伊頓 (ETN) 2010 Q4 法說會逐字稿

(Operator instructions) I would like to turn this conference over to your host, Mr.

Don Bullock, Vice President, Investor Relations.

Please go ahead.

Good morning.

I'm Don Bullock, Vice President of Investor Relations.

Welcome to Eaton's fourth quarter and full year 2010 earnings conference call.

Joining me 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 our conference call today will include forward-looking statements concerning the first quarter 2011 and full year 2011 net income per share and operating earnings per share.

Full year 2011 revenues, our world wide 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 reminder, we have included a presentation on fourth quarter results which can be accessed on the Investor Relations web page.

Additional financial information is available in today's press release, which is located on Eaton's home page at www.Eaton.com.

I'll turn it over to Sandy Cutler.

Thanks, Don.

I am going to work off the presentation, which we have out on our web page.

So my hope is that you have accessed that at this point.

Let me turn to the chart number three, Don has just covered the forward-looking statements with you.

This is a chart titled highlights of the fourth quarter results.

In short, we had an outstanding quarter, operating earnings of $1.69, net income of $1.63, our sales were up some 17%, our operating cash flow was $555 million for the fourth quarter and we did reach $1.3 billion for the full year.

We had record segment operating margins in the fourth quarter which is really notable of 13.7% and significantly, those operating margins, or operating profits represented a 31% incremental from a year ago in the fourth quarter when not including acquisitions.

We also had, as you see, quarter to quarter sequential margin expansion, moving up from the 13.4% of the third quarter to the 13.7% of the fourth quarter.And when you step back and look at the year increase of the whole year, revenues, they were up some 16%, as we noted in our press release.

Our sales increase in developing countries where you know we have been putting quite a point of emphasis, were up some 30%, we are really pleased we also exceeded the goal we set some five years ago for our goals in China, -- our sales in China and our sales in China in 2010 reached $1.1 billion.

If we turn to the second chart, it really is a reflection of our own confidence in terms of the forward-looking environment at this point.

We are increasing our dividend, and also splitting our stock, you saw this morning our intent to raise the dividend from 17% from $0.58 per share to $0.68 per share.

The stock will be split two for one, and the record date for both these actions is February 7 of this year.

And for those of you who have been following our dividend progression, if you look at the increase that we had last July of 2010 and now again in February of 2011, in this short time period we will have increased our dividend from $0.50 per share to $0.68 per share, a 36% increase and I think you'll all note that we did not cut our dividend in 2009.

We turn to the third chart, comparison to fourth quarter guidance a quick reconciliation versus the mid-point of the guidance we gave you for the fourth quarter was $1.60, operating earnings per share.

We did have higher end markets in the fourth quarter.

And the good news is we think the momentum is carrying into 2011 and it is virtually across-the-board in our businesses and our geographies, and that contributed about $0.16.

The R&E tax credit passed in December contributed a positive $0.08.

We had a slightly lower tax rate that was $0.01.

We noted in our press release that we took a provision for a Brazilian lawsuit and I'll comment on that in just a moment in the fourth quarter.

That is a negative $0.15, and our shares were up just slightly, costing us about $0.01, and that's primarily due to option exercises during the fourth quarter.So that is the reconciliation of $1.60 to $1.69.

We think a really strong operating quarter.

If we turn to the next chart, which is titled normalized fourth quarter results, to give you a better insight into the run rate, because there were a number of different items that as I just mentioned that went a number of different directions in the fourth quarter, I think a simple way to think about this from a operating perspective is that we reported the fourth quarter operating EPS of $1.69.

The Brazilian lawsuit and this was a provision we decided to take.

A Brazilian court held that a judgment against a Brazilian company that we sold in 2006 could be enforced against Eaton, we are appealing that decision but nonetheless took the provision in the fourth quarter, that would add back $0.15, obviously, because it was what we would call a nonrecurring item in that respect.

Then the R&E tax credit because it was passed in the fourth quarter, the full year R&E tax credit was recorded in the fourth quarter.

If you took that $0.08, split it up by the quarters, it would say that approximately $0.06 really pertained to activities in the first through the third quarter.

So we in this reconciliation deducted $0.06.

A long way of saying is that we think the operated -- the adjusted fourth quarter operating EPS to give you a feel of the run rate of the business was $1.78 versus the $1.60 guidance that we provided, again why you can understand why we feel it was really an outstanding quarter.

Just a quick run through the individual segments, if you turn to chart seven, the financial summary, I think the big take away on this chart, we highlighted it in our earnings release, is that our segment operating margin at 13.7% was an all time record.

Really pleased here in the fourth quarter to achieve that.

On sales that were up just about 2% from the third quarter, I think you've seen all the rest of the data on this chart, so to be respectful of people's time, I'm going to move to the individual segments, if we can move to chart eight.

Chart eight is the electrical America segment, really an outstanding quarter.

Operating margins of 16.1%, sales were up about 5% from the third quarter, so good growth, sequentially from the third quarter.

The margins are back at mid 2009 levels in a year, you remember where this market is not at peak levels yet, and we will be seeing this market grow next year as nonresidential.

The decline in nonresidential begins to see and we are hopeful we'll see by mid-year this market flatten out and perhaps show some growth in the second half next year.

Fourth quarter bookings up 14%, really solid momentum.

And we did, you recall going back a year and a half ago, we announced that we would to expect to book about $500 million in bookings that related to the US stimulus program.

We actually ended up $516 million, so we reached our goal in that regard.

Very solid outgrowth as you can see again, continuing the momentum.

You can see the impact of the several small acquisitions that we have done this year contributing about 5 points to growth.

If we turned to chart nine, this is the chart for electrical rest of world.

Sales up about 8.5% from the third quarter,12.2% margin.

A record fourth quarter sales in operating profits.

As this business continues to accelerate and really pleased with the margin performance here.

Bookings up some 10% in the segment.

Return to chart ten, Hydraulic segment.

Sales down just slightly in the fourth quarter.

Fairly normal, seasonal pattern for us, they are up about 2% in the fourth quarter versus the third quarter.

Margins of 12.8%.

You can see that the strong markets that continue in this area and we did not note it on this chart, but we did note it in our press release that our bookings were up some 41% in the quarter.

Really completing four extraordinary quarters of recovery in bookings reflecting the V snap back in this market.I would point out however, though, that if we think about the very strong bookings over 100% that we had in the first quarter of this year, the comparables going forward won't have quite this V snap back nature.

So it's been a really great year this year.

But as you'll see our guidance for next year is not quite at the level that we experienced during 2010, in terms of growth.

We are very pleased to have closed Tuthill Couplings acquisition on January 1, and I really feel we came through a very strong quarter in our hydraulics business.

If we turn to chart eleven, that is the Aerospace segment, sales up about 2.5% from the third quarter.

As you can see, they were up 5% from a year ago.

Fourth quarter bookings up 36% and continuing the trend we have been talking to you about since mid-year of 2010, after market bookings were up 9% helping to drive as you can see, that stronger operating margin now up 16% in the fourth quarter.

If we turn to the truck segment, which is chart 12, sales up some 17% from a year ago.

Off just slightly, about 3% from the third quarter.

Again that is a pretty normal seasonal in the business.

Very pleased with the 12.7% margin and I would note that we elected to record about $6 million of nonrecurring operating expenses in the fourth quarter.

They are not related to the ramp up.

And so that margin would be slightly stronger on a run rate basis.

Markets are accelerating, and what we are particularly pleased about is we really are now starting to see the evidence of the recovery in the North American heavy duty truck market.

You saw the orders in the fourth quarter were over 70,000 units.

We think we are starting to get the rate of ramp that we need to support our forecast for 2011.

If we turn to chart thirteen, Automotive segment, sales up some 9% from a year ago.

About 1% from the third quarter.

Very solid margins, 10.9%.

Really strong record of wins in 2010, that we are really pleased with, with a couple of our really distinctive products that are going to drive even stronger growth in the twelve-thirteen time period as we begin to launch those new platforms.

Now if we turn to cash flow, which is on page 14, a very strong quarter of cash flow.

$555 million operating cash flow, we spent $186 million in terms of capital expenditures, so $369 million in free cash flow.

You'll see on the 2010 full year, we basically hit the targets that we had set out in that area and are expecting even stronger cash flow in 2011.

$1.6 billion to $1.7 billion operating cash flow.

Capital expenditures will be up some 40% year to year, part of that obviously is the recovery from the depressed levels in the first half of 2010 and all of 2009.

And if you actually look at our capital expenditure run rate in the second half of 2010, it basically equates to what we will be spending in 2011.

The free cash flow of $1.05 billion to $1.15 billion, so strong, strong expectations.

If we turn to chart fifteen, we expect margin expansion in spite of commodity pressures.

If you look down each of these the guidance we are providing you in terms of the individual segments, we expect the Electrical Americas business to be up to 15%, Electrical Rest of World 12%, Hydraulics 14.5%, Aerospace 15%, Trucks 16%, Automotive 11%, Overall 14%, for a 1.3 point expansion of our margins in 2011 versus 2010.

We do and I will come back and mention this on later charts, expect that we are going to see about $35 million of uncovered commodity expense.

What I mean by that is, that those expenses have moved up very quickly or those costs in the December time period.

We would expect that we cannot fully recover about $35 million, that will be primarily in the first half, as our actions catch up with them.

I'll detail that more in just a moment.

If we turn to chart 16, a look at our 2011 end market growth, I am not going to go through the individual US and non-US growth columns, I'm going to concentrate just on the total but we provided the information for your background.

We expect the Electrical Americas market index to be up about 6%, Electrical Rest of World 7%, Hydraulics 12%, Aerospace 12%, Truck 20%, Automotive 6%, Overall 8%.

What is really significant about this is we began to talk about this in the third quarter.

We expected the markets for all six of our segments to be up in 2011.

Naturally what is going to power this very strong growth in profits I'll speak to you about on the next chart, if we turn to chart seventeen.

Our guidance for operating earnings per share, full year $7 to $7.60 with a mid-point of $7.30, a 30% increase over our achievement in 2010.

First quarter $1.50 to $1.60 mid-point of $1.55.

I'll let you simply read the guidance in terms of the net income as well.

If we flip to chart 18, a quick look at a guidance bridge, to help you understand our guidance in a little bit more depth.

We finished 2010 at $5.61.

We expect our end markets, as I mentioned to go up by about 8%, we're using a 33% incremental margin.

Obviously the middle of our range, the 30% to 35% incrementals that we quote.

$450 million of outgrowth again at a 33% margin that gives you the $1.91 and the $0.78.

We are reconciling back the charge provision we took in the fourth quarter for the Brazilian lawsuit after tax of $0.15.

And then we -- as we mentioned in our press release, we have got about $160 million of incremental revenues from acquisitions we completed, and this is the full year impact, incremental impact in 2011 over 2010 that contributes about $0.08, so overall about $2.92 of positive items.

On the other side, the negatives, a higher tax rate for the year.

We are estimating about a 16% tax rate.

That compares to a lower rate in 2010, thus the negative $0.48.

An increase in pension expense that will cost us about $0.22.

The unrecovered commodity cost that is the $35 million, I mentioned just a moment ago, that is about $0.18 and again, that will occur primarily in the first half.

Increase in the number of shares outstanding about a $0.10 negative.

Other corporate expense charges and this is primarily healthcare and additional corporate expenses that we are investing in developing countries where we are growing very, very quickly.

So a total negative was $1.23 you net those out, and that is how we get the $7.30, the mid-point of our guidance for next year.

If you turn to chart 19, a quick look at reconciling fourth quarter strong results to our first quarter guidance, you recall we finished the fourth quarter $1.69.

Let's take back out the provision for the Brazilian lawsuit of $0.15.

A higher tax rate about 14% is where we think we will be in the first half, in the second half we think we are going to be closer to about 17% to 18%.

That is how you get the overall 16% rate for the year.

But for this calculation, here for the first quarter, we are assuming 14%.

And that is versus about a 6% rate in the fourth quarter.

And the way you get to the 6% is that you saw that our rate was 3.3%.

The impact of the Brazilian provision which was an expense, reduced our rate by about 3 points.

So you add those two together and you get 6%.

That is how you do the 14% to 16% comparison in this calculation, that's a negative $0.14.

Lower seasonal volume, which is our norm, that our first quarter is a little lower in terms of seasonal volume and the primary contributor that as our electrical business.

It is always the weakest quarter for electrical business.

That is on the order of about $50 million, that takes off about $0.08.

Higher pension, this is one quarter of the $0.22 annual higher pension costs.

That higher number shares $0.01.

That is how you move from the $1.69 to the $1.55.

That's the mid-point of our guidance for our 2011 first quarter.

We move to chart twenty.

In summary, what we are forecasting is, what we are giving in terms of guidance is that our 2011 sales will increase by about 12%.

That does take us up to right at record volumes that we achieved in 2008.

But that our change in operating EPS reflecting the leverage of continuing to increase margins will be up 30%.

And so summary on chart 21, we tried to give you a quick summary of the key elements that underpin our guidance.

The market growth of 8%, the market outgrowth which is $450 million or about 3%, the acquisition revenue of $160 million, which is 1%, so again, the way we get to our 12% growth, is 8% market outgrowth -- market growth, 3% market outgrowth and 1% acquisition revenue.

Our tax rate, 15% to 17%, a mid-point of 16%, for the year.

Again, 14% in the first half, 17% to 18% in the second half.

I have already spoken about the operating EPS and the fully diluted EPS guidance.

And our operating cash flow, as you can see, up very handsomely, both on an operating and free cash flow basis from 2010 to 2011.

So with that, we will open things up for questions, before I do so, I think you'll recognize the different voice introducing today's call.

Obviously Don Bullock has taken over this call.

But before we continue with the call, I just want to recognize the many years that Bill Hartman has been in that chair.

He is here with us today but we have him sitting in the second chair.

Bill, we want to recognize for all your years of service and contribution, thank you.

Thank you.

Moving to our first question.

(Operator instructions).

Mr.

Boland, your line is open.

Hello, good morning.

Good morning.

Great.

Hi, everybody.

So, that was a quick transition there.

Thank you, Bill, for me as well.

The question, I guess I had a couple of real quick ones there, just, as I look at your guidance, I guess the thing that kind of strikes me is aerospace, I had looked for slightly larger margin.

I'm wondering if that is just maybe a mixed shift toward more OE, or maybe Sandy, you can peel back the onion a little, and give us what is going on below the surface there.

Well, the volume, we are talking about the market being up some 4% there.

And, it's -- I think you are seeing very different dynamics between the defense side of the business and the commercial side.

I think many of us have been commenting on the very positive or focusing on the very positive trends that are occurring on commercial.

The after markets I mentioned continue to turn up, but there is pressure on the defense side.

So, our 4% anticipates continued pressure on the defense side and also that we continue to carry a very high level of recent year wins, which means we have high levels of development expense.

So, if we were seeing that military side also be strong, I would be in your camp thinking the same might go up further.

But, at this point, we are just a little cautious about the winds that are blowing on the defense side.

And is that the way to think about it, for the medium term as well, for the next two or three years?

I think we are going to be viewing defense as an area that is very muted growth.

Going to depend a lot on which platforms you are on.

The stronger growth as we're talking about, not only in 2011 but some of the line rate increases, particularly on the single aisle side of the market will hit out toward the end of 2011 and going into 2012.

So, that, I think the commercial side may actually be a little stronger out toward the end of the year and the early part of next year.

Okay, great.

Slightly switching gears, you guys have done some tuck in acquisitions here.

Your balance sheet is in pretty good shape.

Could you just talk about your appetite for larger acquisitions?

There's obviously been some speculation in the press and just in terms of your philosophy, Sandy?

Yes, well, let me start, and say that your observation is correct, that our balance sheet is in very good shape, and that we obviously have the capacity to do acquisitions, We obviously felt comfortable significantly increasing our acquisition -- excuse me, our dividend by another 17%.

We have done a company of small acquisitions recently.

In our third quarter conference call we commented that we are back at what I call a more normal level of acquisition investigation at this point.

It is always hard to say whether you're going to have singles, doubles, triples or something larger.

Most of our deals tend to be relatively small.

But you've seen us do our deals with Phoenix Tech, with Moeller, with Powerware.

You can go on down the list.I wouldn't take it off the table but I wouldn't say that's necessarily going to be where we will end up.

I think you can see us returning to an appetite we've historically talked about, trying to add something on the order of $0.5 million dollars to sales through our acquisitions.

That's pretty much what we were averaging before the market went in the tank.

Great.

That is helpful.

Thanks.

Thank you, Steven.

Moving on to our next question, Jamie Cook.

Good morning.

Congratulations.

Good morning.

Quick question.

Just a little more color on the material cost issue that you cited.

Can you just talk about which segments in particular that they are hitting more and how we think about incrementals in the first half of the year versus back half?

Given more first half loaded and, by the back half, are we recovering it, I guess?

Let me answer the second part if I could, Jamie, of your question first.

Our assumption is that we have announced price increases in a number of our businesses, we are working on alternative material substitution, as well.

What really, I think, has surprised many people, was the enormous acceleration that took place at the very end of November and December.

And, it usually will take some time for people to kind of catch up to that fast a spike.

And, so, we can't forecast this with any accounting precision, it is our expectation it will take us a quarter or a little longer than that to fully digest all this.

So, we would expect these 33% incrementals that I mentioned for the full year, we should be getting all that in the second quarter or second half.

We may have a little pressure here in the first half, and that's what we will be working our way through.

Clearly, copper is one of those that has moved very quickly, as has silver.

There is pressure out there, in and around steel, as well.

Copper and silver tend to be used more intensively in our electrical businesses than they are in the other businesses.

But, still, we tend to use a lot in all of our businesses.

Okay.

So, so more electrical and, I guess, are we passing through price increases or surcharges as well, to -- in case they continue to rise, so we don't have the same catch up issue all year?

Yes, so, again, we would review that sort of competitive decisions we'll make as we go forward in each of our businesses.

The net pricing, a lot of our pricing is also transactional pricing, we are bidding on projects on a daily basis.

Some of that is just done in terms of how you set your pricing on a daily basis.

Okay, and then this follow-up question.

Just --Parker was one of the companies to report out of the gate.

They talked about you know, sort of the developed world coming back at a quicker pace than they had originally anticipated.

I'm wondering if you're seeing the same thing in any of your businesses?

And, are you experiencing any issues on supply chain or operating inefficiencies?

I think we mentioned in the third quarter, Jamie, that Europe -- that the northern part of Europe had done much better in terms of demand in that machine tools demand important for us, both in our electrical and hydraulics business.

That trend has continued and I think you are seeing it in all the macro data as well.

The US economy in the fourth quarter was clearly stronger than we and others anticipated it might be.

That's been helpful, as well.

Having said that, the growth that continues to be highly attractive in the developing countries as well for us.

In a year when we were mid-teens, overall sales increase, for the world, as I mentioned, before increase in the developing nations was up some 30%.

I don't think it's either or, it is really a dual driver, for both of us.

On your supply chain issues, again, we mentioned in the second and again in the third quarter, that we were concerned about supply of electronic components.

I think you're hearing that in a lot of sectors right now.

It has gotten a little better than it was during the middle of this last year.

But, we still think that that's going to be an area that's going to be tight through the first half of 2011.

Okay, great.

Thanks.

I'll get back in queue.

Our next question is from Ann Duignan.

Good morning, guys.

Same sentiment to Bill Hartman.

Sorry, we missed you this morning.

I guess, Sandy, a couple of my questions have already been answered.

But, I'm interested in your outlook for Brazil in particular, both on highway and off highway.

Yes, it's been a torrid market.

I think you would have to describe it during 2010.

Our thinking is that you'll see the activities stay up at a pretty high level but the best forecast for sort of the Ag market is that it is going to be flat to off on the order of about 2%.

And, that seems to us to be kind of a reasonable expectation at this point.

You know when they took off the tax incentive for vehicles, excuse me, light vehicles, to be precise, you saw some sag in that last year.

And, the market has sort of digested that as we've gone through this year.

We don't think there is going to be a drop in the light vehicle market, per se.

And, so, we think the bigger flatness really occurs out there, in terms of the Ag and construction equipment.

Okay, that's helpful.

And, then, on your outlook for 30% to 35% incrementals.

I appreciate that's your normalized outlook.

With the combination of the automotive and truck business, into one operating unit and Ken Davis leading that organization, why wouldn't we expect higher incrementals out of that business, going forward, just given all the costs energy.

You have that big pop in 2009 and 2010, where we have a lot of the benefits and now we are doing incremental up off the top of that, at this point.

And, so, I think the structural, the big pop we actually saw occur at this point.

Okay.

So, more -- we should look for more maybe incremental revenue synergies rather than cost synergies, is that the way to think about it going forward?

I think we have gotten structural pieces now.

What we're really pleased about is I mentioned some of the large wins we had that we'll drop into the automotive segment at this point.

I think the rollout of new product and the fact that particularly the truck market will start to strengthen.

You're going to see that top line grow more quickly than we've seen over the last couple of years.

Our forecast, I didn't mention it specifically, but our forecast for the heavy duty market here in North America this year is about 240,000 units.

So, for all the discussions we have had, with many people of this last year, when we get to $1.50, actually the market did get to just a little bit over $1.50 in 2010.

And, we have been talking about a figure that might be in this $2.30 to $2.50 range.

$2.40 is what we are comfortable at this point, and having had the 72,000 orders come in the fourth quarter, we're really feeling like that backlog is in place to have that occur now in 2011.

And, since we're on that outlook, just one final quick one.

Your outlook for hybrids?

The hybrid markets, I would say, has not grown as quickly as we might have hoped.

I think there are a number of different reasons for that.

We've had fluctuations in fuel prices up and down, up and down.

There have been some availability issues in and around batteries, and, frankly, the fastest growing markets have been in some of the developing nations where the governments have gotten involved in putting incentives together to really drive municipal and city bus activity.

The intraplay of electric vehicles and hybrid vehicles here in the US, the market's not growing as quickly as we would have thought it would have.

And, you are not positioned to take advantage of developing markets [and bus]?

Well, that has been where we have been getting most of our growth.

Okay.

Okay.

Got you.

Thank you.

I'll get back in line, I've taken enough time.

Our next question is from Andy Casey.

Good morning, everybody.

And, all the best to Bill.

I'm still here, guys.

It's going to be a parade of that for the next six months, Bill.

A question on the hydraulics segment.

For a company quarters now, there's been a little bit of under-performance versus the end market.

Can you remind us as to why that is going on?

Yes, I think it is the enormity of the size of increase in the marketplace.

Frankly, what's going into inventory, what's not going into inventory, has gotten pretty hard to trace right now.

But, our best view trying to get at this is we're not seeing significant shifts in kind of positioning the marketplace, what we're seeing is our market is growing, just staggeringly strong.

The recovery numbers, that is influencing our ability to whether to do a quarter to quarter analysis on under and over-performance.

Okay.

Is -- would I be wrong in reading what you just said as some supply chain constraints?

No, no, I would not say it's supply chain constraints, at least at this time.

I would say it is far more about the massive de-stocking that went on and then the inventory restocking that's going on, and, again, the strongest part of the hydraulics market during 2010 has been the mobile side, not the stationery side.

That's not to say stationery is not getting stronger, because it has gotten stronger as we go through this year.

But, part of the mobile side like Eaton has been many of our OEMs had de-stocked so aggressively during 2008 and 2009 that if they had begun to build up their own production, they are also restocking and when you get that kind of understocking and overstocking going on, it gets very hard to kind of track a specific market indices.

Okay, that's fair.

And, then, to follow-up on, previous question about truck, roughly 240,000 forecast you threw out there.

If you expect to or are you seeing any at this point, supply chain constraints not from you?

Or larger suppliers, but potentially from the small suppliers that could limit that?

I know the backlog will probably grow, but I'm just wondering about supply side limitations to hit that number.

Andy, you've been around this market for some time, as well.

We haven't seen them yet, but I think everyone who has been around the truck market -- We have been up at 240-type numbers for four or five years here now.

I think it's probably a reasonable expectation that there will be a hiccup somewhere, but it's always very hard to know where it is.

We don't see it in our own operations, but, in past ramp ups, we've seen different commodities have a problem.

When that happens, it can interrupt a supplier.

Haven't seen it yet, but we also are trying to keep our eye out for it.

Okay.

Thank you very much.

Our next question is from Eli Lustgarten.

Good morning, and, welcome, Don.Bill, we'll keep you around awhile.

You'll see him in New York.

He can't go anywhere until the Cavs start winning some games.

That's a long time.

Let's go back to the truck market for a minute.

The margins in the fourth quarter, given the demand, was a little bit disappointing.

Then, you mentioned it was $6 million in charges, not operating costs, that we don't see any place else except that you mentioned to it.

What was that?

Is that anything that -- because that would bring the margin up closer to 14%, which we would expect more?

No, you're exactly right.

That is why I mentioned it, Eli.

There's nothing there in terms of the run rate of the business.

And, you can see what we are doing with our guidance for next year.

So, we just, we knew it would be a concern when people looked at it.

We felt they were issues we wanted to deal with during the quarter and did.

Were they just local issues, nothing to do anything?

Yes, nothing that affects kind of forward run rates.

Same thing too, in hydraulics, the given strength in the marketplace, the margin is also disappointing.

We hear in the field that you have had a lot of production problems getting stuff out the door.

hat we're hearing from distributors or so, is that part of what is contributing to the hold back of profitability in that business?

I would say pretty normal, detrimental, if you actually look at the volumes, actually being a little bit better than our normal detrimental.

Our volumes were down in the fourth quarter compared to the third quarter.

I think your comment in terms of availability of product, we are starting to see people want product very quickly and lead times in the market have moved out a little bit.

Yes, but there is nothing going on.

It just seems surprising the strength of the market and what shipments were like in the industry was that strong that the actual, it was normal seasonal is now down.

Seems it would have gone up a little bit.

I think, Eli, that's why I made the comment.

I appreciate you bringing it up, earlier.

I think one of the things to be careful about is we have been talking to you about quarter on quarter.

These are year-over-year increases in terms of bookings that have really been eye popping all year long.

We will now start to operate against a much better base.

Our tougher comparables, as we work into next year.

As we take our 41% increase in bookings, one can't simply extrapolate that into a 41% increase in volume next year.

It is now going to be comparing to a first quarter and second quarter, and a third quarter that were a lot higher levels.

We look at that shipment level, we were slightly down fourth quarter versus the third quarter.

And, the profitability from an incremental, decrimental point of view was pretty much in line with what we would have expected.

Now having said that, you are seeing the 14.5% guidance we are providing for next year for our hydraulics segment, which we think is a very handsome profitability.

And, one final question.

Can you give us what you are forecasting for the auto sector?

I think you indicated bills of 6% here.

The economics in the US and Europe?

Yes.

One second here.

In automotive, where -- We think that what you see is, we said, the US up about 7%, non-US about 5% and Europe is around 5%.

Okay.

Thank you very much.

Our next question is from Jeff Sprague.

Good morning, everyone.

Good morning.

Sandy, could you give us a little bit more color on what you're seeing in the power quality markets, particularly the UPS market and the US?

We're continuing to see quite good demand.

And, if we look at the kind of single phase UPS in the mid-range or small data centers, they're showing a pretty good growth.

The large data center markets, there have been some project push outs, and the bids are getting bigger as the individual size of the data centers are getting larger.

And, so, there it is really important, whether you are winning or losing on them.

And, I think, as you can see from our outgrowth numbers, Eaton had another really strong fourth quarter.

So, we're feeling a lot better about the demand levels now than we were a year ago.

We see many more data centers being bid and we have been successful on a bunch of them here in the fourth quarter.

Is there anything in particular in the complexion of what is going on?

Is it corporate specific enterprise related or is it more oriented kind of toward the data explosion and kind of broader networking?

I would say two drivers, they're both going on.

One is a simple need more and all the mobile computing online.

The video drive, all that stuff is just, as you know, a pipe and data hog.

And, so, that's driving a lot of kind of what we call the hosting type drive.

The second drive, which is equally powerful, is this enormous energy efficiency push.

And, everyone is trying to get utilization of servers up from the kind of historical 30% utilization levels.

They're trying to figure out --as you start to run all these things at higher levels, you potentially create a lot more heat.

And, som people who can come up with this efficiency, and that's where Eaton is really leading in that area or have a real opportunity.

And, again, that's one of the reasons you have seen our share move so significantly.

Just looking at the electrical, rest of world, I would have expected the margins to look a little bit better there sequentially, given the sequential sales rise.

More acquisitions, integration costs in there but it seemed to fully describe what happened.

Is there anything going on there?

Yes, I would say two issues there Jeff.

Almost half of that volume increase was related to either FX or joint venture acquisition volume, incremental volume.

That would come in at obviously at a lower than incremental rate.

And, then, second is the comment, I can't remember who asked earlier, about are there any areas where they are purchasing or procurement or commodity availability issues.

The electronic component area is an area we have been talking about.

A fair amount of logistical horsing around for availability out there.

That has caused that to be a little lower than we would have expected.

And, just finally for me, the cash flow and on an absolute sense looks obviously very good for next year, $1.1 billion free cash flow.

But on $15 billion in revenues, it's 7% of sales, it's okay but not exceptional.

You're doing that probably, on record margins in 2011, that are maybe a couple of hundred basis points above mid-cycle margins, last cycle, the 2004 to 2007 time frame.

It looks like your cash flow margins in 2011 are same as they were in the middle of the last cycle but your operating margins might be 200 basis points higher.

I don't know if there is tension or something else --.

One other big thing to look at when we set our record profits, which was $6.90 operating earnings per share in 2007, our tax rate was approximately 6%.

And, what you're seeing now in terms of our guidance, we're saying there will be record profits here in 2011.

We're doing this with segment profits couple hundred points higher, more pension expense and a tax rate that is over double what it was at that time period.

And, so, I think that is the missing piece, if you will.

Gas, taxes and pension.

Thanks a lot, guys.

Certainly.

Terry Darling?

Good morning, and, Bill, thanks again from my side as well.

Sandy, wonder if we come back to the outlook for the truck margins.

I think when we look at similar points of past cycles from a volume expectation perspective, anyway, you were closer to 18% margins.

I think you've said in the past earlier in the cycle you would expect incremental to be north of that 30% to 35% range.

Are you just being conservative there?

Is there a mixed differential versus last cycle.

Do you expect a truck to take a hit from the commodity pressures?

If you could just address that.

Fine, Terry.

The way we think about this, again, we've talked about peak margins in the truck cycle, it might approach 20%.

It is true that we have been up over 20% for some selected quarters, but one of the things we have tried to point out over the last couple of years is that our business outside the US is a much larger percentage than it was at one time.

Having said that, at this kind of mid-200 level, these mid teen numbers have generally where we have been.

When we start to push ourselves up higher than the 18% type area, we've got to start to get up in the high 200s, 300s.

We were achieving those peak numbers when the US market was up over, well over 300,000.

So, we think this is a pretty good representation of likely behavior, both as a result of the likely achievement in light of both the mixed change and the fact that we are still only at 240.

So, by most judgments, people look at 240 and say that is slightly below average.

We're looking forward to when the thing gets to a higher number.

Right, and as you pointed out with an order run rate that maybe suggests an upside to that.

We'll obviously be tracking it.

I think we all have been around the truck market, we can tend to not be able to forecast exactly when this market really accelerates.

This is a fairly logical progression.

In terms of how we think the quarters would work.

We'll see at year end how close we were to this being logical or whether it may accelerate more quickly.

Okay, and, then, looking at your electrical America market index, up six, in total, just trying to put some pieces together there, relative to the orders that were up 10%.

So, Mark, if you could give color on the pieces of that order build up and then secondly maybe the nonres starts to turn positive in the second half of the year.

Yes, I think there are a couple of issues to think about.

What's been the red hot part of the North American markets during 2010, for electrical, it's obviously been industrial controlled side of the marketplace.

Where, for a couple years, people weren't buying equipment to maintain machine tools and we saw a huge surge in that regard.

I think you're seeing that across the electrical industry.

That's not going to stay up at these kind of 20% type of numbers.

And, so, we think that cools down a little bit.

I think you can just put residential on the side.

It is just not big enough to matter any more.

We are not bullish on how fast that comes back.

We think you continue to see very solid growth in the power quality markets.

But, the real driver, in terms of understanding our year to year difference and our forecast for this segment is what's going to happen in nonres.

I mentioned in the third quarter conference call, that we had already seen our small project business go positive year to year.

That is usually a pretty good leading indicator what's going to happen in the overall nonres market.

It's true that when you look at the put in place the data for the fourth quarter only one large segment showed increased year to year quarterly market increase of over 10%.

And, that was in the petroleum and mining of sector.

But, what we think is the most likely case and what we are planning upon is that this market will, and you've seen it every quarter this year.

The negative has been getting smaller on a year to year basis every quarter.

We think, by the time we get to the middle of 2011, we're likely to be flat with the year ago activity.

And, we may see some positive activity then in the second half that might get us to a full year that would be zero to 2%.

That's really probably the critical assumption we've got within here.

You've seen us be able to out grow this market while it's been down substantially during this last year.

I think the last year seven to eight years of market share gains are a pretty good predictor of where we are last year.

Okay.

And, just lastly, on your 2011 EPS guidance bridge, the uncovered commodity cost $0.18, presumably that is a net number that includes some assumption for higher price.

And ,wonder if you could share what your higher price assumption would be?

Yes, that is -- you're right, that is beyond what we would do in terms of cost production, material substitution, and supply.

We have been out with price increases in the fourth quarter, in a number of our businesses.

Those numbers are all out there publicly.

We do not publicly discuss a net price achievement number for competitive reasons.

Okay.

Thanks very much.

Our next caller -- question is from Andrew Obin.

Yes, hello, how are you guys?

Good.

I can tell everybody we had dinner with Bill in December, and he looked perfectly fine.

He is drinking coffee here this morning.

I know.

I'm just -- not exactly sure what is going on here.

The question on truck.

And, I appreciate that the business mix has changed.

But, if we were to take a look at your earnings progression back from 2001 to 2004, and if we were to assume that over the next couple of years, we have similar recovery in truck volume, has anything changed in terms of operating leverage within the truck business itself, to assume that we're going to see a different kind of operating leverage?

Yes, the easy answer is a lot of change since 2001 to 2004.

I think the premise of your question is, should you experience -- should you expect operating leverage over a multi-year recovery, that is driven by the North American heavy duty truck market, our answer would be yes.

That is our own expectation, that we would expect to see these volumes ramp up, the fleet's -- the average age is quite old out there.

There are still pressures around fuel economy, emissions, and safety, same drivers, and then I think the other issue, we have to keep an eye on is, what happens in terms of the mix of who's buying out there.

You have fleet buying, vocational trucks buying, that mix can move year to year.

So, hard to know precisely what each year is going to have in that regard.

But, short answer is yes, if this thing goes up well past 240 in the year of 2012, we would expect to do well on it.

And, just a follow-up question.

In terms of capital redeployment, you're clearly showing you want to return cash back in the form of dividends, which we like.

But, how should we be in thinking in terms of priority?

In terms of M&A, dividends and share buy backs given that we are starting to see some share creep?

Yes.

Thank you for bringing up the point on the share creep, Andrew.

We did see some share creep in the fourth quarter, primarily, as I mentioned, from option exercise.

It is our own plan and our own cash plan to go ahead and to buy back on the order of about $150 million to offset option creep at this point.

But, we don't have any plans beyond that.

And, how should I, so, basically, dividends for you guys in terms of returning cash for shareholders take priority over share buy backs?

Is that the right way of thinking?

Yes, well, I wouldn't state it quite that flat.

What we've said is we wanted to maintain a dividend policy which increases dividends in line with our future expectations in earnings.

And, so, over these last company of years, we haven't been quite over 15% that is our stated goal.

That's one of the reasons we had the increase last year and again this year.What we do in terms of looking at the buy back, is always -- and that's beyond delusion I'm talking about now from option exercising.

That's where we go into the examination and create more value for our shareholders through strategic acquisitions.

And, if we don't think we can, then we buy back shares.

We've done that before.

We think at this point, there are plenty opportunities out there in the acquisition market that we want to be able to investigate.

And, that's why we are not in a buy back mode.

Thank you very much.

Next question from Tim Thein.

Good morning, you have been articulating a goal, of $500 million in stimulus related revenues, in 2010 and 2011.

There wasn't any discussion in terms of an outlook for 2011.

I understand that gets harder and harder to track in terms of where -- actually identifying stimulus related projects.

But, do you expect any benefit in 2011 in that area?

Yes, we would expect, and I think you saw that in terms of our outgrowth, Tim, during 2010.

We expect to do just as well on 2011.

We get some pretty good visibility on projects.

Thank you for bringing up the point about challenge of tracking.

Because it is getting harder and harder to track these items at this point.

We don't plan on kind of a monthly or quarterly report on stimulus, versus other growth, it is tending to get packed right into the nonres numbers at this point.

We don't see this as a negative year to year, which some people have asked.

We think this is just continuing our strong momentum.

Again, you have seen so many of these areas where we have real particular confidence, waste water treatment, whether it be a lot of the work being done on a military bases, whether it is a lot of the work going into solar and wind, we do well in every one of those areas.

We expect that to continue.

Okay.

And, then switching gears to Rest of World, in terms of that 7% growth, you called out two of the bigger segments within there, industrial quality, how do each of those segments kind of play into that 7% growth that you are projecting for 2011?In terms of what you are actually guiding into for each of those segments?

Yes, our best view at this point is the power quality market is fairly close to that average number that we see the nonres obviously being zero to 2%.

It's on the low side.

The industrial would be on the high side still.

Up closer probably 10% to 11% in terms of that market.

You mixed all of that together.

I mentioned residential, because it's getting to be fairly small.

The residential market is going to increase that probably above the average.

But, the numbers are so small it doesn't do much in terms of the waiting.

I think the way to think about it is, power quality is about the average of that number.

Industrial's a little bit higher, and then the nonres is the much lower part, but we think on the verge of going positive.

All that is for Americas or Rest of World?

That was for Americas.

When we go outside with the Rest of World,the best way we can cut it for you is 7% there, we think Europe will grow slower than Asia.

Asia will be a premium to the 7%, Europe will be a discount to that.

Okay.

But, Tim we are likely to have power quality markets really around the world growing at a pretty heavy pace.

So, the big difference is going to be the power distribution growth rates.

Okay.

All right.

That is why I asked.

35% of Rest of World growing at that kind of rate, I just wanted to square up as to why you have the index at 7%.That answered the question, thanks a lot.

Our next question from Robert Heimlicher.

I'll just be very brief with a couple of clean-ups.

.

On the commodity recovery, we talked about last time commodities spiked a company of years back, how you had really re-engineered your systems over the last up cycle to ask for and get pricing faster.

Are you feeling more push back in this recent spike or is it just that the spike is faster?

And it is all -- What does it feel

No, I would not say.

I think we are actually in better shape having had the muscle exercise from 2003 to 2007 time period.

That actually was a little bit more challenging up front, because you recall, there really wasn't a lot of material inflation, the fifteen years before that.

What's happened now is the speed of the additional spike that occurred in the December time period, really where we feel it is prudent there will be some lag to catch all that have.

But, we have some lag the last time, as well, this is actually a little shorter lag than we had the last time.

Perfect.

One last clean up, Sandy.

Is the build in 1Q for truck sufficient to give you a lot of upside to the 244 that keep coming in or is 1Q sort of a donut that would allow the recent orders for the later in the year and that's one reason the numbers are not higher?

Our view of the quarters, and this supports the 240.

It would run at about a 46,000 rate in the first quarter, about a 58,000 rate in the second quarter.

Approximately 64,000 in the third quarter and then get up to 72,000 in the fourth quarter.

Now, the one thing I can tell you sitting here today is that won't be right.

But, that's our best view, as to how to kind of model this, at this point.

As is always true, this backlog tends to fill in from the back forwards.

So, people want to fill in that back part of the year.

That's why we are starting with this little lower activity in our forecast at this time.

Perfect.

Thanks very much.

Next question is from Jason Feldman.

Good morning.

Good morning.

So a lot of ground has been covered but I wanted to follow-up a little bit on the comments about nonres construction and electricals.

You have pretty good electrical segment sales growth throughout Rest of World and the Americas this year, considering how the head winds were in residential and nonresidential construction.

Do you think that some of us have overestimated how much construction there is in those businesses?

Was it really market outgrowth or is it just that the construction parts of the businesses were incredibly strong?

Well, you know, I can't comment on how everyone would have thought about it but I would say, I think industrial came in stronger than both we and others expected it would this year.

Power quality, as I mentioned to an earlier question, has stayed well.

I think the piece that may have surprised people is that while you are still seeing publicly reported nonresidential data declining, there was a fair amount of activity starting on the small end of the business.

We were doing well there and we were also doing quite well with a number of these larger stimulus bills -- or stimulus bill driven projects, where we've got an unusually large front end on our business and have been in touch with those same contractors and specifiers over many years, and so that gave us a really good visibility into the marketplace.

Okay.

So, I guess the question is when those markets actually do turn around, you have a sense there's still a fair amount of upside, and that it is likely to result in further benefit that is material for the benefit, if and when the markets actually do recover?

Yes, I do.

Okay.

And, then, real quickly on aerospace, it finally looks like after market bookings have caught up to flight hours.

How much of a lag before you really see that flow through the business.

It's -- still you have sales growth rates a little behind the orders, is that going to convert very quickly?

Yes, I would say within a quarter.

I'd say if you get a significant up turn in I would say one quarter, I think by the time you are in the second quarter you are starting to feel that in shipments, yes.

Okay.

Thank you.

Our next question is from Robert McCarthy.

Good morning, everybody.

Thank you for taking the questions.

I was a little surprised at the truck segment revenue in the fourth quarter, given that truck build in most of your markets, I believe, was up sequentially fourth quarter over third.

And, while I recognize there's traditionally a seasonal impact, as you guys well note, sometimes that disappears when you are ramping up.

So, could you talk about what is the missing link in my description of what happened in the fourth quarter?

And, maybe use that as an opportunity to also update us on what the mix of the business is, as you exit 2010, in terms of NAFTA truck, Rest of World truck and non-truck markets?

Yes, the biggest issue is in terms of thinking about third versus fourth is while activity continues relatively consistently as you correctly noted here in the US, that's not true in South America.

And, you'll find in most South American businesses, and we have a large presence in our truck business in South America, a significant portion of December turns into a vacation.

And, so, you really get kind of two months of activity.

That's the biggest driver for us, in terms of what drops off.

Now, the majority of our truck business is outside the US today.

And, that's this balance that is different and I think an earlier question that was asked about 2001 to 2004.

That there's been a change.

That starts to come back a little bit in the other direction as heavy duty starts to recover.

So, I think what you'll find is if heavy duty recovers along the lines, that we believe it will this year, that the balance of revenues for the business will go back to being slightly more in the Americas than it is in the rest of the world.

But, to help us set the base in 2010, can you give us a are rough estimate of how big NAFTA truck is within the segment?

Just revenue contribution, rough?

We really break out Americas separately.

Roughly speaking, you can think of starting the year, you're going to be at roughly 40, well, if you do all of the Americas, most of the business is the Americas.

So, that's the way to think about it.

But, obviously the Brazil business has grown enormously over the last several years.

So, the NAFTA part is starting at a much lower percentage than it did in the last run up.

All right.

And, I also, to make sure we are calibrated correctly, in developing your $35 million uncovered commodity cost assumption, I presume that, and then that you'll be able to catch up, et cetera, we're assuming that year end commodity price levels persist through the year.

Or, have you baked some cushion in terms of inflation into the underlying assumption?

Yes, we -- our best anticipation of how we think these costs are going to proceed through the year.

We've got in our assumptions for the balance of the year.

Okay.

Thank you.

And our final question is from Nigel Coe.

Yes, thanks for sneaking me before the employee close-off.

One final detail, just want to take a step back on the guidance, and we've seen acceleration along of the indicators towards the end of last year.

We've some incentive coming through, which I assume will be more second half in terms of the division allowances.

How do you handicap these factors in your guidance?

Well, I think what we try to do, Nigel, is look at the quarter on quarter, not year to year, but quarter on quarter progression of bookings through this year.

We obviously do a lot of work, as you know, on sort of macroeconomic issues, as well.

We have increased in the fourth quarter, our own view of the strength in the US.

But, having said that, we still think you have to be founded in some fundamentals.

We think global GDP is likely to grow slightly less than 3.5% next year.

We think that's a reasonable expectation.

We think there is still some uncertainty around sovereign debt situations, particularly in Europe.

And, so, that let us have a little lower growth view in Europe.

We think the interest rate increases you've seen in many of the emerging nations are there to cool inflation.

And will probably slightly cool demand.

And, as a result, we step back and say as we look at this overall 8% growth rate for Eaton this year, it's down a couple percent for the end market growth rate that we would have experienced in the first year of this big recovery.

Where we had V-like recoveries occurring in hydraulics, that were really driving it.

We look at the 8% and feel it is well calibrated at this point, for the year, and there are obviously a lot of individual factors, as we've mentioned as we've gone through some of these questions about the individual market elements.

But, that's kind of the way I would call the yin and the yang of how we try to think between the micro and the macro to develop these market forecasts.

Okay.

That's very helpful.

And, then just dig into the electrical guidance, I think you said zero to 2% for the nonres, which I think is in the Americas.

Correct.

So, I wanted -- that is a bit lower, we were seeing some other, not your direct peers, but certainly some electrical and H-back players, are talking about high growth rates.

Is that because you saw some stimulus activity in 2010 and, therefore, you've been a bit more cautious there?

And, then, secondly, if we talk about year over, I'm assuming that's all negative?

No, we don't think there is any kind of negative stimulus impact in these numbers.

I think the one thing to be careful of when you talk to people who play in the North American electrical businesses, are they talking about the residential put in place market, which is the numbers that we are talking to you about?

Or are they talking about what's called the NIMA product indices, which tend to run a little bit more positive than the actual construction market index?

We're talking the construction market index here, because it is the one that is most publicly available.

Some people will talk to you about what they think the NIMA product index will be.

And, that may be the difference you are getting between the two.

Okay.

And, then, finally, again we are seeing play a little bit of price cost pressure coming through on some of the electrical businesses.

Would it be fair to say you've seen from a pinch coming through there more than other areas per family?

The copper and silver are primarily used in those markets for us out of the whole basket of industrial metals, yes.

Okay, thanks.

Thank you all for participating in today's call.

As is customary, both Bill Hartman and I will be available for the remainder of the day, and later in this week to answer any follow up calls you may have.

Thank you very much.

Thank you, and that concludes our conference for today.

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