伊頓 (ETN) 2007 Q2 法說會逐字稿

Welcome to the second quarter 2007 Cooper Industries Ltd.

earnings call.

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host of today's call, Mr.

Jon Safron, Director of Investor Relations, please proceed.

Thank you.

Welcome to Cooper Industries second quarter earnings conference call.

With me today is Kirk Hachigian, Chairman and Chief Executive Officer; and Terry Klebe, Senior Vice President and Chief Financial Officer.

As mentioned in our press release, we have posted a presentation on our website related to the second quarter results, which we will refer to throughout the call.

If you'd like to view or download the presentation, please go to the investor center section of our website, www.cooperindustries.com and click on the hyperlink for management presentations.

Before we proceed, let me remind everyone that 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 as a result actual results may differ materially from those anticipated by Cooper.

A discussion of these factors may be found on the Company's annual report on Form 10-K and other recent SEC filings.

In addition, comments made here may include non-GAAP financial measures to the extent that they have been anticipated, reconciliations of those measures to the most directly comparable GAAP measures are included in the press release.

And now, let me turn the call over to Kirk.

Good morning, I've assumed that you've all had a chance to download the exhibits we've posted on our website.

We are clearly entering the back half of 2007 on a very positive note.

With the Company posting 14% overall growth and 8% core growth for the second quarter of 2007.

One of our best core growth rates in over 2.5 years.

If you turn to page 2, electrical products was up 15, 4% from acquisition, slightly less than 2% from foreign exchange, and a very strong 9% core growth.

Tools was up 4% with 3% of that coming from foreign exchange.

3 of our 4 end markets were expanding, residential was down as anticipated.

We're still very optimistic about the global industrial, utility, and nonresidential markets and we'll talk with you more about that as the call goes on.

Earnings per share was $0.78, up 22% from the second quarter of 2006, which was up 25% from the second quarter of 2005.

We had solid leverage on incremental sales, from strong productivity and pricing execution.

Income from continued operations was up 22% to $146 million, electrical products return on sales was 16.8%, up 70 basis points, leveraging 22% on incremental sales.

Tools return on sales was 11.3%, again up 70 basis points leveraging at 28% on incremental sales.

And year-to-date cash flow was $154 million, putting us right on track to deliver our seventh consecutive year of free cash flow in excess of income.

Turning to page 3 of the exhibits, for the electrical products segments, the key drivers in the quarter were strong utility demand, especially strong in C&I reliability products and international markets, solid industrial demand, factory utilization at 81.7% with continued strong demand in oil, gas, and metals.

And an improved global outlook for capital spending.

We continue to see sales momentum in developing countries, up 30%.

North America electrical distribution was strong, up double digits, and five of our seven electrical businesses had double digit sales growth.

And we also had solid execution on pricing practices and productivity as I mentioned earlier.

Issues facing the electrical segment during the quarter were continued slowing in the residential and retail markets, particularly affecting our wiring device business and our Halo product line and our lighting division.

Our EBS go live at Bussmann and continued pressure from metals and energy costs.

Net net, core growth was 9%, acquisitions accounting for 4% additional growth, and margins at 16.8% electrical had an excellent quarter.

Turning to page 4 for the tools group, we continue to see strong demand in aerospace and the Weller product line, and we're able to offset commodity inflation with effective pricing policies.

Hand tools was up slightly with improved penetration at retail while the U.S.

automotive continues to be soft.

And now, let me turn the call over to Terry to provide you additional details on the quarter and update you on our full-year outlook.

Thanks, Kirk.

As Kirk mentioned, we had a great second quarter.

Before turning to the earnings for the quarter, I'll provide some highlights on our free cash flow and balance sheet.

On slide 5, as Kirk noted our free cash flow for the first half of 2007 was $154 million compared to $141 million in the first half of 2006.

As is typical in the first half of the year, annual customer, employee incentives are paid which results in the first half having lower free cash flows in the second half of the year.

As Kirk mentioned, we continue to anticipate delivering the 7th year in a row where free cash flow exceeds income from continuing operations, excluding the income tax adjustments.

Our balance sheet remains in great shape with our debt to total capitalization net of cash at 19.7% compared to 19.1% on December 31, 2006 and 22.6% on June 30, 2006.

This was after spending $24.5 million on common stock purchases, net of proceeds, and $171 million on acquisitions during the first half of 2007.

During the quarter, we issued 300 million of 10-year notes and effective interest rate of 5.75%.

Following this debt issuance our debt maturities are favorably staged and we're very happy with 10 year money at 5.75%.

The proceeds funded $300 million of debt that matured on July 1, 2007, which is why you see debt and cash on our balance sheet increasing significantly.

Our debt in capital structure remain in great shape and provide us outstanding flexibility.

Turning to slide 6, our inventory turns in the first half of 2007 were 6 turns, up from 5.9 turns in the first half of 2006.

The dollar investment in inventory is impacted by the increased material costs compared to a year ago as well as the acquisitions completed during the first half of 2007.

We expect continued improvement as 2007 progresses.

On receivables, we reduced our day sales outstanding as of June 30, 2007 by 2 days to 66 days compared to 2006.

A very nice improvement.

Payables continue to reflect our initiatives to move suppliers to terms closer to the terms our customers demand.

As a result, our operating working capital turns improved to 5 turns compared to 4.9 turns in the first half of 2006.

Overall, solid performance in the first half of 2007, our operating working capital, especially considering our initiatives to improve customer service and acquisitions.

On slide 7, our capital spending -- expenditures were up 40% in the first half of 2007 to 56 million.

For the year, we continue to expect capital expenditures of 110 to 120 million.

In the 2007 second quarter, we purchased 698,000 shares of our common stock spending $35 million against proceeds from issuance of $28 million.

In the second quarter, we issued 1.3 million shares for stock option exercises, matches to our 401K and other stock programs.

For the first half of the year, we've purchased 1.6 million shares against issuances of 3 million shares.

We will be increasing our share buybacks to ensure purchases are at least equal to issuances for the year.

Turning to the results for the second quarter and slide 8.

As I noted in the first quarter conference call, we are close to finalizing U.S.

tax audits, and we could end up recording a significant income tax accrual reversal.

As it turned out, we resolved all issues through the 2004 audit cycle, including a significant issue where the internal revenue service asserted that we should pay $140 million of federal withholding tax plus accrued interest.

Also in the quarter, the state of Texas issued guidance that resulted in the recording of a tax adjustment.

In total we recorded 63.5 million in income tax accrual adjustments, which increased income per share by $0.34.

Setting aside the bookkeeping benefit reflected in our results, the real positive here is resolving two significant nonrecurring tax contingencies in getting through the tax years where we inverted.

Turning to slide 9.

Today we reported a revenue increase of 13.7% with both electrical and tools coming in at the high end of the forecast.

As Kirk mentioned, the top line growth was aided by currency translation and acquisitions, which contributed slightly less than 6% to the revenue growth in the quarter.

Reported $0.78 in earnings per share, excluding income tax adjustment, which is at the high end of the guidance we had increased $0.76 to $0.78 cents at the EPG conference in late May.

Like the first quarter, the results were given primarily by above forecast performance in the power systems business and international operations.

On the 14% total company revenue increase, we leveraged to a 22% earnings per share increase, exclusive of the income tax adjustments.

If you recall, in the fourth quarter of 2006 we received for the first time since 2002 a payment from Belden under the agreement related to the IPO of Belden in 1993.

In the second quarter, we received an additional $3.3 million from Belden.

However, we incurred incremental legal costs that offset the Belden income primarily related to an old discontinued operation.

On slide 10, our overall cost of sales as a percentage of revenue improved 60 basis points, resulting in gross margins increasing to 33% from 32.4% in last year's second quarter.

Our strong organic growth was composed of approximately one-half volume and one-half price realization.

As anticipated, we have had higher overall price realization in the first and second quarter to offset the increase in copper, electrical grade steel, and transformer oil.

This impacts our gross margin as well as our leverage realization.

Overall, we've been very successful in achieving price to stay at least even with material cost inflation and the second quarter was no exception.

Also, our recent acquisitions are having an impact on our reported improvement in margins, leverage, and return on sales.

With purchase accounting and the amortization of intangibles, acquisitions have lower earnings in our base business in the early periods after consummation of acquisitions.

Overall, acquisitions contributed 4% to revenue growth with the incremental revenue contributing an average return on sales in the low double digits.

All that being said, we had great execution in underlying productivity in the quarter.

Selling, general, and administrative expense for the quarter as a percent of sales was 18.4% compared to 19% in the prior year second quarter.

The Belden income is included in general corporate and the segment income statement as is the increased legal costs that offset this income.

Our continued investment in our global growth and initiatives were leveraged during the quarter by the revenue growth.

Turning to slide 11, solid execution on cost initiatives while continuing to invest in our company-wide growth initiatives and great execution across our businesses on price realization drove a 23% increase in operating income and our operating margins up 120 basis points to 14.6%.

Continuing on to slide 12, our net interest expense our tax rate and income.

Our net interest expense was up $0.5 million compared to the 2006 second quarter.

Slightly higher interest rates accounted for the majority of the increase.

Our effective income tax rate, excluding tax adjustments for the second quarter of 2007 was 27.3% versus a 25.5% for the second quarter of 2006.

The increase in the tax rate is primarily from the incremental income being taxed at the statutory U.S.

federal and state tax rate.

Despite the higher income expense and the higher tax rate in the quarter, our income from continuing operations increased 22% on the 14% revenue increase.

Turning to the segments and slide 13.

For the quarter, our electrical product segment revenues increased 15.3%.

Currency translation contributed 1.5% to revenues and acquisitions contributed approximately 4.5% to the revenue growth.

The strong organic growth of over 9% was approximately one-half volume and one-half price realization in the second quarter with both Bussmann and power systems meeting and realizing the price increases to cover increases in material costs.

Core revenue growth for electrical products was strong in all regions of the world with Asia Pacific and the Middle East having the strongest growth.

Electrical distribution revenues were up double digits with strong growth in North America.

Our power systems business had great quarter with revenues excluding acquisitions up again strong double digits.

The North American residential market has been a challenge and it now appears will continue to be challenging into 2008.

As expected, sales through North America retail channel, declined low single digits against weak comparables in the prior year.

Overall, electrical product segment earnings increased 21% and return on sales increased 70 basis points to 16.8% from 16.1% in the second quarter of 2006.

Our incremental earnings leveraged at 22%.

However, this significantly understates the true leverage we are achieving.

Incremental revenues from acquisitions diluted return on sales, approximately 20 basis points and on incremental earnings leverage by close to 400 basis points.

When you consider that currency translation and price that recovers material costs and inflation dilute earnings leverage and the acquisitions take a couple of years to achieve segment margins we continue to have terrific leverage to the bottom line.

Turning to tools segment on slide 14.

Now our tools business, sales increased 3.9% with currency translation adding 2.7% to the sales increase.

We continue to see solid revenue and earnings growth in aerospace, but weak sales to motor vehicle end markets.

Retail sales were up low single digits as a result of new products and customers offsetting softness in the residential market and relatively weak comps compared to the prior year.

Tools operating earnings increased 10% on a sales increase of 4%.

Our reported tools operating margin as a percentage of sales increased 70 basis points to 11.3%.

Operating margins were impacted by the sales mix of hand and power tools and the strength of Latin American currencies, which impacted the cost of source product from this region.

Before turning the call back to Kirk for his final comments,I'll provide some brief comments on the Federal Mogul bankruptcy and our forecast for the third quarter and year.

Turning to slide 15 on Federal Mogul asbestos.

The judge presiding over the Federal Mogul bankruptcy case concluded the hearings on July 10.

She has now set a schedule for briefs and final arguments that will likely not include -- conclude until the 1st, of October.

While it is not possible to predict how the judge will ultimately rule, there was nothing unexpected in the testimony or the conduct of the hearings.

We, of course, are disappointed the Federal Mogul bankruptcy confirmation has not been concluded.

But at this point, the process remains on track.

New cases have been less than 500 per quarter for the last two quarters with total outstanding cases flat, close to flat with year-end 2006.

Turning to slide 16 in our third quarter and year outlook.

In the third quarter, we're forecasting revenues to increase 11 to 12% with the electrical up 11 to 13% and tools up 3% to 7%.

Acquisitions are forecast to contribute close to 3% to revenue growth and currency translation close to 1% leaving a forecasted 7 to 8% core revenue growth.

Earnings per share forecasted to be in the range of $0.78 to $0.82 per share, an increase of 13 to 19%.

For the full year, we are now forecasting a top line growth of 10% to 13%.

Acquisitions add slightly over 3% to the revenue growth and currency translation about 1%.

As we noted in our press release for the third quarter, our tools business has strong comps in the prior year and will be shipping low margin assembly equipment as we continue to wind down this part of the tools business.

We expect earnings and return on sales to increase significantly in the fourth quarter as the sales mix improves.

Earnings per share, excluding the tax adjustments are now forecast to be in the range of $3.07 to $3.12 per share, an increase of 19% to 21%.

Let me turn the call back to Kirk for final comments.

Thank you, Terry.

In summary, we've had a very strong first half of 2007.

The end market diversity is generating strong core growth, industrial and utility remain strong.

Nonresidential is firming.

Just recently the Architect and Building Index was released which shows some very favorable trends.

Clearly we're able to offset the continued softness in the residential segment.

International markets remain strong, developing countries, which are half of our total international sales are up 25% with China and India -- excuse me China and the Middle East both up over 60%.

And we're on track to deliver nearly $2 billion of total international sales in 2007.

The Company's orders were greater than sales for the quarter with 5 of our 8 businesses having orders in excess of sales.

Our team is executing extremely well, delivering core growth, productivity, price, and working capital.

Our M&A pipeline remains active, acquisitions contributed 4% of our overall growth for the quarter, and our balance sheet remains in outstanding shape.

We've been delivering solid core growth at over 20% earnings per share growth while we're improving our overall capital structure.

And so we expect a strong close to a very solid year.

Lastly, if you turn to page 18 of the exhibits, we continue to be very excited about key long-term global macro trends that are driving the underlining core growth of our businesses.

And we continue to look to deploy capital to build our global position in these markets.

These trends include increased global energy demand driving higher energy and commodity prices.

Obviously the need to define alternative forms of energy, improving efficiencies, and reliability and protecting the overall environment.

Continued investment in developing and mature economies, and infrastructure whether it's the utility grid, LNG facilities, or industrial factories or refineries.

And lastly, with all of this expansion, electrical safety including arc weld protection, explosion proof, grid reliability play an even more important role as does signaling and mass notification.

We expect these key long-term trends that we're uniquely positioned for to sustain our long-term growth rate.

And now let me turn the call back over to Jon to open it up for your questions.

Thanks, Kirk.

At this point I'd like to open up the call for questions.

Operator?

Yes, sir.

Thank you.

(OPERATOR INSTRUCTIONS) And your first question will come from the line of Bob Cornell with Lehman Brothers.

Thanks.

And it was a good quarter.

Kirk, you mentioned the strong close of the year.

I just wondered if you'd comment on the track through this particular quarter.

Was the business collectively gaining momentum as you did the quarter?

Or were their months up and down?

Well, Bob, going into EPG, of course we decided to take up the guidance and put a couple of cents on the estimates.

So April was good and solid.

We had a little bit of an issue with the SAP go live with Bussmann.

We talked about that in the first quarter.

And as we expected, April was down there, but May came in reasonably good and we gained momentum.

And June finished very strong for the quarter, Bob.

Yes, sounds like it.

Obviously you mentioned all of the end market macros, that type of thing.

I get that picture.

But just flesh out the idea about the strong close of the year, in particular, is there anything out there you want to point to to give us some visibility?

Well, clearly, the international continues very, very strong.

We saw orders, as I said strong on a number of our businesses, Crouse had a very strong quarter.

The European business was particularly strong.

Really, the part of the industrial market that we play, a little bit of automotive was soft, of course.

But in the spaces we plan in industrial market solid and strong, I said the utility business while we saw little weakness on the single phase pull them out, pad them down, we saw great growth in the C&I, the reliability products, and the international products which more than offset that softness.

So we're continued to be a positive there.

And I think this nonresidential, I know a lot of you are cautious, but it still continues to firm and gain momentum.

I think we'll see a strong back half to the nonres side.

That mix, your guidance -- you say revenues are 10 to 13%, but you're running 13% so far in the first half.

A strong back half.

There's no way you're going to get to 10.

Maybe Terry, I'll take you off the hook and let Terry comment on the 10 to 13 for the year.

If you're 13 year to date and a strong second half.

Yes, Bob, on the revenue side of it, there's less currency in the back half of the year as we're forecasting it right now.

And there's less acquisition contribution.

So when you look at your pure core growth, it's pretty close to what we have in the first half of the year, which was very strong, especially on the energy and utility side.

One further question, I wasn't clear what you meant with regard to the tools outlook.

It sounds like the third quarter is going to be softer, and the fourth quarter strong, is that what you meant with regard to the assembly tool issue?

Right, we expect the third quarter as we mentioned in the press release to be down year-over-year.

We had a very strong third quarter in 2006.

Right.

2007 at this point we expect earnings to be down a little bit in that segment.

Which impacts clearly our earnings growth for the third quarter and then the fourth quarter we see it pick back up.

Got it.

Thank you, guys.

Thanks, Bob.

Your next question will come from the line of Nicole Parent.

Please proceed.

Good afternoon.

Hi, Nicole.

I guess, first, just you're getting some nice price realization, can you comment a little bit more on commodity cost escalations in what you're seeing there and what you're doing there?

It's a mixed bag, Nicole.

Some commodities as you've seen have come down.

But year-over-year, copper, transformer oil, and core electrical grade steel are up very significantly, which is -- those are the ones that are really impacting our net price and cost structure.

The rest of the commodities pretty much balance out.

They've been up and down a little bit.

But no big movements.

And do you have a year-over-year delta increase?

Well, right now price is running about half of our core revenue growth.

And that will decline as the year goes on simply because of the fact that a lot of the increase happened on copper in the first half of last year.

Okay.

I guess the next question is just the M&A environment.

You've been active.

Kirk, can you just remind us how big you want to go and what we should be thinking on that front?

We continue to see very interesting properties.

I think our experience has been the bigger the property, the higher the price goes very quickly.

And so we've been disciplined.

We're seeing -- we're looking at a lot of pieces.

We've probably got maybe $200 million of revenue that we should be able to close on between now and the back half of the year, although those are always dependent on not finding something unusual in the due diligence process.

A lot of the properties continue to be on the international front.

But there's not a shortage of interesting opportunities.

I think it just keeps coming back to this issue of being outbid the last minute on numerous occasions.

In some cases for premiums, Nicole, that are significantly more than we're willing to pay.

Sure.

Thanks.

And just one last one on new product, the new product initiative.

Where do you think the biggest opportunities are when you think about that from a revenue perspective?

Well, I think it's big across the board.

We're tracking our top 25, and I think we're pretty much on track with the majority of top 25.

We've been working on this net promoters score thing.

These are the issues that our Chief Marketing Officer has been championing for the last year now.

He's been on board a year and he's just getting to learn the business.

I think across the board, there's, every one of our businesses we're measuring the vitality index, we've been going out and doing strategies in the field.

Some of them bring products to market much quicker, obviously.

The lighting business.

The longer lead cycle businesses are the Crouse-Hinds and the power systems where it takes more of an adoption rate to get it into the market.

But overall, I'm very impressed with what the guys are doing organically.

And we've got some other things we're working on to stimulate our organic growth.

This international piece on organic growth is really paying dividends, obviously, as well.

Our timing was good, our people are executing well.

We've got very talented people in these remote locations.

And they're helping us drive our growth very, very well.

Thank you.

Thanks, Nicole.

Your next question comes from the line of Robert McCarthy with Bank of America Securities.

Please proceed.

Good morning, everyone.

Good morning.

First, on the corporate line, it looks like you did a pretty good job of driving some costs up there.

Should we think about a new run rate for the corporate line in terms of underlying costs going forward?

We're probably at the run rate, generally, the general quarter we'll run in the 22, 23 million.

Okay.

But historically it's been as high as 25.

It looks like your run rate is coming down pretty significantly there.

You would think about modeling 22, then?

Somewhere around that.

Okay.

And just in terms of your -- I think you highlighted on the call that your acquisition growth in this quarter was one of the greatest it's ever been in some time, it's about 4%.

Do you know what the underlying margins of those acquired businesses were for you?

And what do you expect in terms of margin lift going forward there as you continue to integrate them and take cost out?

Well, clearly in all of our models, Rob, you end up by year two or three we expect them to be at the average for the segment.

And usually for the business.

But sometimes some businesses are much higher margins.

I look at it generally from the incremental side of it.

In this quarter for incremental revenues, the ROS, return on sales on that was in the low double digits.

And so you'd expect that to improve significantly throughout the back half of the year into next?

Yes.

Okay.

And then on the aerospace side, in your tools and hardware segment, any kind of quantification of the growth you're seeing there just from the market or from your new product introductions?

Anything you can talk about there?

Well, it's interesting, Rob.

Boeing was the leading one there for a while, tooling up on a lot of the new products.

They're coming out with, obviously their orders have been very strong.

And as of late now, it's been more Airbus that's coming on strong.

Military is still very strong.

So I think overall it's going to continue to be an attractive end market for us.

Okay.

And then switching to utilities, obviously you're citing strong underlying demand there and you do have more of a long cycle business.

You may have already commented on your underlying book to bill there, but could you talk about what you're seeing there?

And another company out there, I think Valmont Industries, talked about the underlying propensity of investor-owned utilities start to spend particularly on more long cycle type stuff whereas I think WESCO highlighted the fact that in the quarter actually more of the short cycle MRO and distribution spend actually came down.

Could you talk about any kind of nuance you're seeing there in the composition of spending or whether it's coming your way?

Yes, I think what some of the distributors are seeing -- you've got to be careful if you're talking about a North American business or a global business.

Our strength was clearly on the reliability products, some of the global operations of that business, and some penetration and some new segments that we have not been historically focused on.

So we've been more of a utility, we're doing a better job on the commercial and industrial side.

And there haven't been any storms as of late.

And normally you'd expect to see those in the later part of the summer.

But yes, if you're doing just pure distribution or [Paul] hardware or some of the other products, you're going to see some softness in that and we're experiencing the same thing.

Rob, on that the other impact too has been the wet weather in certain parts of the country this year.

It's been very, very wet and hard for the utilities to get out.

But as you mentioned, we are more longer cycle make to order products.

So the only place we really see that to a great extent is on what I'll refer to as the shelf good side.

Understood.

And then switching over to lighting and lighting fixtures.

Are you seeing any kind of significant pickup in kind of energy efficiency retrofit activity, particularly among big box?

Well, if you're talking about big box in the ceiling, absolutely.

There's been a huge movement afoot on these (inaudible) products and energy efficient.

So a lot of companies now are looking at relamping distribution centers, warehouses.

The REITs have programs going on nationally to relamp their facilities with the higher energy costs.

That's a huge part of what's driving and going to continue to drive the growth of that business, absolutely.

Do you think you'll start to quantify or cal that out?

I know GE has started to call out that actually in some of its own earnings calls?

I don't know exactly what they're calling out.

But we could look and try to dissect that as it progresses.

The overall lighting business had a pretty good quarter.

The C&I was up nicely, retail, of course, resi was down and margins were up nicely.

And again, that space continues to be improving, I think on the lodging the government education offices.

There's been higher rents, lower vacancy rates.

So the overall macro look for the commercial or the nonresi portion of the economy still looks favorable to us.

Finally, just on capital structure.

What -- I know you've talked about this before, but what do you think could be ideal capital structure given relatively large acquisition?

How much could you bear in terms of net debt to cap ratio?

Clearly, we could go up to 40%, probably 45, maybe even higher than that for a short period of time.

All right.

Congratulations on a great quarter.

Thanks, Rob.

Your next question will come from the line of Jeff Sprague with Citigroup.

Please proceed.

Hello, everyone.

Thank you.

Hey, Jeff.

Hey, just a couple things.

First on utility.

So did you build backlog in the quarter?

Is that one of the businesses where orders exceeded sales?

Right at book to bill one, just about.

And can you give us a little update on how the whole kind of energy automation systems business did the Cannon business and what are the current developments there in the quarter?

Good, we continue to integrate Cybectec.

We're ahead of our acquisition model.

And I don't know, Terry, do you have anything else to say?

No, it's -- the business is growing faster than we had anticipated in the acquisition models.

The number of opportunities out there is growing -- has grown substantially.

So we're very optimistic as that business develops over the next year or two.

And then, Terry, on this tax settlement and everything, does this in any way change how you accrue for the going forward having this behind you?

Or are we still just kind of on the same trajectory that we think about the 35% on the incremental and we just kind of glide a little higher over time on the tax rate?

No, it really -- these all were very nonrecurring type items.

Really don't impact the longer term of any sustainable amount.

Your comment was right, Jeff.

That's the assumption you ought to make.

Then on, just thinking about tools, are you guys completely out of the assembly tool business effectively by the time you're through Q4?

In the U.S.

we were never in the full line assembly business, we were always making the substations or the spindles, or these parts of it..

Stations.

Stations.

And in Europe we've taken on the burden of doing these whole lines.

And I think the latest thought is we want to minimize our participation on the long full lines and do the same thing we do here, which is the stations and the spindles and some of the ancillary pieces of the whole line.

I think that's -- we have a better chance of being able to be more accurate in our estimates and quoting and all those other things.

It's always been a margin issue.

It's not a huge part of the the business.

But it's just been a nuisance for us.

The volume side of the dollar value of it continues to decline, Jeff.

But these -- some of these contracts have three phases or more phases than three sometimes to them.

And so that business on the long, large, or the large projects actually will extend out into 2008.

And just one final one on utility.

If I think about kind of the range of products and equipment that you sell in the U.S., what percent of that offering is available in global markets?

In other words, you have half your product line now available.

And what international markets really were driving the business in the quarter?

We are looking to expand our offering of course around the world of the products that we don't have the global standard in their, the IEC type of standard, right.

Our transformer portfolio, Jeff, is a domestic offering, right?

And so the capacitors and some of the other reliability type of products are more international in nature.

If we sat down and kind of took you through the China strategy, what we're trying to do is bite off either acquisitions or organic investments that expand our local manufacturing capability.

So we don't have to ship so much product around the world.

Same with South America and same with Europe.

So that's part of the expansion plan as we look to globalize that business.

Right now, Jeff, we run -- we're improving, it's growing but it's a little bit over 20% of our revenue come off from international in the power systems business.

And as I said, that's growing and as Kirk mentioned, a lot of that is in capacitors we're building out an IEC connector business there.

It depends on the standards around the world, which tend to be different in every country.

Some of them still use even North American standards.

Thank you very much.

Thanks, Jeff.

Your next question comes from the line of Deane Dray with Goldman Sachs.

Please proceed.

Thank you.

Question just to follow-up on the China question.

I believe you said it was 60% growth in the quarter.

So I think we can characterize that as hypergrowth.

And what types of management challenges is that posing for Cooper today?

What types of investments do you need to make to get to capture your fair share of this opportunity, partnerships, acquisitions and so forth?

So right, we probably oversized, Deane, having lived out there, we probably oversized our initial team given the revenue that we had two or three years ago.

We put in the tech center, we got the VP, the finance, we've got the Corporate overhead in place.

And so, I don't think we struggle much at all managing this kind of growth because of the way we sized and scaled it.

Now, the people side of it always becomes a challenge.

You have a higher turnover on the higher educated engineers and management talent.

But I think we do a very good job there.

And the acquisitions are challenging.

Because there's no large properties, per se in any of the markets that we're looking at.

We did do that Bussmann fuse acquisition, we bought the largest electrical fuse company over there, which was still less than 20 million in revenue.

But building out the sales forces, building out your geographic presence, and finding substantive acquisitions that give you size and scale for the hassle, for the effort of negotiating a contract and doing all your due diligence, I would say is the biggest challenge.

Is China ahead of plan so far this year?

Oh, yes.

Yes, I think our overall international, we're still seeing great strength in South America.

It's pretty broad our growth there.

Those Middle East and China, we call it the greater China, which includes Hong Kong and Taiwan.

But very, very strong.

Korea's very strong.

Really across the board, Deane.

Well, I believe you said Middle East was up 70% last quarter.

That also fits that hypergrowth mode.

If we can just go into a more mundane topic if we could on asbestos.

It's our view, it shouldn't matter for the stock whether you end up plan A or plan B, but it does matter for cash flow.

And what might there be in terms of is there any question if it does end up being plan B whether you end up in that whether that 138 million might be challenged in any way.

Well, the way the agreement is set up, it's pretty hard for somebody to challenge the 138 without Federal Moguls restarting their bankruptcy process.

That was part of the negotiation we went through.

We gave up our right to object to the confirmation hearing, Deane, as part of that plan, B right?

Correct.

If they denied plan B and denied plan A, they would basically have no ability to come out of bankruptcy and have to start the whole process and renegotiate with us all over again.

So it does work out to plan B, would you be willing to explore some of these new capital market solutions for long-term indemnification?

Is that a potential scenario?

Yes.

Ever since we've gone public with this, right, there's been a number of insurance companies and other people with different schemes to come to us and suggest for what you're paying for plan A, here's what we can do.

Of course we look and listen, but while we're going through the process, there's no reason to entertain any of that in a serious way until we really understand where we are.

And I'm sort of with you on this, Deane.

If we picked up $138 million, kept our insurance, we're much more sophisticated at managing this liability today than we've ever been.

And I think we could be fine either way, here.

And your plans are stable.

I would agree.

Thank you.

The thing is we've just gotten so much better at this.

We never thought we'd be at this for as long as we have been.

We're litigating a lot of the frivolous cases.

We've got better legal representation in the field.

We understand it, we've got a better understanding of our insurance policies.

And so I think we're in pretty good shape on this now.

I never thought I'd say that, but experience is a good teacher, I guess.

We'd agree.

Thank you.

Your next question will come from the line of Alex Rygiel, with FBR.

Please proceed.

Thank you and good morning, gentlemen.

Morning.

Two quick questions.

First on the utility side, can you talk a little bit about where you stand from a capacity utilization standpoint?

And I know you mentioned adding some capacity over in Asia, are you also adding capacity domestically?

And then secondly on that topic, are you witnessing any increasing competition from Asian competitors due to the very long lead times that you're seeing right now?

The answer on the capacity is yes.

In fact, in our capital plan this year, almost all of the increase in CapEx that we have forecasted is for Cooper power systems.

And the majority of that investment is domestically.

The challenge that they have had is like in any other technical businesses, just finding the engineers and the people capable of putting that capital to the work fast enough.

That's been the one issue.

With that said, though, we continue to add in other locations both in South America, Mexico, and Asia.

Your second question was interesting, we were out with some customers several months back.

And they did mention that they are buying some Korean power transformers.

Now, of course we're not in that business due to the large, very long lead hard to get type of transformers.

But I was surprised to hear that.

We've not seen anything on the distribution side.

But these are very expensive, very large, and like I said very long lead time items now.

So one of the customers did tell us that they have evaluated and are accepting Korea-made power transformers.

Thanks.

And then my second question, as it relates to your marginal improvement through the years, you've obviously been working through a number of different cost savings initiatives, as we stand here today what is your number one or number two most important internal initiatives that you think over the next 12 to 18 months is going to internally generate the most cost savings opportunities?

So you're focused on just cost, you don't want to talk about growth; is that correct?

That's correct.

Well, I think there's two.

The productivity piece while you guys think we've been at it for a while.

Having come out of the GE background and having just hired this woman to be our Vice President of Operations at the Corporate level and she had 17 years with Honeywell, it's pretty clear that we're barely in the early innings of that.

There's lean opportunity.

We just had Cooper U do a presentation to the senior management staff about our distribution centers.

They went and toured a bunch of our distribution centers and we went and toured a bunch of world class distribution centers and they came back with significant opportunities for us to drive out costs and improve efficiencies on that side of things.

I think there's a whole big continuous improvement that we can still get on cost of goods sold, variable cost productivity.

And on the SG&A, I think we'll continue to lever that up, as well.

We've been pretty generous in the money that we've spent.

I think SAP is going to continue to give more productivity tools to us.

The majority of our businesses now have gone live on the system, Bussmann was the last one.

And again you can see the lights dim in the month of April, come back nicely the following.

June closed very strong.

That's the last of the large installations that we have to do.

And I can't tell you -- you guys know maybe better than I do how cumbersome and time-consuming and the amount of lost productivity you go through on those large conversions.

Terry, do you have anything else you want to add?

No, I agree with Kirk, we are in the infancy of opportunity on the operations side of it.

Lots of opportunity for additional cost.

And quite frankly, that was our strategy.

We started out with what we called MVP, get people trained, projects, now we've piloted some lean factories moving into the S&OP process across the organization as well as into the distribution now that we have the EBS system in place.

That's perfect.

Thank you very much.

Thank you.

Your next question comes from the line of Christopher Glynn with CIBC World Markets.

Please proceed.

Thank you.

Good afternoon.

Hey, Chris.

On the nonres growth, I was wondering if you could talk a little bit about what the pure, if you have a sense of what the pure unit volume growth was on that side of things as well as the influence of the easy comps lighting?

And when those easy comps kind of circle back around?

The easy comps at lighting?

Wow.

The retail business, I don't think had such easy comps.

And on the C&I side, we're getting out and doing a better job on service and capturing our fair share.

That's a pretty easy segment to look at on peers.

Because a number of those peers are publicly traded companies.

And you get a pretty good look on what's going on out there.

Terry, do you have a comment on the split between volume and price on the lighting?

Just for C&I maybe?

Pardon?

Just for C&I, really.

Oh, for C&I, nice price realization on C&I, volume up nicely on it, project bids, building momentum there.

We've got pretty good outlook into the fourth quarter on that and it's looking pretty good.

I think the pricing environment overall on the lighting space has gotten better over the last year, as well.

We're going out with another increase.

I think the market has been a little bit more accepting of the increases because of the increases on raw material, as well.

So the C&I, that's why Kirk had mentioned we see a little bit of momentum building as the year progresses on the C&I side.

The tough area is the residential side, clearly.

That has continued to get a little more challenging as the year goes on.

Okay.

And then overall, within lighting, could you talk about your mix between the project business and stock and flow?

I really don't have a lot of stats on that Chris.

We can see -- the Halo product line is traditionally a residential line.

It goes through both the retail channel and it goes through the C&I channel, as well.

So we have pretty good information about that was negatively impacted.

And of course that's directly the Florida market, the California market, the Arizona market.

But I don't have any specific numbers in front of me.

Okay.

And then just finally, you've articulated some margin targets with time unspecified, 18% at electrical, talking about being in the infancy of the productivity initiatives.

Seems like you could probably do that in '08.

And then the 14% in tools and hardware, you're a little lumpier there.

How different is your visibility on getting to those targets between the two segments, would you say?

No, I think you're right.

Right now the electrical is getting the core volume and we've got better predictability.

The industrial markets are firming.

The tools business just has some softer pockets.

It's got a heavier piece on that automotive.

Whether it's the U.S.

or global automotive markets.

They're doing a better job penetrating Europe and Asia so they'll get some more stability and more diversity there.

This one piece in Germany has been sort of the the Achilles heel of some of the continuous margin expansions.

But overall, we're still very pleased with the margin.

The other issue you've got to be careful of is as we continue to press the inventory where we've had some of the worst inventory turns, obviously that has an affect on your margins, right.

Because you get less volume for your factories and you have a harder time driving productivity.

So I think that's the other issue.

You got almost sort of a double combination of pieces there going on.

You're trying to get the inventory out, at the same time you're trying to maximize your margins.

They do a very good job on productivity.

The U.S.

tools business, the Weller business, the Chain business, all showing substantive improvements.

But again, I'd rather have the cash than the margin.

We'd always rather error on the side of taking the hit on the factory variances and driving the cash out of the business.

Great.

Very helpful.

Thanks a lot.

Thank you.

Ladies and gentlemen, in consideration of the time, our final question will come from the line of Bob Cornell with Lehman Brothers.

Please proceed.

I hope it's worth it.

You're start and end.

You're the bookends, I guess, Bob, today.

Well, just remind me, you talked about the Belden gain and then the offset.

Just remind me what it is that contributes to the Belden gain.

And then are we looking at further increments in the second half and next year?

Well, the Belden gain our income is -- when we spun off Belden we stepped up their tax basis and entered into an agreement as part of the spinoff that they had to pay us 90% of the gain or the taxes that they recouped from the government.

So it's totally -- the payment is totally contingent upon how much taxable income that Belden has.

And it's more complicated than that, Bob, because it gets into how much of it relates to the original business versus they've gone through several mergers and acquisitions.

These increments seem to come irregularly.

Is it likely that we'll have something in the second half of this year in '08?

At this point, I would say it is likely.

But we are at the stage where we book those when we are going to get the cash.

And that's one of the reasons why you're talking about corporate being a little lower than maybe previously we had modeled?

I don't build that into any of the guidance we give, Bob.

A final comment then is, every question got asked except for the inversion question, the tax rate.

Have you guys been able to begin tax planning such if the inversion issue finally does land on a bill that you'll be able to deal with it in any sort of expeditious way?

We have continuing efforts in that regard.

And have started some initiatives across the world to drive it down.

But that's still in early stages.

And the other issue, Bob, is we have made our point now very clear to a number of senators and a number of congressmen that retroactive legislation is poor policy.

And I could take you through all of the details.

We've hired a lobbyist, we've met with all of the senators and congressmen from our districts where we have large facilities, we've leveraged our voice in D.C.

on this issue and we obviously pushed it back on the minimum wage bill.

And there's been some other discussions.

But it's just bad policy.

I know.

Thanks very much.

Thank you.

I would now like to turn the presentation back over to management for any closing remarks.

Okay.

As we conclude this call, let me remind our listeners that they may follow-up with me for additional questions or clarifications either later today or any other day.

With that, thank you for joining us today.

Ladies and gentlemen, this concludes your presentation.

You may now disconnect and have a great day.