Eaton Corporation plc
Q3 2009 Earnings Call Transcript

Published: 22 Oct 2009

[Operator:]

Good day, ladies and gentlemen and welcome to the third quarter 2009 Cooper Industries Plc earnings conference call. My name is Louisa and I’ll be your operator for today. At this time all participants are in listen only mode. We will conduct and question and answer session towards the end of this conference. (Operator’s Instructions) I’ll now like to turn the call over to Mr. Mark Doheny, Director of Investor Relations, please proceed, sir.

[Mark Doheny:]

Thank you, Louisa. Welcome to the Cooper Industries third quarter 2009 earnings conference call. With me today is Kirk Hachigian, Chairman and Chief Executive Officer, and Terry Klebe, Senior Vice President and Chief Financial Officer. We have posted our presentation on our website that we will refer to throughout this call. If you would like to view this presentation, please go to the investor center section of our website, www.cooperindustries.com and click on the hyperlink for management presentations. As a reminder, comments made during this call may include forward-looking statements under the private securities litigation reform act of 1995. These statements are subject to various risks and uncertainties, many of which are outside the control of the company and therefore actual results may differ materially from those anticipated by Cooper. A discussion of these factors maybe found in the company’s annual report on Form 10-K and other recent SEC filings. In additional, comments made here may include non-GAAP financial measures. To the extent that they have been anticipated reconciliations of those measures to the mostly directly comparable GAAP measures are included in the press release and the web presentation. Now, let me turn the call over to Kirk.

[Kirk S. Hachigian:]

Thank you, Mark. Good morning. I think 2009 is shaping up to be a year where Cooper Industries is going to redefine itself. As we deliver top core tile results from 2003-2008, with our core growth rate averaging 6% and our overall growth at 10%, we also leveraged earnings per share growth of 19% over that same five year period. However many investors still questioned how our portfolio business processes and leadership team would respond in a down cycle. And while nobody enjoys the operating environment over the last 12 months, our teams have done exceptional job positioning the company for slower economic growth while still delivering strong financial returns to our shareholders. From here while it may take some time, we believe our global end markets will recover, our margins will improve and our cash generation ability will remain strong leaving us many exciting opportunities to invest in our future. I want to thank our 28,000 employees worldwide for their dedication and hard work. If you turn to page 2 of our handout, let us provide you with some of the details on exactly how we’ve repositioned the company over the last year. During the third quarter our revenues were down 26% with our core down 24%. Electrical products revenue was down 25% with the core down 23%, but showing some signs of flattening out sequentially over the year. Tool sales were down 31 in the quarter with a core down 28, with again, continuing modest sequential order improvement over the course of the year. We have solid execution on resizing our cost structure, our headcount, SG&A, and cost to goods sold were all down nearly 20% over the prior year. Our operating margins improved 160 basis points from the second quarter after restructuring – excluding restructuring. And our overall deleverage was 21% on revenue decline of 26%. A very solid performance. Electrical products operating margins were very strong at 15.1%, up 150 basis points from the second quarter. And tools margins came in at 4.9%, up 280 basis points from the second quarter. We had a record year-to-date cash flow, $569 million or 14.9% of sales year-to-date and 180% of conversion to net year-to-date. Our inventories were down $213 million or 30% year-over-year and our receivables down 27%. An outstanding job by the entire team and we’re on track to deliver now our ninth year of free cash flow greater than net from continuing operations. Great execution and continued sequential improvement in a very difficult environment. If you turn to page 3, I’ll make a few comments on our end markets. Industrial, our biggest end market at 40% of sales were negatively impacted, by lower capacity utilization. August was about 67.5%, reduced capital spending and reduced industrial production. We are however, seeing improved order trends in MRO and global orders in oil, gas, refining and petrochemical activity. Commercial construction are 25% of our sales last years. We continue to see a steep falloff in new construction activity and delays on new projects. Overseas activity, energy efficiency programs, stimulus spending are all helping offset some of that weakness. However, we still expect to see commercial construction decline over the next 12 months. Utility markets are 21% of our sales last year are stabilizing, albeit at low activity levels. Transformers, switch gear and hardware are stable while capacitors and smart –good solutions perform well with double digit growth in the quarter. International markets continue to improve. And lastly, retail or residential are 9% of our sales continues to show modest improvement being down only mid teens in the quarter. And there are signs that overall retail sales are stabilizing and housing starts will begin to recover in 2010 from very depressed levels. If you turn to page 4 of the handout, electrical products results, which represent 90% of our sales. We saw continued trends from the second quarter. North American Electrical is still weak with modesty stocking. Retail sales, again, continue to be down only mid teens. And again, are expected to improve in 2010. International, excluding foreign exchange, was also down mid teens. But again, also appears to be improving. And we’re still seeing strong activity around energy efficiency products, alternative energy, wind and solar, and increased stimulus spending, which will impact 2010. Our book to bill for electrical in the quarter was right at 1. And lastly, despite the steep drop over in volume over the prior year, electrical revenues now have essentially been flat for three quarters and our margins have improved dramatically sequentially exceeding 15% in the quarter with exceptional cash flow. If you turn to page 5 of the handout now, for the tools group. We continually see negative impact by the sluggish automotive, depressed aviation, and low industrial production. Despite these tough conditions we continue to improve our cost positions and generate strong cash flow. We also seek sequential order growth and what appears to be the worst of the downturn behind us. Our book to bill in the quarter was slightly better than one and our margins continue to improve sequentially with the third quarter reaching nearly 5%. Now, let me turn the call over to Terry to provide you some additional details on the quarter, update you on our full year and make a few comments on 2010. Terry?

[Terry A. Klebe:]

Thanks, Kirk. Well, the economic recovery is spotty around the globe. At this point the positives are beginning to outweigh the negatives. We believe that the actions we took starting one year ago has positioned us very well for the future. One year ago we communicated that we would rapidly adjust our business to current economic realities and sacrifice earnings in the process. Our results reflected these actions in the first six months of the year. And while we continue to aggressively manage our business for current market conditions and efficiencies, our business has turned the corner in the third quarter and delivered strong incremental results. In Cooper’s over 175 years of history the company has never previously adjusted this rapidly, especially in environment with unprecedented market collapse. As we begin recovering I believe we’ll demonstrate that the changes we’ve implemented over the last seven years in the way the company’s managed, the investments we have made in our enterprise business systems which provide real-time information analytics to help us proactively manage the business, investments and new platforms and the execution of our strategic initiatives will allow us to deliver superior returns to our shareholders. I’ll cover the highlights of third quarter in a few minutes. But first some highlights in our free cash flow and balance sheet. On Slide 6 as Kirk noted, we have record free cash flow. In the third quarter free cash flow was $248 million compared to $265 million in third quarter of 2008, a 205% convergent of net income to free cash flow. Our free cash flow in the first nine months of 2009 was $569 million 183% convergent of net income, which is a record for the first nine months of the year. Our balance sheet remains in great shape with net debt to total capitalization at 16% at September 30th, compared to 26.8% on December 31, 2008. Turning to Slide 7, our net debt at September 30th was $547 million compared to $952 million at December 31, 2008. As you can see in Slide 7, at September 30th we had no commercial paper outstanding and with $658 million at cash on the balance sheet we have tremendous liquidity. In November 2009, we have $275 in notes maturing, which will be paid off. However, with 10 year borrowing below 5% at some point over the next 12 months we may issue new debt to replace the maturing notes. During the third quarter we established a new credit facility to replace the facility that matured in November. Due to significant increase in the cost of a credit facility, we established a three year, $350 million facility to replace the maturing $500 million facility. In this current economic environment we are very pleased with having our debts capital structure in great shape and we are well positioned to utilize our balance sheet as a strategic asset to acquire businesses and to return capital to our shareholders. Turning to Slide 8, our operations had another outstanding quarter executing on working capital. We reduced the inventory a further $5 million from June 30th. Our inventory was $503 million at September 30th compared to $716 million a year ago, a 30% decrease, and an outstanding performance by our operations team. Our inventory returns were 6.7 compared to 6.4 returns at the end of September 2008. For receivables, our days sales outstanding at September 30th decreased one day compared to the prior year and decreased three days from the second quarter. Receivables to client $322 million from September 30, 2008, a 27% decline. Similar to inventory an outstanding performance by our businesses at difficult credit environment. As with the prior quarter, you can tell from our results that we’re aggressively monitoring credit collections and continue to make progress on collecting receivables within the terms granted to our customers. Our payables declined $161 million or 27% from September 30, 2008 driven by the inventory reductions in our capturing discounts offered by suppliers. Overall, operating working capital turns increased 0.1% to 5.2 compared to 5.1 for the first nine months of 2008. From September 30, 2008 to September 30, 2009 our operating working capital declined 28% demonstrating our ability to quickly resize our balance sheet to the current market conditions. Our aggressive actions on right sizing our operating working capital eliminates the drag on income in the future periods. On Slide 9 our capital expenditures were $14.9 million in the third quarter 2009 compared to $37.6 million in the third quarter 2008. Year-to-date capital expenditures was $71 million compared to $96 million last year. Capital expenditures continue to be forecast at $100-$110 million for the year. We are in process of capitalizing on the weak commercial real estate market and are close on purchasing a couple of lease facilities which could increase our capital expenditures if these transactions are completed before year end. In the third quarter of 2009 with our Ireland reincorporation process we did not purchase shares. Year to date, we purchased 1.3 million shares of common stocks, spending $26 million against proceeds from issuant of 4.5 million for the 1.2 million shares we issued in the first nine months of 2009. Our outstanding average diluted shares for the third quarter decreased by 7.4 million shares from a year go, are 4.2%. Under existing board authorization we can purchase an additional 12.8 million shares. Our balance sheet’s in great shape and we consistently generate very strong cash flow. As a result, we have tremendous flexibility to fund organic and acquisition growth, pay a competitive dividend and purchase our common stock. Turning to the results for the third quarter in Slide 10. There are a couple of items that impacted our results in both third quarter of 2009 and the third quarter of 2008. In the third quarter we reported a pre-tax charge of 6.5 million or $0.03 per share in restructuring. We forecasted charge of $0.05 for the quarter, however, the announcement of a factory closing occurred after September 30th and therefore the charge will hit the fourth quarter versus the third quarter. Currently, a total of 10 factories and warehouses have been approved for closure with six of these substantially completed by the end of the third quarter. We expect to realize $24 million of benefits in the last three months of 2009 from the restructuring actions completed to date. We do anticipate incurring additional $0.03-$0.05 per share of charges in the fourth quarter. And for the year restructuring charges are forecast to be $0.16-$0.18 per share. We also recognized a discreet tax benefit in the third quarter of $1.2 million or $0.01 per share. In the prior year third quarter we recognized a discreet tax benefit of $18 million or $0.11 per share. Excluding the restructuring and discreet tax benefit in the third quarter of 2009 and 2008, we reported $0.70 per share compared to $0.97 per share in the third quarter of 2008, a decline of 28%. You will note that excluding the discreet tax benefit that our effective rate was 17.1% for the quarter compared to 18.9% for the first six months of 2009. We continue to realize new benefits and now expect the rate for the year to be around 18.2%. The lower tax rate added $0.01 per share in the third quarter. We also recognized $0.04 per share in discontinued operations gains related to insurance settlements that were not accrued. And the prior year quarter recognized a $0.09 per share gain from the accounting for the (inaudible) asbestos insurance and liability. Turning to Slide 11, unusual items for the first nine months of 2009. In the first nine months of 2009 for continuing operations we recognize $25.7 million of restructuring charges or $0.13 per share, and a discreet tax benefit of $0.06 per share. In the prior year first nine months we recognized $7.6 million or $0.03 per share in restructuring and discreet tax benefit of $0.13 per share. Excluding these items, the first three quarters of 2009 earnings per share was $1.76 compared to $2.75 in the prior year first nine months, a decline of 36%. Turning to Slide 12 on revenue and earnings per share. Today, we reported a revenue decline of 25.5% with electrical revenues declined 25% and tools revenues decline 31%. Currency translation reduced revenues 2% and acquisitions attribute a very nominal amount of revenue in the core. Looking at revenue from a product line perspective, what we’re seeing is a MRO type of product lines are continuing to build momentum from the depressed levels of revenue experience in the first half of 2009. And product lines that are longer cycle that saw revenues decline at a slower place in the first and second quarter are bottoming out in the second half of 2009. Core revenues declined 23.7% with electrical core revenues done 23.1% and tools, 27.8%. Inventory destocking by our customers and end users is moderating as the year progresses. More frequent smaller quantity of orders are also becoming the norm. Activity on projects that were delayed due to high commodity cost and credit conditions are also showing activity which could be beneficial as we move into next year. Continental Europe and developing markets, especially China are also showing some light. The US continues to be the weakest market with core revenues declining about the same as the second quarter at 26%. In total, international core revenues declined 19%, slightly higher than the second quarter decline offer some really tough comparables. What we consider developing countries reported core revenue down 22%, again off of tough prior year comparables. Our book to bill continues to be around 100% indicating that we have stability, albeit at a much lower revenue level. As I covered earlier we reported $0.70 in continued earnings per share exclusive of restructuring and the discreet tax benefit. We had excellent execution by our businesses in managing price, material economics and we realizing the benefits of the cost actions we’ve taken. In the third quarter the lower share count provided about $0.03 continuing earnings per share. Turning to Slide 13. Gross margins declined to 31.9% from 32.3% in last years third quarter, but improved a strong 160 basis points sequentially from the second quarter of 2009. Great execution on productivity. More normal volume and stabilizations from the rapid adjustment to factory production in continued execution on price versus material economics drove the sequential improvement from the second quarter of 2009. With inventory reductions of $45 million in the quarter we recognize some LIFO liquidations that offset the impact of the lower volume resulting from these inventory reductions. We manage and measure our businesses on price versus material economics. And while as expected price realization declined from the second quarter. It was more than offset by material cost declines. We expect this trend to continue in the fourth quarter and into 2010. There have been a lot of questions on the discipline, on price versus material economics and our ability to achieve price in the current depressed economic environment. While each product line or family has unique characteristics and dynamics that require a different strategy, it is in our DNA to effectively manage price and material economics. And we’ve been extremely successful at it going on six years now. Last quarter I made a comment that we expected price realizations to decline as the quarter has progressed, as certain mail costs flow through. If you recall in the first quarter we had approximately 2% price realization, second quarter 1% price realization. In the third quarter price realization was close to 0. Very, very close to our forecast and yet margins improve. Why? Let me give you an example. We have a business with very high steel content. And as you know, steel prices are down significantly from a year ago. This business had double digit negative price realization in the quarter, but actually improved earnings sequentially in the third quarter. My point is, that we have a very diverse portfolio. And while price realization is important, it alone does not drive profitability. If anything, at this point I have to say we are probably leaving some revenue and earnings on the table from being too aggressive at managing price versus material economics. At a normal practice, we hedge commodities through derivatives and supply agreement, with a rapid decline in the cost of copper and aluminum at the end of 2008, our mark to mark on these hedges were over 30 million negative at the end of the year. However, with the increase in copper price and the burn off of the hedges at the end of the third quarter we only have approximately 2 million of losses to absorb. So, in general administrative expense for the quarter is percent of sales was 19.5% compared to 17.8% in the prior year third quarter. And decline 10 basis points from the second quarter of 2009. SG&A declined $57 million year-over-year for the quarter. General corporate expense in the segment income statement decreased from $23.9 million, last years third quarter to $21.5 million. General core for other is above the 20 million per quarter in normal run rate. We expect primarily as a result of the legal and other costs incurred as a result of our reincorporation to Ireland, which cost us $0.01 per share in the quarter. I’ll point out that Cooper, like a number of companies, has aggressively taken actions to reduce our cost structure for current market conditions. However, we have not taken actions that impact our long term prospects or our ability to grow as markets recover. Our new product development, our sales organization, and our developing market investments remain intact. And unlike some companies, we have no issues with future comparability due to furloughs and eliminating employee retirement contributions, which would result in a significant incremental expanse when reinstated. While discretionary expending will increase as markets recover, the absence of temporary structural cost actions should allow us to leverage SG&A nicely as revenue growth returns. Turning to Slide 14, operating earnings declined 36% from the record quarterly operating earnings of the third quarter of 2008. On a sequential basis from the second quarter operating earnings increased 17%. A very nice improvement on a sequential revenue increase of 1.3%. Exclusive of restructuring our operating margin was 12.3% in the third quarter of 2009. A solid sequential improvement compared to the 10.7% in the second quarter of 2009. But declined 220 basis points from a year ago. Continuing to Slide 15. Our net interest expense decreased $1.4 million lower debt balances more than offset a slightly higher interest rate and lower interest earnings. Our effective income tax rate for the second quarter was 17.1% versus 26.5% for the third quarter of 2009. The decline in the effective rate is driven by the client earnings providing a tax benefit of 36% under the client earnings partially offset by realization of new benefits. In the third quarter as I mentioned earlier, we also have the impact of adjusted the first half 2009 effective tax rate. At the lower end of our guidance for the year we would expect to be around the 17 ¾% effective tax rate for the year and at the higher end of the guidance around 18 ¾% effective tax rate. We continue to implement tax strategies to reduce our effective tax rate and began realizing benefits faster than originally forecast which help reduce our third quarter and full year effective tax frame. Our third quarter continuing income excluding the restructuring discreet tax benefit decreased 31% on the 26% revenue decline. Turning to the segments in Slide 16. For the quarter, our electrical products segment revenue has declined 24.8% with a core revenue decline at 23.1%. Currency translation reduced revenues 1.8% and acquisitions contributed 0.1%. Price realization was approximately flat in the third quarter. From a year ago, demand for electrical products has weakened in all regions of the world. Developing markets held up better than developed economies but no region of the world has been immune to the decline in economic conditions we’ve experienced. Global electrical distribution sales declined approximately 23% from the third quarter of 2008 as end markets contracted. As I mentioned earlier, MRO is slowly picking up and later cycle product line stabilizing. The retail channel continued to be weak with revenues declining in the electrical segment mid teens from the third quarter of 2008. Utilities sales declined at close to the overall segment decline against the record prior year quarterly revenue. We have seen stabilization of orders and revenues in the replacement type of product like, but currently are not seeing utilities stepping up spending. However, the pricing environment has stabilized. On the utility side, the lack of pick up in activity from the low volume experienced in the first nine months is disappointing but at some point we should begin to see higher order rates as infrastructure requirements have not changed from the double digit revenue growth we were experienced prior to the US credit markets freezing up last year. In China, we continue to see orders and opportunities driven by the government’s stimulus. Overall, electrical product segment earnings decreased 31% and return on sales decreased 130 basis points to 15.1% from 16.4% in the third quarter of 2008. We deleveraged at 20%, a very solid performance in environment where revenues declined 25%. On Slide 17, our electrical product revenue increase 1.4% from the second quarter of 2009. Sequentially return on sales improved 150 basis points from the second quarter driven by realization of the cost actions we took in the fourth quarter of 2008 and first half of 2009. Solid performance on managing price and material economics and stabilization of our factory performance. If you look at the last economic downturn, electrical return on sales bottomed in 2002 at 12% on single digit declines in revenue. And it took four years to get back to 15%. This year we have electrical revenues declining in the first nine months 22% and have return on sales at 15.1% in the third quarter. This is with operating working capital down greater than the decline in sales. This will be another very positive signal to the market that Cooper is a different company than it was seven years ago and even with this unprecedented economic crisis demonstrates the benefits from the investments and changes that we have implemented over the last several years. Turning to the tools segment on Slide 18. In our tools business sales declined 31% from the third quarter of 2008, currency translation reducing revenues 3.2%. The hand tool side of this business has stabilized with retail sales declining 13% compared to the third quarter of 2008. And the industrial side of the business while depressed is slowly improving. Tools operated at $6.8 million in profits for the quarter, excluding restructuring. Compared to the $2.9 million in the second quarter. On Slide 19, tools sequential revenues were flat with the second quarter of 2009. And tools earnings continue to recover with a 4.9% return on sales in the third quarter compared to 2.1% in the second quarter. A 280 basis point improvement. Turing to Slide 20. With the third quarter continuing to be difficult in the revenue side, with revenues declining 26% we continue to aggressively manage our cost structure and operating working capital. The normalize for acquisitions in both periods and the consolidation of the joint venture the results demonstrate how quickly we write sides of business. From one year ago operating working capital is down 28%, inventory 30%, SG&A is down 19%, cost of sales 25% and our total head count 18% from one year ago. While we continue to take actions to reduce our cost structure, we’ve got a very solid foundation to capitalize on growth. Turning to Slide 21 on restructuring actions. Cumulative fourth quarter 2008 and first nine months 2009 restructuring totaled $61 million. In the first quarter of 2009 we recognized $13.6 million in benefits with $19.7 million recognized in the second quarter and $25.5 million recognized in the third quarter. We well recognize an additional $24 million in the fourth quarter. With actions complete to date we have approximately $13 in incremental benefits that’ll be recognized in 2010. Before turning the call back to Kirk, I’ll comment on our forecast. Turning to Slide 22. Before addressing our overall outlook for the fourth quarter of the year, some comments on what is built into our forecast. Across all of our markets we do experience seasonality with fourth quarter and first quarter revenues typically below the second and third quarter. We are anticipating weaker commercial construction activity as the year continues to progress, especially in the United States, offset somewhat by energy efficiency, retro fit and better performance on the international side. Pricing conditions well remain competitive and it will be challenging implementing price increased. Actions that we’ve taken to reduce leakage on discounts and authorized deductions will help. Overall however, we expect to have negative pricing in the fourth quarter primarily driven by the year-over-year decline in steel and certain metal prices. However, material economics well offset all of the year-over-year price decline in the fourth quarter and our price material economics will continue to be positive. Factory production absorption in the fourth quarter will not be significantly different than the third quarter with the exception that Cooper, like a number of companies, will take more extended factory shutdowns over the holiday periods in the fourth quarter which will impact absorption. And we will see a benefit, of course, from the restructuring benefits in the fourth quarter. The bottom line is that we expect the markets to continue to be challenging but expect to continue deliver strong earnings. Turning to Slide 23, our 2009 outlook. For the fourth quarter we’re forecasting revenues to decline 16-20%. The forecast includes a relatively small negative effect from currency translation and contributions from acquisitions. As I mentioned earlier, we anticipate additional $0.03-$0.05 per share of restructuring in the fourth quarter. And excluding this charge our forecasting earnings per share of $0.60-$0.70. The midpoint of the forecast assumes we’ll have weak December as customers delay shipments into 2010 to capitalize on 2010 growth incentives. This is very unpredictable and could result in a weak December shipments. For the year we’re forecasting $235-$245 exclusive of unusual item, narrowing our range by $0.05 on the low end and $0.05 on the top end. We’re forecasting revenues to decline 20%-23% for the year. And as I’ve said, restructuring charges of $0.16-$0.18. And with our record free cash flow in the first nine months of 2009 we expect free cash flow to exceed $650 million for the year. Turning to Slide 24 and our outlook for 2010. We will be conducting our annual business reviews over the next couple months and developing our detailed 2010 forecast. At a high level, Slide 24 provides what we are currently building into our forecast. We currently anticipate that our utility business and most of our businesses serving industrial and residential market to show growth for 2010. Albeit at what maybe a low single digit rate. It is likely that commercial markets will be very tough in 2010 and will decline around 10% net of energy efficiency revenue increased and better performance on the over 1/3 of the commercial revenues that are outside the United States. Developing markets should have reasonable growth and international developed markets are anticipated to grow. We’ve taken our lumps in 2009 on right sizing the business and adjusting to the economic crisis and have considerably more positives than negatives on earning lever for 2010. While commercial construction will be weak, this market segment has lower margins and more variable cost structure. Revenue growth in industrial and utility will leverage very nicely and could easily more than offset commercial earnings weakness. Price material economics will be challenging, but manageable. And with absence of the hedge material cost absorbed in 2009, at this point we believe in a worse case basis a small net positive for 2010 overall. And of course, factory absorption will be a positive, especially in the first half of the year comparable. And as I know, the question will be raised, pension expense at this point is somewhat of a wild card as the expense is driven by year end discount rates at asset market values. Our major plans are frozen and well funded at this point. And we may make some additional contributions which should contain the impact on 2010. Restructuring benefits, as I said, are at this point are $13 million and lower interest expense will add to earnings. Our tax rate will increase as earnings grow at approximately 36% rate on the incremental earnings grow. While we’re not prepared to vie in earnings per share forecast for 2010 until our February 2010 outlook meeting, our expectation is for earnings per share to grow if not double digits, at a minimum close to double digits exclusive of a restructuring an unusual items. Now I’ll turn the call back to Kirk for a wrap up. Kirk?

[Kirk S. Hachigian:]

Great. Thank you, Terry. In summary, we have aggressively restructured our cost positions and our balance sheet to respond to the global economic crisis. As Terry mentioned our electrical margins bottomed in the first quarter at 12.4% and have already recovered to north of 15%. A feat that took us nearly four years during the last downturn. We continue to fund key strategic growth initiatives. Our new product vitality index is robust. We just returned from a week in the Middle East and a week in Asia in the last quarter and continue to see incredible opportunities for us to continue to grow. And we continue to hire and develop leadership talent within the organization. We’re focused on returns to the shareholders providing guidance. Continuing to pay a competitive dividend and now (inaudible) with our repurchases of our stock are at average prices below today’s market price. We strengthen our balance sheet over the cycle, reduced inventory receivables in debt and we have the strongest balance sheet in over 20 years with our debt to total cap at 16%, down nearly at half from the first quarter of 2008. And of course now moving forward we have a heavy emphasis on growth and continuing to invest in the front of our business. Over the last three quarters we’ve been internally focused and now it’s time to get back out and play some offense. We have the right portfolio, big global diverse end markets. We have the right strategy focusing on our five initiatives that deliver results. And we have the right leadership team in place to deliver strong operating results for our shareholders. With that conclusion I’ll turn it back over to Mark to take your questions.

[Mark Doheny:]

Thanks, Kirk. At this point we would like to open up the call for questions. Louisa, first question, please.

[Operator:]

(Operator's Instructions) And your first question comes from the line of Jeff Sprague with Citi Investment Research.

[Jeff Sprague:]

Thank you. Good morning in Houston and everywhere else. Hey, Kirk, maybe a little bit on growth. So if you're going to go to cost related defense to kind of growth related offense, where do you actually see the opportunities and maybe split them between organic growth — you talked about investing in your front end versus M&A? You and everybody has been a little bit of an M&A holiday here for the last year and a half. Do you see anything opening up there?

[Kirk S. Hachigian:]

Good question. So let me talk about organic because that's what we focused on first. I think Terry made the comment, we really have not cut sales, engineering, product management, and tried to sustain the core growth capability. If you went back and looked at the five year up-cycle, Jeff, we had 6% core and I think that's really sort of the best in class of an industrial company out there and so we think we can kind of get back on that. It has to do with Smart Grid, it has to do with LED technology, it has to do with lighting controls, it has to do with solar and wind and getting into some of these markets that are seeing growth. I think the MRO business comes back. I think our electronics business out at Bussmann is going to see good growth going forward, and I think the international, Jeff, while we're doing a better job and we've gone from a $1.2 billion to $2.4 billion last year internationally, boy I got to tell you, the Middle East we just opened that new plant, Korea the EPCs, China — just tremendous opportunities. We're still 10 years behind some of the big Europeans and stuff that's been out there for 30 or 40 years now. So we can do a much better job on all that. The acquisition side, you're right we've been taking a little time off, not on purpose because we just couldn't get a line on valuations, but we still have a good deck of projects that we're looking at. The question gets back to valuation on these things and as we have in the past we've never let the money burn a hole in our pocket, but we think there's some great opportunity of course given our balance sheet now with a debt to total capital at 16% to do some damage there too.

[Jeff Sprague:]

And justo n this MRO point, do you think you're seeing a genuine pickup in MRO or is it just an end of destocking or maybe a little bit of restocking? Is true activity level picking up.

[Terry A. Klebe:]

Jeff, I'd say that on some customers we have point of sale information and it's normalized so you're really getting the end user demand. I'd say we haven't seen any restocking in the channel at all.

[Jeff Sprague:]

Okay. So your comment that it's getting better is just a little pull-through on growth?

[Kirk S. Hachigian:]

Yes. And that's where you'd normally see the improvement in the earliest part is the MRO.

[Jeff Sprague:]

And, Kirk, just on margins you said margins go up from here. Do we build on this Q3 number in Q4 or you're talking more year over year changes now on margins?

[Kirk S. Hachigian:]

No, more year over year changes. The fourth quarter, as Terry said, sequentially will be down because of just the topline and some other absorption issues, but I think, Jeff, when you look at the whole piece of it and you look at incremental leverage from here, you ought to be thinking about 30%. And so I think again, the point we keep making is well, it took us a couple of quarters this time to resize ourselves and this was the point I was making at EPG, how do you go from $6.5 billion to $5 billion and get your margins back in line? Well, I think we're ahead of where we thought we would be both on the balance sheet and particularly on the electrical margins. So I think Terry's giving your outlook for 2010, but yeah, you ought to assume that margins go up because the first three quarters of '09 obviously were a little bit weaker, but getting to this 15+% on this kind of volume for us in that short of a period is pretty good. We feel pretty good about that.

[Terry A. Klebe:]

Yeah. Jeff, I'd say as we move into the fourth quarter, if we get a little bit of sequential revenue increase, the margins will go up. The concern we have is that we have incentives across especially the distribution channel so we will likely see some deferral of revenue into 2010 because of clearly the incentives on the growth side which will not be achieved in 2009. So we have that risk. And then the other piece of it is us, like a lot of companies because volumes are relatively low, over the holiday periods we'll have factory shutdown much longer than normal during that period. So we could see a small decrement in margins in the fourth quarter or on the other side if sequential revenues pick up we would expect to see the continual increase.

[Jeff Sprague:]

One other nuance on Q4, do you guys have fewer days? That's kind of going around a lot out there for Q4.

[Terry A. Klebe:]

Yes. There's fewer days, and the way the holidays fall this year it's not as conducive to it, but we don't let people use that as an excuse internally.

[Jeff Sprague:]

Great, thank you.

[Operator:]

Your next question comes from the line of Robert Cornell with Barclays Capital.

[Robert Cornell:]

Yeah. You guys fired in that comment very late that you thought 2010 could be up double digits or close to double digits. I mean, I guess first of all when you ran down the business review (inaudible), I mean does that summary result in organic growth for next year or not? Let's just start there.

[Kirk S. Hachigian:]

Well, our base model at this point, and like I said we have not gone back through and had all the business reviews at this point, but we are looking at flattish top line, potentially up a little bit, but I'd say the middle of our range toward the bottom of the range will have flat revenue.

[Robert Cornell:]

Just again, I want to get to the double-digit earnings comment in a minute, but — and if you can't answer this I apologize, but when do you think you might see a quarter with positive organic growth? Is it the first quarter, second quarter?

[Kirk S. Hachigian:]

You get up against some pretty ugly comps very quickly so I think if you think about the first quarter, Bob, I mean I'd be helpful we'd have a better look at it as we exit the fourth quarter, but I'm hopeful by that first or second quarter, sure. I mean, not huge, but you'd begin to see at least things flatten out so you'd have zero year over year or modest sequential growth, sure.

[Terry A. Klebe:]

Yeah. Bob, I would say it'll be in second quarter, maybe worst case into the third.

[Robert Cornell:]

My model shows first quarter. Anyways, how do you get to this double-digit or close to double-digit earnings growth comment you just made?

[Terry A. Klebe:]

When you look at what we did in the first half of the year where we took production down so hard across our businesses and disrupted the factories, we have significantly less disruption on the absorption issue and as we roll into 2010. And the price material economics, we had a very big hit on hedged materials as we rolled into 2009.

[Robert Cornell:]

What quarter was that, Terry?

[Terry A. Klebe:]

It really hit first and second the hardest. Third quarter we had $3 million or so of hit, fourth quarter would be a million or so probably. So we have that piece of it. So as long as we can continue to do what we've been very successful at doing which is managing the price material economics, that will be a nice plus as we roll into 2010. And then of course our interest expense will be down. We're paying off $275 million of debt 1st of November here so that's some big positives.

[Robert Cornell:]

Yeah. Could you just go back into managing the price cost? I think the price, you did say two, one, zero, and all that stuff, but it seems like yourselves and other companies are managing the price versus material issue better than some might have thought and of course now commodities are starting to come up. I mean how comfortable are you that you have the deal with price cost if materials come back up? And I think you said one business you were getting a double-digit price compression because of customers looking over your shoulder so when you look at it in 2010 I mean, how do you see managing that process?

[Terry A. Klebe:]

Same as we always have. I mean, it's not going to be the carte blanche across the portfolio price increases, but there are opportunities to continue to selectively raise prices. We've done that this year which has surprised some people on it so it'll be tougher if we don’t have the volume, but we can do it. We've done it before.

[Kirk S. Hachigian:]

And I think there's some new tools, Bob, we're using on the pricing side with C&D items and some better matrix pricing. So I think we have a better handle around some of these new tools and some of the leakage that we've had historically that we should be able to prevent going forward as well.

[Robert Cornell:]

Well yeah, and just in that respect, I mean in the last cycle the lighting business was probably called out as being the least disciplined on the pricing side, no laughing please. I mean what do you see going on there now?

[Terry A. Klebe:]

Well, on the lighting side you’ve got a lot of new technology coming through and that's the nice piece about LEDs and such and we've got a more competitive footprint. So that business is actually a reasonably good year despite some tough top line. I think the outlook on that whole construction side could — I think maybe we're all being a little too negative there as well. I think the residential could come back a little bit and some of the government spending there could back and in international I think there will be more play for us on some of the mass notifications and some of their businesses that we sort of put in that commercial bucket. So we'll see. We'll budget for a little bit negative performance there, but I think we still got an upside on that side of it. And the price material equations and margins in lighting have held up very nicely actually.

[Robert Cornell:]

I'd say they've done a very good job at price material economics and projections into the future are very good for them.

[Terry A. Klebe:]

Yeah. And it's one of our best vitality businesses so a lot of new products coming out of there both on the controls and on some of this LED solid state side of the business as well — still seeing real good demand on the emergency efficiency side.

[Robert Cornell:]

Sounds good, guys. Thanks very much.

[Operator:]

Your next question comes from the line of Rich Wall (ph) with Wells Fargo.

[Rich Wall:]

Hi. Good afternoon or good morning where you are. Kirk, the comment regarding Europe, things stabilizing, things better than North America, could you provide some more color there? Because it seems like the sentiment has been a little more negative on the European side, at least expectations for 2010. Just wanted to get your thoughts there.

[Terry A. Klebe:]

I'll handle that. Really on continental Europe, UK is very difficult. I mean, their economy is as bad if not worse, than the US, but if you go onto the continent. Most of our revenues are derived in Germany and France and we have tremendous new products coming out in both of those countries both for local consumption as well as export. So our business in continental Europe has actually held up pretty well and actually looking out into 2010 it looks pretty good.

[Kirk S. Hachigian:]

Yeah. They’ve done a nice job on new products. We have all local teams out in those markets and they know the markets and they know the products very well.

[Robert Cornell:]

Okay. And then, Terry, for next year, are there any one time costs that are going to be reversed or cost actions that you took this year that get reversed next year? I think you mentioned something earlier in the call regarding some things on benefits and whatnot, but is there major stuff that gets reversed next year?

[Terry A. Klebe:]

No. I mean, we have not done any thing this year that's structural at one time in nature that comes roaring back in 2010 as it changes. As I said, we didn't do furloughs, we did not take down our benefit plans.

[Kirk S. Hachigian:]

I think the tax issue will be the only issue as we earn more —

[Terry A. Klebe:]

But that's normal. Our tax rate will go up because of our structure on the incremental earnings, but really it's really totally discretionary type spending which some of that will come back so we should leverage out extremely well if we can get a little bit of growth. And commercial businesses tend to be much more variable costs, much lower margins than our industrial businesses so we get a little growth on the industrial side and it'll leverage up much higher than the total company.

[Robert Cornell:]

Okay, great. And then in terms of raw materials, with steel moving up here — I know it's down pretty significantly on a year over year basis, but started to move up sequentially, how are you thinking about the trend in 2010 and then in terms of hedges and whatnot, it doesn't sound like you’re going to be hedging anything, but what's your strategy there preliminarily in terms of 2010?

[Terry A. Klebe:]

We've been a little cautious hedging too far out. On steel, typically we will lock in 30-60. Some of our businesses that do not "adjust to local markets" we'll go out a quarter or two. We do not have a lot of big hedges built in on the rest of the metal sides into 2010. But typically the big hit to us would be on the steel side and there, a lot of those products are bid and quote type activity and they adjust with the market as prices go up. So much more variable type of cost structure and flow-through.

[Robert Cornell:]

Okay. So if steel moves up from here, you don't feel necessarily that there's going to be a lot of pressure on the business or at least relative to where your expectations are right now?

[Terry A. Klebe:]

No. If steel prices or any other commodities go up 50% in a very short period of time we could be squeezed for 2-3 months.

[Robert Cornell:]

Right. Okay, great. Thanks so much.

[Operator:]

Your next question comes from the line of Christopher Glynn with Oppenheimer. Please proceed.

[Christopher Glynn:]

Thanks. A little on the tools business and maybe a little more impacted by the under absorption, inventory liquidation, things like that with the smaller size of it, but when you're thinking about a breakeven point there, what's the opportunity with a little bit of volume? Any cost allocation things there between electrical and tools?

[Terry A. Klebe:]

No. I mean, the tools business has really kind of gotten it from all sides; the automotive side, the truck builds' side, the aerospace side, the factory utilization, both domestic and globally. We have been seeing the revenue line pickup sequentially on the order side of the business and so that bodes well for getting back to some decent kinds of margins. If you look at the cost structure of the business, it has also done a nice job on the SG&A, on the headcount, and some of those other areas. I still think that we've got room on the balance sheet. On the working capital it's got some opportunity there, and it generally has a larger footprint because it's more global and so we've been working on that with some restructuring in that business. But you've seen that business kind of go up and down before. We've never seen a topline take the kind of hit it's taken, but I think as you see the business conditions come back and again we're already seeing the order rates sequentially improve, you'll see the margins pick up with that business as well.

[Christopher Glynn:]

Okay. And then on the electrical side, if we just take the quarterly rate above 15% and forgetting about mix, price, cost, the hedge positions, is that kind of the baseline to think about for flattish revenues for next year and then the leverage is off of that 15?

[Kirk S. Hachigian:]

Well, you could use 15 as a base, but the expectation — and like I said, we have not done our detailed rollups, but my expectation would be to continue to see improvement through 2010.

[Terry A. Klebe:]

I mean, I guess, Chris, the way to think about it is the incremental leverage is going to be huge and so that's going to help you a lot on the margin percentages as you sort of roll through the year if you get any incremental volume.

[Christopher Glynn:]

Sounds good. And then lastly, the cash flow — you've done tremendous work on the working capital this year. It's going to be a little bit of an odd comparison with the working capital position on the balance sheet next year. For cash flow would we kind of expect that?

[Terry A. Klebe:]

We still think we'll be north of one on a conversion. We're not ready to give up on 10 now. Now with that said, if we have some really nice organic growth, of we're going to build back the balance sheet. But I think on the leverage side, if you think about $100 million of sales, you put $30 million to the bottom line and if we can hold our working capital to sort of 20% on inventory receivables and such, it'll still work out pretty well. We're still hopeful that we can be north of one next year on the conversion.

[Christopher Glynn:]

I believe you. Thanks.

[Operator:]

Your next question comes from the line of Scott Davis with Morgan Stanley.

[Scott Davis:]

Hi, guys. A couple of kind of small cleanup items here. I mean first, Terry, you talked about pension. I know you guys froze your plan quite some time ago. I mean, can you help us understand kind of the fenced in range? Are we talking about a nickel here and there, are we talking about something a little bit greater?

[Terry A. Klebe:]

My expectation based on where we're at today on fair market value of assets and discount rate would be we're talking $0.01 or $0.02 either direction.

[Scott Davis:]

Okay. So not really a big move. And then talk a little bit about FX. I mean, you do sell a fair amount into Europe and the weak dollar is going to help, but I’ve just noticed that you did swap some US dollar debt into European debt. I mean, talk about how that kind of changes your net exposure there.

[Terry A. Klebe:]

Well, on the debt side of it essentially historically we've always carried debt in Europe. Because of the cost of issuing debt, what we did was we issued debt in the US. This was two plus years ago, and then converted it into euro debt. So that's been in place for several years and it really doesn't impact the P&L side of it. What it did for us was lower the effective rate to 3.5% on the coupling on the debt which is 5.75 or something. So that really has no impact going forward and I think that matures in 2012. From the currency side of it, actually the weak dollar and the stronger euro and pound help our European businesses because they source a fair amount out of China which is pegged to the US dollar so it ends up being a plus on the material economic side of it. And so if we can go next year with flat to plus on the currency, that's a nice pickup on two fronts; on is just translation and the other is where we source from.

[Scott Davis:]

Right. Okay, great. And just to followup a little bit on some of the previous questions. I mean, we talk about 30% incrementals. Obviously if you've got rising material costs and some of your competitors are talking about price starting to leak a bit how conservative have you been or how have you thought about that kind of an incremental margin into some uncertainty that's out there?

[Terry A. Klebe:]

If you go back, Scott, historically, you go back to the '03, '04, '05, I think that's where we get our confidence from. We've been through this before and there have been people who didn't think we could kind of hold it. I mean, you look at our businesses. In Bussmann you got 35,000 different skews. You look at the vitality of the product line, new products — I don't think people give the portfolio enough credit for our ability to be able to go out and get price. We've got brands with market leadership so we've been through this before and I'm not concerned about it. I think that we'll go out and do what we need to do on the right items and price ourselves through it if that's what we need to do. We also can drive productivity back through our businesses again as volume comes back into our businesses and so if you went back and you looked at our incremental leverage, back in the '04, '05, '06 periods, we've done those kinds of numbers before. And especially in a cost structure that we've got and a balance sheet that we've got today with our inventory where it is, I think you're going to be very pleasantly surprised on how it runs through the business.

[Scott Davis:]

Okay. Encouraging, thanks, guys.

[Operator:]

Your next question comes from the line of Deane Dray with FBR Capital Markets.

[Deane Dray:]

Thank you. Good day, everybody. With regard to the utility outlook, I know you may want to defer some of this to the February meeting, but what's baked into your assumptions there regarding the drivers of growth and the utilities for next year? Is it the smart grid demand management products, what about some of the transmission-transformer outlook?

[Terry A. Klebe:]

Yeah. Well, obviously on the reliability products which would be capacitors and Smart Grid and some of that sort of stuff, we've been growing nicely this year. The international piece, South America, Mexico, Asia, are continuing to come up and grow so I would expect those to continue to grow and then the US was taken down so hard at the utilities that by and large you'd expect them to see at least flat to some increase back in getting back to sort of more normal order patterns in 2010. So I think it's like everything else, the worst is behind you and the question is what's the steepness of the curve as you come out of this? But I think what Terry was talking is our expectations are very modest improvements next and we'll be hopefully pleasantly surprised as the year progresses.

[Deane Dray:]

Got it. And then I'm not sure I followed when Terry — maybe they weren't connected, but he said no buy backs in the quarter, and then was that related to the move to Ireland? I might have missed that.

[Terry A. Klebe:]

Yeah. During that period we were blocked out for part of it and then of course because of the Irish reincorporation we have to go through some regulatory hurdles which essentially are done this week so we're pretty much open after this week to do whatever we want.

[Deane Dray:]

Are there any other regulatory approval hurdles in the move to Ireland?

[Terry A. Klebe:]

No.

[Deane Dray:]

So you're done?

[Terry A. Klebe:]

Yes.

[Deane Dray:]

I just don't hear an accent yet (laughter).

[Terry A. Klebe:]

Drink enough beer over there I can tell you (laughter).

[Deane Dray:]

Great. Thank you.

[Operator:]

With no further questions in the queue, I would like to turn the call back over to Mark Doheny for closing remarks.

[Mark Doheny:]

Thank you. And with that, thanks for joining us today. Please feel free to contact me with any followup questions you may have.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a great day.