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SPX Corporation (NYSE:SPW)

Q1 2010 Earnings Call

May 5, 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

Bob Cornell – Barclays Capital

John Inch - Merrill Lynch

Steve Tusa - JPMorgan

Jeff Sprague - Vertical Research

Scott Davis – Morgan Stanley

Operator

Welcome to the SPX Corporation first quarter 2010 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, and good morning, everyone. Thank you for joining us. 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 May 19, and I 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 discuss today. Our earnings press release was issued this morning and can also be found on our website.

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

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

Chris Kearney

Thanks, Ryan, and good morning, everyone. Thanks for joining us on the call. In the first quarter we saw positive signs that the recovery of the global economy is underway. To provide you with some context for what this means to SPX I will begin this morning with an overview of what we experienced during the quarter in our key end markets.

We continue to see various stages of improved performance in our businesses that serve early cycle markets. Broadly speaking, orders in our General Industrial businesses increased globally quarter-to-quarter. In the U.S. the recovery of the auto industry is beginning to have a positive impact on our Test and Measurement segment. Our run rate in the U.S. after market increased sequentially and year-over-year in Q1.

We are also seeing signs of improvement in orders for replacement tools at OEM dealerships. We have made good progress so far this year with the OEMs in Asia. To date in 2010 we have won awards for new OEM diagnostic platforms with Suzuki, Geely and Cherry. Additionally in our Flow segment component orders for the food and beverage market increased quarter-to-quarter driven by distributor restocking and customer driven maintenance and repairs. As you may recall, however, about 2/3 of our business is mid to late cycle and about 40% of our annual revenue is from sales into the power and energy markets. These markets continue to be impacted by the recession.

Our backlog reflects these trends. At the end of Q1 our backlog was $2.9 billion, down 6% from year-end as declines in late cycle power orders offset increased orders in our early cycle businesses. Looking at the backlog by segment Thermal backlog declined 8% organically as industry orders for power generation equipment declined globally in Q1. As we have noted in the past, quarterly changes in our Thermal backlog are highly influenced by the timing of large orders. We view the decline in our Thermal backlog as a reflection of contract award timing particularly in emerging markets as well as continued restrained spending by U.S. and European utilities.

Fundamentally the demand for power infrastructure remains strong and should increase as economic recovery continues. In the second quarter we have already been awarded a large dry cooling contract for a new gas fired power plant in South America. This contract is not reflected in Q1 backlog.

In our Flow segment the backlog increased 7% from year-end to $620 million. Sequentially orders for food and beverage components increased by double digits. In the Oil and Gas sector we saw a slight quarter-to-quarter increase in spending driven primarily by maintenance and replacement parts. Large system orders for food and beverage processing continue to be deferred in Europe and in the United States. However, in Asia Pacific we saw a nice pickup in system orders during Q1.

Power and energy orders in Asia Pacific were also strong for our Flow segment. This was highlighted by a $5 million order for dehydration equipment to be installed in a new LNG plant in Australia. Our Industrial segment ended the quarter with a backlog of $358 million, down 9% from year-end. The transformer backlog declined 19% sequentially more than offsetting the positive order trends for signal monitoring equipment and hydraulic tools.

Looking at our visibility for the remainder of the year we now have 56% of our 2010 estimated revenue either already recorded or included in our backlog. About 2/3 of our annual revenue is generated from short cycle orders and we are highly sensitive to trends in these markets particularly in our Flow and Test and Measurement segments.

Looking now at our financial results for the quarter, we reported $1.1 billion of revenue, down 6% from the prior year. Sales into Europe and North America declined offsetting more than 20% growth in the Asia Pacific region. Revenue in our U.S. based medium power transformer business declined nearly 30% organically reflecting a decrease in both volume and price from last year.

As anticipated, the decline in this business had a significant impact on our Q1 profitability. Segment income declined 16% to $106 million and margin contracted 110 points. Although the year-over-year performance was down our reported segment income exceeded the high end of our target range by $14 million. We reported Q1 EPS of $0.37 per share versus our guidance range of $0.20 to $0.30 per share. Free cash flow which is seasonally weaker in Q1 was a net investment of $37 million.

Based primarily on the strength of our Q1 operating performance we have raised the midpoint of our EPS guidance $0.05 to $3.15 per share. Our revised guidance range is now $3.00 to $3.30 per share. We have provided a bridge on this chart that reconciles the notable changes in our EPS guidance. We have increased segment income expectations by $0.18. This is net of a $0.09 currency headwind primarily from the continued weakening of the Euro. Our tax rate for the year is modestly higher now primarily related to the impact of the new healthcare law. We have increased other expense to reflect a non-cash charge recorded in Q1 that was not in our previous guidance.

Based on our increased operating expectations we have raised our free cash flow guidance by $20 million to a range of $180-220 million. Patrick will provide more details on our full-year targets later on the call.

From a strategic perspective we continue to focus on expanding our global presence in our three core markets. In Q1 we completed the acquisition of Gerstenberg Schroder. Gerstenberg is a leading global supplier of highly efficient processing lines that manufacture products such as butter, oils and salad dressing. We believe it is an excellent strategic fit. It’s system technologies complement our APB designs and expand our large system capabilities for food processing. We believe this combination increases our competitive advantage for large scale systems.

Gerstenberg is headquartered in Denmark and had approximately $70 million of revenue last year. The purchase price was about half of annual revenues and we used cash on hand to fund the acquisition. We expect the acquisition to be accretive to earnings in the first 12 months. The integration is underway and we are pleased to add Gerstenberg Schroder and its employees to our Flow Technology segment.

Looking now at our financial position our cash position is down from the end of the year due to the Gerstenberg acquisition and a Q1 cash flow investment. However, with $454 million of cash on hand at the end of Q1 we are still in a very strong cash position. The acquisition market continues to look attractive and we can execute acquisitions with cash on hand without impacting gross leverage. Debt increased modestly to $1.3 billion and our gross leverage was 2.2 times.

At this time now I will turn the call over to Patrick to provide details on our Q1 results.

Patrick O'Leary

Thanks Chris. Good morning everyone. I will begin this morning with a review of the Q1 earnings per share.

We reported Q1 EPS from continuing operations of $0.37, $0.07 better than the high end of our guidance range. However, down 52% from the prior year. This was primarily due to the year-over-year decline in power transformer volume and pricing that Chris has already mentioned. In total, segment income from our Industrial segment declined $0.43 per share, offsetting $0.13 of combined operating improvement in our other three segments. Our reported tax rate for the quarter was 40%. The elimination of a portion of the tax deduction associated with Medicare Part D resulted in a one-time non-cash charge of $0.12 per share. This was partially offset by some discrete tax benefits recorded in the period.

Our other items netted to a $0.02 benefit for the quarter. It should also be noted we recorded a net non-cash charge of $0.12 related to currency losses on our South African contract. This charge was driven by the weakening of the Euro to the Rand and also variances in the timing of expected cash inflows and out flows which caused the discontinuance of hedge accounting we put in place last year. It was recorded in the other expense and non-controlling interest lines of our income statement.

On a consolidated basis our reported revenue for the quarter was $1.1 billion, down 6% from the prior year. Organically revenue declined 12% offset partially by 3% growth from acquisitions and a 3% currency benefit. The organic decline was primarily driven by our industrial and flow segments. Segment income declined 16% to $106 million or 9.8% of revenue. This was largely due to the organic decline in our Industrial segment. Test and measurement and Thermal both reported year-over-year increases in segment income and margins.

Looking at the results by segment beginning with Flow. Flow reported revenue of $354 million in Q1, down 10% from last year. Organic revenue declined 15% and currency increased revenue 5%. The Gerstenberg acquisition was completed at the end of February and increased revenues by less than 1%. The year-over-year organic decline was primarily due to reduced sales to the oil and gas sector. In addition our revenues from large food and beverage systems were down versus last year. Segment income was $41 million, down 18% and segment margins declined 100 points to 11.7% primarily due to the organic decline in the oil and gas sector.

In Q1 we reorganized this segment by region. We now have management teams overseeing operations in the Americas, EMEA and Asia Pacific. We believe the new structure increases our opportunity to leverage our products across industries and geographies. We are making good progress in Asia Pacific. In Q1 orders there increased by more than 50% year-over-year. We recently consolidated all of our Flow manufacturing in China into our [Shidou] facility. We believe this will increase our ability to serve our customers in that region.

Moving onto our Thermal segment, reported revenue for Q1 was $353 million, up 3% from last year. The SPX heat transfer acquisition contributed $28 million of revenue or 8% year-over-year growth. Currency changes increased revenue 3% year-over-year. Organically revenue declined 7%. This was primarily driven by a decline in wet cooling system revenue in the U.S. and Europe. Sales into China increased $45 million and sales into South Africa increased $23 million.

Segment income improved 47% to $32 million. Margins increased 260 points to 8.9%. The profitability improvement was due primarily to a favorable revenue mix, the SPX Heat Transfer acquisition added incremental profit and was also modestly accretive to segment margins.

In Test and Measurement we are clearly seeing signs of recovery. Segment revenue grew 4% to $204 million in Q1. Organic growth and currency each increased revenue by 2%. The organic growth was driven by increased sales into the global vehicle service after market. Sales of portable cable and pipe locators also increased year-over-year. Regionally, revenue grew by more than 50% in Asia Pacific. We also had positive revenue growth in the Americas. Revenue in Europe declined modestly versus last year.

Segment income more than doubled to $13 million and margins improved 360 points to 6.6%. This improvement was largely a reflection of the cost savings associated with the restructuring actions taken last year. We also benefited from leverage on the organic revenue growth.

Our fourth segment, Industrial Products, reported revenue of $174 million in Q1, down 24% organically from the prior year. This decline was primarily driven by reduced volume and lower pricing of medium power transformers into the U.S. transmission and distribution market. We expect this trend to continue in Q2. Q1 revenue from this business was down 30% versus the same period last year. Sales of broadcast and crystal growing equipment also declined year-over-year.

Segment income was $20 million, 11.6% of revenue. As a reminder, the transformer shipments we made in the first half of 2009 were from orders received prior to the global economic downturn. As a result we are seeing a greater impact from the recession in the reported results for the first half of this year. We expect about $250 million of revenue from the Transformer business in 2010.

Through Q1 we had 75% of this revenue target either shipped or are in our order backlog. During Q1 open market pricing for transformers remained depressed. At this point we don’t expect a recovery in this business to have any significant impact on our projected 2010 results.

Equity earnings accounts for a little more than 10% of our annual pre-tax income. These earnings are primarily related to our EGS joint venture with Edison Electric. EGS is a supplier of industrial electrical products for hazardous environments to diverse end markets. This business is also seeing signs of stabilization. In Q1 we reported equity earnings of $9 million, down from $11 million in the prior period. For the year we have increased our target modestly to $28 million, slightly below last year’s results. As a reminder, we report our portion of the EGS earnings on a one-quarter lag.

Moving on to cash flow, Q1 is historically our weakest cash flow quarter. This year’s performance is consistent with our historical experience. We reported a cash investment into the business of $37 million. That is 27% better than last year. This was due to a combination of reduced capital spending and cash payments on restructuring actions as well as a lower net investment in working capital.

In the quarter we invested $12 million in capital expenditures and $11 million in restructuring. For the year we are targeting about $200 million of free cash flow. This is down from $369 million in 2009. The decline is primarily due to lower net income. However, we also anticipate making working capital investments in the latter part of the year as the economic recovery continues.

Now I will review our 2010 financial targets before I turn the call back over to Chris. In Q2 we expect consolidated revenue to grow between 1-5% year-over-year. This is primarily driven by acquisitions. Segment income is targeted to be between $120-130 million. That is down about 4-12% from Q2 last year primarily due to the power transformer business. We expect segment margins to be between 10-10.5%. Our Q2 EPS guidance range is $0.65 to $0.75 per share. Changes in short cycle order trends, timing of restructuring actions and volatility in foreign exchange rates could obviously impact actual results.

Looking at the full-year targets by segment, these targets reflect the Q1 results and our updated expectations for the remainder of the year. Note that our previous targets were based on January exchange rates. Since then the strengthening of the dollar has reduced our 2010 expectations. This is reflected in our updated targets. Notwithstanding the foreign exchange headwinds we have increased the margin targets for three of our four segments.

In our Flow segment the changes in currency rate since January have lowered our revenue expectations by about $30 million. We expect the positive order trends in Q1 to offset this decline. We now expect total revenue to be flat to up 4% year-over-year. Our updated revenue target for Flow reflects 3% growth from the Gerstenberg acquisition, a modest organic revenue decline and an immaterial impact from currency.

As you may recall our previous margin target for this segment included a $12 million headwind from a long-term raw material contract we inherited with the APB acquisition. During Q1 we reached an agreement to revise the contract to more closely reflect the current economic environment. As a result our segment margin expectations have increased to a range of 12.6-13.3%.

In our Thermal segment the changes in currency rates since January have lowered our revenue expectations by about $30 million. We have also reduced our revenue target to reflect risks related to contract timing on large projects particularly in South Africa and China recognizing potential construction delays on such large contracts are not uncommon. We now expect revenue to be flat to up 4% year-over-year. This reflects 7% growth from the SPX Heat Transfer acquisition, low single digit organic decline and about a 1% decline from currency. We expect Thermal margins to be between 9.5-10.5%. This is unchanged from our previous target.

In our Test and Measurement segment we have narrowed our revenue target to 5-9% growth. This is all organic and offsets the modest decline from currency rates. We have increased our target margin range to 7.4-8.1%.

For Industrial we have increased our revenue target range by about $25 million. We are now targeting revenues to decline between 9-13% from last year. This reflects a small hydraulic systems acquisition we closed in April and improved order trends in our hydraulic tools and signal monitoring business. We have also increased our target margin range 20 points to 10.5-11.5%.

On a consolidated basis we are targeting between $4.8-5 billion of revenue in 2010. This represents a total revenue change from 2009 of between a 1% decline and 3% growth. We are expecting organic revenue to be down between 1-5%. Acquisitions are expected to increase annual sales by 3-4%. Currency fluctuations are projected to have a neutral or slightly negative impact to revenue for the full-year. Segment income margins are expected to be between 10.4-11.2%.

We are using a 35% tax rate for the full-year. This includes the tax charge from the new healthcare legislation and the discrete tax benefits recorded in Q1.

Our earnings per share guidance range is $3.00 to $3.30 per share with a midpoint of $3.15. We have included a full earnings model to the midpoint of our guidance in the Appendix of this presentation. Our free cash flow guidance is now $180-220 million. This includes approximately $40-50 million of cash restructuring, $35 million of pension funding and $90-100 million of capital investments.

I would like to remind you we have about 50 million shares outstanding. This makes our EPS model highly sensitive to changes. For example, $1 million of net income is now equal to $0.02 of earnings per share. Also certain events noted on this chart could occur over the balance of this year and could impact our EPS and cash glow guidance.

With that I will turn the call back to Chris.

Chris Kearney

Thanks Patrick. In summary we are encouraged by the improvement in the global economy. As anticipated there will be different inflection points for recovery in each of our businesses. We have seen various levels of improved performance in our early cycle businesses through the end of Q1. However, our mid to late cycle businesses are still being impacted by the recession. We raised our EPS and free cash flow guidance for the year based on the strength of our Q1 operating performance. We remain confident in the long-term strategy for our three core markets and we are committed to executing it.

We believe the actions we have taken to enhance our business during the global recession have us well positioned for growth when our markets do recover. So with that we will be happy to take your questions.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Nigel Coe - Deutsche Bank.

Nigel Coe - Deutsche Bank

The backlog trends in both Thermal and Industrial were a bit weaker than I expected. I am curious to know if they were more or less in line with your plan? I know you had one Q1 guidance conservative. I am just wondering were they in line with expectations? When will we see the backlog stabilize to get to your FY10 plans?

Chris Kearney

Let’s talk about Thermal first. As a reminder, I know we say this a lot because we mean it but the quarterly data for our Thermal segment generally whether it is revenue margins or backlog will fluctuate and sometimes materially just due to the large size of the projects and the timing associated with that. In that segment we don’t really view quarterly data as much of a meaningful indicator of trends in this segment just given the large project nature of the business.

We did experience a decline in orders year-over-year in thermal in Q1 for cooling systems and thermal equipment and the backlog declined by 10%. We are currently involved though in bidding and quote activity in Asia Pacific, the Middle East, EMEA and Americas and there is more activity in Asia Pacific than other regions. So we continue to believe that the fundamental demand for replacement and new power infrastructure remains strong. It is just the timing of contracts as they are awarded get pushed out for various reasons.

So you mentioned Industrial. In Industrial, the biggest impact there obviously is the recovery of the transformer business. Nothing is happening with respect to transformer that is really at all inconsistent with what we talked about in our guidance presentation and in our Q4 report. Pricing is still pretty challenging in that business. We continue to see recovery occurring sometime later in the year.

Patrick O'Leary

Sequentially Industrial was down about 9%. We did have a $30 million Thermal order in Q4 2009. So really in terms of how Industrial is developing it is very much in line with the expectations we had at the beginning of the year.

Nigel Coe - Deutsche Bank

Given your guidance it seems given your guidance the backlog for Industrial should I guess be up in Q2 or at least stable?

Patrick O'Leary

It is still predominately a short cycle segment. So for most of the segment the orders are coming in and turning the same quarter. The effect on the backlog is still predominately related to the Transformer business. Logically that will level out as we get into the back half of the year.

Nigel Coe - Deutsche Bank

The 19% decline in the transformer backlog in the quarter was that all volume?

Patrick O'Leary

It was predominately volume. We still expect that business to deliver about $250 million of revenue this year. Year-over-year that is down a little over 30% and it is still kind of half price and half volume. As we implied in the script we still saw a pretty competitive open market and I would say it is pretty much the same as the last time we spoke publically.

Nigel Coe - Deutsche Bank

Just to clarify is that half price and half volume?

Patrick O'Leary

No it is predominately volume.

Nigel Coe - Deutsche Bank

You have a fair bit of cash on the balance sheet. Patrick you mentioned in your prepared remarks the EPS volatility caused by the low share base. Where do you sit right now with share buyback? You have done a few deals. Is there an appetite to do more share buyback given how low your share base is?

Patrick O'Leary

Basically we look at acquisitions and share buyback in parallel. We are still using fundamental economic tools to make those decisions. As Chris mentioned in his prepared remarks we are seeing a very attractive acquisition environment right now in terms of pricing but our fundamental approach to capital allocation has not changed at all. We still look at what we think will be the best thing for our long-term economic model.

Nigel Coe - Deutsche Bank

The FX charges came in below the line predominately Euro/Rand movements. Is there an offsetting positive within the Thermal segment income so you take a charge on the FX translation but you get a benefit because of the lower translation of costs within segment profits?

Patrick O'Leary

Over the long-term there should be some benefit in the operating income side. Really the largest part of that charge in Q1 was in fact reversal of deferred hedge accounting.

Operator

The next question comes from the line of Bob Cornell – Barclays Capital.

Bob Cornell – Barclays Capital

One more question on the Transformer business. What are the margin levels you assumed in the 250 embedded in the guidance for Industrial?

Patrick O'Leary

We have said that the business would come down to single digit margins.

Bob Cornell – Barclays Capital

How about a comment on the pricing and backlog overall? Is pricing holding up in [a] cross price mix?

Chris Kearney

I would describe the pricing dynamic across most of our businesses as being fairly competitive in Q1 and challenged in transformers. That is not really different than we have described it in the past. Transformer pricing is really the only place in the business we have seen a material impact on the company’s results.

Bob Cornell – Barclays Capital

You talked about acquisitions and a very favorable environment. You have been very successful acquirers. What is the chance you do something on a larger size? APB size or even bigger going forward?

Chris Kearney

We have been pretty disciplined in terms of the process as you know over the past 5-6 years and I think we have been successful. What we look at first is strategically where these opportunities fit within our three core platforms. So as we have always said those come in all shapes and sizes and in different geographies. We look first at where they fit strategically and then whether they pass our two primary financial hurdles. Those can come in various sizes. We have a pretty active and dynamic [inaudible] and radar screen that is active with opportunities and when we find the right ones and they pass the financial hurdles I think we have flexibility to act.

Bob Cornell – Barclays Capital

Could you give us some color around the thermal project slippage in China, South Africa? Is that a function of electricity growth being down? Financing issues? What is really going on there?

Chris Kearney

It is really more project timing than anything else.

Bob Cornell – Barclays Capital

How does the EGS Balance sheet look? Do you and Emerson extract the cash from that business or is there a cash build up? What is going on there?

Patrick O'Leary

It looks splendid. It is actually an unlevered entity and so we have no debt. Basically what we have been doing for the last several years is distributing the vast majority of the earnings in cash. Both companies have a responsibility for the tax obligation of the joint venture and so you need to get cash distributions to at least cover the cash. We are in fact distributing substantially all of the cash flow in the joint venture to the two partners.

Bob Cornell – Barclays Capital

Is there any discussion about levering that up with interest rates being what they are and giving a more substantial cash dividend to the partners?

Patrick O'Leary

I won’t comment on that. What I would say is we have an excellent relationship with Emerson. They are doing a fabulous job running this. We are in fact open to deploying more capital in that joint venture notwithstanding the fact we have only a 44.5% interest. That frankly reflects the operating discipline and success they have shown in the downturn they have been able to maintain a high teen’s operating margin, close to 20% EBITDA. They have just done a really good job. It is probably the longest standing joint venture in the S&P 500. It was formed, as you know in 1997 just prior to our acquisition of General Signal and we are really happy with the way it has been operating and the amount of cash we get.

Our balance sheet basis is really low. It is less than $80 million. In a normalized environment we have been getting over $40 million of cash a year from it.

Operator

The next question comes from the line of John Inch - Merrill Lynch.

John Inch - Merrill Lynch

Firstly, the $0.10 of other expense in the bridge this year I am assuming this was all of the South African hedges. Can you confirm that all hit in the first quarter so that was part of the $0.37?

Patrick O'Leary

That is correct. It was net of that.

John Inch - Merrill Lynch

Traditionally the first half of the year is about 1/3 of your yearly earnings. Are you expecting any of your businesses based on the first quarter trend so you adjusted for seasonality to actually get worse in the second half or worse from here? It sounds like the businesses are improving to a degree or holding their own. Am I missing something or is anything getting worse?

Patrick O'Leary

Just the transformers that we have previously discussed. Other than that you are correct.

John Inch - Merrill Lynch

So if we were to add the $0.10 back to the $0.37, add the $0.12 for the healthcare charges, if you take the midpoint of the second quarter that is $1.29 or $1.30. If you annualize that it is closing in on $4. If you were to subtract the $0.12 for healthcare and the $0.10 you see where I am going with this. You are getting a midpoint that seems to be substantially above the $3.15. Is there some other adjustment factor we should be thinking about or is this just conservatism?

Patrick O'Leary

Right now in terms of the way the first half and the second half line up we have got kind of $1.07 in the first half and about $2.08 in the second half. We are still predominately short cycle. We have talked about that. There is a ramp up in the Flow income and Thermal income between the two halves. We have got the personal heating business in Thermal very skewed to the second half. Really for what we are assuming in industrial right now the first half and the second half look very similar to each other. Net we are showing flat. What is going on in Transformers is we are dealing with the pain through the first half and the truly short cycle businesses there are actually starting to show some significant improvement. Then there are significant movements below the line. When you go to the other expense it is creating about $0.17 difference between the first and second half.

Right now if you look at where we are standing in terms of the guidance we only have 11-12% of the year delivered in Q1. We are taking an appropriately prudent position with respect to expectations for the rest of the year. Once we are through Q2 we will have decent visibility in the short cycle businesses through let’s say the end of Q3. I think we will be in a good position then to talk about the rest of the year.

John Inch - Merrill Lynch

Do you have any sort of a perspective the improvement you have seen in your short cycle businesses may be sort of somewhat more fleeting if you will? Perhaps inventory restock or something that may not be sustainable?

Patrick O'Leary

No I think the trends we are seeing in the short cycle business are typical with economic recovery. You are not going to have perfect monthly linear progression but when you look over the last 5 months I think you can certainly see a line where things are improving. Test and Measurement is extraordinarily short cycle. We talk about daily tool orders. So I would say we are optimistic there.

If you look at the broad company we really are a mid to late cycle story. I think this is now more about 2011 than it is about 2010.

John Inch - Merrill Lynch

You mentioned Test and Measurement. The car companies have anticipations of launching all of these new vehicle models. Does that begin to hit you in 2010 at the end of the year or early 2011? How significant could that be?

Chris Kearney

We see some impact in the later part of 2010 as those new programs ramp up. But we see a larger impact in the years following in 2011 and 2012. We are seeing some of it. We are particularly pleased with the success we have had recently as I mentioned in my comments this morning in the Asia Pacific market with those new customers. I think the momentum will build going beyond 2010.

John Inch - Merrill Lynch

You took out a lot of capacity if I am not mistaken in that business. Do you have the capacity to meet the anticipated demand? Do you have to hire people back or how does that work?

Chris Kearney

What we did was a lot of consolidation particularly here in the United States going from 7 facilities actually down to 2 right now with our distribution center in Chicago. We have acquired businesses in Europe and in China. We are absolutely confident we have the capacity to meet the demand. It is also important to remember the nature of that business is shifting not only in terms of its geographic emphasis but in the nature of the products that they make that account for the lion’s share of revenue in that business moving more from a specialty tool business to a global diagnostic business. So the business is shifting geographies and customer focuses and it is also shifting somewhat in terms of its product base.

John Inch - Merrill Lynch

Could we get an update on Thermax? What kind of revenues are you anticipating from that business? Probably less this year and more next year. What is the trend line expectation? The Indian economy seems to be doing pretty well. How does this play into that?

Chris Kearney

First of all Thermax is a joint venture with a minority partner so what we get out of Thermax will be recognized in equity earnings. What we said about that venture when we announced it was it would take some time for that business to ramp up for us in India but that over time as that business normalizes and grows and I think we gave about a 3-year time horizon, we said revenues were going to be somewhere in the $100-150 million range.

John Inch - Merrill Lynch

You still think that?

Chris Kearney

I think that. It is probably still right.

Operator

The next question comes from the line of Steve Tusa – JPMorgan.

Steve Tusa - JPMorgan

A question on transformers and maybe other power products. The utilities have seen a little more demand from their industrial customers. I guess their residential customers also kind of bottoming out here and they are a little more positive on demand trends. What does it take to get them off the sidelines and start to put a little more capital to work? Is it just a couple quarters of uptick in demand? Do we have to see more substantial increase? I am curious as to the conversations you are having with your utility customers.

Chris Kearney

I think volume in that business for us will follow steady increase in electricity demand. I think it is also important to be a little bit careful in terms of broad industry data that we look at for transformers generally. We play into a distinct part of that market and I think some of the data we look at sort of amalgamates data across small, medium, large and very large transformers and there are different I think demand and replacement cycles and different new capacity needs in those markets. I think from our perspective as the economy normalizes as we see it beginning to do we will start to see a positive impact in that business that will just lag the early cycle parts of our business. I think it will occur naturally as the economy recovers. I think in part because of increased demand but also in part because of the focus on the aged nature of the product out there and the reliability standards that support replacement.

Steve Tusa - JPMorgan

So I am curious, have the conversation levels picked up with customers? Is there any kind of change whatsoever in the tone you are hearing from your guys on the ground on utilities? I am curious of the nuance there.

Chris Kearney

I think the next couple of quarters are going to be important for us to determine exactly what happens.

Steve Tusa - JPMorgan

Second quarter guidance, what is the organic growth guidance for the second quarter or decline or whatever you are putting out there?

Ryan Taylor

For Q2 our guidance assumes 1-5% total growth. That is mostly acquisitions. There is a slight FX benefit as well. It would imply a modestly lower organic growth versus last year.

Steve Tusa - JPMorgan

Any change in the outlook on South Africa projects in Thermal?

Chris Kearney

No. We are proceeding along on those contracts as we are required to do and get the product out. I think the forward guidance we have with respect to that segment reflects significant currency headwinds and just the project timing nature of those big projects like the ones we have going on in South Africa and China. I think we have to be a little bit careful and conservative in terms of how we see that just because of what we have experienced in the past on construction timing of those projects but other than that nothing is really any different.

Patrick O'Leary

We have selected about $180 million of progress payments in conjunction with those projects and we are about 3-6% of the total project. So from our point of view so far I think things are progressing.

Operator

The next question comes from the line of Jeff Sprague - Vertical Research

Jeff Sprague - Vertical Research

One more on transformers for me. Trying to understand the mix underneath the surface. If we look, industrial revenues have been $170-180 million for three quarters but the margins have gone from 19.5% to basically 11.5%. Clearly that is kind of stuff planned through the backlog as it relates to transformers but give us some view of the sequential look on transformers into the second quarter and whether we are finding some stabilization of the margins there.

Patrick O'Leary

In terms of the margins they are kind of where we expected them to be going into the year with the decline you see in the overall segment. What is really happening is we are still through Q1 and Q2 working off of somewhat higher price backlog and that is working its way out through the income statement. That should level out. Typically at the bottom of the cycle for us, last time we were mid to low single digit margins. I think we will be slightly better than that this time.

Really if you look at 2010 for us as I have tried to infer in the comments the cake is pretty much baked. We have three quarters of the year either done or in the backlog. Pricing going forward, delivered results is really going to be a mix of direct negotiated sales and open market sales. I think again it is really about 2011. Sequentially you can see we actually gave a transformer decline in the backlog 19% predominately volume. Nothing has really changed with respect to our views for the year. It is kind of going along as we expected with about $250 million, down about 30% year-over-year delivered and about half of that in volume and half in pricing.

Jeff Sprague - Vertical Research

Is the backlog kind of sequentially linear? In other words, the flip side of having a 75% baked is 25% is not baked. Does that imply Q2 and Q3 are in hand and you have a hole in Q4 or kind of the hole is kind of spread out?

Patrick O'Leary

The hole is concentrated in Q4. It really isn’t linear because we participate in the open market to fill the factory up. There is some periods of time when you see obviously our profitability is a function of running the two factories as full as we can run them in each quarter. So we have a period of time. It obviously shortens at this point in the cycle. It goes up as much as a year at the top of the cycle.

As Chris mentioned, volume and resultant pricing between now and the end of the year is really going to be important for the forward look. I don’t currently expect anything different to happen for the 2010 results than we are currently outlooking.

Jeff Sprague - Vertical Research

On the cost side, I am sure that is a challenge but it is helping on price. I see AK Steel took electrical price up $300 a ton last week. Is that changing the price discussions with your clients?

Patrick O'Leary

Not significantly. The reality is that the transformer market has moved to price flexing predominately or customers not taking the risk. So we basically quote at current prices. We do have some limited hedging activity on copper. If you look at what is actually affecting the backlog and the reported results it is predominately the existence of lower volume demand and as important the fact this depressed demand has, as in past cycles, brought pricing down to this level.

Jeff Sprague - Vertical Research

Finally, on Thermal was actually an upside surprise relative to where I was at. You mentioned Yuba but it sounds like actually it was maybe more mix in the core. Can you elaborate on that? Or is there…

Patrick O'Leary

If we have more wet cooling in the prior year and we have more dry cooling this year and so it really was mix and execution.

Jeff Sprague - Vertical Research

Do you have some good stuff in the backlog you acquired or is that business inherently more profitable than kind of the aggregate thermal business?

Patrick O'Leary

Not it is kind of around the average margin for the segment. It will affect perhaps quarterly comparisons because there is quite a swing between the quarters in the segment but it really wasn’t significant.

Operator

The next question comes from the line of Scott Davis – Morgan Stanley.

Scott Davis – Morgan Stanley

Excuse me if I didn’t hear this right but can you refresh my memory on this other expense, the $0.10 non-cash charge you talked about and what that actually is?

Patrick O'Leary

Basically a large amount of it is unwinding of previous hedge accounting with respect to the South African contracts. The requirements to maintain hedge accounting are quite onerous and so it really relates to that. $0.12 in the aggregate with some of it being allocated to the minority interest.

Scott Davis – Morgan Stanley

I guess my question is to clarify the accounting. I am sorry I don’t understand this but if you are hedging you actually have a cash loss and that is fine because it is a hedge right. Why would it be a non-cash charge?

Patrick O'Leary

Because the accumulated hedge accounting we had through the end of the year which is effectively suspended in the balance sheet in other comprehensive income actually simply unwinds from an accounting point of view. So it was previously a debit on the balance sheet and now it is just expense.

Scott Davis – Morgan Stanley

I should have paid attention in my college accounting classes. You didn’t spend a lot of time talking about Europe and it has been 20% or so of your total business and the rate of change over there over the last few weeks just looks pretty dismal. Is there anything your guys are telling you over there that could lead you to believe that some of these contracts can get pushed to the right or anything you might have in the hopper there for the rest of the year that is at risk?

Chris Kearney

Not especially. It is actually more than that. It is closer to 30% of our total revenue. It has generally been across all of our businesses fairly depressed over the last year and a half or two years. So nothing significant has changed. With respect to those risks we see in the market those are taken into consideration with respect to the guidance we put out.

Ryan Taylor

That is our last question for today. I will be available in the office today if you have any follow-up questions. We thank you for joining us. This concludes our Q1 earnings call.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Thank you and have a nice day.

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