伊頓 (ETN) 2013 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Eaton, third quarter earnings call.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, this call is being recorded.

I would like now like to turn the conference over to our host, Vice President of Investor Relations, Don Bullock.

Please go ahead, sir.

Good morning.

I am Don Bullock, Senior Vice President of Investor Relations.

Welcome to Eaton's third-quarter, 2013 conference call.

Joining me this morning are Sandy Cutler, Chairman and CEO, and Rick Fearon, Vice Chairman and CFO.

As has been our practice, we will begin today's call with comments from Sandy followed by our traditional question and answer session.

Before I do that, I draw your attention to the statement on page 2 of our presentation, regarding forward-looking statements included in the presentation.

There we outline some factors that could cause actual results to differ from our statements.

Those factors are noted in today's press release and also relayed in Form 8-K.

Please take a moment to review those.

In addition to the presentation -- also in addition, the presentation also includes certain non-GAAP measures that is defined by SEC rules.

A reconciliation of those measures to the comparable GAAP equivalent is provided in the investor relation section of our website at www.Eaton.com.

And with that I'll turn it over to Sandy.

Great, thanks Don, and welcome everybody this morning.

I am going to work from the earnings presentation that was posted earlier today, and I am going to start on page 3 since Don has already covered the forward-looking statements qualifications.

That's the chart that's labeled highlight of the third quarter results.

We are very pleased with the third quarter, as we noted in our press release.

All-time record sales and operating earnings.

And again, the $1.12 of operating earnings per share compared to our guidance of $1.05 to $1.15 with a midpoint of $1.10.

Our sales as we noted were up some 42%.

Slightly less than we had thought they would be at the beginning of the quarter.

You may recall when we provided guidance at the beginning of the quarter we talked about an expectation that sales might increase by $75 million.

They increased closer to $5 million.

So relatively flat overall revenues second quarter to third quarter.

But really pleased that when we look year to year, core revenue growth of 3%, we think that's significant.

Segment margins 15.6%, the same as our record second quarter.

So we think on very similar volumes, very strong achievement.

We think the real news of the quarter is in this next bullet point.

It's the really strengthening bookings in our electrical, hydraulic and aerospace.

The reason we don't quote vehicle here is we really don't have bookings data in that business.

So in those businesses we have bookings 5% up in electrical, 8% up in hydraulic, 6% in aerospace, and I think significantly October has also started strongly.

And then significantly our Cooper integration activities and savings remain on track with the same projections provided you at the end of the last quarter.

If we turn to the next chart, the one that's labeled comparison to Q3 guidance, pretty simple reconciliation versus the guidance we provided at the beginning of the quarter, $1.10 was the mid point.

The lower revenue of roughly $70 million up about $0.05 less earnings.

Slightly higher corporate expense.

You'll recall that we had told you at the beginning of the quarter we expect that our corporate expense to go up by $15 million.

It went up a little bit more than that.

Accounted for about $0.01 negative.

Then the lower tax rate of 1.4% versus the 9% we provided -- provided the $0.08 as a result we came in $0.02 over our guidance in line with consensus.

Turning to the next page, page 5, tilted financial summary, you have read most of this information, I am confident by this point.

Really we just bring out one point again is that sales volume in the second quarter of 2013 was 5.602 compared it to the 5.607.

So again as you look down this chart, segment operating profit was virtually the same not only from a percentage but from a dollar point of view, that we think again a strong quarter in terms of the core growth of 3%.

Let's get into the individual businesses at this point.

And if you'll turn to page 6 labeled electrical products segment, a couple comments here.

Second quarter revenues you will recall were $1.758 billion.

So this quarter's volume of $1.817 billion up some 3.4%.

Very strong incremental margin performance having increased to 17.1% from 16.2% in the second quarter.

You will recall that all of the data shown in this chart under third-quarter 2012 is pre the acquisition of Cooper.

So not directly comparable.

Really pleased with the very strong combined bookings of 7% versus last year.

It really confirms some of the data we get from industry association market share data, which you shows us notching very strong booking gains in terms of market shares here in North America in particular this year.

If you look within that 7%, I would think somewhat predictable pattern you might anticipate, we were up some 10% in Americas really with kind of double-digit increases in bookings in residential and lighting and [busman], and particularly pleased that we have talked to you about this technology opportunity within the lighting business moving to LED.

Over 30% of our volume is now LED based.

We are really leading the industry in that very important technology change.

About a 1% increase in the EMEA region really led by the Middle East.

We have some very exciting wins I think throughout the Middle East at this point building upon our strength there.

And then about 5% increase in Asia-Pacific.

And I would really highlight that the single phase power quality business has been the business that has come back most strongly in that particular region.

So overall we think a very strong quarter of performance here.

As we did talk about -- as we looked at the month, well, September accelerated you have heard this from I think a couple of peers, the second half of September in terms of bookings wasn't quite what we thought, but we're feeling quite good about how October has start off.

If we turn to the next chart on page 7 labeled electrical systems and services segment, volumes in the second quarter were 1.624.

So about a 1% quarter to quarter increase as you can see.

Very strong continued margins and our systems and services businesses are a [14%, 7%].

A little flatter incremental.

Didn't get a lot of incremental on the additional volume.

That really had to do with a slightly negative mix change.

A little weaker service activity, particularly as it relates to the government sector.

If you can imagine, that has been a little confused over the last three months in terms of the demand, and the utility area continues to be weaker as we commented this year than it was a year ago.

Again, on the bookings side, 3% up, 3% in the Americas.

Continuing to do really well in our large assemblies businesses, the three-phased power quality business but offset by the weakness in utility and service as I mentioned.

Europe still weak, still negative number, and Asia-Pacific pretty powerful snap back, up 8% really led by a great strength in the three-phase power quality business and the beginning of some comeback in the solar markets at this point.

The acquisition number that you see in the lower green box on the left-hand corner of this chart, that does include not only Cooper as was true in the previous chart, but also Rolec and Gykom acquisitions.

If we turn to the next chart, which is -- that's page 8, it's labeled hydraulic segment, second quarter volumes were $772 million.

So the third quarter declined by about 4% from the second quarter.

That's pretty much in line with the typical seasonality in this particular business.

Margins came down from 14.5% in the second quarter to 13.1% this quarter, but they were up solidly from last year's 12.8%.

If you think about those incrementals on about a 33% volume decline from the second quarter, the decremental was maybe about $4 million higher than we might normally expect.

Nothing really material in there really more of a mix issue.

We're not concerned about anything out of pattern in that respect.

Then of course versus last year where volumes are down about $24 million from last year, and profits only down $1 million.

You can see the real beneficial impact of the restructuring activities that were initiated in the fourth quarter of last year.

Bookings I think maybe the most significant number on this entire page, up 8%.

It's the first year over year increase since the fourth quarter of 2011.

Within that 8% the distributor demand was up about 4%, OEM demand up about 12%.

And if you cut the market differently and think about the mobile versus stationary side, mobile up about 9%, stationary up about 19%.

Oil and gas being a real driver in that stationary area and ag demand actually was a driver in the mobile area.

When we look around the world today the softness continues as you have heard from a number of large OEMs in the construction and in the mining marketplaces and we continue as we have said really for the last 12 months to believe the most difficult end market to figure out from a geography point of view is the China market where there appears to still be significant over capacity in the construction equipment market and inventories.

Moving to page 9, aerospace segment, flat volumes versus the second quarter as we had expected.

Pretty much a $446 million in the second quarter, $448 million in the third quarter.

You can see the operating profits slightly down from -- they were 15% in the second quarter, 14.3% in this quarter, 11.7% a year ago.

So again very strong incremental performance.

A 52% incremental versus last year.

A little weaker in terms of the -- versus the second quarter.

But frankly, we are talking about a $2 million change in sales and a $3 million change in profits.

Nothing really significant there.

If you look in the bookings, up 6% versus last year.

Very pleased with that.

And I think you may have all had the opportunity to read about two very significant wins we reported this week.

The Dassault Falcon 5X advanced hydraulic power generation system, and the [Embry Air] E2 Platform, and that hydraulic system is estimated to result in about $400 million of shipments over the next 15 years of the program.

We have talked a lot this year about after market orders and trends in the market place.

We saw a pretty consistent pattern here of strong commercial after market offset -- being offset by weak military demand.

As a result overall after market demand was relatively flat, and part of the story when you look inside the margins for our third quarter of '13 versus the second quarter of '13 as while our shipments -- excuse me, versus last year, while our shipments went up some 7%, after market shipments only increased by 4%.

So that again is that mix change we have been talking to you this year about, the strong OEM and not quite as strong after market shipments.

Turning to page 10 labeled our vehicle segment.

A very strong quarter performance, you may recall the second quarter was $1 [billion] and $2 million versus the $964 million shown on this chart.

So about a 4% decline from the second quarter to this quarter.

Up 3% from a year ago.

If you look at the incremental and decrementals in this particular segment, [68%] incremental over last year, again reflecting a very strong results coming out of both running the business well and the restructuring we initiated in the fourth quarter last year.

It's about a 29% decremental from the second quarter of this year.

Again below what we would normally expect in this business.

I think really good cost control.

So I think 16.7% a very strong representation in the quarter.

NAFTA heavy duty truck builds, were forecasting at 245,000, and those of you who keep track of this by quarter, we're thinking it was -- our estimate is 55,000 in the first quarter, 67,000 in the second quarter, 63,000 in the third quarter and 60,000 in the fourth quarter.

Recall, we came into this quarter thinking it would be about 68,000.

So market was weaker in the third quarter.

It's one of the reasons we have taken our forecast for the full year down to 245,000.

We recognize there is some forecasters out there still slightly over 250,000, 245,000 is our best estimate at this time.

If we turn to chart 11, labeled 2013 end market growth forecast, I would represent the changes on this chart are more tuning than I think they are anything of large magnitude.

You see in the electrical markets between the two segments virtually the changes are insignificant.

Hydraulics we did weaken slightly here in the US and that took the overall down from 5% to 6% this time.

And then vehicle we have dropped by 1% in terms of the total market.

That really was fundamentally around the NAFTA heavy duty change from down 260,000 units down to 245,000.

All of that had the impact of reducing our end market growth from 1% to 0%.

And I think it's in line with the fact that we have seen slightly lower revenues here in the second and third quarter, and that's our anticipation when we will talk about the fourth quarter guidance here in a minute.

If we turn to chart 12, which are labeled 2013 margin expectations, just one change here.

You may recall at our full-year margin expectations for our hydraulics business had been 13.5%.

We've lowered it to 13.0% in light of the little lower market activity in this area.

No change to the overall Eaton consolidation.

Really doesn't affect that overall rounding.

Turning to chart 13, comparison of Q3 to Q4 of 2013.

Just really three items in terms of this reconciliation.

Obviously, it starts with the $1.12 that we reported for the third quarter.

We expect the normal lower seasonal volume, about 1%.

So it's something on the order of about $70 million, and that throws off about a negative $0.05.

We do expect the tax rate to go back to -- in the range of 6% here in the fourth quarter, versus the 1.4% in the third quarter.

That is about a negative $0.05.

And then the additional synergy realization from what we realized in the third quarter to the fourth quarter, same projections we had provided you with earlier in the year, about $0.03.

That's how we come up with the $1.05 for the individual fourth quarter projections.

Turning to chart 14 labeled 2013 EPS guidance.

A couple comments here.

We've trimmed the top end of our guidance by $0.10, and that's really in light of the weaker markets that we've seen here in the third and we anticipate that to continue in the fourth quarter, but we've maintained the low end just as we did in the last quarter at $4.05.

That has really been possible -- made possible by the additional work we've done on productivity, and I'll comment on that in one of the upcoming charts here.

Chart 15 is the guidance bridge that we provide you to give you some help in terms of what has changed versus the last time.

If we step down this, looking first at the green boxes, in the acquisition area, that has come down by about $0.03.

That's really the impact of about $100 million of volume, primarily in hydraulics and then to a little bit the electric utility markets coming out of those projections.

Organic growth at the 33% margin.

That has come down by $0.21.

I will give you some dollars on that in the next chart.

Additional expense control has moved up by $0.09.

You'll recall in our last conference call, we talked about $55 million of additional expense control and productivity that we anticipated we would achieve for the full year, beyond our 33% incremental margin and beyond the synergy savings.

We have been able to identify an additional $35 million, so now a total of $90 million for the year of 2013.

That's what's driving that additional $0.09 or the full $0.24 on the chart.

If you go to the yellow segment of the chart, the several negatives, no change in the higher number of shares.

About $0.02 improvement in the other corporate expense.

About a $0.10 improvement in the higher tax rate.

And then about a negative $0.02 in terms of slightly increased pension expense versus our earlier estimates this year.

So that segment sums to a positive $0.10, whereas the green segment above would sum to a negative $0.15 change.

And the net of those two obviously gets you the $0.05 decrease or the $0.05 in the mid point of our range.

So $4.10 full-year operating earnings per share at midpoint.

If we turn to chart 16, just a couple updates again for your records.

We've tried to give you a summary of some of the key elements that underline our guidance.

The core revenue growth of $125 million, that compares to $350 million in the previous guidance we provide you, again reflecting the market change.

Net acquisition revenue was $6 billion.

Now it's $5.9 billion.

No change in the incremental margin of 33%.

The tax rate we had provided you was 7% to 9% guidance prior, now 5%.

I just covered the change in the full-year operating EPS.

Operating cash flow down by about $200 million.

It had been $2.5 billion to $2.6 billion.

We have reduced our CapEx from $650 million to $600 million as demand has been a little less this year.

And that results in the free cash flow coming down $150 million instead of the $200 million that operating cash flow came down.

Chart 17, we have simply provided for your record no change here.

Still forecasting the $115 million of operating synergies.

All that work is continuing to go very well.

We are very much encouraged by the integration as we've updated this number twice.

You will recall it started at $75 million for this year.

We increased it to $90 million.

And then in our last earnings conference call we increased it to $115 and that's where we accept it will close this year.

And last but not least, we know significantly in terms of your thinking at this time of the year, a few comments about the year, and then looking into 2014.

As we said at the end of the last earnings conference, we have been really working very hard to offset these kind of slower growing markets.

Markets that are growing a less than we had accepted when we came into the year with additional improved productivity and some very significant synergies that come out of the Cooper and other acquisitions.

We are in an environment today where we think the US environment is improving slowly in spite of what goes on down in Washington, that Europe is clearly beginning to recover, that China is stabilizing, and that we think that, that is an environment as we look into next year, that will drive modest improvement in global GDP.

Our best view at this point is that means that our markets are likely to grow 3% to 4%.

As we detailed on the chart that we just covered on the Cooper synergies, we still anticipate incremental year to year synergies of $95 million.

That's no change from what we said earlier this year.

Obviously, it gets hard to call exactly what pension expense will be at this point without knowing exactly where the interest rates in this roller coaster is going to end up.

Obviously we are looking a little better a couple weeks ago than they look right now.

We think something on the order of $20 million is probably a good estimate at this time for a decline of expense.

We think a very modest reduction in interest expense from year to year, and then we would expect our tax rate to return to the rate of more on the order of 8% to 10%.

Now, as we think about this from a business perspective, and obviously electrical hydraulics, aerospace and vehicle have slightly different market outlooks, we think there are a couple elements that you might give consideration to as you peer into next year.

We continue to believe that the residential markets here in North America will strengthen.

We think non-residential is actually strengthening at this point, and some of the data that's available from July and August would certainly underpin that.

The three-phase power quality markets have been strengthening.

We think Europe has turned and that Asia-Pacific is strengthening at this point, although the large infrastructure projects that typify the Chinese economy in particular a couple of years ago, have not begun to materialize at this point.

In the hydraulics market we have commented on a number of forums this year that our expectation is that, that market would turn to positive growth in 2014 and that still is our view as the US is gradually improving.

Europe, we think has begun the turn.

And the real issue is trying to predict the Asia market where so much of the market is driven by the Chinese construction market.

And you've heard us say that we think that probably doesn't turn until we get well into next year.

On the aerospace market I think we see conditions being fairly consistent to what we're seeing this year.

I think there is a lot of data available on that one.

So no really significant change.

And on the vehicle markets a little slower growth, but the light vehicle markets look fairly health around the world.

Clearly, Europe is better than it was a year ago in Europe.

Continuing to see strong demand in Brazil, US and in Asia.

The truck markets really most significantly for us, I know a number of you follow North American heavy duty, it's early to call that.

Obviously with our having taken the demand down to 245,000 this year, it would have an implication for next year as well.

But we think still a year of some growth next year.

So that's sort of our best view of the color that we can provide you with as we look into next year.

But I think we take some real encouragement from this bookings acceleration that we've seen here in the third quarter, and that continued strength here early in October while not all of those bookings are shippable in the fourth quarter, they certainly do build a very strong base for going into 2014.

So with that, Don, I will turn things back you to.

We look forward to everybody questions.

At this point in time our operator will give you instructions and then we will turn it to questions.

(Operator Instructions)

Steve Winoker, Sanford Bernstein.

Trying to make sure I understand that slide 13 walk from 3Q to 4Q.

I was just a little bit confused.

Is the core growth about $200 million -- I get about $283 million or so implied based on your $125 million full year.

Is that in the range of what you're talking about?

Chart 13?

Sorry.

Slide -- yes, slide 13.

3Q to 4Q.

And I'm basically looking at sort of what's implied organically in terms of growth and then the implied incremental margin on that compared to, you know if you are looking for $125 million in the full year now, given your run rates in 1Q and now 3, that sort of, the math works out to $283 million implied in the fourth quarter.

And then I am look for what kind of incremental on that.

I am just trying to basically understand the seasonal volume commentary in light of it being a little bit lower and yet actually year on year, you know, that still is going to be a positive core growth number, right?

Yes.

And I think the way we would urge you to think about is it roughly $70 million of volume lower than the third quarter of 2013 at roughly a 33% incremental.

That's what we have been using this year.

Okay.

All right.

And that $70 million captures Eaten and Cooper excluding the synergies?

Yes.

Okay.

Great.

And what is your assumed pricing versus cost tail winds?

How is that kind of played into your performance and where do you see that -- how do you see that outlook going forward?

We have seen, as I think as everyone has commented this year, that commodities have been a little bit more docile this year than they have been in other years.

The way we try to think of things, Steve, is that we try to run a model that basically says between productivity, new product introductions and price increases, that we roughly come out equal versus commodity prices.

So no material headwind, tailwind this year.

Okay.

Okay.

Although pricing strength has been pretty significant for a lot of, I guess, other companies.

That's why I was wondering.

But you are basically saying it's a neutral impact for Eaton?

Yes, that has been our guidance for this year.

Okay.

Just one last question.

On your 2014 guidance, you know, how confident are you in that non-res construction piece of it?

And what maybe gives you some of that confidence in light of this past year's experience?

I'd say a couple things, Steve.

We have been talking about this for several months with investors, is that the way we think you have to think about the US construction cycle is that really the first couple of years coming out of this downturn of 2008, 2009 were very atypical in that residential, which is normally an early driver, early cycle, did not come back for all the reasons we understand.

And you saw a short-term non-res boom and some of those numbers went up into double-digits.

We think we are now into a more normal if you look at the '12, '13, '14, '15 time period.

That is developers are beginning to buy land again because they have built out most of their residential areas.

That then leads to the beginning of what we call the small commercial activity.

These are the shopping malls.

All of the strip stores.

That then leads you into the larger construction activity.

If you look at the actual data, which has just become available in the last two days because of some of the delays of the data streams, the July, August data for non-res, private put in place, I think surprised most people with its strength.

We think that is building.

We are seeing pretty good bidding activity looking out ahead of us.

If you look at some of the consensus numbers that have also come out in the last couple of days from a number of people who forecast US put in place private, they are talking about numbers that would make a 5% type number next year look quite realistic.

Fantastic.

Thanks.

John Inch, Deutsche Bank.

Just to pick up Sandy on your point about price, what sort of mix or price are you seeing in your bookings increase?

And just to confirm, those ship over what duration?

Kind of a year, so that helps out the first part of 2014?

Yes.

Bookings -- let me talk to kind of bookings timings for a minute.

When you look at our electrical products sector, that's largely in one month, out same month, or maybe out the beginning of the next month.

But because it's product, it's standard product, it tends to be the type of thing that is stocked, distributed with carriers and they are refilling.

So that's, to the most part kind of an in and out business.

In the electrical services and systems business, that can be anything from a panel board that might ship in a couple weeks to switch gear that might not ship until six to eight months later.

And so you can have quite a range in there.

I think a good way to think about that is that's generally a kind of a three to four-month outlook, if you will.

When you get into the hydraulics business the distributor side, generally when that's coming in, that tends to be shipped the same month or the next month.

The OEM side often can be orders that go out as far as six months or longer.

And so what we are seeing there in hydraulics, because I'm sure a number of people have questions if you have an 8% increase in bookings, why won't the fourth quarter immediately evolve higher, which we would like but we don't think that's necessarily going to happen, is that a number of those orders are from both agricultural, construction, a variety of areas where people are kind of laying in their order pattern for next year.

It's part of the reason that we're a little bit more bullish thinking about that market for next year.

On the aerospace side, obviously when bookings -- excuse me, when after market comes in, that's generally a one to three month that, that's going to get shipped.

The orders for the OEM side can go out quite a bit longer than that, as you can imagine, in terms of a build program for OEM platforms.

So that makes sense.

What about what are you seeing with respect to the mix of your -- what your bookings look like?

Is it better or is ti sort of consistent?

I would say consistent with what we've been seeing.

No big changes one way or the other, John.

Okay.

And then, you know, just to cover to interpolate your guidance, do you think electrical products, because it's obviously we don't like compares with Cooper, pro forma or anything, do you think electrical products get better in terms of profitability or profit margins in the fourth quarter?

I am just curious how this is going to play out.

Maybe you could comment on both the products and the systems and services business?

Generally, again, what we'll see is in the electrical business the strongest quarters are normally your third and second quarters.

Your weakest quarter is normally the first quarter.

And then as you think about the fourth quarter, it tends to be the third strongest quarter, if you will.

And that trend is fairly true year to year.

You can you always get a little bit of difference depending particularly in the electrical systems and services as to you may have some large projects that are going to ship one year versus another.

But I think in the products business, that's a pretty good rule.

Okay.

So that sort of implies you are going to end the year around 16% margin for the products business.

I guess if I add all this up, right, and --?

We actually still think we're going to be closer to 16.5% in the products business and we think we will be around 14.5% for the full year in electrical services and services.

I am sorry, you're right.

That's how the math works.

All things equal Sandy, as we kind of look at what is happening in non-res, the progress you are making on Cooper, kind of electrical products being weaker this year but then there is some obviously signs of improvement, does this business -- I'm assuming we can still retain the 33% variable contribution margins in next year.

Sounds like this business should be over 17% margin based on your guide, all else equal, unless I'm missing something?

Remember just one footnote in terms of the rate of improvement.

Yes, we definitely think the business will continue to improve because again we are we are going to be dropping some $95 million of incremental year to year synergy into these two segments.

But again if I could just go back to the guidance we provided in early February for this year.

We said that our normal incremental for the whole Company would be around 28%.

The reason it was 33% this year is that we took $50 million of restructuring in the fourth quarter last year and that we really felt to be intellectuality honest in this we needed to back that out and give you and incremental over that.

I think a 28% incremental in somewhere between 25% and 30%, that's how we get to 28%, is probably a more realistic overall margin for the Company.

We have not completed our profit planning for next year, so we're not providing a particular guidance.

But if you were to kind of use what we would have used this year without the restructuring from last year, that would have been the range.

Still sounds like you are driving towards over 70% -- or 17% next year, right?

We will see how the performance comes out.

And we will obviously give you a better insight on this when we get together to do our guidance for next year.

Okay.

Got it.

Thank you.

Julian Mitchell, Credit Suisse.

Just a question around the sort of non-Cooper related additional expense control.

You said that this year you are now looking at $0.24 of help from that versus $0.15 back in July.

How much sort of more are you doing right now in kind of Q4?

In other words, are some of these non-Cooper cost out issues, are they going to be a tailwind into next year as well?

Or are you kind of drawing those to a close because the bookings are good and you expect the markets to accelerate?

I understand the question.

I think the way to think about the additional savings of beyond the $55 million we talked about as they drop in the third and the fourth quarter, and we think the base of this year then is a realistic base to build off of as we think next year.

Your point about the momentum, it does feel to us like there is a momentum change with these bookings.

And in spite of, I think, the fact that we all were somewhat discouraged watching the poor theater in Washington several weeks ago, and that we all anticipate we're going to see another stage of that as we get to the early part of the winter or spring next year, these economies feel like they are continuing to improve in spite of that, and some of the businesses where we had not seen as good order activity in the second quarter, that reversed itself in the third quarter.

So that gives us, I guess, Julian, the additional confidence that this sort of range we're thinking about for prospective market increases next year looks very realistic to us.

Got it.

Thanks.

Then your OpEx was up quite a it's about.

I mean, R&D to sales was up 40 bps year on year in Q3.

Is that sort of a top up going on in some of the electrical businesses in R&D, or is that something that is sort of a multi-year program in some channel areas?

I would say more a timing issue than anything else, Julian.

We've got -- our development cycles in each of our businesses are fairly long.

And one of the areas we have really been careful about trimming is that basic investment in new power management solutions.

So I don't think there is a big conclusion to be drawn one way or the other there.

Got it.

Thanks.

Lastly, very quickly, I remember at the beginning of the year you kind of -- you tried to move way from talking about Eaton growth relative to end market growth.

Do you have any sort of sense on your growth rate this year relative to the markets, or do you kind of think it's the markets and then your plus 1% on top of that sort of thing?

We are still having a little bit of a challenge trying to get these data streams to settle down.

It was not helped at all by the fact that we went through this period of not having US government data.

And so we don't even have full data for the third quarter yet, you know.

Some of the data just came out for the month of August.

So I can't give you a good feel on that one.

I would say that the -- in the industry associations where we get good market share data, and one of those is for the electrical business here in the US, the news is quite encouraging.

And whether that's on a shipment basis or even more strongly on the bookings basis, I think it's verifying our view of the incremental sales capability that we have put in place with Cooper.

Thanks.

Joe Ritchie, Goldman Sachs.

A follow-up on the commentary on October having started strongly.

Sandy, maybe you can provide a little bit more color by segment on where you are seeing the strength, and specifically as it relates to electrical?

Looks like the comps get a little bit tougher in 4Q.

I am wondering whether you can see an acceleration versus the 5% bookings number you saw in 3Q?

All we can really do at this point is give you a sense for kind of year over year so far in October.

What we'll see in November and December plays out.

But in both of our electrical business and our hydraulics business, particularly in the US, we're off to a very handsome start.

Let me put it that way, on a year on year basis in October.

One month doesn't a quarter make.

But it's an awfully good start.

And we're very pleased by that.

I think part of the reason that I think it's worth talking about that October for a moment is I think you have heard not only from us but from a lot of other companies that there was some strange kind of order patterns in flow businesses during the last two weeks of September.

I can't tell you and I don't think our team can tell you that we know that was related to.

But the early part of September was going quite well.

The back end of September seemed to slow down.

Whether that was related to all of the activity in Washington, you know, we don't know.

But the good news is it has snapped back strongly here in October.

And so whatever caused that seems to be behind us and we seem to be on with strong numbers.

In spite of that slowdown at the end of September, though, you saw the 5% in our electrical businesses.

You saw the 8% in hydraulics.

You saw the 6% in aerospace.

So we think very powerful numbers in the third quarter and off to a really good start in the fourth quarter.

That's helpful commentary.

On the government slowdown, the shutdown, did that have any impact at all to your 4Q estimate reduction?

I'd say really it's our view of the markets, what's going on in the markets.

It's hard for us to tie specifically what impact, you know, that has per se.

The markets just aren't behaving quite the way we thought they would this year.

But as we see some of the activity we're seeing now, and I think the whole backdrop to this is that this is a gradually improving economy.

It's not one that is rocketing back here in the US.

The most significant change, and we were talking about it in the second quarter as well, is that Europe seems to have bottomed.

So regardless whether you think Europe GDP is going to be a positive 1 or a positive 0.5 or a positive 1.5, versus it being negative this last year, that's a fairly powerful change year to year, and I think the other one that for us is significant in our watching is what's going on in Asia-Pacific where you have had a very weak Australian economy.

You have a Chinese economy going through a very substantial transition.

And within that transition the consumer side that for us, for example, auto has been quite strong.

The major industrial and infrastructure has been quite weak.

We are beginning to see some change in that.

And the key issue for us now in China is to see the inventories of construction and mining equipment come into balance because it's a fairly important influencer for the overall global hydraulics market.

We do not see that happening yet.

We have said we thought it would be at least the middle of next year.

And I think that's probably the hardest piece for us to call in that respect.

But having said that, a positive Europe, a slowly growing US, a strong Latin America, and a stabilizing Asia is a lot better than what we looked at in 2013.

Great.

I guess one more question on the Cooper revenue synergies.

Can you just comment on how that's progressing?

And as we get into next year I just want to make sure I understand it correctly, the 25% to 30% incrementals that you were talking about earlier, that is ex-synergies, correct?

Yes, that is correct.

And a quick update in terms of how the revenue synergies are going.

We really are quite pleased.

We had commented when we rolled out this guidance originally that the first year would take a year to get a number of changes put in place, obviously, to start to put the capabilities -- combined capabilities in front of our customers.

We are very much on track on achieving, as you can see, this roughly $10 million of incremental profits that comes of -- I am talking $10 million within the overall $115 million in 2013, that jumps up to $235 million next year.

We are really pleased where we are right now.

And so feel very good across those four primarily elements that we talked about, introducing a service business capability to the Cooper power systems business, major increases in terms of our effectiveness across channel partners, the ability to move into countries where one company or the other was significantly stronger than the other, and then some of these target markets like oil and gas where it's very clear that we have got a very substantial capability having put these two companies together and may have one of the broadest offerings available under that segment.

We are quite pleased with that and have really a great sense of confidence that we are right on top of these numbers.

Thanks everyone.

I will get back in queue.

Nigel Coe, Morgan Stanley.

Really good color here on 2014.

So I appreciate that.

Obviously, the incrementals next year will be partly a function of the mix of businesses and how your different businesses grow.

And so I'm just wondering, do you have any strong views in terms of how some of your high leverage businesses like truck, hydraulics and products will kind of compare to that 3% to 4%?

You know, I think as we've talked, it really does matter just as you mentioned what that market percentage would be.

I do think that the aerospace business is going to likely see demand that is fairly similar to the demand increase we saw this year.

We don't see any of those fundamentals changing.

I think the hydraulics business, you correctly mentioned, is one that has some fairly high incrementals and decrementals.

And we expect that, that business will have positive market experience next year versus the negative it's been struggling with this year.

And with all the work we have done in terms of trying to improve profitability -- incremental profitability.

You can see that in the comparison of this quarter's performance versus last year's in hydraulics.

We think that there is an opportunity there, obviously, for us to do well.

I think the electrical business is one that is likely to be close to those incremental numbers we mentioned.

But I think the biggest year to year market difference is likely to be in the hydraulics business.

Okay.

And you mentioned the Chinese construction market as being one of the big question marks for '14 in hydraulics.

Obviously mining and ag are two big question marks as well.

How do you view the progression of mining and ag and maybe give us some currents into what you are seeing right now in those two markets?

You mentioned ag was quite strong but how do you expect that to progress?

I think ag is frankly, we talked a lot about it as one of our difficult markets to call right now because you seem so have two schools of thought that are about 40 yards apart.

Clearly, it's been a big production year.

Prices have declined.

It really depends a little bit by segment.

We continue to think that the capital equipment market in South America will be quite strong.

Again we think Europe and Western -- and the US are replacement markets.

So they get heavily influenced by this issue of excess cash of the farmer and the ability to reinvest.

We follow really our major OEMs in this regard and one of the large ones that has the color that you recognize is quite bullish next year in terms of their numbers.

So far that's the order pattern we see and that's what supported my comment when we had a stronger hydraulics booking led by ag this quarter.

What we'll have to see -- I think these are single digit, mid-single digital numbers.

I don't think these are big booming numbers more than that, mining is very much depends upon which commodity is being mined.

Obviously, coal, everyone was down in the ground about it.

But if you look at some of the shipments of coal to China recently, that has begun to increase fairly significantly.

Now, that has to increase a lot before you -- you have to have a lot of additional commitment.

But the demand is starting to move in that right direction.

Copper investment in South America continues fairly actively in terms of it's changing by country because they are trying to get to places where there is better ore grade and yield and lower electrical costs.

But I would guess on this whole mining and construction area, it's still mining is going to be slower than we saw a couple years ago and construction's got to go through the bleed off of the inventory that particularly is still necessary in Asia.

Okay.

And then just quickly on pension.

You put down $20 million place order for next year.

I think if you snap the line Rick, on discount rates you get a bit more than that.

I am assuming that prior loss and amortization would be lower next year given the move in market returns.

I am wondering are there any offsets to discount rates and amortization?

Well, the $20 million we've laid out, Nigel, assumes a 4.7%-ish type discount rate.

Obviously, if things differ from that, that will impact things.

That's about a $60 million impact for 25 basis points.

The other factor, though is that our plan, when it was under 80% funded, and now our plan is funded in the high collectively the high 80%'s for both plans, a little bit lower for the Eaton-only plan, because we are now over 80% we are now offering full lump sum settlements.

And that means that as people retire, because we're not completely funded, there is a bigger expense.

And so that will be a drag on the pension expense next year.

So you've got to balance out the interest rate, whatever it's going to be, with the fact that you'll have slightly higher lump sum settlement expenses.

Understood.

Thank you very much.

David Raso, ISI Group.

Quick question.

Just trying to think through the end market guidance.

This time last year you were coming off a quarter where the orders were down mid single digit and you were still thinking up 2% to 3% on the end markets for next year, and it proved to be optimistic, right, end markets now flat.

Still just thinking about how you are going through the process of forecasting.

This time last year orders down mid single.

Still thought up 2% to 3% the following year in end markets.

But now we are actually looking at up mid single, October is off to a good start and you are thinking 3% to 4%.

Simply with that analysis tells you are you being more conservative on the guidance because you saw last year you were too optimistic, or should I read something about the end markets from not -- in a way I think the 3% to 4% is actually a little better than I would have thought.

But still if the orders are up this much, to only do 3% to 4% is interesting compared to what you were thinking last year off a lot weaker orders.

I think, David, maybe the missing piece, and it's always a hard one to call, is what is the relationship going to be between manufacturing and industrial production, which tends to be actually a better surrogate for our end markets than simply GDP.

When we came into last year we started the year really with a belief that industrial manufacturing production would be higher than GDP, which is the normal relationship when GDP expands, normally industrial manufacturing production expands more.

That actually has not been true this year.

And for the reasons both of inventory reductions and lower CapEx spending, we think what we have seen is manufacturing in industrial production will be slightly less than GDP.

Our expectation is over what we think has been an adjustment year in that year, in this year, that we're more likely to see the slightly stronger global GDP next year really led primarily by Europe going from a negative to a positive, but a return to a pattern where manufacturing and industrial production would be higher than an expanding GDP.

That's probably the biggest variance in that respect.

Our fake out, if you will, this year is that manufacturing and industrial production is going to be lower than GDP.

And that had more of an impact than we foresaw coming into this year.

Yes, I guess taking that thought further let's say you knew this year industrial production would be less of a relationship with GDP.

You know, below.

And say last year you said our orders just came down mid single and we are thinking '13 end markets are flat.

Just even if you knew that then, you would argue if your orders are up mid single right now and October is healthy, even going up 3% to 4% seems to have an air of conservatism?

Clearly, it's justified.

I am just trying to get into your head a little bit on what's making you a bit cautious on that outlook?

Is there something very tangible, or is it a little bit maybe lessons learned from last year on wanting to start with a little more conservative relationship between your orders and how you are seeing the end market?

A couple of things, David.

I would say remember one, some of our -- a large portion of our orders in our businesses, as I was mentioning earlier I think maybe to John's question, come in and go out in the same month.

So they don't necessarily build the foundation for the next year.

We have seen this year-end slowdown occur three of the last four years.

And we have the prospects sometime in the first quarter of next year for having some more theater in Washington.

Hard to know exactly how that is going to impact the year.

Our best estimate is this 3% to 4% range.

We are encouraged, as you correctly note by both our third quarter bookings and the strong start in October, love to see a November and December behind it of that level of strength and then I think I would feel a little differently about 3% to 4%.

But you'd have to say we're off to a good start against it.

All right.

I appreciate it.

Thank you.

Jeff Sprague, Vertical Research.

Just about interesting expense.

If interest expense finishes Q4 flat with Q3, your annualized benefit for 2014 relative to '13 ought to be some $20 million at the tail.

I don't know if that qualifies as very small, but then on top of that don't you have some debt reduction that you would be expecting next year?

So if you could maybe just kind of size what's really going on there and if there is some other missing piece?

Yes, it's Rick.

We do have a debt maturity of just over $500 million towards the end of the second quarter and clearly we have over the course of this year put on some fixed to floating swaps that you have to forecast exactly how those perform.

All of that tells us we will have some reduction.

We just haven't quantified exactly how much the reduction is.

But as a starting point, looking at our interest expense in Q3, and expecting that over the course of next year it will likely come down some, that's a reasonable way to think about it.

And then I was just wondering also on kind of the -- the step up in pension expense sequentially this quarter and then actually the lack of the step up in amortization, I think on the Q2 call there was some talk of some rejiggering of some of the Cooper balance sheet items that is going to take amortization up.

That didn't happen.

Do those numbers track sideways from this Q3 level?

Is there any change in run rate we should think about there?

They do track pretty well sideways into the fourth quarter.

On pension, the reason the costs did increase from Q2 to Q3 really is because of the increase in these lump sum settlements.

We came out of restrictions on lump sum settlements in the third quarter.

So that's the impact you are seeing there.

And on amortization, we had made an adjustment to some of the purchase price bookings on Cooper at the end of the second quarter, and that reset the amount of amortization.

And so, yes, those will trade relatively sideways.

And just on, you know, other corporate within corporate, Rick, you know, you had the inventory step up in Q1.

That line came down a little bit in Q2.

It's kind of back up again in Q3.

How should we think about that?

Is there any kind of discrete noise we can think about modeling, or is that kind of a trend line assumption also?

I would assume that this other corporate was 97 in Q3.

The number in Q4 will be in the mid 90s as well.

That's our expectation.

And then, finally, just on tax, can you give us a little color what drove it down the way it did?

You know, it doesn't seem as highly related to kind of income fluctuations as I you would have tried to guess.

I know it's much more complicated than that.

But give us a little color there and how should we think about cash taxes?

Are they tracking as low or even lower than your book tax rate?

Well, at the start of this year coming off of the closing of Cooper November 30 of last year we indicated this would be a year of transition as the very significant changes in our legal structure, the fact that we're now a high-risk corporation and all of the related transactions to that settled down.

And so really what you're seeing is the continuing effects of settling down that transaction.

And, you know, it's a complex thing to model.

All of the income effects from the various entities around the world.

And so you're just seeing the impact of those effects.

Next year the 8% to 10% that we're forecasting will be a much more normalized reflection of the structure that's in place.

I might add that one reason that the rate will be higher next year from the 5% this year is, in addition, there was two years of benefit from the research and experimentation tax credit in the US in 2013.

And it's our expectation right now that you probably won't have any benefit from R&D tax credits in 2014.

So that itself is a couple of rate points.

And then the other changes, there were several one-off type impacts of the Cooper transaction, and we don't expect those next year either.

And so when you take the 5% for this year, you make those two adjustments, you get into the 8% to 10% range.

Right.

Thank you very much.

Steven Bowman, Jefferies.

I am wondering, Sandy, as you were talking about incrementals for next year does it make any sense to think about the productivity, I guess, gains that you have made this year?

Do some of those bleed into next year and maybe help us a little bit?

I think the way -- and as I mentioned earlier, we are not all the way through our final operating planning for next year.

I think the way to think about it, Steve, assume it's the base for this year and that we'll work the incrementals off of that base.

Both the incremental synergies from the Cooper plus incremental that we will get on additional non-Cooper related synergy revenues.

Okay.

Great.

That's helpful.

And then maybe just quickly can you give us a sense of the -- you mentioned some market share gains in electrical.

Can you give us just a sense of exactly what we're talking about there?

We don't quote our exact share numbers.

We are really pleased that if even a stronger gain on the booking stream than it is on the shipment stream.

I think that gives you an indication of the kind of the momentum we have.

Just maybe types of product or types of end market?

It's pretty broadly across the products that we sell in the US.

And I think it's a reflection of the fact that whether it's in the channel or whether it working with users and OEMs, the capabilities we now have, plus all the new products we have launched, are being received really, really well.

I mentioned to you in the last call this wave stream technology and our lighting business has gotten off to just a banger of a start.

And that's the LED introduction and that really resets lighting.

We've introduced a whole new line of mid-range UPS with the high efficiency that we talked to you about that we have always had in the large-three phase.

That's off to a great start as well.

I think it's that kind of push of new products plus the combined effectiveness we have that's allowing us to really drive this forward.

So more to follow as we come out of the full quarter.

But we're very, very pleased with the momentum.

Super.

And then just lastly, quickly, anything you'd like us to keep in mind vis-a-vis capital allocation for 2014?

Well, I think as we've said, you know, before a couple elements here is we are committed to the same practices we have had around dividend.

We don't run either a yield model or a pay out model.

We expect to increase dividends over time in line with earnings.

Number two, we want to continue this pay down of debt, as we've said.

And Rick has detailed to you in terms of the kind of payback schedule to get to a total of $2.1 billion paid down from the start of our -- the start of the Cooper acquisition.

We generally make our US pension contribution in January.

So you ought to be counting on that again.

Probably not out of pattern with what we've been doing the last couple of years.

And we think in terms of the M&A market it means that we're not in the M&A market in any material way until we get that $2.1 billion paid back.

So I'd say that's the primary activity.

And then capital expenditures likely to be that same number we've talked about.

Roughly 3% of whatever you project the current year's revenues would be.

So I say no dramatic change, and we would continue to kind of buy back shares only to the extent at this point that we're offsetting options, dilution, and we've generally suggested to you that's kind of a planning number of around $100 million.

Josh [Fokoinski], NKM Partners.

Thinking about 2014 and the bookings growth here, and you made some comments, Sandy, on commercial construction starting to pick up here in the US.

I guess historically you guys have talked about greater strength or product capability in more of the industrial side and the power distribution, industrial CapEx, those types of markets.

Obviously, that mix has changed a little bit with Cooper.

What sort of environment do you see, characterized either, top line or earnings leverage if CapEx stays depressed but commercial picks up?

Is that a positive environment for Eaton or is that, you know, kind of all wash out and be more neutral?

Yes, great question, Josh.

If we go back to some of the guidance we provided in the first quarter of this year when we were trying to give you a feel for what are the end markets that support our individual segments, you recall that just a little bit less than 50% of our electrical products business, the portion that's here in the US, is related to residential and non-residential construction.

So, obviously, a powerful play on that continued cycle at this point.

In the electrical systems and services, it's around 30% of that particular business that plays in those two markets as well.

Obviously, the hydraulics business has a play in terms of commercial construction and to a little less extent the residential construction.

And the truck business, obviously, within our overall vehicle business has a play in that area, obviously, as residential housing and commercial construction picks up, you know.

Most of those materials are carried by a truck.

So as we think about the environment of a strengthening residential and commercial construction market in the US, those are all very good things for us.

Now when you get down within the overall mix of US private put in place construction, about half that market is what you would call commercial.

About half is what you would call the kind of heavy industrial side.

And that includes utilities as well as mining as well as telecom and the traditional big areas like energy and power.

Our market shares are very similar across that entire range.

So, you know, our real interest is do we see an overall private put in place number that's a number like in that 5% range?

That becomes pretty sweet music for us in terms of end market conditions.

Okay.

So you are a little agnostic, I guess, within some of those verticals?

We are.

Got you.

Appreciate it.

Thanks.

Eli Lustgarten, Longbow Securities.

So you talked about the strength in orders.

Can you differentiate what's going on in the marketplace from the easier comps that we pull in September, October, November, from a year ago versus what you might consider more strength in the marketplace, and particularly maybe more market share gains?

Because it looks to me like your strength is more a combination of easier comps and some market share gains, particularly in electrical.

Yes, I guess I'd have to look in detail at all of those future comps, Eli.

I would say we tend to look at this on not only a year over year, but also on a quarter-over-quarter basis.

You know, we saw better activity here in this third quarter than we were seeing, obviously, a little earlier in the year.

We think that's a reflection that we're starting to see, Europe is clearly getting better and has bottomed.

We think the same is true in Asia in many of our markets.

That was not true earlier this year.

And the US is on this kind of steady recovery.

Nothing, highly fancy.

But it's getting better except for these occasional interruptions we have that come out of budget discussions.

But it's getting better.

So I think that maybe the most significant things that we have been watching kind of around the world is it looks to us like the oil and gas industry is going to be spending a lot of money in '14, '15, '16.

Clearly, the additional assets we put in front of that with the Cooper acquisition that we think are very advantageous and our combine capability helps.

The quality markets, the three phase business which is one that was quite weak a year and a half ago has definitely picked up.

This construction market that -- and mobile and stationary users in hydraulics, clearly we think that market is changing as well.

Our feeling is it isn't simply an issue of weaker comps.

We think we are seeing a momentum change.

All right.

And final question.

Last year, you know, you are looking at roughly almost 1.5% margin improvement in effect with 0% end market help.

You know, the Cooper -- the synergies are similar from Cooper incrementally year over year or so.

Is there a chance of getting anything close to the kind of margin improvement in '14 versus '13 if you do get some of the end market growth that you are starting to think about?

Yes.

I think that there is no question that if we can get some market expansion with the incrementals in this kind of -- if they turn out to be in this 25% to 30% range, that's going to be helpful.

I guess the way I would urge you to think about this is you get the $95 million of incremental year to year synergies.

That's a plus.

And then we'll get the incrementals based upon whatever kind of volume that we can drive off this 3% to 4% anticipated market and then outgrowth of that end market.

So getting a similar kind of margin improvement next year versus this year, it is, you know, something within a framework that we can think about and talk about given --.

And again when you think about trying to select an incremental margin on the non-Cooper synergy volume, I think somewhere in that 25% to 30% is the right range.

Not the 33% that we used this year because that, as I mentioned earlier in the call, came from the fact that we took the $50 million of restructuring the previous year.

All right.

Thank you very much.

Thank you very much for joining us today.

As always, Mark Doheny and I will be available to take your calls and questions immediately after our call today.

And again thank you very much for joining us.

That does conclude our conference for today.

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