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Executives

Jonathan Safran – Director of Investor Relations

Kirk S. Hachigian – Chairman of the Board, President & Chief Executive Officer

Terry A. Klebe – Chief Financial Officer & Senior Vice President

Analysts

Robert Cornell – Barclays Capital

Nicole Parent – Credit Suisse

[Jeff Brage - City Investment Research]

Christopher Glynn - Oppenheimer & Co.

Deane Dray - Goldman Sachs

Alex Rygiel - Friedman, Billings, Ramsey & Co.

Scott Davis - Morgan Stanley

Cooper Industries, Ltd. (LTD) F3Q08 Earnings Call October 23, 2008 10:00 AM ET

Operator

Welcome to the third quarter 2008 Cooper Industries Limited earnings conference call. My name is Becky and I will be your coordinator for today. At this time all participants are in listen only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call Mr. Jon Safran, Director of Investor Relations.

Jonathan Safran

Welcome everyone to the Cooper Industries third quarter 2008 earnings conference call. With me today is Kirk Hachigian, Chairman and Chief Executive Officer and Terry Klebe, Senior Vice President and Chief Financial Officer. We have posted a presentation on our website that we will refer to throughout the call. If you’d like to view this presentation please go to the investor’s center of our website www.CooperIndustries.com and click on the hyperlink for management presentations.

As a reminder, comments made during this call may include forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which are outside of the control of the company and therefore actual results may differ materially from those anticipated by Cooper. A discussion of these factors may be found in the company’s annual report on Form 10K and other recent SEC filings.

In addition, comments made here may include non-GAAP financial measures. To the extent they have been anticipated, reconciliations of these measures to the most directly comparable GAAP measure are included in the press release and the web presentation. Now, let me turn the call over to Kirk.

Kirk S. Hachigian

As many of you know Cooper is celebrating its 175th anniversary this year and as you can imagine this company has seen its share of economic cycles, technology shifts, wars and general adversity. What has allowed create companies such as Cooper to strengthen and build throughout these difficult times are our dedicated and talented employees, our strong process and accountability based culture, a clear and executable strategy and our ability to learn and consistently reinvent ourselves based on changing market trends.

Clearly based on everything we’ve seen and experienced over the last six weeks, we’ve entered a period of unprecedented volatility and uncertainty. What I can assure the stakeholders of Cooper industries is that this company is well positioned for these volatile times and we’re taking aggressive pro-active actions, some discussed today and others contingency plans that will enable us to address the short term economic conditions while we allow ourselves to continue to focus on our long term strategy and maximize long term shareholder value.

The exhibits posted on our website for today’s call build upon those that we have shown in the past but have also been modified so that we can properly align the investor community with our shorter achievements and also how we’re positioned to respond to the current economic situation. If you turn to page 2 of the handout our team delivered an exceptional third quarter.

Our total revenues were up 15%, 7% of that core again demonstrating the quality and breadth of our portfolio. Our electrical products group was up 17%, 8% from the core, 8% from acquisitions and 1% from foreign exchange and out tools division delivered plus 1% growth minus 3% core in a very, very difficult economy. We continue to see strong growth in industrial, energy and utility. In fact, those trends remain consistent with the first half of 2008.

Residential and retail was still weak and commercial sales began to soften. We continue to see strong international growth with now representing 38% of our sales, was up 20% in the third quarter. Our earnings per share of $0.97 were up 17% and that was on top of earnings per share growth last year of 20%. Electrical products return on sales was 16.4%, down 80 basis points partially diluted by acquisitions, mix and steep inventory liquidation.

Tools return on sale was 11.9%, up 90 basis points. Year-to-date free cash flow was strong at $473 million, up over $100 million from last year and again we expect 2008 to be our 8th consecutive year where our free cash flow will exceed our net income. If you turn to page 3 I’ll talk about the end market conditions. Industrial markets are 38% of our sales, experienced mixed results. Automotive, aerospace and general industrial are slow while we continue to see strong sales in oil and gas, refining and petrochemical with particular strength overseas.

Our order rates in the third quarter were solid and our trending expected levels as we enter the fourth quarter. Commercial markets are 26% of our sales, held up well in the third quarter but we continue to anticipate an accelerated drop in overall activity as we enter the fourth quarter and all of 2009. Slowing overall business activity, poor retail sales and non-existing credit will lead to a contract marketing.

Overseas activities, new products and energy efficiency retro fits should provide some relief. Utility markets are 22% of our sales, had solid order rates and we continue to forecast growth. Aged infrastructure, reliability products and international sales remain strong. Lastly, residential shows no signs of improvement with housing starts at 17 year lows and our sales down 7% in the quarter.

If you turn to page 4, for the electrical products segment which is 88% of our sales in the quarter, we saw solid industrial demand particularly on the energy markets, strong North America demand through electrical distribution channel, strong international sales up over 20%, utility demand was up double digits and retail sales down mid single digits. Total electrical orders were approximately equal to shipments in electrical products and in a quarter where our sales were up 17% we consider this a good indicator of the momentum in to Q4. But, we’re very cautious given the macroeconomic environment.

Lastly, acquisitions, mix, inventory liquidation and rapid steel inflation drove electrical margins down to 16.4% or down 80 basis points. Turning to page 5 of the handout for the tools group. We had a very solid performance across the board in a very difficult economy. Despite softening retail sales, weakening automotive and Boeing’s strike, sales were still up 1%, our order rates were roughly equal to sales and our margins expanded by 90 basis points over last year driven particularly by productivity, positive mix from existing the assembly line business and aggressive pricing actions.

Now, let me turn the call over to Terry to provide you some additional comments on the quarter, update you on our capital structure and provide guidance for the remainder of 2008.

Terry A. Klebe

As Kirk mentioned, we delivered a great third quarter even with the credit markets freezing up towards the end of September. Before turning to the earnings for the quarter I’ll provide some highlights on our free cash flow, balance sheet and liquidity. On slide 6 our free cash flow for the first nine months of 2008 was $473 million compared to $373 million in the first nine months of 2007, a 27% increase.

Great execution during the third quarter drove third quarter free cash flow up 21% over the prior year. Cooper’s strategic initiatives continue to drive performance and as Kirk mentioned, we anticipated delivering the 8th year in a row where free cash flow exceeds recurring income. Our balance sheet remains in great shape with our debt to total capitalization net of cash and investments at 24.3% on September 30th compared to 24.8% on December 31, 2007 and at 20.9% a year ago.

Over the last 12 months we’ve funded $412 million in acquisitions, $165 million in dividends and $364 million in stock buybacks net of proceeds. That totals to $941 million while maintaining a very conservative capital structure. While interest expense increased $5 million in the third quarter of 2008 compared to last year, our share count is down close to 10 million shares or 6% of our shares and our net to EBITDA is only 1.1 times.

Our debt and capital structure is in great shape and we have outstanding flexibility to capitalize on opportunities. Turning to slide 7, our inventory turns in the first nine months of 2008 improved to 6.6 turns compared to 6.2 turns in the first nine months of 2007. This is with the $1 investment in inventory impact by increased material costs compared to a year ago as well as the MTL acquisition completed in February and other acquisitions completed in 2007.

In the third quarter we aggressively went after reducing inventory levels and expect to continue to do so in the fourth quarter to ensure we do not build inventory in a period where our customers will likely be cautious in taking down their inventory. Our receivables days sales outstanding decreased by four days to 63 days. As you can see by our results with the current credit crisis we are aggressively monitoring credit and collections.

Our operating working capital returns increased to 5.4 turns compared to 5.2 turns in the first nine months of 2007. Overall, a solid performance with room to continue to improve. On slide 8, our capital expenditures increased $4.5 million in the first nine months of 2008 and we expect for the year for capital expenditures to continue to be in the $120 to $130 million range. In the third quarter we purchased 1.1 million shares of our common stock spending $42 million against proceeds from the issuance of 6 million.

Through September 30th we have purchased 7.8 million shares spending $325 million against proceeds from the issuance of 17 million. We did issue 1.6 million shares for stock options, matches to 401K and other programs year-to-date. But, as a result, year-to-date, our outstanding shares decrease by 6.2 million shares. Under existing board authorizations, as of September 30th we can purchase up to an additional 9.6 million shares.

In October we received $141 million from the Federal-Mogul bankruptcy and we purchased 3.3 million shares for $111 million to capitalize on the weak stock market in October. Our balance sheet is in great shape and we consistently generate very strong cash flow and as a result we continue to have tremendous flexibility to fund both organic and acquisition growth, pay a competitive dividend and purchase our common stock.

Turning to slide 9, as everyone knows, the credit markets have been in turmoil. Commercial paper markets during certain days that experienced interest rate volatility and lower demand. The good news is the government’s actions to buy commercial paper and other activities should calm these markets over time. We’ve maintained a small presence in the commercial paper markets to keep our name out there but do not need any issuances to fund our cash needs.

We are currently forecasting excluding acquisitions and further share buybacks to end 2008 with no commercial paper outstanding and cash in excess of $450 million. We do have a couple of small acquisitions that could close by year-end but clearly have more than ample cash to fund them. As we look forward to 2009, we have our $500 million credit facility maturing in November and $270 million in notes also maturing in November 2009.

We’ve been in discussions with our banks on renewing the credit facility and at this point there’s no indication that we’ll have issues replacing the current facility. We likely will have a new facility in place in the first half of 2009. As for the debt maturity, we are going to operate as if we have to retire this debt until such time as interest rates are attractive. With no commercial paper issuances and the retirement of the $270 million in debt, our forecast is to have in excess of $600 million of capital available for acquisitions and stock buybacks through the end of 2009.

The bottom line is that we have more than adequate liquidity without any reliance on the credit markets and absent any additional stock buybacks or acquisitions we’d end 2008 with net debt to EBITDA significantly below 1 to 1 and we’d end 2009 with net debt of less than $355 million and be essentially debt free in 2010. Before turning to the results for the third quarter, I’ll cover Federal-Mogul asbestos on slide 10.

At the end of September, the judge presiding over the Federal-Mogul bankruptcy ruled that we could not participate in the Federal-Mogul 524(g) asbestos trust. While we and the other parties involved believe the judge erred in the ruling, we concluded that appealing and continuing to drag out the outcome was not in our best interest. We believe the liability is very manageable and ultimately it will be much more economical to resolve the cases through the tort system than it would have been through contributions to the Federal-Mogul 524(g) trust.

As our financial statements previously were prepared as if we participated in the 524(g) trust, we had to revise them to present insurance assets as a receivable and the estimated liability based on projects of future indemnity and defense costs. As a result we recognized a $0.09 per share discounted operation gain from the revised accounting in the third quarter. Now, we accrued 45 years of indemnity costs estimated at $460 million and 45 years of defense costs estimated at $355 million.

These amounts are not discounted which would decrease the liability by over 40%. Insurance receivables of $192 million were recorded. The insurance receivable only represents insurance in place agreements and settlements. We will collect additional insurance as we enter in to agreements with insurance carriers. Over the last three years our indemnity and defense costs net of insurance have averaged less than $25 million a year.

The last time any asbestos products were produced by Avex was in the 70s. The population that can claim exposure is steadily declining and should make the management of the liability easier as time goes on. Now turning to the results for the third quarter on slide 11. First there were items that impacted both the third quarter of 2008 and 2007. In the third quarter we recorded discreet tax accrual items of $18.3 million primarily related to the expiration of statutes of limitations.

This item increased third quarter earnings per share $0.11. In the prior year third quarter we recognized $23.5 million of Belden income partially offset by $6.4 million in legal accruals related to old previously disposed of operations. These two items increased our earnings per share by $0.10 in the third quarter of 2007. Excluding these unusual items, our earnings per share would have been $0.97 in the third quarter of 2007 and $0.83 in the third quarter of 2007, a 17% increase.

In the third quarter 2008 excluding the tax accrual adjustments, our effective tax rate was 26.5%. As I am sure you are aware, the accounting rules require us to reflect tax strategies and other events in the period they are actually implemented. As a result the rate would have been 28% except that the first six months were at a higher tax rate and the impact to bring the nine months rate to 28% flows through the third quarter.

This catch up added $0.02 earnings per share in the third quarter. Now, in the third quarter we were also required to take a $3.9 million pre-tax charge for the curtailment of an international pension plan. We started freezing this plan and discontinuing it back in 2006 and finally got approval which meant the plan had to be revalued and we had to take a charge when that event occurred. This charge decreased electrical products earnings and our reported EPS by approximately $0.02.

Turning to slide 12, year-to-date in 2008 unusual items totaled $0.10 per share in the prior year $0.44 per share. Excluding the unusual items, the first nine months of 2008 continuing income per share totaled $2.75 compared to $2.31 in the prior year an 19% increase. Turning to slide 13, today we reported a revenue increase of 15% aided by currency translation which added 1% and acquisitions which added 7% leaving a 7% core revenue growth.

Revenues were at the top end of our forecast with the electrical segment exceeding the forecast and tools falling short of the forecast. Revenues tracked through the quarter at a relatively consistent rate each month. However, we saw the reactionary effect of the credit crisis and media coverage in late September where we saw stock type product sales becoming volatile and demand weakness in some products.

October to date has been mixed with a pickup in activity in some product lines and continued slowness in others. Clearly, our customers are going to be cautious on carrying inventory over the next couple of quarters. Growth in businesses serving energy markets is continued with double digit growth and our utility business posted double digit growth. We delivered core revenue growth in every electrical division except one in the tool segment.

Interesting, even with all the negative indicators and news flow and a volatile end to September, our orders remain strong in the quarters with orders exceeding shipments in electrical. Tools on the other hand had sales exceeding orders. Exclusive of the unusual items I covered previously, we reported $0.97 earnings per share, a 17% increase.

Now, our results were impacted by product mix and slowing our manufacturing production and material inflation during the quarter which I’ll touch on in a minute. But, overall we performed very well in a tough economic environment. I discussed in our February, 2008 outlook meeting that reducing our share count would be a nice contributor to our earnings per share growth in 2008. Simply taking the reported lower share count, 6% of our earnings per share growth was from stock buybacks.

However, as you know, this is more like 4% when you consider the additional interest expense incurred to finance the share buybacks. Turning to slide 14, as I mentioned earlier, acquisitions contributed over 7% to our revenue growth. The incremental revenue from acquisitions contributed slightly over 10% return on sales with higher selling and administrative costs. Our gross margin declined 60 basis points resulting in the gross margins being 32.3% in 2008 versus 32.9% in last year’s third quarter.

Gross margins were impacted by sales mix within the electrical segment and our intentional reduction in production volumes to bring inventory levels down. Steel and certain other metals and energy have increased significantly year-over-year creating a challenging environment. In the third quarter material inflation alone was $29 million in excess of our forecast at the beginning of the year.

As I mentioned last quarter, our tools group in the second quarter did not recover price in excess of material costs primarily due to LIFO inventory accounting which requires the expensing of material cost increases in the current period. I’m pleased to report that tools did achieve adequate pricing to offset the increased material costs in the third quarter. We did however see two of our larger businesses challenged with material inflation in the third quarter.

Both of these businesses are in LIFO inventory accounting for their US operations and did not achieve adequate pricing to offset material inflation and probably were not as aggressive as we’d like on achieving price versus sales volume. Both of these businesses due to their backlog will continue to impact margins in the fourth quarter.

Selling, general & administrative expenses for the quarter as a percentage of sales were 17.8% compared to 18% in the third quarter of last year. Incremental impact of acquisitions added 30 basis points to selling and administrative costs as a percentage of sales and include a very nice improvement in reflecting of the actions that we’ve been taking in the last 12 months to reduce costs.

From a segment reporting perspective, the third quarter of 2008 reported $23.9 million in general corporate and other expense compared to $23.3 million in the comparable quarter of 2007 excluding the $6.4 million of unusual items. During to slide 15 operating earnings increased 12% excluding the unusual items in the third quarter of 2007 with operating margin declining 30 basis points to 14.5%.

Continuing to slide 16 on net interest expense, our tax rate and net income. Our next interest expense was up $5 million in the quarter driven primarily by the acquisitions and stock buybacks. Exclusive of unusual items our effective income tax rate for the third quarter was 26.5% and as I mentioned earlier, this reflects the catch up effect of the tax rate in the third quarter of 2008. A great job by our tax team successfully implementing tax improvements in the third quarter that drove the rate down.

Now, in the fourth quarter our rate well reflect the R&D credit that passed in to law in October which will likely result in the fourth quarter tax rate in the 26% to 26.5% range. For the year, we’re currently forecasting around a 27.5% to 27.75% tax rate excluding unusual items. Our income from continuing operations increased 12% on a 15% revenue increase excluding the unusual items.

Turning to the segments and slide 17. For the quarter our electrical products segment increased 17% excluding currency translation of 0.7% and incremental revenue from acquisitions of 8% with core revenues growing 8%. Price realization represented close to 3% of the growth. The businesses serving the energy market continue to excel with core revenues up double digits against tough comparables. Our international operations also continued to perform well.

Electrical retail sales were down mid-single digits driven by the continuous weakness in residential and light commercial end markets. Our lighting business more than offset the retail channel weakness with solid sales increases in the commercial industrial market and delivered low single-digit core revenue growth in a very challenging market.

Our power systems utility business grew core revenues double digits aided by the hurricane that hit the Gulf Coast.

Revenue growth for electrical products was strong both in the US and internationally. Developing country revenue growth was 25% and electrical distribution revenue was up double digits with very strong growth in both North America and the rest of the world. As I mentioned previously, our softest channel was retail where we declined mid-single digits. The residential market continues to be weak partially offset by new customers and products.

Overall, electrical product segment earnings increased 11% and return on sales declined 80 basis points to 16.4% from 17.2% in the third quarter of 2007. Excluding the incremental impact from acquisitions, return on sales would have been 16.8% and would have been 17% excluding the pension curtailment charge. As I mentioned earlier, sales mix and material inflation and inventory reduction efforts decreased return on sales.

Turning to the tools segment on slide 18. In our tools business sales increased 1% with currency translation contributing 4% of the growth. We had a tough quarter on the top line for tools. The Boeing strike, a tough motor vehicle end market and close to a double-digit decline in retail sales impacted results. However great execution with tools operating earnings increasing 10%. Our tools operating margin as a percentage of sales increased 90 basis points to 11.9%. The results were aided by the benefit from the prior year downsizing of an international facility and favorable product mix.

Turning to slide 19. Last quarter we said absent a significant global or US economic downturn, we continue to remain confident that we can deliver double-digit earnings increases in these tougher economic times. Beyond the unprecedented turmoil in the credit markets and the significant impact on the forecasted growth rates in the global economies will impact Cooper as well as most other companies.

We believe it’s prudent to take additional actions now to adjust our cost structure. Before year end we anticipate reducing our global workforce over 1,000 employees. We anticipate a severance charge of $20 million to $22 million in the fourth quarter and expect to realize a benefit of over $50 million annually. We are also additionally evaluating plans and consolidating production volumes and other contingency planning.

We will be conducting our annual business reviews over the next couple of months and developing our 2009 forecast. We currently anticipate that our utility business and most of our businesses serving industrial markets will continue to show growth for 2009 albeit at what may be a low single-digit rate. It is likely that commercial and residential markets will be tough in 2009. However developing markets should have reasonable growth in energy efficiency products and new platforms should offset some of this weakness.

As I know the question will be raised, pension expense and currency translation will be a headwind. However the lower share count should offset these headwinds.

Now we do not have a crystal ball on how long or deep the recession will be; however we are proactively adjusting our cost structure in advance of a slowdown and continuing to position Cooper to outperform in what looks like will be a tough environment over the next year or so. Before turning the call back to Kirk for his final comments, I’ll provide comments on our forecast for the fourth quarter and year.

Turning to slide 20, in the fourth quarter we’re forecasting revenues to increase 7% to 9% with electrical up 9% to 12% and tools down 5% to 10%. Core revenue growth is forecast to be low single digits. We anticipate that customers will reduce inventory levels in the fourth quarter and believe it is prudent to assume that we will not experiencing the normal customer purchasing to achieve year-end incentives.

In tools we’re forecasting very weak retail sales for the Christmas holiday and weakness across tools end markets. Typically, the fourth quarter is the strongest quarter for tools. This year is it is unlikely that we will experiencing the normal sales and earnings pattern in the fourth quarter. Earnings per share are forecast to be in the range of $0.83 to $0.92 per share flat to up 11% from the $0.83 we reported in the fourth quarter of last year exclusive unusual items.

As I indicated we expect customers to react to the credit crisis and significantly reduce inventories. We are likewise factoring in to our forecast extended holiday manufacturing facility shutdowns to ensure that we do not build inventory. We implemented contingency plans and are aggressively reducing headcounts and discretionary spending to prepare us for what will be a more challenging environment. This guidance does not include the severance or other charges in the fourth quarter.

For the full year we’re forecasting our top line to grow 12% to 14% and excluding unusual items in the fourth quarter charge we’re forecasting $3.58 to $3.67 earnings per share. Let me turn the call back to Kirk for his final comments.

Kirk S. Hachigian

Turning to page 21, as Terry and I have reviewed we are extremely well positioned to continue to execute our long term strategy. Core to that strategy is our alignment around our business initiatives. These initiatives enable us to deliver exceptional results in a strong economy but even more importantly will allow us to outperform in a weakening environment. Customer loyalty, Cooper Connections, C3, innovation and globalization have dramatically accelerated our core growth profile and allowed us to penetrate new and expanding markets around the world.

We’ve also built strong process capabilities around strategic sourcing, value engineering, lean and productivity, driving margins and free cash flows to record levels. Lastly, over the last several years we’ve made significant changes to our management team to allow us to execute these initiatives including operating a major structure. We’ve developed a culture around accountability and we’ve created incentive programs that reward pay for performance.

On page 2 I want to make it perfectly clear that we’re facing in to the reality of this new economy. While the credit markets have frozen we’ve positioned the company with great liquidity and to continue to invest and return capital to our shareholders. Our dividend is secure and further share repurchases remain an option. We anticipate commercial construction to have significantly weakened over the coming quarters and taken today’s [inaudible] reactions in anticipation of slowing and have other contingency plans in place.

We will continue to invest in emerging new technologies including LEDs, lighting controls, mass notification and we’ll expand our global footprint to offset weakness in North America and western Europe. Our acquisition integrations are on track. We expect our industrial businesses to continue to grow albeit at a slower rate. Emphasis on energy, energy efficiency, safety and developing market infrastructure should offset a slowing mature market.

We will continue to fight for share in the declining housing and residential markets. These markets will be attractive and growing over the next few years. Lastly, we will offset the fx and pension expense with additional share repurchases at attractive prices. Heading in to 2009, we have a heavier emphasis on cost management and cash flow but we’ll continue to invest in key growth opportunities, acquisitions and other ways to maximize shareholder value.

Let me turn the call back over Jon to take your questions.

Jonathan Safran

At this point we’re going to open up the call to questions. I just want to remind our listeners to please enter the queue using your own name. Out of respect to others waiting to ask a question we will not take questions to people who enter the call queue using someone else’s name.

Question-and-Answer Session

Operator

Our first question comes from Robert Cornell – Barclays Capital.

Robert Cornell – Barclays Capital

Both Terry and Kirk touched on this but let’s go over the decline in electrical margins again. How did that break down and how does it look going forward? Again, if you don’t mind.

Terry A. Klebe

There’s 40 basis point impact from the incremental impact of acquisitions and 20 basis points from the pension curtailment charge we took in the third quarter. So, absent acquisitions and that charge we would have been at 17%.

Robert Cornell – Barclays Capital

You did mention that you’re behind the eight ball on price costs. Can you just get in to that a little bit and why did that happen? Which businesses are involved? Where you are on the catch up? I heard your comment about backlog in the fourth quarter.

Kirk S. Hachigian

So as you think about a tightening economy, I think we found it a little harder to pass through some steel more than anything else in the quarter which was a little unusual but I think if you looked at the core growth rate which I thought was exceptional for the quarter that was sort of the trade off. I think the other piece of it too was the decline in inventories.

We took a harder approach on factory efficiencies and not running the factories for efficiencies and probably taking a bigger bit out of the inventories in participation of a slowing economy. That certainly showed up in the free cash flow as well.

Robert Cornell – Barclays Capital

What implicitly is the margin you’re looking at in the electrical in the fourth quarter in guidance? That isn’t clear.

Terry A. Klebe

On the fourth quarter we intend to continue to go aggressively after inventory. The worse thing would be to enter 2009 with excess inventory and we’re not going to let that happen. So, that will have some impact and typically the fourth quarter is lower volume and we are shut down in factories towards the end of the year. So I’d anticipate that we would probably be running somewhere in the 16% or so margins on electrical.

I’ll give a caveat on that. As you can see in the fourth quarter we have a pretty broad earnings estimate for the fourth quarter. The markets are extremely volatile, currency rates have bounced all over the place over the last at least three or four weeks and as I mentioned we are not real comfortable on what the customers will do at the end of the year to reach incentive goals as well as how much destocking they’re going to do which can impact what the margins overall will be in electrical as well as tool.

Kirk S. Hachigian

I think the other thing we talked about in the past Bob is when you get those margins up to 17% in electrical you’ve got to be careful managing percentages because what you’ll do is you’ll basically shrink the business if you don’t take 16% 16.5% incremental margin business. That’s a bad decision long term on cash flow and on overall growth of earnings. I think there’s a little overt as much attention brought to the percentages versus the absolute cash flow and the absolute performance of the earnings.

Robert Cornell – Barclays Capital

Just one final question for Terry actually, when you go back to the asbestos settlement plan a, plan b, what are you running through the P&L now with regard to asbestos if anything? I think a lot of it is coming out of the reserve. Compared to what you’re reflecting in you actual 08 period costs, what will be reflected in the period costs going forward under plan b?

Terry A. Klebe

Absent additional insurance collection and changes to the accrual which we anticipate we’ll reevaluate that once a year towards the end of the year, the only thing that flows through the P&L is the internal costs related to our attorneys that work on that which that flows through continuing operations.

Robert Cornell – Barclays Capital

What ballpark is that, around a $5 million number? What is that?

Terry A. Klebe

It’s probably, I don’t have that number but my guess Bob is it’s more like $1 million to $1.5 million.

Robert Cornell – Barclays Capital

So that doesn’t change, it’s not a headwind in ’09 versus ’08? It’s the same number?

Terry A. Klebe

No, it should be relatively consistent.

Operator

Our next question comes from Nicole Parent – Credit Suisse.

Nicole Parent – Credit Suisse

Kirk, could you just give us a bit more color on commercial softening? I guess with respect to kind of orders, quotations, inquiries, cancellations? You kind of alluded to international still being a positive offset, maybe flesh that out a little bit?

Kirk S. Hachigian

It’s tough because if I looked purely at the numbers in the third quarter, our book-to-bill rate, our core growth rate, it doesn’t look any different than say the second quarter did or really any of the quarters over the last two years. It was solid. We saw good quotation activity and again in a quarter where you grow revenue 17, if your order rates are equal to that +/- just a small fraction, it would suggest that you have good momentum going out.

But I think what makes us nervous out there on this commercial construction site is availability of credit. If you look at the ABI numbers, if you look at the ISM numbers, we don’t see anything in our business yet that would suggest where this thing is going to go.

But I think if you look at the external macro numbers, you’ve got to believe that this thing is going to fall off dramatically probably not too bad in the fourth quarter but certainly into the first quarter of ’09 and continue through most of ’09 would be our guess at this point. So I think it’s more macro anecdotal things that we’re looking at that would suggest that. If you look at the backlog at lighting for instance on the commercial side, it held up very well in the quarter. It didn’t burn into any backlog of power systems.

If you look at all those internal system indicators that we would normally look at even into the month of October, we still feel pretty good. But I think you’re naïve if you’re looking out the back window to drive the cars forward. I think it’s just crazy in this market.

Nicole Parent - Credit Suisse

When you talked about electrical you said shipments equaled orders. Was that across the board in each of the businesses or any major differences across the businesses within electrical?

Terry A. Klebe

It was pretty consistent across all of our businesses. As Kirk said, when we look at our order rate through the quarter, they were pretty consistent July, August, September. If it wouldn’t have been for all the news and happenings late in September quite frankly, we’d have had much better flow business because that did impact our lighting business on the stock business, Bussmann business, on the industrial side, and that’s why we had the comment quite frankly on a little bit of the mix going into the quarter. But it also makes us make sure we want to plan ahead because we saw the volatility that the news flow did on the inventory and the stocking by our customers. We’ll see how it plays out toward the end of the year but that’s why we have some caution there.

Kirk S. Hachigian

I think on the international side, while I sort of read the papers like everybody else, I just came back from a trip. I was in China, India, and the Middle East. We still have tremendous opportunity over there. Even if we’re doing $100 million in some of these markets, it’s very small penetration. We’re putting in distribution centers, we’re putting in local manufacturing, we’re still scaling up our teams and access to the market. So I think we can still grow those things significantly as we move into 2009 as well.

Nicole Parent - Credit Suisse

On capital allocation priorities, obviously where the stock is where it is, you talked Terry a little bit about share buy-back authorization left. Maybe give us a sense when you think about buy-back versus M&A, and I know you alluded to a couple of small things that you might get done in the fourth quarter. But as we look over the next six months?

Terry A. Klebe

Our view on the M&A side is it’s going to be difficult to get reach agreement on the outlook on a lot of these acquisitions. It has a significant impact on the valuation of it. As we look forward at least for the next six months or so, I think it’s going to be a little tough to get the sellers and buyers to agree on the valuation and price. My guess at this point is that you won’t see a lot of acquisition activity over the next six months which will mean we’ll have a lot of capital available to buy back shares.

Kirk S. Hachigian

If you look at our business model, we’ll take down cap ex next year because in a slowing economy we won’t need the kind of cap ex we’ve been running on. If you hold your inventories and receivables flat because you’re not growing, our cash flow characteristics ought to get better in a flatter slowing economy. Our expectation is that we can throw off even more cash next year than we threw off this year if we do a right job managing the balance sheet, and as we’ve discussed taking down the inventory into the fourth quarter is part of that plan.

Operator

Our next question comes from [Jeff Brage - City Investment Research].

[Jeff Brage - City Investment Research]

Kirk on the issue of price, this difficulty of pushing price forward in Q3, are you starting to hear and get more of the dialogue of actually people asking for price back on the downside? Obviously you’ve got a delayed reaction on costs but your customers are certainly watching costs come down from a headline basis.

Terry A. Klebe

I’ll field part of that question anyway. Part of what’s going on in the market place is carbon steel year-over-year is up 67% yet, but sequentially it’s been coming down. Of course a lot of the other commodities have been coming down, some of them relatively rapidly. So clearly you get this dichotomy where price in the market is tougher because everybody reads the same thing that you and I read; it’s coming down.

Then that’s exasperated by the fact that we’re on LIFO inventory, a big piece of our businesses, so we ended up taking a charge or an expense in the third quarter to the tune of $16 million to $17 million because we’re on LIFO. Quite frankly we underestimated a little bit on what that impact was going to be. We had originally thought that’d be somewhere in the $10 million to $12 million and it was a little bit higher. Those two things drove us a little bit on the price material economics. The good news on being on LIFO of course is you’re not delaying that into the future periods.

Kirk S. Hachigian

But I would say commercially in a quarter where we grew the core in electrical 8%, probably not feeling much pressure on the decline on the pricing. It’s our expectation that we’ll be able to hold a lot of the price increases that we have put in the market place. I think again as people read the economic news out there, you’re probably a little less likely to want to push hard on price commercially in the market place.

I would say this quarter we probably erred a little bit more on the side of taking growth and not so much on pushing price through commercially in the market. I think we’ll live through that through the first quarter but it won’t be a big issue. I don’t think it’ll be a big issue.

[Jeff Brage - City Investment Research]

I was just wondering if you could address the payback on the charge? You’re getting kind of a 2x benefit relative to the charge. Usually we think of these things kind of being a 1x proposition. Why is this particular cost saving action so lucrative?

Terry A. Klebe

Everything that is in those numbers is peer taking out the individuals and the workforce.

Kirk S. Hachigian

Salaried workforce.

Terry A. Klebe

So there’s nothing buried in there for other charges for writing down assets or those types of things.

[Jeff Brage - City Investment Research]

And you’ve got some of that on the drawing board as you’re thinking about preparing for next year it sounds like?

Terry A. Klebe

We’ve had contingency planning going on for a year and a half now so we had a lot of plans where we could trigger some additional moves, etc. and we always do some of that. But depending on what the market starts looking like in 2009 as we go through the planning process, we may trigger some of those.

Kirk S. Hachigian

If you look at our businesses, other than power systems, they’re not really capital intensive businesses with giant brick and mortar. If you go back and look at the last five years of how we’ve grown the company, we haven’t added any significant brick and mortar in the US or in Europe. So for us to scale the business back is primarily through workforce reductions and salaried reductions. I think that was the approach that we took going after this first slug here; trying to resize ourselves at the salaried level first and try to take a first look at what this thing’s going to look like as we go out six months from here.

[Jeff Brage - City Investment Research]

Finally on the storm impact, can you articulate what that was and what you think the tail might be? Is it a one or two quarter thing from here or is it about played out?

Terry A. Klebe

It’s a mix. Actually that did impact a slight bit on the electrical side because it clearly kicked in on the wiring device because of the low stocking in the channel. So we got 1 million or two extra on the wiring side of it.

It impacted the power systems business because clearly pole transformer demand went way up and we added shifts, etc. to kick out more. Now part of that was of course our plant is in Texas so we didn’t exactly have a great workforce for a week or two and it took a while to ramp that up. We probably got $3 million to $5 million of revenue in the third quarter. Some of that will flow into the fourth quarter but most of that’ll primarily be on the utility side and also it tends to be a little lower margin product line.

Kirk S. Hachigian

There’ll be some residual Crouse over time but they’re still assessing a lot of that and that’ll be a slow gradual.

[Jeff Brage - City Investment Research]

Kirk, just one more. Are you getting any vibes of people kind of reconsidering oil patch projects? We kind of got a fixed handle on oil now. It doesn’t sound like anything like that has materialized in the near term but I just wonder if the tone of conversation is starting to change a little bit?

Kirk S. Hachigian

I’d say almost the opposite. I was in India and I was in Southeast Asia. All those Asian countries want to be independent even “when the next cycle comes back.” So Vietnam, Southeast Asia, China are going to put in these refining and exploration. India’s going on what little they have on upgrading their refineries. I can’t tell you how bold Saudi Arabia still is. And if you looked at our order trends in North America and around the world, we saw a little slowness in Europe but outside of that I think the spending patterns and the capital outlay is still very, very strong.

Operator

Our next question comes from Christopher Glynn - Oppenheimer & Co.

Christopher Glynn - Oppenheimer & Co.

On the inventory liquidation, I wondered if you could quantify a little bit of what that is and with the further liquidations in the fourth quarter if that gets you to where you want to be with a tough demand environment next year or if this is going to be with us indefinitely?

Terry A. Klebe

It goes in a nice position going into the fourth quarter and I would expect that we will do about a similar reduction in the fourth quarter. It’s a little difficult to predict that exactly because it depends on the volume that’s flowing through there and the day-to-day demand out there in the order book. Like I said earlier, we have a pretty wide range in the fourth quarter right now on that side.

But in any event we expect to be right sized on the inventory as we enter into 2009 and we do not intend to build inventory in the first quarter of next year, which typically happens somewhat because of the seasonality of the business. We will not see that typical build. Key metrics for us, we’re on top of it with everybody and we’ll keep adjusting that as we look at the forward demand.

Kirk S. Hachigian

I’d even say on our compensation plans we’re looking at a heavier weighting on the cash portion going into 2009 because we want to make explicitly clear that we don’t run the plants for efficiency or productivity and really want to focus on the working capital. I think that we’ve had good progress, you saw the numbers that Terry showed on inventory turns and some of the progress, but I think cash flow and managing these businesses for cash is going to become more relevant over the next 12 to 18 months.

Christopher Glynn - Oppenheimer & Co.

Any way to quantify what the impact was even roughly in the quarter from those inventory actions in the electrical [inaudible]?

Terry A. Klebe

It’s hard to quantify the exact number but I would suspect that that had somewhere in the 10+ basis point impact.

Christopher Glynn - Oppenheimer & Co.

And the $50 million in savings from the headcount reductions, when would you expect to hit the run rate on that?

Terry A. Klebe

We have started actions today on it and it’ll go throughout the fourth quarter. So we’ll get some impact in the fourth quarter. Most of it will roll of course into 2009 with lower employment.

Kirk S. Hachigian

And that’s it. We expect to have all of them done by the end of this year so you would have the full benefit into 2009.

Operator

Our next question comes from Deane Dray - Goldman Sachs.

Deane Dray - Goldman Sachs

At the beginning of the year Kirk, you talked a bit about having a six-month visibility across your businesses based upon backlog, based upon project work, and so forth. As it stands today with the credit market uncertainty, economic uncertainty, how much has that visibility shrunk and how confident are you over the next couple of quarters and so forth?

Kirk S. Hachigian

That’s a great question. Again, if I look at the metrics of the third quarter and I get a briefing book for these conference calls of course a week and a half in advance and I go through all the metrics, so you look to the book-to-bill ratio, you look at the incoming trend rates, and I could look for two years at what our core growth rate trends were and all the metrics that we look at. I would tell you that the third quarter was as solid a quarter as we’ve had in the last two to three years and we’ve got great momentum heading into the fourth quarter which ought to carry the fourth quarter and the first quarter easily into ’09.

With that said, most of our end users rely on capital, from small distributors to building new retail strip centers and commercial buildings and things like that. I am extremely concerned that there are enough indicators out there that you’re seeing that come to a quick end. For some reason it’s not quite showing up in our order trends yet so that’s why I’m concerned.

Now our MRO business, our short-term business, will still be good solid replacement business. Most of our industrial business is not new construction; it’s replacement business. I think that’ll do very well but even still when you see the weakening automotive sector, you see Boeing on strike, none of that is good for the industrial base of this economy so even there I’m concerned. If we aren’t running the factories how much MRO business are these places going to use and consume.

The macro piece of me makes me much more cautious than looking at the specific metrics of the third quarter, if that’s clear at all to you.

Terry A. Klebe

I’d add to that, what concerned us was the extreme volatility we saw in that stocking business right at the end of September. It makes us very cautious on events that could happen in the fourth quarter, etc.

Kirk S. Hachigian

I don’t think our distributors are sitting on a lot of inventory. I think the channel’s pretty clear there. I’ve seen them now order smaller quantities on stocking items than normal size stocking and we’ve not seen any defaults or delinquencies out of our payment schedules out of our distributors as well. So there’s nothing going on there. We’re keeping an eye on that. I’ve got to tell you this; you don’t have to be a genius to pick up a newspaper to figure out what’s going on out there.

Deane Dray - Goldman Sachs

On the asbestos side, it’s kind of ironic in the middle of all this you had to get the asbestos issue and you did get it resolved and Plan B looks to be pretty much a non-event. Two questions. One is you got that cash payment from the trust. Did it end up being a little more than you were expecting?

Terry A. Klebe

The agreement was that they had to pay us the equivalent of interest on it while it sat from the time they got out of bankruptcy until they paid it to us. So that’s an incremental amount on it.

Deane Dray - Goldman Sachs

What’s the plan here? You will litigate these on an ongoing basis or could you seek some other remedies, maybe partial indemnification? What should the expectation be?

Kirk S. Hachigian

There are other things that you can do. There are other options out there for us on insurance and other ways of managing through this. But I think at this point it’s early to speculate on any of those.

Operator

Our next question comes from Alex Rygiel - Friedman, Billings, Ramsey & Co.

Alex Rygiel - Friedman, Billings, Ramsey & Co.

I want to compliment you on recognizing the risks of the storm clouds out there starting to plan for them now. You did highlight one segment of your business that has a pretty favorable outlook in 2009, that being your utility segment. Could you expand upon some of the pluses and the minuses across either your inventory or your customers’ inventory, storm impact, wind farm activity, metering, new construction, so on and so forth? Just highlight some of the pluses and minuses in that segment next year?

Kirk S. Hachigian

First of all, on the reliability products, switch gear products, capacitor banks and general replacement business in the US is strong.

As of late the transformer business, because of the hurricane as Terry mentioned, we put the second and third shift on Nacadocious and that picked up. It tends not to be the greatest margin business for us but that’s picked up where that had normally dropped off because of the housing market being slow, and that’s an infrastructure project for the housing market.

The overseas business is very strong. And I would tell you the EAS business continues to be strong and we continue to look at little niche acquisitions in that space to augment the other two acquisitions that we’ve made on the EAS side. So that’s a place you could see us continue to be active.

It feels pretty good to us overall. That’s a space that on the oil and gas side we’d expect that to be a marketer’s space we continue to see good strength into 2009 as well.

Operator

Our next question comes from Scott Davis - Morgan Stanley.

Scott Davis - Morgan Stanley

I don’t think you mentioned energy retrofit and that’s one area that I’m trying to gauge how recession proof that business is going to be. Do you have a sense if that’s a business that when times are tough people just kind of give up on it or is this all full speed ahead?

Kirk S. Hachigian

Here’s what you do as a leader. We’re still building our R&D center down at lighting. We’re still looking at some interesting technologies around LEDs. We’re still hiring very talented, very sophisticated people on electronics and design engineers and such.

Whether that is an area that people pull back on because they look at their capital budgets and say even though it’s a two-year payback I could probably delay this for another year, we’re going to continue to invest down that path. Occupancy sensors, fluorescents, energy efficiency in the LED space and the control space are going to continue to be areas that we’re going to protect and continue to fund.

My guess is you’ll see some pull back in that area. When people are retrofitting, you’ll see them put in energy efficient products but I’m concerned you will not be able to stimulate the demand that you could have maybe three or four months ago when we were talking about this the last time.

Scott Davis - Morgan Stanley

Obviously an awful lot has changed since even you folks were at our conference just a month ago and commodity prices have started to come back pretty drastically. Let’s assume you’re a little bit behind the price cost curve now because of FIFO but obviously steel and copper prices have come in a lot, so when do you hit this crossover point where you’re actually capturing a little bit of margin even if it’s in near term before you have to give it back? Is that a near-term issue?

Kirk S. Hachigian

We were talking about it. We haven’t gotten a negative purchase price variance in I think it’s been four or five years. We had the strategic sourcing department. If you go back six or seven years ago and you’ve been in this job long enough that you remember we used to report productivity and negative purchase price variance because we could negotiate contracts and actually get deflation. Well, we’ve had inflation now for five or six years and we’ve had to push commercially prices through.

I think ’09 looks easier if you get deflation on the back side of it and people act in a rational way and we can hold, not take a price increase but just hold market pricing relatively flat, you’ll get a net kiss. I think there’s something there.

As Terry said though, the biggest commodity we consume is still steel and the one commodity that’s up year-over-year still 65% to 68% is steel. So it’s starting to roll over and with the automotive industry flat on its back I would expect that you’ll continue to see that roll down. But that would be the biggest help that we could get. Now oil will help because of freight costs and all the other sort of stuff but steel will be the biggest single help that we can get on the cost of goods sold side for Cooper.

Scott Davis - Morgan Stanley

Actually I said FIFO but I meant to say LIFO so you actually get a benefit earlier. Then my last question on share repurchase, you were pretty aggressive in 3Q and again I know you did talk about this a little bit but give us a little bit of an indication of [inaudible] to come. You had some one-time issues there in 3Q that allowed you to step up a little bit more aggressively. That’s all good. What’s kind of left? Is share repurchase now funded out of cash from operations or are you actually willing to lever up a little bit?

Kirk S. Hachigian

We’ve got the $275 million coming due in ’09 and as Terry said we’re going to prepare ourselves to pay that off and not have to go to the credit markets if we don’t like the rates to place that debt. So we’ll preserve that. I think that we can look at additional free cash flow. I’m not sure we want to go to the credit markets to repurchase shares but I think we’ll have ample cash to go ahead and continue to buy back shares as we see fit.

I don’t want to take us out of the M&A game either because I think prices are going to come back into a very nice perspective here in the near term and we’ve got several things on the books that we’re still looking at. So I’m not pulling away from the idea that we want to grow the company. We’ve done these niche acquisitions to build out these very interesting platforms. It was $600 million of new stuff that was less cyclical, higher growing, more spec’d, and that’s stuff that’s going to help us weather the storm. That stuff is still in pretty good shape and still growing out there.

So we’ll use a balanced strategy but I think this year you can see how we came a little bit more aggressive at it because I think the stock price just doesn’t reflect the value of the company.

Jonathan Safran

Thank you for joining us on the call today. As always, please feel free to follow up with me with questions or clarifications that you may have. Thank you very much.

Operator

Thank you for your participation on today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Cooper Industries, Ltd. F3Q08 (Qtr End 09/28/2008) Earnings Call Transcript
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