Eaton Corporation plc
Q1 2011 Earnings Call Transcript

Published: 29 Jun 2011

[Donald Bullock:]

Conference Call. Joining me this morning are Sandy Cutler, Chairman and CEO; and Rick Fearon, Vice Chairman and CFO. As has been our practice, we will begin today's call with comments from Sandy, followed by a question-and-answer session. The information provided on our conference call today will include forward-looking statements concerning the second quarter 2011 and full year 2011 net income per share and operating earnings per share, second quarter and full year 2011 revenues, our worldwide markets, our growth in relation to end markets and our growth from acquisitions. Those statements should be used with caution and are subject to various risks and uncertainties, many of which are outside the company's control. Factors that could cause actual results to differ materially from those in the forward-looking statements are set forth in today's press release and related Form 8-K filing. As a reminder, we've included a presentation on the first quarter results, which can be accessed on the Investor Relations webpage. Additional financial information is available in today's press release which is located at Eaton's homepage at www.eaton.com. I'll turn it over to Sandy.

[Alexander Cutler:]

Great. Thanks, Don, and let me add my welcome to all of you for joining us this morning. I'm going to work from the set of exhibits that Don referenced and so if you'll move to Page 3, it's entitled Highlights of First Quarter Results. We're really pleased to have a strong start to what we continue to believe is going to be a record year in both sales and profits in Eaton's 100th anniversary year and so just highlighting what's on this chart, operating earnings per share obviously at $0.84 here in the quarter. That was $0.04 above the increased guidance that we provided at our February Analyst Meeting on February 25 and obviously $0.09 above the preliminary guidance we provided in our January conference call, so very pleased getting off to a strong start. Net income per share of $0.83, up 80% from a year ago. Sales, up some 23% at $3.8 billion, confirmation of the continued strong momentum in our business and really the advantages of the broad diversification we have across many markets. End markets were up some 14%, a little bit stronger than we had originally anticipated, so again, we think still building momentum in our markets. And 26% of the sales significantly came from developing countries, obviously where the fastest growth is currently. If we turn to Page 4, just a quick analysis of our results versus the guidance we provided at the end of February. The midpoint of our guidance for operating earnings per share was $0.80; the higher markets than we expected in the first quarter, obviously good news, contributed about $0.03; higher other income than a year ago, still within the half of 1% band that we provided in terms of the guidance for this category but it was higher than the year ago by about $0.02; then a higher tax rate than we had anticipated here in the first quarter, a negative $0.01, and that's what leads to the $0.84 of operating earnings per share, up 85% since a year ago. As I mentioned, that's a 5% improvement over our prior guidance, and it's actually a 12% improvement over the midpoint of $0.75 that we had originally provided in our January guidance for the first quarter. So all in all, a very strong start to what we believe is going to be a record year. If we turn to Page 5, titled Financial Summary, just a couple of items to draw your attention to. And if you've read the press release and earnings release, you've seen most of these numbers already. Let me just start on the green box that's on the lower left-hand column, up 14% market growth over a year ago; outgrowth of five points, a real confirmation that the products and the services we're offering are garnering increased share and helping us enter new territories. And then if you drop to the bottom of that green box, second line from the bottom, ForEx, a 2-point impact. And you recall coming into this year, we thought the likely impact of ForEx would be neutral. You'll see when we talk a little bit about guidance, we now think that there'll be several hundred million dollars of increased revenue from ForEx, about a 2% contribution here in the first quarter, coming primarily from changes in the relative value of the euro and the Brazilian real. Now if you pop back up to the column that is titled First Quarter 2011, segment operating margin of 13%. That is consistent with the guidance we provided for this year, where we talked about, during the first half, we expected about $50 million of uncovered commodity costs. We said that would be likely to be split pretty equally between the first and second quarter, and we did incur about $25 million or about half of what we had said, and that's the primary reason that that margin is a little lower than some of you had estimated but it was consistent with our guidance. If we move to the next page and just quickly take you through our individual operating segments, our Electrical Americas segment, a very strong quarter, met our margin expectations, beat what we would have thought would have been volume and what is always the seasonally weak first quarter. You'll note that volume is down from the fourth quarter about 4%. That's pretty much in line what generally happens fourth quarter to first quarter. Remember, there's a large construction-related portion of this business and then also the single-phased power quality market always is one that starts a little bit more slowly early in the year and builds in the second, third and fourth quarter. Very pleased with the 14% margin, really delighted when you look at the market growth, some 14%. We're continuing to outgrow. Our bookings were up again, a very solid 21%. And I'd be glad to talk more about the individual market segments that are contributing to that. Strong industrial markets, I think you're hearing that not only from us but from others that that activity is quite strong in the Americas. And we are revising our full year market growth for this segment from 6% up to 7%, really due to two primary drivers

[Donald Bullock:]

Our first question comes from Rob Wertheimer. [Morgan Stanley]

[Robert Wertheimer:]

Just a couple of questions. On the issues from the tragedy in Japan, have you heard any OEM shutdowns outside of auto? And if you can, can you mention how many days and such in auto and another?

[Alexander Cutler:]

Not really. What we've heard primarily, Rob, is the kind of rolling announcements that you're seeing here in terms of impact led most strongly by the Japanese OEMs in automotive. We have said in other forums that we think there obviously will be some of these interruptions in the automotive scene and the other place that you will see some impact of components and the electronic components which are used across a lot of different industries. That impact is in our guidance.

[Robert Wertheimer:]

Do you have a sense of -- I mean, do you feel like it's been figured out at this point, or is it going to take another two or three quarters to fully understand the flow? In other words, are you seeing new problems pop up faster than the ones you can figure out?

[Alexander Cutler:]

Yes, we're not seeing new problems popping up, but I think you're seeing just by the amount of speculation on this subject and the kind of changes in day-to-day information or speculation that it's probably going to be a couple of months before this can be fully sorted out.

[Robert Wertheimer:]

Okay. And then just a quick follow-up on price costs, you have the numbers in your bridge. Is that mostly a 1Q and 2Q hit and you fully recouped it by the end of 2Q? Can you give a sense of timing on how fast you've been able to respond to the increased commodities?

[Alexander Cutler:]

Yes, and what we have said, Rob, going back to our February, both our January and our February conference calls, remains our same guidance today is that normally, we would expect to not have a margin pressure from the net of cost reductions, alternative material substitution and as well as price increases. And what we saw in December was things moved so quickly that we have this $50 million bubble developed that we thought we would see entirely in the first and second quarters. And so we're still confident of that. That's still our game plan, and the first quarter pretty well laid out, pretty well occurred the way we thought it would.

[Robert Wertheimer:]

Now that's perfect. I'll let somebody else take it over. Thank you.

[Donald Bullock:]

Our next question comes from Jamie Cook. [Crédit Suisse]

[Jamie Cook:]

Two questions. One, Sandy just on your top line growth assumptions, I think the first quarter, your organic growth came in at 19% and we're only assuming about 10% growth for the year. So I'm just trying to understand the disconnect especially with what we've seen on the order rate for some of your businesses. It seems a little conservative. I wonder if it's just supply constraint? And then the second question, just on to follow up on Rob's questions, Rob's question with incremental margins. I mean, should incremental margins in the second quarter be more comparable to Q1, maybe a slight improvement and then they ramp more in the back half of the year to get to the 33%? I just want to make sure I understand that.

[Alexander Cutler:]

Okay. On the first point, remember, our 10% that we're talking about is for the market. So on top of that, we're talking about the additional growth we get through outgrowth, acquisitions and ForEx. So the total is that we think full year is the 16% number, and we've started the year with a 23% in the first quarter. Obviously, the comparables, as we go through the year, we're building off of bigger quarters in the second half of last year. I think where a number of people have asked understandable questions is in Hydraulics where we're booking numbers that are significantly higher than the individual -- than our market forecast for the year. You saw, if you take a look just at the Hydraulics sheet on Page 8, we just went over, that while the market grew at 27%, our organic growth was 35%. So we are outgrowing there, and our bookings were actually 39%. So there's not that much of a disconnect between those two. But we are seeing some OEMs put in longer-term orders as well, and so that's a piece of this as well.

[Jamie Cook:]

But just to be clear, there's no, in your guidance, there's no degree of conservatism related to supply chain issues or that you're capacity constrained in any of your businesses? Again, that's what I'm trying to understand.

[Alexander Cutler:]

No. We think that all of that, that cumulative, just what you talked about, is in our guidance in that regard. Obviously, whenever a market starts to ramp up, there are always bumps but I wouldn't say that they're disproportioned with what we've experienced before. On your margin question, our 33% margin guidance was 33% minus $50 million, you remember. So that the impact that that has here in these first 2 quarters right off the bat is on the order of 4 to 5 points that you get just from that impact. Once we get past this first half, yes, we would expect to get back to the 33%.

[Jamie Cook:]

Thanks, I'll get back in queue.

[Donald Bullock:]

Our next question comes from Steve Volkmann. [Jefferies & Company]

[Stephen Volkmann:]

Sandy, I was hoping to take you up on your offer to provide us a little more color on what's driving the order book in Electrical Americas and in Hydraulics?

[Alexander Cutler:]

Okay, great. If you get into Electrical Americas, there are obviously a lot of different pieces in the business, and I'll just try to highlight a couple of them for you. When you go through the individual market segments, oil and petrochem is back, and we're seeing orders both in the upstream and downstream side of the business. The stimulus and public funding side is at a slower pace than it was last year, but we're still finding that wastewater treatment is quite active in there; energy solutions, energy savings, a lot of programs in that area; mining and metals continues strong; residential is still slow, not much of a surprise; industrial, very strong; utilities, back on a little bit of an uptick; the commercial construction continues to be weak but remember, that's about half of non-res and so when you see ABI come out this morning, that's really talking to just the commercial side. It's not really talking to the other side of the business. And then we're seeing almost all aspects of the Power Quality business picking up significantly on orders, and we think that's going to continue to build. We're seeing a lot of big data center projects being bid through this time. And then I would say that almost any of these end markets, whether it's a play on energy efficiency, alternative energy, quite a lot going on there and obviously, our large service and ESCO capability is playing well under that. And then lastly, I would say that the EV or electric vehicle charging segment is one that's quite busy right now. If you move to Hydraulics quickly, the biggest action has continued, just as we saw last year, to be on the mobile side, it's up a multiple of what we've seen on the stationary side but the stationary side is coming back as well. One of the hottest areas within stationary is energy, and we're pleased to see that. We're also a little bit different than what we were seeing in 2010 with our orders being up very, very strongly. Distributor orders are up as well. They're not up as strongly as the OEMs are but their strength has grown vis-a-vis say, 3 to 6 months ago.

[Stephen Volkmann:]

Great. Thanks very much, that's helpful. And then I wonder if I could switch gears a little bit and just ask you a question on the balance sheet. You've talked about getting a little more aggressive with acquisitions, and I guess I'm trying to figure out how your pipeline is looking and what your appetite might be for sort of the bigger deal, and where you might be comfortable with your debt-to-cap ratio on a kind of a shorter-term basis.

[Alexander Cutler:]

Yes, let me start now and I'll ask Rick to address the debt-to-capital ratio more specifically. But as we have commented, really, starting with the second half of last year, we said the green light was on for acquisitions from the point of view that we had really completed the majority of our integration work and our balance sheet was in increasingly good shape. Since then, obviously, we announced the closure of Tuthill, the COMAC joint venture, the ACTOM low-voltage business in South Africa, the Internormen that happens to be in Germany, Filtration business. And we've got a pretty active -- we've returned to a pretty active pipeline at this point. I would tell you what I've always told you on this subject is that we will be successful with more singles and doubles than we are with triples and home runs. That's the way this market works. And I would guess that would continue to be our mix going forward. But I see the market's return to a much more attractive pipeline of potential for us and we're in a position where now we got the balance sheet and the management bandwidth to be dealing with it again. Rick, you want to comment on the debt-to-capital issue?

[Richard Fearon:]

Yes, I'd be happy to, Steve. As we've indicated from the last several calls, we believe that the appropriate positioning for our net debt to total capital ratio is in the mid-20s. We were, at the end of March, at 26.1%, a bit higher than the end of the year because we put so much money into our pension plan, $282 million in the first quarter. For short periods of time, we believe that we can live with a slightly higher ratio than our target, maybe into the low 30s. But our clear strategy is to keep the ratio in the mid-20s for the great bulk of the time. So I think that gives you some parameters that we would operate under as we think about our acquisition program.

[Stephen Volkmann:]

That's perfect. Sandy, in the past, you've done equity offerings occasionally when the right opportunity has come along. Should we consider that that's probably still on the table or do you have a view on sort of the strategy there?

[Alexander Cutler:]

I'd say, it's still an arrow in the quiver. And it's something we would consider if we saw the right transaction. But that all gets back to do we find the right transaction? And I mean in that right property, right pricing, right contract, all the rest or not. But I wouldn't take it off the table.

[Donald Bullock:]

Our next question comes from Jeff Sprague. [Vertical Research Partners]

[Jeffrey Sprague:]

Sandy, can you give us a little bit more granularity down in the Power Quality now specifically? And what you're seeing in the U.S. in both the single-phase and the three-phase market? And your comment about data centers, I think you're referring mostly to the U.S., but if you could elaborate there too on maybe outside of the U.S., what you're seeing?

[Alexander Cutler:]

Yes, let me start on the U.S., Jeff, if I can here. Single-phase UPS and sort of midrange or flow product which tends to be getting at kind of a small data centers, that's showing pretty steady growth. Where there had been a sort of a hole out in the marketplace was in the fourth quarter of last year, the large data center awards, there was fair amount of quoting going on but the awards were much slower than we had seen in other quarters. So that led to some slowness in sort of the shipment side of things early this year, but that has picked up definitively in the last couple months. And so we're really seeing that activity pick up. I would say the government side, not surprisingly, tends to be slower, and I think we all can figure that, that goes a lot right along with all of these jarring budget debates that are going on. So that we would expect to see this large data center project activity continue to build through our early part of this -- or the later part of the first half and the second half of next year. But I'd say that the same drivers are there around the energy efficiency issue that's continuing to be a major, major push. When we go Rest of World, if I could just hop there, again, Power Quality markets are remaining strong. We're seeing that in the emerging nations, quite a continued growth in that regard and Europe has been relatively strong as well. So I'd say actually didn't see quite the dip that we saw a little bit at the end of last year here in the U.S. on the big end.

[Jeffrey Sprague:]

Could you put it all together and give us kind of a sense of revenue growth and order growth for the entire Eaton Power Quality franchise in the quarter?

[Alexander Cutler:]

Yes, we don't roll them that way because we report it really by region but I think the way to think about this is you can generally conclude that Power Quality is growing 1 point to 2 points faster than the Power Distribution franchise.

[Jeffrey Sprague:]

And could you also give us an update on where your rollout of the passive cooling product is?

[Alexander Cutler:]

This is the acquisition of the Wright Line business. And for some of you who may not be as familiar with it is a thermal management capability that really allows the cooling element of the solution to be significantly reduced. It has been primarily sold here in the U.S. Although we have just, in this last quarter, recorded a number of wins in Asia-Pacific. So we are rolling this business now out to Asia Pacific and into Europe. The initial successes have really been in Asia-Pacific. We're really pleased with them at this point and it's showing that the same capabilities that we had thought were so attractive for application here in the U.S. They absolutely play into this game to help reduce energy usage by reducing the cooling requirement in the data center, which means you can really downsize then, the cooling equipment. And that cuts a lot of electricity.

[Jeffrey Sprague:]

And I'm sorry, just one last one on that. Is there any particular characteristic of the type of data center that's willing to use that sort of technology in terms of size and market type of customer? Is there any common theme there?

[Alexander Cutler:]

Well, I'd say the common theme because it's not going to be in what I call your data center in a closet. It's not going to be that smaller application. So it tends to be your mid- and larger-sized data center. But frankly, those are the people that are looking for the energy efficiency and that's why it's playing so strongly there.

[Donald Bullock:]

Our next question comes from Ann Duignan. [JPMorgan Chase]

[Ann Duignan:]

My first question is just on your bridge, your earnings bridge. I'm a little bit confused about the increase in pension expense given that in Q1 there was basically no increase year-over-year. And I don't think about pension expenses being highly volatile as we go through the year. Can you just address that?

[Richard Fearon:]

Yes, Ann. Well, pension expense does move around slightly, and it moves around based on lump sum settlements when individuals do decide to retire. So it's our view that for the full year, we still think the estimate that we have out there is the best we have at this point in time. But you will see some movements between quarters. They can sometimes be several million dollars.

[Ann Duignan:]

Yes, but $0.11 is quite a significant increase going forward for the...

[Richard Fearon:]

The bridge that we have there, Ann, is exactly the same that we had in February. And so our expectation is that pension costs will be higher this year actually by about $45 million, and the reason is mainly because you had a lower discount rate. And so we haven't changed our expectation that we laid out at the start of the year.

[Ann Duignan:]

Yes, I know I appreciate that. It's just that Q1 came in much lower than we expected. And then my other question is the same on the acquisitions. Your acquisition pace has been quite steady but you haven't changed your outlook for EPS impact from acquisitions. Was the original guidance kind of a stretch and now you're just filling it in, or could there be upside to that to the contributions from acquisitions this year?

[Alexander Cutler:]

What we had was we had a pretty good sight on what we've announced at this point, Ann, so that it would be anything that we were successful in completing beyond what's out there in the announcement that would then make a contribution to that line.

[Ann Duignan:]

Okay, so if we see sizable acquisitions going forward, there could be upside to this number. Is that the way to think about this?

[Alexander Cutler:]

Yes. And we would, as we always do when we announce acquisitions, we would give you a sense for what that impact is. That's correct.

[Ann Duignan:]

Okay. And I know you won't answer a question but speculation over Larsen & Toubro Ltd. Perhaps I could ask in some way that you might address, as I look at the business and look at that product mix effect in the company, that product overlap looks pretty reasonable, looks like something that Eaton might strategically be interested in. Is there a way that you could comment on it without commenting on the speculation? But just looking at the business mix, it does look quite complementary.

[Alexander Cutler:]

All I can say, Ann, is what I'd say to a question on any acquisition. You're exactly correct is that we don't comment on rumors.

[Ann Duignan:]

Okay. I didn't think you would but I thought I'd give a try. Okay, I'll get back in the line, guys. Thanks.

[Donald Bullock:]

Our next call comes from Eli Lustgarten. [Longbow Research]

[Eli Lustgarten:]

Just a couple of clarifications. You had basically a 16% gain in volume this year and 10% coming from markets. Can you split out outgrowth -- that's foreign currency now and acquisitions? It looks like currency is 1 or 2 and acquisitions is 1 or 2 and you normally split the...

[Richard Fearon:]

Yes, Eli, the way to think about it is roughly 10% market, 3% outgrowth. It's about a point from acquisition and a point or -- and it doesn't actually get exactly to 16% because of rounding but it's a little bit more than a point in FX, a little bit more and about a point in acquisitions. You put that all together, you get to just about 16%.

[Eli Lustgarten:]

Can we talk about pricing across the company and maybe some idea what's going on, where prices are stronger than the average and below it? Because it looks there's been -- with all the core materials and regulatory stuff going on, there's a lot of pricing movement in the company.

[Alexander Cutler:]

As we mentioned in February, Eli, that we had announced the number of price increases in the fall in our businesses. We also announced price increases during this winter. And those price increases have ranged from sort of 3% to 5%, depending upon market and timing. But that's the set of -- 2 sets of price increases which we have felt gives us the ability to get our arms fully around, and that's in addition to all the cost reduction work and all of the alternative metal substitution work we've been doing that will allow us to really be hitting our incrementals by the second half.

[Eli Lustgarten:]

But that 10% market growth includes 3% to 5% pricing in it, is that correct?

[Alexander Cutler:]

It's a little higher when we look at the markets to completely pull-through once the effective rate of all the price increases. But it includes our best attempt in that regard, yes.

[Eli Lustgarten:]

And is there any area where costs have really become more of a problem than you sort of expected? Are you meeting any resistance from the pricing that you're going into -- that's going on right now?

[Alexander Cutler:]

I'd say there's always a timing difference. And I'd say, this is not different than it has been in the past. Generally, in your distributor channels and businesses, your price increases tend to get into effect more quickly. We tend to be working where we have contracts in place with people that takes a little longer time period to put those in place. But I'd say that this time period is very analogous to what we all saw in the fall of 2003 through 2007 where you have this very strong driving of industrial metals. And I think people at all levels of the supply chain recognize that these materials are costing more and you're starting to see it pass through the chain.

[Eli Lustgarten:]

And one final question, you raised your truck to 265,000. Have you lowered your outlook for automotive both here and in Europe because of the combination of Japan and the $4-plus gasoline price we're seeing?

[Alexander Cutler:]

We started with a -- you'll recall a fairly conservative forecast for the global automotive market this year, our forecast was 6%. Many people were saying, "Gee, that should have been more, in the 7% to 8% or 9% level." So we frankly, based upon the first quarter, if you had not had the terrible disaster that occurred in Japan, we would have probably been taking our forecast for the market up. As a result, a better lucky than smart on this one, when we think our forecast is about right and it does anticipate this global production reduction in the second quarter.

[Eli Lustgarten:]

All right, thank you.

[Donald Bullock:]

Our next question comes from Jeff Hammond. [KeyBanc Capital Markets]

[Jeffrey Hammond:]

Yes, can you just run through how you think the ramp in truck comes out? How does this 265,000 look on a quarterly basis?

[Alexander Cutler:]

Yes, I'll be glad to. I think we were all pleasantly surprised with the first quarter and having come in a little bit stronger than we thought. So we think that 265,000 most likely lays out to 52,000, first quarter; 63,000 second quarter; 71,000 third quarter; 79,000 fourth quarter.

[Jeffrey Hammond:]

Okay, great. And then, can you just go into the aero issues a little bit? You mentioned execution. What are the execution issues? And then, what specific programs are being impacted by delays, scope change outside of the obvious 787?

[Alexander Cutler:]

Yes. We are not going to talk about specific programs, Jeff. There are many programs and many of them are customer confidential. And so all I'll really will say on it, is that the combination of both some scope changes and schedule changes. And then frankly, my expectation is that regardless of those, we would perform on these, and I don't think we performed the way we should have, and that's why I'm disappointed with the performance. In the first quarter, I think we'll have our arms back around this fully by the time we get to the second half but it did impact our margins. You saw that come in at 11.6% during the quarter and that's well below our targeted levels.

[Jeffrey Hammond:]

Okay. Thanks, guys.

[Donald Bullock:]

The next question comes from Andy Casey. [Wells Fargo Securities]

[Andrew Casey:]

Before I get to a question that's kind of been bounced around, just a very specific question on truck. Are you seeing any flattening or moderation in NAFTA order intake at this point?

[Alexander Cutler:]

No, we've not. I mean, I know there's talk out there about at what level of fuel price will you start to get some pushback. But if you, frankly, the big drivers that are really driving this are still there. The ability to announce price increases as a trucking company have been quite strong so profitability is up, fleet's old freight is growing. And so we're pretty comfortable at this level. And when you take a look at the first quarter production levels, and that's where we start to get comfortable with this 265,000 type of range, what was being produced in the first quarter was already running at a 207,000-unit annual rate. And so frankly, part of the big step-up from a production point of view has occurred. It's not that there isn't more to go, but the industry has already come up a big level at this point. And so we think this increase from 52,000 to 63,000 to 71,000 to 79,000 isn't as big a crush as some of the jumps when we were trying to get ourselves up from much, much lower numbers.

[Andrew Casey:]

Okay, thanks. And then I guess this encapsulates a lot of questions that have already come and it kind of goes back to the Investor Day, but when you look over the next few years and I'm not asking for a specific future guidance because I know you're not going to give it, but as the margin recovery kind of tapers off, as you're getting closer to that longer-term goal, some of the businesses are showing strong growth today but they're probably going to flatten out in the future, are you now shifting to a greater focus within the business model on acquisitions?

[Alexander Cutler:]

No. I don't believe we are, Andy. What we tried to lay out in February, and I appreciate your referencing that, is that we believe during this period going through 2015, we can grow our revenues at 12% to 14%. And I think you remember that an important part of that, is 7 points, is from end market growth. So yes, that's lower than we think this year will be. But then you got about another 3 points from outgrowing and we think we've demonstrated our ability to do that. And the last 2 to 4 points come from acquisitions. And so 2 to 4 points out of a total of 12% to 14% says we still have very strong organic growth. I think a couple of drivers to remember here is that non-res, we're hoping bottoms this year. And that means we ought to set up a couple years of growth. We're coming into the strong portion of the Aerospace growth segment as well. We think the Hydraulics business is coming up to a very attractive level here but has more growth. And the truck industry is just starting to swing back into a growth mode. So very significant that we've got a lot of drivers in Eaton that are starting to come on at a much fuller basis. And I think it's important to remember that our first quarter, this very good first quarter we have, our volume is still 11% below our quarterly all-time record of $4.3 billion in the second quarter of 2008. So I think the really good news is our ability to generate cash and our earning or our profitability is really very good now. And that's why we feel quite good about these projections to the 2015 time period.

[Andrew Casey:]

Okay, thank you for that clarification. One last one on the non-res, Sandy, given the commodity price spikes that we've seen, have you noticed any push-out of any of the project activity as a result?

[Alexander Cutler:]

No, I'd say the side of that market, Andy, that's so busy right now is the piece that most people don't look at it. ABI tends to focus people on the commercial side. That's not where the big activity is right now. You got a lot of activity going on in petrochem. And with the pricing that we all see everyday when we go buy gasoline, we know why that investment is going on, and that's not getting pushed back at all. You got pretty strong manufacturing export going on. That's got activity on it as well. Mining's got a lot of activity right now for all the reasons we understand. So our short answer is no. We're not seeing that slow it down at this point.

[Richard Fearon:]

And Andy, I might add that if you look at the government put in place private non-resi construction spending in Q1, half of that sector showed growth on a year-over-year basis. And so it really is concentrated in this industrial oil and gas area. But nonetheless, it says that the market is a lot stronger than it would look if you just look at commercial construction.

[Donald Bullock:]

Our next question comes from Joshua Pokrzywinski. [MKM Partners]

[Joshua Pokrzywinski:]

Just trying to think about the pricing environment here versus kind of the last shock we saw in 2008. How has realization held up versus plan? Is it easier, harder, the conversation with customers?

[Alexander Cutler:]

I think, let me go back, Josh, to this period of 2003 to 2007. I think because there had not been significant material inflation really during the '80s, that the 2003 to 2004 time period was a very challenging time in industrial businesses just from a point of view that both companies were learning how to think about price increases, and customers were working through their first challenges in terms of how also to pass on that cost. I think, generally, the industrial segments have learned those lessons during that time period. And so while we took a year off, if you will, from this pressure in late 2008 and 2009, we were right back into it in 2010 and '11 because the emerging nations started heating up so quickly, there was immediate pressure on these commodities again. So I wouldn't say this is significantly different than what we've faced just a couple of years ago.

[Joshua Pokrzywinski:]

Okay, that's helpful. And then just digging in here on the Electrical Rest of World bookings, I understand you're starting to bump up against some tougher comps there. But is there any signs of kind of the industrial controls segment or more? I know it had been strong in 2010 or any of these other emerging markets that are kind of showing signs of stalling out or bumping up against tough comps or losing momentum?

[Alexander Cutler:]

We don't see that. I think that what's out and around, you and we and everyone has been talking about though, as you watch these inflation rates in the BRIC countries and you're starting to see interest rate increases in a number of these countries which we believe are prudent, at some point, that starts to slow things down, but these growth numbers are still very attractive, which is one of the reasons we're pleased to have reached 26% of our sales in the segment being in the developing countries. But I'd say the short answer is no. But I think everyone's got to keep an eye on interest rates here vis-a-vis the domestic inflation rates in a number of these very fast-growing countries.

[Joshua Pokrzywinski:]

Got you. Thank you very much, guys.

[Donald Bullock:]

The next question is from David Raso. [ISI Group]

[David Raso:]

Thinking about the longer-term goals and you're thinking of revenues kind of more low double digit, but EPS growth, really in the low 20s from '11 to '15. And the more cyclical businesses you have in the latter part of that timeframe, you probably have a harder time really giving much leverage. So the Electrical Americas business in particular is probably an important part as you mentioned non-resi hopefully beginning a bit of an up cycle. That said, when I'm trying to think about the incremental leverage in that business, the last couple of quarters, you've had some pretty healthy growth but the incremental margins in Electrical Americas not terribly different than the operating margins. Now part of that is acquisitions have added 4% to 5% to the revenue growth the last 2 quarters, and obviously that limits the incrementals. But how should we think about that business looking out? When the pieces of Electrical Americas, for example, that are not currently strong recover, are those big benefits to your incremental margins? Are those lower-than-average margin businesses? I'm just trying to think of the leverage in that business looking out to specially '12, '13, '14 to be able to total company leverage at low double digit revenue to such a stronger EPS growth rate.

[Alexander Cutler:]

Yes, David, I have two perspectives that I'd add on that. One of the businesses that is incurring a fair amount of uncovered commodities is the Electrical Americas business. And so that is accounting for this lower kind of incremental activity now, and as I said earlier, we expect to have our hands kind of fully around that here for the second half. The other is, as we shared in New York, we shared a lot of numbers but this number was that we really think that this is a business that ought to be in the 16% to 17% kind of margin area. And so we're coming up out of a time period now where we've had the very weak non-res, which is a significant part of this business, and then we hit the commodity pressures here. And so we're quite confident we'll get both those back, so that that becomes a handsome business for us because you recall again that we're talking about segment margins in total for the company of about 16%. This business would be at or above that. So that's how we think about it. We got to get non-res to start coming back and we got to get through this kind of uncovered commodity period here in the first half.

[David Raso:]

Would you care to share the detail of the $25 million of unrecovered? How much, for example, is on Electrical total or even ideally, how much is Electrical Americas for the quarter?

[Alexander Cutler:]

Yes, what I could tell you is that while it's about a 4%, 4.5% impact across the company, that's the $25 million, it was probably closer to twice that in that segment.

[David Raso:]

And that's for Electrical total or Americas?

[Alexander Cutler:]

Electrical Americas.

[David Raso:]

Okay, that's helpful. I appreciate it. Thank you.

[Donald Bullock:]

Our next question comes from Terry Darling. [Goldman Sachs]

[Terry Darling:]

Yes, thanks. Sandy, wondering if you could back and just review with us what you have said in the past about return criteria willingness to take near-term dilution on larger, more strategic acquisitions?

[Alexander Cutler:]

Yes. We've been pretty consistent, I think, over the last 11 years saying that we're not a company that believes that synergy plans are laid out over 5 to 6 years are realistic plans. And so we tend to -- too much changes in that time period. So we tend to, when we shared with you on both small and larger deals that talked about integration plans with half and over a 2 to 3-year time and have to start to get to the target returns. We've talked about wanting to be able to achieve 300 to 500 basis points over our cost of capital. And those have been our really 2 kind of cornerstone criteria we've used as we've talked to both you and internally in terms of our expectations for acquisitions.

[Terry Darling:]

Okay, that's helpful. And then just revisiting the incremental margin discussion kind of in a segment basis. I think that the Truck guidance of 17% for the full year would imply that your incremental margins dropped over the balance of the year from the mid-30s down to closer to 30. And just wondering, is that a function of some acceleration in investment levels that you are making to try to prepare for incremental volumes in '12 and '13? Is that being conservative, some combination or some other factor?

[Alexander Cutler:]

It's probably a little bit of all of the above, Terry, but not to be cute on it, it's early in the year at this point. We had had a guidance out there of 16%. We're really pleased that the team did such a good job in the first quarter that frankly, got us off to a little faster start so we popped it up a point. And let's see how we do for these next couple of quarters.

[Terry Darling:]

And then just lastly on Japan, you've been clear on the auto impact but you got a lot of other components that go into a lot of other parts of your business, and I'm not really hearing your concerned about those supply chain uncertainties at all. Can you just comment on how much visibility you really have on suppliers of suppliers and unintended consequences and how concerned we should be about that issue?

[Alexander Cutler:]

The second area, I did mention, Terry, is that in electronic components, which they're going through lots and lots of things but we would feel them, most particularly, in our Electrical business as well and that's in our guidance. And frankly, we would hope to have a little higher revenue in the second quarter if we didn't see the need to take some precautions about what may come out. I mean, this has been a horrific, horrific tragedy on a human basis, but it also has been now in terms of the supply chains in Japan. And that's why I say, I think, prudence says it will take a couple of months before people are able to fully assess what the impact of that is. And so we've tried to take that into account and it is reflected in our guidance.

[Terry Darling:]

And just lastly, within the Electrical business in terms of where some of that impact might be, is it disproportionate Power Quality versus the other segments within Electrical or pretty broadly spread?

[Alexander Cutler:]

It's pretty broadly spread because you end up using a lot of these components in a lot of different products. I think people's initial reaction would be more of Power Quality but frankly, electronics, they're used in -- we don't produce many devices that don't have some form of intelligence or monitoring capability in them.

[Terry Darling:]

Okay, thanks very much.

[Donald Bullock:]

The next question comes from Mark Koznarek. [Cleveland Research]

[Mark Koznarek:]

I just want to tie together a couple of things that have come up already with regard to the pricing that you've announced, that 3% to 5% debt, that's an across-the-board number, is that correct?

[Richard Fearon:]

Yes, it varies a little bit by business-to-business. And remember, there have been kind of two tranches, Mark, of price increases. There were price increases last fall and early -- well, late, late fall and then, there have been increases again this year.

[Mark Koznarek:]

Okay, yes. Okay, so now 3% to 5% overall for the company and now unrecovered raw materials of $50 million, $25 million this quarter, $25 million next quarter, disproportionately in Electrical. So you're going to be recovering that unrecovered cost later in the year, which means that your Electrical pricing is going to be going up disproportionately, I'm assuming. In light of those two factors, it would seem like both the Electrical Americas and the international outlook, both of them at 7% seems kind of modest because if we subtract the way a pretty large contribution from price, the underlying volume seems like it's neutral or just very small. So can you comment on all of that? Does that logic make sense? And how would you comment on that? Is this part of this earthquake dynamic that you're cutting back on your outlook for volume in that business?

[Alexander Cutler:]

Yes, maybe a couple of comments, Mark. Obviously, a lot of questions inherent in that. I would say, don't be quite so literal about the 3% to 5%. If that's what's announced, it's not always what's fully realized. It doesn't all end up just in one business as you mentioned, and we've done our best to try to approximate a price impact in the global markets but I would tell you that that's a little less precise than everyone might like from a detailed spreadsheet point of view. So we think again, if we step back from the global markets and say, if you're going to see your global market expansion on the order of 10%, I guess the way that I would encourage is to not try to disaggregate it quite as finitely from a pricing point of view. It's going to represent what gets realized in markets out there, and those are global markets. Those aren't necessarily exactly how we compete within the market.

[Mark Koznarek:]

Okay. But specific to Electrical, it still seems like you're directionally going to be pushing price more, meaning that the 7% total market revenue outlook is a pretty cautious one?

[Alexander Cutler:]

Yes. And I guess I wouldn't be quite as comfortable with the decimal point that we're pushing price more there. It's the number of the markets are being -- or excuse me, the businesses are being impacted by these commodity issues and how we go about either getting a price increase or changing the utilization or product or working cost reductions. We're really working at this from a margin enhancement or preservation point of view, not so much the deductive on the top line.

[Mark Koznarek:]

I got you. Okay, thank you.

[Donald Bullock:]

Our next question comes from Christopher Glynn. [Oppenheimer & Co.]

[Christopher Glynn:]

Thanks. Just going back to February, you started to talk a little bit about market share strength in the data center side. Could you elaborate and update that a little bit and also comment on the degree of the proprietary nature of any technology around Wright Line?

[Alexander Cutler:]

In terms of the market activity, I think I'll be repeating what I said earlier. We think that normally what you'll see during a year is that the single-phase business is stronger in the last 3 quarters than it is in the first quarter. And that's partially why you get this lower first quarter seasonal that occurs, not just this year but it's an annual item. So that business has been pretty strong. It's continuing to be strong through here. It's aimed at the smaller data centers. The flow side of the business, which is sort that midsized data center, that's continued quite strong. I'd say the one that perhaps has been of a little bit out of pattern was the large data center business where we would have hoped to have seen stronger bookings through the late part of the fall. It was weaker. I think you saw that from several different competitors. That contributed to a little less shipment activity in the first quarter. But what we're very pleased about is that we're seeing not only a heightened quotation activity but also heightened bookings, which you saw on our bookings in the first quarter, and that will lead to stronger shipment profiles now over the next couple of quarters. So that's sort of how we see the year shaping at this point. On the Wright Line issue, in terms of the proprietary nature, there is a lot of what I would call proprietary use technology or knowledge in the business and that comes from a lot of application knowledge. And that's the key element of what we're doing there.

[Christopher Glynn:]

Okay, that's really helpful. And then just on the Moeller and Phoenixtec global synergies, if you could add some incremental color on what you're seeing there, channel-wise and otherwise?

[Alexander Cutler:]

Well, I think some of you may recall Tom Gross's presentation on this in our New York meeting on February 25. We have gotten the 2 years, this was 2009 and 2010, of $0.30 accretion per share. And that's what we said we would get, and we're really pleased when that happened. Probably even more valuable long term is the fact that the products of these 2 acquisitions have allowed us to enter the vast geographic portions of the world that we were not involved in, and so really helping us there from a channel perspective. When we bought this business, you may recall, small acquisition we did last fall called CopperLogic, that actually was a distributor for North America of Moellers and it stood separately. And what it allowed us to do now is to get at even more some of the OEM solutions for our EC products here in the U.S. Similarly, the capabilities of the Phoenixtec business have allowed us to take that product outside of Asia into other markets where we really had a need from our customers for a single-phase product that was configured a little bit differently than the product we've had traditionally. So we're really pleased with the products from both businesses, the ability to take them to new channels. And yes, they're selling outside the traditional geographic footprint that they were involved in.

[Christopher Glynn:]

Thanks a lot.

[Donald Bullock:]

Our next question comes from Nigel Coe. [Deutsche Bank]

[Nigel Coe:]

So just going back to Japan. I mean, obviously, Japan is a big of exporter of hydraulics. And I just wondered if you could maybe could comment on what you're seeing in terms of any disruptions to their production and whether you see any opportunities to pick up some of the slack?

[Alexander Cutler:]

I think it's just early, Nigel, to know in that regard. I mean, again, the catastrophe has been such a disaster, and there's a huge need for construction equipment out there at this point, just being filled by a lot of different suppliers. We've heard the speculation also that there are going to be share dislocations as a result of this. I just think it's way too early to speculate on that. Our operations fortunately were not damaged. Our employees are safe, and we're grateful for that, and we think it gives us the platform to compete off of, I think, it's too early to declare our results.

[Nigel Coe:]

Okay. And then on Hydraulics, by the way I fully understand on that commentary, but in terms of the recovery there, we must be getting back to close to peak volumes. And I'm just wondering, are you running into any capacity constraints as we go into second half of the year?

[Alexander Cutler:]

Yes, you are correct that the Hydraulics business is probably the business within Eaton that best typifies a V recovery when we were all debating the alphabet two years ago. This is the one where the V really did occur. Yes, it is the one that's backed up at those kind of levels. And we've seen, we would think, that this year, that the markets will be back where they were in 2008, again, led most strongly by the mobile side, and it's not simply the construction side because remember what's happened with food pricing, you've got very strong agricultural equipment markets around the world as well. Frankly, there's more room to go on the industrial side as well, and so we don't see this market peaking at this point.

[Nigel Coe:]

But do you see any capacity constraints in terms of having to add...

[Alexander Cutler:]

No, we do not. I'd say this has been more an issue of getting the supply chain ramped back up. And, of course, we've been at that for a year now. And so we're actually starting to see things be a little bit more orderly in that regard.

[Nigel Coe:]

Okay. And then finally, just obviously, there's been a few questions skirting around the M&A issue, but you said that the back load is looking pretty active right now. But in terms of the opportunity sets, how do you characterize electrical versus non-electrical? And maybe over the next few years, where do you see the mix with electrical assets versus non-electrical?

[Alexander Cutler:]

We said, Nigel, consistently that there's sort of two trends to watch in the company from a use of discretionary cash. Let me talk first to acquisitions by product. We've said that there were 3 businesses we wanted to expand or continue to expand via our acquisition because we thought there were some very attractive profits zones we weren't yet involved in, and that's Hydraulics, Aerospace and Electrical. And then we've said also that as we continue to try to grow the company outside the U.S. not by reducing our U.S. business but by complementing it, and there, we said we want to get our revenues to 60% of total revenues being outside of the U.S., with 30 of those 60 points being in emerging nations. That you are likely to see us work to, in large, through acquisition, those businesses that are outside of the U.S. So those remain the same, so that over time, what you're likely to see is total revenues are likely to be a little bit more heavily loaded into our Hydraulics, Aerospace and Electrical businesses, and you're likely to see the growth, that percentage outside of U.S. growth.

[Nigel Coe:]

Okay, great. That's good information. Thanks.

[Donald Bullock:]

The next question comes from Robert McCarthy. [Robert W. Baird]

[Robert McCarthy:]

I'll try to be quick. Sandy, you have variety of businesses that are on the ground in China. Well understood that the central authority there is trying to constrain overall economic activity. Are you seeing any signs yet in the order books across any of your businesses outside of the slowdown in automotive that would support the idea that it's having an impact?

[Alexander Cutler:]

I think that the one market where you can get good public statistics right now where the first quarter was somewhat of an interruption to what you've seen in other businesses is the truck industry we actually saw -- excuse me, truck production in both the heavy-duty and medium-duty actually come down. Now having said that, last year was an enormous boomer of a year in China so this maybe a digestion as much of anything else. I think more specifically, what you tend to see is where the money is being spent is changing, so much less spending in what I would call the kind of a Tier 1 cities, tremendous focus in the Tier 2s and Tier 3s.

[Robert McCarthy:]

So it's a geographic shift, nothing more than that?

[Alexander Cutler:]

Quite a shift. I think what everybody's been debating is will the market grow at 9%? Well, I'm talking GDP, will it grow at 8%? Will it grow at 8.5%? Frankly, for Eaton, it doesn't really matter very much because you're seeing industrial production growth being about twice of that and that's a very nice field to run on.

[Robert McCarthy:]

As we think about the progression of growth in your forecast for the full year, are you still anticipating better than 10% organic growth as we exit the year, in another words, fourth quarter?

[Alexander Cutler:]

This is year-over-year growth of end markets?

[Robert McCarthy:]

No, I'm talking about for Eaton's combination of end market growth and outgrowth, organic, in other words.

[Richard Fearon:]

Yes, Rob, I'll just comment on that. Obviously, there's a lot of forecasting involved in that number. But in general, we wouldn't be surprised if you had the combination of market and outgrowth getting you still 10% or maybe even a little north of 10% in the fourth quarter.

[Robert McCarthy:]

And then just as clarification, did I understand you a little bit earlier, Sandy, as you were answering a different question to qualify that the market growth estimates are not specifically Eaton-weighted, if you will?

[Alexander Cutler:]

The way we construct the market, they're weighted by -- if we have a very different participation in a broad industry, we will then -- we'll weight it according to our participation because it doesn't tell you very much if our participation is very different. But for example, in Hydraulics, just the entire Hydraulics market, there's really no different weighting for us versus the entire market.

[Robert McCarthy:]

Okay, fair enough. Thank you.

[Donald Bullock:]

We have time for one more question. Tim Thein. [Citigroup]

[Timothy Thein:]

All right, thanks, will be quick here. Just on, I guess, Rick, for you, on the operating earnings guidance, you've now lifted that 3 times, I guess, this year by a total of $70 million or $75 million, but the operating cash flow guidance hasn't changed. I think the pension contribution that you flagged earlier had been spoken for already in the initial guidance. So is there an assumption around higher commodity cost driving more or higher levels of working capital, or what's going on there as to why that hasn't translated to better free cash flow guidance?

[Richard Fearon:]

Well, Tim, it's still early in the year. I mean, we're only through March. And clearly, as your sales go up, we fund 17% to 17.5% of that in working capital. And so if you look at -- you do have higher operating earnings but you are funding your working capital to reflect the higher sales, so it's possible that the cash flow could be a little better than we've laid out. But we do think it's early in the year to make a reforecast.

[Timothy Thein:]

Okay, fair enough. Thank you.

[Richard Fearon:]

And I mentioned, Tim, just for your record, we've increased guidance twice, not 3 times.

[Timothy Thein:]

It seems like 3 times, thanks.

[Donald Bullock:]

We will be available to take questions afterward following the...

[Alexander Cutler:]

And let me just make one last comment. As some of you heard a voice in the background behind Don Bullock, this is Bill's last earning, Bill Hartman's last earnings conference. And on behalf of all of you who he has worked with, I want to thank all of you and I'm sure you extend along with me the best wishes to Bill for a long and healthy retirement. Bill, thanks very much.

[William Hartman:]

Thank you for your comment.

[Alexander Cutler:]

And with that, I guess we sign off.

[Richard Fearon:]

Thank you.

[Operator:]

And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.