Director, Investor Relations

Chris Kearney - Chairman, President & CEO

Patrick O'Leary - EVP & CFO

Analysts

Nigel Coe - Deutsche Bank

Shannon O'Callahan - Barclays Capital

Jeff Sprague - Vertical Research.

John Inch - Merrill Lynch

Steve Tusa - JPMorgan

Deane Dray - FBR Capital Markets

Terry Darling - Goldman Sachs

Operator

Good day everyone, and welcome to the SPX Corporation fourth quarter and full year 2009 results conference call. Today's call is being recorded. At this time, I'd like to turn the call over to Mr. Ryan Taylor, Director of Investor Relations. Please go ahead, sir.

Ryan Taylor

Thank you Ally, and good morning, everyone. Thank you for joining us today. With me on the call this morning are Chris Kearney, Chairman, President and CEO of SPX and Patrick O'Leary, our Chief Financial Officer. This morning's call is being webcast with a slide presentation which can be accessed in the Investor Relations section of our website at spx.com. This webcast will be available until March 11, and we encourage you to view the webcast as we reference the detailed information on the slides.

Please note that the slide presentation also includes supplemental schedules which will provide reconciliations for all non-GAAP financial measures we referenced today. Our earnings press release was issued earlier this morning and can also be found on our website.

Before we continue, I'd like to point out that portions of our presentation and comments are forward-looking and are subject to Safe Harbor provisions. The 2010 guidance and targets we discuss today are on a GAAP basis from continuing operations and please note the risk factors in our most recent SEC filings.

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

Chris Kearney

Thanks, Ryan, and good morning, everyone. Thanks for joining us on the call as we review our Q4 and full year results. 2009 was a year marked by the most severe financial crisis of our life time. The loss of liquidity and the rising cost of capital interrupted a robust economic cycle and fueled a deep recession.

The resulting business environment was challenging for many companies including SPX. Weakened demand led to a double digit year-over-year decline in our revenue. Faced with these challenges, we focused on operating execution, reducing our cost base and maintaining liquidity while at the same time continuing to invest in new product development and global expansion.

As we entered 2010, the global economy appears to be stabilizing. Recent macroeconomic data suggest that industrial markets are in the beginning stages of recovery. Consistent with this, our early cycle businesses had favorable sequential order trends in the second half of last year. However, the majority of our business is mid to late cycle which we expect will lag recovery of the broader economy.

We anticipate our earnings to trough in the first half of 2010 and expect to see some level of recovery in many of our key markets in the second half. We remain confident in our long-term strategy and believe the actions we executed in 2009 have us better positioned for growth when our markets do recover.

The strategic changes we have made over the past five years continue to positively transform our business. Today, SPX is a multi-industry manufacturer with annual revenue of nearly $5 billion and operations in more than 35 countries. We are a leading provider of engineered products and technologies that support evolving global need in three strategic markets, infrastructure, process equipment and diagnostic tools.

To increase our focus on these markets, we have completed 18 divestitures since 2004, including the sales of Filtran and the desert product line last year. And yesterday we completed the sale of PSD a small service and design business that was reported in our industrial segment.

As a result of these divestitures, we have now completely exited four markets. With the divestiture proceeds and our free cash flow since 2005, we have invested $4.6 billion in share repurchases, debt reduction, acquisitions and dividends. We continue to target acquisitions and partnerships that will expand our product offerings, geographic presence and customer reach within our three target markets.

Last year, we entered into a joint venture with Thermax to market select energy infrastructure technologies to power producers in India and other countries in Southeast Asia. In December, we acquired the assets of Yuba Heat Transfer, a US supplier of thermal technology to the power generation industry. This acquisition has significantly strengthened our position and customer relationships in the US power market and enhanced our capabilities to address the aging US energy infrastructure.

Earlier this year, we signed a definitive agreement to acquire Gerstenberg Schröder, a Danish manufacturer of highly efficient food processing equipment and system lines. We expect this transaction to be completed in Q1.

During 2009, sales into our three strategic markets accounted for 84% of revenue. Infrastructure sales, primarily into the power and energy market, contributed more than half of our revenue. Our global presence enabled us to sell our products and services into more than 150 countries.

51% of our revenue last year was generated outside North America. Sales into emerging regions accounted for $1.1 billion or 22% of our revenue.

We expect our expansion in emerging regions to continue in 2010 particularly in South Africa. We also believe the economic development of India represents a significant opportunity for SPX over time. We continue to make progress with our operating initiatives. We executed a number of proactive restructuring actions over the last two years that resulted in 16 facility closures and a 15% headcount reduction. Savings from these structural changes benefited our performance in 2009 and we expect incremental savings to impact this year and 2011.

We've also enhanced our global business systems and services by migrating to regional support centers. In Europe, we are in the early stages of centralizing key financial and human resource services in Manchester, England. In China, our next stage of development is a centralized manufacturing campus. This is a multi-year project designed to improve our cost structure and leverage our resources to support future growth. Between 2005 and 2008, we averaged 8% organic growth and more than a 100 points of margin expansion per year.

This performance underscores the benefits of our strategic transformation and the focus on our operating initiatives. During 2009, the recession had a significant impact on our financial results. Reported revenue declined 17% to $4.9 billion, and segment margins were 12.1%, down a 160 points year-over-year. Adjusted earnings per share were $3.90, down 40% from 2008. In contrast, our cash performance was very strong. We reported $369 million of free cash flow, a 27% increase over 2008 reflecting our focus on liquidity.

Notwithstanding the challenges of 2009 we were able to improve our financial position during the year. At year end, we had $523 million of cash on hand, $47 million more than the prior year and we reduced our debt 5%.

We are encouraged by the progress we made to improve our company and we will continue to focus on executing our long-term strategy. The environment for acquisitions in our strategic markets looks more attractive than it was a year ago. And with our strong cash position, we can execute acquisitions without impacting gross leverage. And with that I will turn the call over to Patrick for an analysis of our Q4 and full year results.

Patrick O'Leary

Thanks, Chris, and good morning everyone. I will begin with a look at earnings per share. For the quarter, we reported a loss from continuing operations of $1.63 per share. This included the non-cash impairment charge that we announced on January 13. Our annual impairment testing of goodwill and intangible assets determined that the fair value of our service solutions business unit was less than its carrying value at year end.

This was primarily due to the difficulties experienced in the global automotive industry in 2009. The net charge recorded in the fourth quarter was a $165 million or $3.32 per share at the top of the range we had announced. We also recorded a $0.07 impairment charge related to trademarks and our personal comfort heating business. Additionally, the reported EPS includes a $0.43 tax benefit related to the recapitalization of certain European entities.

Our adjusted EPS in Q4 and the full year excludes the impairment charges and the tax benefit. On an adjusted basis, Q4 EPS was $1.35 at the middle of our guidance range. Year-over-year EPS declined 34% in the quarter primarily due to lower segment income.

Looking at fourth quarter operations on a consolidated basis, our reported revenue was $1.3 billion, down 12% year-over-year. Organic revenue declined 17%, offset partially by a 4% currency benefit. Segment income margins declined 230 points year-over-year to 12.7%. As expected a significant decline in pricing and volume in our US based power transformer business had the biggest impact on our margins.

Our actual margin performance was somewhat below the target range we communicated last October, primarily due to project timing in our flow and thermal segments. We ended 2009 with a $3.1 billion backlog, down 4% from Q3.

Q4 orders declined on a year-over-year basis. However, sequentially orders increased sharply from Q3 particularly in our early cycle businesses. For the quarter, Flow reported revenue of $438 million, down 9% from last year. Organic revenue declined 15%. Shipments in most key markets were down year-over-year. Sales into the oil and gas market in particular declined more than 30%. Foreign currency increased revenue by 6%. Segment income was $63 million in Q4. Reported margins were 14.3%, down 60 points from Q4 2008.

Sequentially revenue grew 8% and margins improved 210 points. Demand across our key Flow end markets increased sequentially. Q4 orders grew 10% from the third quarter and were flat as compared to Q4, 2008. The order increase was primarily driven by book and turn business that was shipped in the period. Despite the positive order trend, the backlog declined 6% sequentially to $579 million.

Moving on to Thermal. In Q4, Thermal reported total revenue of $488 million, down 2% year-over-year. Organic revenue declined 8%, offset partially by a 5% currency benefit. The Heat Transfer acquisition increased revenue 1%. Q4 segment income was $63 million and segment margins were 12.9%, down from 14.1% year-over-year.

We continue to see strong order trends in the Chinese power market. In Q4, we were awarded a $36 million order to supply an indirect dry cooling system for a new coal-fired power plant. Year end backlog for the segment was a little less than $2 billion, that's down 6% from Q3.

Test and Measurements fourth quarter revenue declined 12% over the prior year period to $219 million. Organic revenue declined 17% and currency benefited revenue by 4%. The revenue decline was driven primarily by continued global softness in demand from OEMs and their dealer networks.

Despite this, segment income was $19 million, up 8% year-over-year and margins improved 170 points to 8.9%. This was primarily due to organic growth in our higher margin niche businesses and a favorable LIFO adjustments of $4 million due to a reduction in inventories.

Segment income and margins also benefited from restructuring citings. As we expected, the fourth quarter results for our Industrial segment declined significantly. Reported revenue was a $179 million, this was a 36% organic decline from Q4 2008. The primary driver of the revenue decline was reduced volume and pricing of transformer sales. This had a significant impact on profitability.

Segment margins were 13.1% inline with our target, however down sharply from the 24.1% reported in Q4 2008. Our industrial segment ended 2009 with a backlog of $393 million, down 27% from 2008, however up 3% sequentially.

During the quarter, we received a $30 million order to supply crystal growers to a Chinese solar panel manufacturer. It was our second order of the crystal growing technology out of China in the past six months. Globally, however order activity in this market continues to be sluggish. In the Transformer business, we didn’t see any signs of recovery, pricing in Q4 for new orders remained depressed and competitive much like it was at the end of Q3.

We have a 44.5% interest in a joint venture with Emerson Electric called EGS, which reported about $430 million of revenue in 2009, down 25% year-over-year. Our portion of the EGS income accounts for the majority of our equity earnings. In Q4, we reported $8 million of equity earnings, down 40% from last year. For the year, equity earnings were $29 million, roughly 15% of our adjusted pretax income.

Looking at the 2009, consolidated results adjusted earnings per share were $3.90, down 40% from 2008. The decrease was predominantly due to lower segment income and increased restructuring expenses. 2009 revenue decreased 17% to $4.9 billion. Organic revenue declined 14.5% and currency reduced revenue by 2.6%.

Segment income for the year was $587 million, down 27% from 2008. Segment margins declined 160 points to 12.1%. Our 2009 margins benefited from restructuring savings on actions taken in 2008 and 2009. However, these savings were more than offset by the organic revenue decline.

Looking briefly at the full year results by segment, Flow reported revenue of $1.6 billion last year. Organic revenue declined 14%. Segment income margins expanded 70 points to 12.9% as restructuring savings more than offset the decline in volume. Thermal reported $1.6 billion of revenue. Organic revenue declined 4%. Underlying the segment revenue decline, our Balcke-Dürr branded heat exchangers and pollution control systems reported 12% organic growth.

The operating margins for these products are typically lower than the segment average and thus the growth in this business was dilutive to margins which were reported at 10.7%. Full year results for our Test and Measurement segment were impacted by the stress on global OEMs in the dealership networks. Revenue for our Test and Measurement segment declined 26% to $810 million.

Margins declined 360 points to 6.3%. We expect to see 5% to 10% revenue growth in this segment this year. Our Industrial segment reported just over $800 million of revenue in 2009, down 23% organically. Segment income margins were 19.1%, down from 23.2% in 2008. The results for this segment reflect the impact of the recession and the market dynamics in the transformer business that I’ve already mentioned.

Moving onto cash flow and liquidity, in Q4, 2009 we generated $193 million of free cash flow for the year. Free cash flow was $369 million, a 190% conversion of adjusted net income and this was after we invested $93 million on capital improvements and $67 million on restructuring actions.

This level of free cash flow allowed us to return capital to shareholders and make strategic investments while still improving our liquidity. In 2009, we repurchased 3 million shares of SPX stock for $113 million and paid an annual dividend of $50 million.

As Chris mentioned, valuations on acquisition targets have become more attractive. In Q4 last year, we invested about $130 million on the acquisition of the Heat Transfer assets and we expect to complete the Gerstenberg acquisition this quarter. Last year, we also allocated $74 million to debt reduction. Our financial position and flexibility remain strong. Our growth leverage at the end of 2009 was just over two times, slightly above our target range. We expect that this will remain near this level throughout the year.

As Chris mentioned, we ended 2009 with $523 million of cash on the balance sheet. In terms of liquidity, we expect about $1 billion of available capital at the end of 2010. As such, we have the flexibility to make strategic investments without impacting our growth leverage.

Looking at 2010 consolidated earnings estimates, these have not changed from those we communicated in our January 20 Investor meeting. For the full-year, we are targeting between $4.8 billion and $5 billion of revenue. This represents a total revenue change from 2009 of between a 1% decline and 4% growth. We are expecting organic revenue to be down between 1% and 6%.

Acquisitions are expected to increase annual sales by 3% to 4%. Currency fluctuations are projected to benefit reported revenue 1% to 2%. Segment income margins are expected to be between 10% and 11%. Our earnings per share guidance range is $2.90 to $3.30 per share with the mid-point of $3.10.

We expect cash conversion between 100% and 125% of net income. Our free cash flow guidance is $160 million to $200 million. This includes approximately $40 million to $50 million of cash restructuring, $30 million of pension funding and $90 million to $100 million of capital investments. In Q1, we expect consolidated revenue to decline between 6% and 9% with double-digit organic decline. Segment income is targeted at $87 million to $92 million, down about 29% from Q1, 2009 driven primarily by the decline in our power transformer business.

We expect segment margins between 8.1% and 8.5%. Our Q1 EPS guidance is $0.20 to $0.30 per share. Changes in short cycle orders trends and volatility in foreign exchange rates could impact the actual results. Q1 is traditionally our weakest earnings quarter, however year-over-year comparisons are particularly challenging this year due to the timing of the decline in the transformer business.

This business which is reported in our Industrial segment is expected to be the primary driver for earnings decline in 2010. Certain events could occur in 2010 that may impact our earnings and cash flow guidance. Also note that with our low share base, our EPS calculation is highly sensitive to any such changes. With that I will turn the call back over to Chris.

Chris Kearney

Thanks, Patrick. In summary, we have successfully transformed SPX over the last five years to focus on our three core markets. We’ve managed prudently through a difficult 2009 and we enter 2010 with a reduced cost base and a solid financial position. Orders in our early cycle businesses have improved and pricing is firm in most of our end markets. Operationally, we remain focused on continuous improvement through the advancement of our global business systems and services.

We are also focused on project execution particularly on the large power orders in South Africa and China. We are targeting an additional $35 million of restructuring expense in 2010, which includes actions to integrate the two recently announced acquisitions. Our strategic emphasis this year is on expanding our presence in emerging regions and new technology innovation. We believe the drivers for our key markets are positive for 2011 and beyond. We remain confident in our long-term strategy and we are committed to executing it. So thanks again for joining us and at this time we are ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Nigel Coe of Deutsche Bank.

Nigel Coe - Deutsche Bank

Can you comment on the current trends you are seeing in transformer pricing and volumes and the reason I am asking is that we are seeing more positive trends at the PPI level, I am just wondering if you are seeing any of that.

Chris Kearney

Yes, from our perspective Nigel, pricing for medium power transformers remains depressed and still highly competitive. It was depressed and highly competitive in Q4. Unit volumes in Q4 were consistent with the prior-year period. Quoting activity continues to also be at depressed price levels. Our 2010 guidance does assume that and it assumes that pricing remains at uneven levels really throughout the year.

And as we said in our guidance meeting, Nigel, and in response to questions subsequent to that, it's really difficult for us to predict when we will see recovery in this market. We believe that increased electricity demand as the economy recovers will be a key driver and then historically what we've seen is that volume increases for a period of time in advance of those price increases.

So it's consistent with what we’ve said at our guidance meeting and really consistent with how we've seen things going back to when we talked in Q4 when we gave our Q3 results.

Nigel Coe - Deutsche Bank

So would you say that the quotation activity has come to a pricing point lower than what you're currently recognizing in the backlog, but even though that's consistent, just want to make sure the message is clear?

Patrick O'Leary

Basically our guidance for 2010 reflects revenue from this business of about $250 million and that's down about 33% from last year and about half of that is volume and half of it's pricing. At this point, going into the year, we've really, at this point, kind of filled up the first half of the year and the two factories and we're kind of waiting to see how things go, really the pricing over the next three to four months is going to determine how the backend goes.

Nigel Coe - Deutsche Bank

Patrick, you called out the LIFO impact within Test and Measurement this quarter, but I’ve got to think that with the inventory down, $100 million during the quarter that you suffered more from lower production levels, how do we think about the inventory reduction, the impact on earnings, LIFO good, but fixed cost absorption bad. How do we think about that?

Patrick O'Leary

Obviously, volume is the overwhelming thing. I look at the LIFO simply as an arithmetic reduction or reduction in the layers and so called it out, so people would understand it. If you take LIFO out, you know the margins in that segment would have been about 6.9% which are frankly right where we thought they would be. And so really the volume in the business has been the overwhelming level and absorption obviously is a problem.

So, the service solutions business came down to sort of breakeven levels as volume came down as much as 30% at different times over the last 18 months. So, I really look at the LIFO just as a one-time item.

Nigel Coe - Deutsche Bank

The small tweaks to your revenue guidance, is that FX related or is there something else?

Patrick O'Leary

It’s really the actual results for 2009 coming in and those comparisons just changing slightly, so nothing significantly changed from what we discussed at our investor meeting in January.

Operator

Our next question comes from Shannon O'Callahan of Barclays Capital.

Shannon O'Callahan - Barclays Capital

So on Flow you have seen the orders pick up a little here sequentially. Can you just kind of go through the end markets there and give us a sense of what you are seeing food and beverage, industrial, oil and gas?

Chris Kearney

Yes, I think in the short cycle business, the recovery we are seeing in order rate is really across most of those end markets with the exception really of oil and gas. So, it’s encouraging what we are seeing so far and again not inconsistent with what we talked about just a month ago when we were at a guidance meeting.

Shannon O'Callahan - Barclays Capital

On Thermal, it looks like Eskom is going to get about a 25% increase out of 35%, do you guys have a view yet on how that could impact timing of your business there?

Chris Kearney

Well I think the fact that they were able to get their second increase, remember they got a 31% rate increase a year ago and they have gone in asking for a 35% and got 25. I view it as a positive step forward to them being able to fund their gap that they had identified for 2011 and 2012.

So I think the fact that the rate increase of 25% was approved is a positive step towards closing that gap and remember that their intention was to help fill that gap through getting an additional rate increase and then looking at raising some additional international debt to close the gap. So we view it as a positive step forward.

Patrick O'Leary

Just to be clear, the 25% is 25% raise in each of the next three years, which is obviously quite a substantial change in the overall cost environment. It doesn’t fully address their financing needs in the 2012-2013 range, but they have other discussions and activities going on that look promising.

Shannon O'Callahan - Barclays Capital

Patrick, you had talked a little bit recently about the large transformer market being mainly import related and wonder if you could just fill that out a little bit more, why would such a large product be so import driven versus the medium market.

Patrick O'Leary

Well, if you look back historically in the US transformer market, at one point it was characterized by a number of different players with very large factories. And with the business as cyclical as it is, the US landscape has actually changed and to some extent we contributed to that by closing our large power plant in California at the last downturn.

So it really is just historical changes that have taken place in the US market and the capacity that exists particularly in Asia and elsewhere and some of the European manufacturing, so historically, and even recently now as much as 80% to 85% of the market is served with imported transformers, there’s good data available.

As you know, our remaining two factories have focused on the medium power transformer market where we really are concentrated on replacement business. Most of the transformers we sell are in fact replacing a transformer in service at a sub-station.

And looking at the future, the projection show that the growth rate in the large power market maybe higher than the medium power market, partly driven by the changes in generation that are being talked about and partly based on the need for new infrastructure in certain parts of the country.

So, we do see it as an attractive market, we do see it as a way of leveraging our existing brand and we are getting positive feedback from US customers about their interest in a source of US supply and obviously, we've historically sold not super large transformers, but certainly some transformers over a 100 MVA to those customers in the US market.

Operator

Our next question comes from Jeff Sprague of Vertical Research.

Jeff Sprague - Vertical Research

First, just back on transformers, Patrick , your comment that orders the next three or four months will probably kind of determine how the year plays out. Is there at this point any early customer dialogue or project movement that you can see that gives you some view on how those orders actually do play out over the next several months.

Patrick O'Leary

No, I really think things have not changed in terms of the overall market from the last time we spoke, Jeff. At the top of the market our business is predominantly done directly with what we call MBA [ph] customers and then when the market comes down to these levels the majority of our business can in fact be from the open market. And while there is some positive commentary about, we really don’t see that in orders yet and we are hanging back a little bit to see how the open market develops here because we do have the business for Q1 and Q2 already booked.

So I really would have to say that the current information we have is that pricing has not improved in the open market from the last time that we talked.

Jeff Sprague - Vertical Research

Can you just give us a little bit of color on how to think about the mix in Thermal and how that plays through margins in 2010, obviously we know South African revenues are going up. Some of the developed world stuff can really swing the margins, just any other granularity there would be great.

Patrick O'Leary

The biggest issue we are facing relative to the historical margins is that the dry business in the US and Europe has not been strong. The margins that we are experiencing in Asia are for dry are the same as our overall historical dry business and the biggest dynamic that I referenced in the script is that the sales of heat exchangers and pollution abatement equipment are in fact growing organically as we expected, largely these are replacement type projects and those margins are below the average margins of the segment and they are pulling us down.

Jeff Sprague - Vertical Research

You did mention good overall demand in China. Can you just give a little bit more color on what’s going on there wet versus dry, is your story still shifting kind of westward towards dry.

Chris Kearney

It’s been consistently a dry cooling business for us in China, Jeff, and we had a pretty robust order year in 2009 in China. That order and quoting activity that we see coming into 2010 is consistent with what we saw last year.

Patrick O'Leary

Pretty much old coal-fired, at some point there will be some nuclear business in China that will obviously be wet.

Jeff Sprague - Vertical Research

Although we think of Flow as being largely short cycle, is there a bunch of longer cycle long lead time stuff in that backlog where parts of that backlog maybe not be as quickly deliverable as we may think externally looking in?

Patrick O'Leary

We’ve got one large order with about $100 million for nuclear squib valves, partly for domestic and partly for Asian consumption and a handful of smaller-sized projects, but frankly one of the issues in Flow, despite the very positive short cycle order trends that we talked about sequentially is that people are not placing very large orders the way they were, so at some point we expect to see that but about three quarters of backlog is expected to be converted this year.

Operator

Our next question comes from John Inch from Merrill Lynch.

John Inch - Merrill Lynch

Chris or Patrick, you talked about your “shorter cycle businesses” are seeing sharp increases in order rates. I know a lot of that is Flow, can you just remind us again what portion of SPX is short cycle and what you're defining as short cycle, say across the segments?

Chris Kearney

First of all, I'm talking about early not short.

John Inch - Merrill Lynch

I'm sorry meant early.

Chris Kearney

And sharp wasn't the word I use, I said it was a continuous positive trend in those orders and so that is encouraging and when we look at our businesses, John, and the disparate markets that they serve, we look for some of our businesses that are good leading indicators, either up or down in terms of where markets are trending and so some of those businesses are earlier as opposed to the majority of the company which is mid to late cycle.

So we see some of that in flow, and then in our industrial segment, in some of our broader industrial applications like in the hydraulic tools business, for instance, where we see positive movement in those businesses, they are better early cycle indicators and some of those businesses we've seen positive movement.

John Inch - Merrill Lynch

Your cash this quarter, Chris and Patrick, it looks like you got some sequential benefits from receivables and inventories, is something going on there from a customer or one off perspective?

Patrick O'Leary

There is a tremendous amount of liquidity in the industrial world. We did have some people paying us in the last week of December in advance of their required payment dates. And that really explains most of the difference between our cash flow guidance than what results we actually achieved.

John Inch - Merrill Lynch

Your first quarter guide, the $0.20 to $0.30, are there obvious swing factors, you got two months under your belt right at the first quarter. With one month to go, what are basically the swing factors that gave you the kind of the $0.20 versus the $0.30? How should we think about that?

Patrick O'Leary

Well, obviously with the share count so low and this level of performance, it's really very, very sensitive to performance. In the macro sense right now, external factors, FX continues to go against domestic exporters and people with significant international activities. So I would say for the business, actually things like pricing are fairly stable other than the discussion that we had with transformers and so it really is short cycle orders and project execution.

And then I think we have got some level of restructuring this year and the timing, how it hits by quarter, notification to employees, execution could also be the difference between $0.20 and $0.30.

John Inch - Merrill Lynch

Transformers, firstly, what did the backlog do sequentially? And, secondly, if you look at the transformer progression, say, at the beginning of the last cycle, if I remember correctly I think it was a fairly slow rate of expansion until maybe 2004. This recession has been steeper and obviously there is the surplus power generation systematically in the US. Are you expecting that when things do pick up, they going to pick up more quickly or should we be thinking about modeling longer-term based on the relatively slow progression of expansion of transformers at the beginning of the last cycle?

Patrick O'Leary

Sequentially, the backlog declined obviously based on the facts that we talked about on units and volume. With respect to the recovery, it really is very difficult to say, John. I mean if you look at it historically, it’s been as much as two years, our experience is that volume recovers first and then pricing starts to recover and the step up in performance takes place over two to three years from let’s say bottom of the cycle to top of the cycle.

This environment we are in right now is pretty unusual where people are waiting for indications of policy and so our visibility at this point in the market is 4 to 6 months and we just really need to wait and see how the next several months develops in terms of volume and pricing and whether or not some of that volume is negotiated directly with customers or whether it’s open market bidding.

Operator

Our next question comes from Steve Tusa of JPMorgan.

Steve Tusa - JPMorgan

Just a question on the – sorry to beat the transformer issue, but I guess some of the steel producers have been putting through modest surcharges on electrograde steel and I guess at the same time they are talking about volumes being weaker than they would have anticipated a couple months ago. Can you just talk about that dynamic between how the electrograde steel and raw materials cost play into price in the industry?

Patrick O'Leary

Sure, basically, in this market, we offer customers the choice as to where they want the material rates to go. Obviously, we are not big enough to take huge material risk. If they leave the material risk with us, we demand cash deposits and we move those deposits in the supply chain in order to manage the costs going through and frankly about 70% of transformer customers are taking the fixed price option with us, taking material risk and the rest, the other 30% are on a passthrough basis.

Steve Tusa - JPMorgan

So how does that compare to? I would assume, is it different than at the peak?

Patrick O'Leary

It hasn’t changed, it's quite interesting, it has not changed and so obviously at some level when you're transferring the risk, at that level, you're making a statement about how you perceive the potential for material inflation versus the potential for material deflation. And so really with respect to materials, what is going on with volume and pricing related to fundamental demand is by far and away the most important factor in this market. I am not going to say that’s a non-event [ph], but it's not significant to the guidance number that we've given, Steve

Steve Tusa - JPMorgan

We have all these companies coming out, talking about how everything has bottomed, and giving longer-term targets, and talking positively about the future and I guess you know you are calling the bottom, too. How confident are you that this is not just in your short-cycle businesses or some sort of a temporary restock. Is it the broad-based nature of the demand? Could you just give a little bit of high-level color since all the detailed questions have been asked on why you're so confident in calling the bottom in your markets?

Chris Kearney

Because if you look back over the course of Q4, Steve, what we have seen is consistent positive movement in those order trend. And like most people in the world, when we look at those positive trends, we are consciously optimistic because I think everyone is still a little tender coming out with very difficult year. But as the months pass and we continue to see recovery in those order cycle, we begin to feel more comfortable about it, and all that is obviously in balance with still the longer-term stress that we have talked about in this call today with respect to transformers and its impact on the year, and also the really still difficult markets we have in the Thermal businesses in the United States and in Europe in terms of reconstruction.

Patrick O'Leary

Flow is like the biggest driver of our OP dollars when you look at where the business is at right now and while Q4 was not actually at the operating level we targeted, margins above 14% on sequential short cycle order increases of 10% and so flattish year-on-year, that’s actually a pretty good place to be. And so the core of that business for the shorter cycle order has a pretty good tone, and if you look through the market at the food and beverage companies, they are having pretty decent results and they are talking openly about their expansion plans in Asia and elsewhere. And those are the kind of things that give us confidence that we really are at the bottom of our stock coming back up.

Steve Tusa - JPMorgan

I just want to clarify. I know you have made a lot of good commentary on this, but the transformer pricing, so you said the next few months, the next couple of quarters are important. What is the risk that pricing takes another step down, or are you saying it just won't recover and that we've kind of flat lined here when it comes to transformer prices?

Patrick O'Leary

Well, currently, the open market pricing is at the same difficult level it was the last time we spoke, which is about 25% of peak pricing and frankly not showing signs of coming up. I mean it’s very difficult to predict what’s going to happen. Logically at some point, volumes start to come back up, we just obviously have not seen that yet.

Steve Tusa - JPMorgan

But you're not saying that price takes another step down, it is just that you're looking forward and not trying to time when it turns up. So you think you're comfortably close to the bottom on transformer pricing?

Patrick O'Leary

We just don’t know how long it will last at this level.

Operator

Our next question comes from Deane Dray of FBR Capital Markets.

Deane Dray - FBR Capital Markets

If we could follow up on Patrick's comment on Flow for a moment. There was a comment in the intro remarks about project timing in some of the business and usually that is a euphemism for delays. Are these project delays financing-related or just logistics, is it stimulus, or is there any particular color that you could add?

Patrick O'Leary

Actually, it wasn’t a euphemism for delay, it was simply that we decided to recognize the revenue in 2010 instead of 2009. It primarily relates to a single project and the actual activity with the customer is in fact on track.

Deane Dray - FBR Capital Markets

This could be a stretch, but was curious to know in light of all of the recalls that Toyota is doing and some of it is electronics-related. Does this have any impact on your business?

Chris Kearney

It has a tiny bit of impact. There is some opportunity for us to help them recover from that, but it's not measurable.

Deane Dray - FBR Capital Markets

Lastly, this is a bit of a look back. It was interesting that you chose not to reaffirm guidance for the fourth quarter back at the outlook meeting and now we kind of look at these numbers and it seems relatively uneventful and within the guidance, but was curious was there something you were signaling in not doing that?

Patrick O'Leary

No. we never do that. We're basically in the middle of the audit processing and this is very consistent with our prior practice. The last several years, we've tried to separate information about the forward-looking upcoming year from the historical results, so that we can have two separate discussions around that.

Operator

(Operator Instructions). Our next question comes from Terry Darling of Goldman Sachs.

Terry Darling - Goldman Sachs

Guys, I want to talk about Europe a little bit more, in terms of what you're seen in February and January and we've seen some macroeconomic forecasts get cut here off the back of all of the excitement there. I am just wondering if you are seeing anything there? Whether you hearing from your customers a little bit more hesitancy on the shorter cycle businesses that you've got?

Chris Kearney

No, no real different tone. I think if you look at the success that I've talked about in terms of improving order trends and some of those early cycle businesses, we are seeing that really across the board, but what we were not seeing in Europe and United States in those developed power and energy markets is the replacement business really picking up. I mean that is still depressed from past levels, Terry, and so our experience in Europe hasn’t changed dramatically.

Terry Darling - Goldman Sachs

Patrick, I am wondering if maybe you can help us with EPS sensitivities around some of the currency movements of late. I think the 1% to 2% year-over-year positive would imply probably euro dollar in what the low to mid-40s?

If we took that to the mid-130s, are we talking $0.05 to $0.10, is that roughly the right range to be thinking about that? Or it is it different significantly from that?

Patrick O'Leary

It’s probably in that range. If you look at the rates were used in the guidance, our revenue target included a currency benefit of about 1.5%, which is about $70 million of revenue, and you can use incremental OP dollars and so we are facing a little bit of a headwind there. We convert about a little over 20% of our total revenue from the euro and after that the Chinese Yuan is about 8% to 10% and so obviously there’s been a decline in the euro rate between January and today.

Terry Darling - Goldman Sachs

And in terms of your revenues in Europe or your business in Europe, what percentage of that business would be coming from shipments out of US facilities? I'm trying to think about your competitiveness relative to local European competitors.

Patrick O'Leary

A very small amount. The vast majority of it is local and frankly that would obviously hold true for Asia as well.

Terry Darling - Goldman Sachs

You talked an awful lot about pricing, but I am wondering if we can extend that question beyond the transformer business into the some of the shorter cycle businesses. As these orders are picking up, are you seeing pricing sort of stay steady in that context or what are you seeing there maybe across the Flow business and maybe the Test and Measurement business as well?

Chris Kearney

Steady is a fair way to describe it, Terry. We see it same, with the exception of our transformer business, it’s stayed pretty firm across the rest of our businesses.

Patrick O'Leary

And you can see that in the gross margin, Terry, in terms of -- Flow is a particularly good example of slight strengthening in the gross margins partly from the restructuring actions, but really pricing is not a factor at all outside of the transformer business.

Terry Darling - Goldman Sachs

Maybe just finish up then on that restructuring point. Patrick, 4Q is a little stronger than we thought. Are you still thinking $35 million is the right number for 2010, two-thirds in the first half and one-third in the second half?

Patrick O'Leary

Yes.

Ryan Taylor

Thanks, everybody. This is Ryan Taylor. I will be around in the office today if you have any follow up questions, but at this time we are going to thank you for joining us and close our call. Thank you.

Operator

Ladies and gentlemen, that does conclude today’s conference. You may all disconnect and have a wonderful day.

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