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Executives

Mark Doheny – 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

Jeff Sprague - Citigroup Investments

[Bob Cornell] - Barclays Capital

Nicole Parent - Credit Suisse

Scott David - Morgan Stanley

Christopher Glynn - Oppenheimer & Co.

Cooper Industries, Ltd. (CBE) Q4 2008 Earnings Call January 27, 2009 12:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2008 Cooper Industries, Ltd. earnings conference call. My name is [Katrina] and I'll be your coordinator for today. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Mark Doheny, Director of Investor Relations. Please proceed.

Mark Doheny

Thanks, Katrina. Welcome to the Cooper Industries fourth 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 this call. If you would like to view this presentation, please go to the Investor Center section 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 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 10-K and other recent SEC filings.

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

Now let me turn the call over to Kirk.

Kirk S. Hachigian

Good morning. I can certainly say that 2008 did not end up as any of us anticipated. We did, however, end our 175 year anniversary with many terrific accomplishments - record alltime revenue at $6.5 billion, up 10%; EPS at $3.59, up 14%; and record cash flow, over $700 million, after CapEx.

We unfortunately also saw our market value decline by over 40%, obviously reflecting a much more challenging outlook for the global credit markets and negative macro conditions for all of our global end markets. The fact that our shareholders did not share in our record performance is certainly foremost on management's mind.

As you can imagine having just completed our 175th year anniversary, we've experienced many cycles, recessions, crises, and have not only survived, but have prospered and adapted to changing market conditions and emerging technologies. For many years we've benefited from dedicated and talented employees, conservative and ethical leadership, and experienced an insightful Board of Directors.

We enter 2009 better prepared than in any time in our history. Our portfolio is diverse, vibrant and strong. Our operating model is metric-based, disciplined and proven. Our employees are aligned, focused and energized. And most importantly, we are extremely well positioned from a capital structure perspective.

Despite spending $137 million on capital investments, making four acquisitions, and repurchasing 8% of our outstanding stock, we end the year with $952 million of net debt, no commercial paper, a $275 million note due in November of this year, and no other debt due until November 2012, and all of that debt at rates below 6%.

If you turn to Page 2 for a summary of the full year, all in we had a terrific year. As I said, revenue was up 10%, earnings per share 14%. It's very interesting to note that our company went from 7% core growth in the third quarter to a negative core growth rate of 3% in the fourth quarter - that's how fast these markets deteriorated - which presents an incredible challenge to a $6.5 billion manufacturer as vertically integrated as Cooper, especially with the massive deflation we experienced over the same period in raw materials - steel, cooper and aluminum.

As we said during the quarter, our focus was on slowing production rates quickly and liquidating high-cost inventory of raw materials, WIP and finished goods, and as you see, we did an excellent job during the quarter leveraging our new enterprise business system to understand order patterns, shut off materials flow, reschedule factories, and drive balance sheet efficiency.

If you'd now turn to Page 3 for more details on the fourth quarter, our total revenue was down 1% with core being down 3%. Electrical Products was up 3%, with core flat, and Tools was down 25%, with core down 20%. As I mentioned, economic conditions deteriorated rapidly. In every business and in every market, all global regions, including developing markets, were down. And we were very limited with year end customer pull-throughs or buys in Electrical Distribution, Utility and in Retail. Essentially, nobody wanted to take additional inventory.

Earnings per share came in at $0.84, up 1% from last year, aided by a lower tax rate and long-term incentive adjustments, and Terry will address these issues specifically in a few minutes.

Electrical Products return on sales was 14.6%, down 180 basis points, and Tools return on sales was 10.6%, down 240 basis points.

Full year cash flow came in at $761 million, a new record, 120% conversion and our eighth consecutive year where free cash flow was in excess of income from continued operations.

If you'd turn to Page 4, I'll discuss the end market conditions. The industrial markets that are 40% of our sales in 2008 held up reasonably well. Energy was flat to slightly up; however, automotive and general industrial were down. While October was strong overseas, we saw significant market softness in November and December. We anticipate our industrial markets continue to soften, with factory utilization rates now falling to the low 70s%.

In commercial construction or 25% of our sales in 2008 we saw sales decline mid single digits. As we noted in our third quarter conference call, we continue to expect commercial construction to weaken with the lack of credit, increasing unemployment, extremely poor retail sales, and state budget deficits.

Utility markets were 21% of our sales last year, had slightly positive revenue growth driven by energy, automation systems and reliability products. We did, however, see orders soften dramatically as utilities struggled to get access to capital. In addition, transformers experienced heavy margin pressure, with a more competitive market environment and higher grain steel prices.

Lastly, residential or retail sales were 9% of our sales last year, weakened substantially during the quarter, with housing starts now off 75% from their all-time highs. Pools and lighting were hardest hit and we see no signs of recovery until 2010.

Turning to Page 5 of the handout, segment results, for the Electrical Products segment, which is 88% of our sales for the year, we saw a high single-digit sales decline in North America in electrical distribution, OEM and retail sales. Our international sales were down high single digits, driven mostly by foreign exchange. Bookings were 88% of sales for the total Electrical group, and while productivity and spending controls were accelerated, higher material costs, less pricing leverage, and lower factory production drove margins lower, which was certainly anticipated as we went through the quarter.

Turing to Page 6 of the handout for the Tools group, we saw a very difficult quarter, with sales down 25%, core down 20%. Sales were down dramatically in hand tools, industrial power tools, and automated assembly, both domestically and overseas. Our order rates were roughly 85% of sales for the quarter and margins again were negatively impacted by factory shutdowns.

Now let me turn the call over to Terry to provide you with more details on the quarter, update you on the year end capital structure and provide you with an early look at 2009.

Terry A. Klebe

Thanks, Kirk.

As Kirk mentioned, the fourth quarter was challenging with the credit markets dysfunctional and an unprecedented deterioration in economic conditions. Clearly, economic conditions deteriorated faster and deeper than anticipated as the fourth quarter of 2008 progressed.

Our fourth quarter reported results are somewhat complicated by items that adjusted full year results that flow through the fourth quarter. I'll spend some time today clarifying the results, but first I'll highlight our free cash flow and balance sheet.

On Slide 7, as Kirk noted, we have record free cash flow for 2008. Free cash flow increased 12% to $761 million compared to $682 million for 2007. In October 2008 we received a $141 million payment from the Federal-Mogul bankruptcy and in December 2008 made $60 million in voluntary contributions to pension plans. After income taxes, these two items had a net increase to cash flow of about $60 million. Even if we exclude these items, we had record free cash flow in 2008, an all-time record for the company.

The $60 million contribution to pension plans in 2008 precludes us from being required to make any mandatory contributions in 2009 and results in our pension plans - that are funded plans - being at approximately an 88% funded level.

Our free cash flow in the fourth quarter was $288 million and is a testament to the Cooper operations quickly adjusting to the new economic reality.

Our balance sheet remains in great shape, with our debt to total capitalization net of cash at 26.8% on December 31, 2008 compared to 24.8% on December 31, 2007.

The significant appreciation of the U.S. dollar, the decline in the stock markets, the impact on pensions and marked-to-market on derivatives reduced stockholders equity by $249 million in 2008, with most of this hitting the fourth quarter. This, coupled with share repurchases, more than offset earnings, resulting in a decline in shareholders equity. While this impacts the net debt to total capitalization ration, it has no impact on our [inaudible] ratios, which are very solid and improved in 2008.

Turning to Slide 8, our net debt at December 31, 2008 was $952 million compared to $940 million at December 31, 2007 and our net debt to continuing EBITDA was 0.9 times versus 1 time at the end of 2007. This was after returning to shareholders $500 million in common stock purchases net of proceeds and $170 million in dividends.

As you can see on Slide 8, our debt maturities are very well positioned with fixed rates below 6% and, as Kirk mentioned, at year end we had no commercial paper outstanding.

As I mentioned in our last call, during 2009 we had a $500 million credit facility maturing in November as well as $275 million in notes. We've been in discussions with our banks on renewing the credit facilities and should have a new facility in place in the first half of 2009. As for the debt maturity, we're going to operate as if we have to retire the $275 million in debt that matures in November of this year. With $281 million of cash, we already are in a position to fund retirement of this debt, and currently both commercial paper and long-term debt markets are stabilized for A-rated companies and issuances are occurring at favorable rates.

The bottom line is that we have more than adequate liquidity without any reliance on the credit markets. Our debt and capital structure are in great shape, and our balance sheet is a strategic asset in the current economic environment.

Turning to Slide 9, we are very pleased with the performance and operating working capital in the fourth quarter and for the year. Our operations proactively brought inventory levels down and collected receivables in a challenging environment. As I mentioned in last quarter's conference call, we planned on taking extended shutdowns on factories and executed on these plans, plus a lot more, as the economy deteriorated.

Our inventory turns in 2008 were 6.8 turns, up from 6.3 turns in 2007. Inventories actually declined slightly from December 31, 2007 and would have been down an additional $25 million absent the consolidation of a joint venture and an acquisition at year end.

For receivables, our days sales outstanding in 2008 decreased by 4 days to 61 days. As you can tell from our results, we are aggressively monitoring credit and collections in today's economic environment and continue to make progress on collecting receivables within the terms granted to our customers.

With the inventory actions, our payables did decline $41 million during 2008, partially offsetting the improvement in inventory and receivables. As a result, our operating working capital turns improved to 5.6 turns compared to 5.4 turns in 2007. Overall, an excellent performance in 2008 on operating working capital.

On Slide 10, our capital expenditures were up $21.5 million or 19% in 2008 to $137 million. Capital expenditures in 2008 exceeded our $120 to $130 million forecast as a result of expenditures on a new MTL factory that was committed before we acquired MTL. On a cash flow basis, the sales proceeds and government grants from the property MTL is obligated to vacate will offset most of the capital expenditures for the new facility. While the net cash flow impact of the new factory is not significant, the capital expenditures to date of $15 million for this factory are included in the $137 million of capital expenditures and most of the proceeds will occur in 2009.

We also funded the Cooper Technology Center in Houston and a China factory for the expansion of our Bussmann Zeon business acquired a couple of years ago.

In 2008 fourth quarter, we purchased 6.6 million shares of our common stock, spending $192 million against proceeds from the issuance of 100,000. For the year, we purchased 14.4 million shares and issued 1.9 million shares. As a result, our outstanding shares decreased by approximately 12.5 million shares in 2008 or 7%. Under existing Board of Directors authorization, we can purchase an additional 3 million shares, plus the shares issued for stock option exercises and other stock programs each year.

As I said, our balance sheet's in great shape and we consistently generate very strong cash flow and as a result we have tremendous flexibility to fund organic and acquisition growth, pay a competitive dividend, and purchase our common stock.

Now turning to the results for the fourth quarter on Slide 11, there were a number of items that impacted our results in both the fourth quarter of 2008 and the fourth quarter of 2007. First, I'll cover the restructuring impairment charge.

In the fourth quarter we recorded a charge of $44.8 million or $0.19 per share composed of $33.8 million in severance, a $9.1 million impairment, and $1.9 million for the termination of a lease and other items. In the last conference call we had forecasted a severance charge of $20 to $22 million. As the quarter progressed and economic conditions deteriorated, we took additional actions. In total, 2,244 positions are being eliminated, which is approximately 8% of our salaried work force and approximately 7% of our hourly work force. In addition, we have significantly reduced part-time positions and furloughed certain hourly positions.

We expect to realize $60 million in benefits in 2009 in addition to the $5 million we realized in the fourth quarter of 2008 from these actions.

We also during the quarter took control of a historically 50% owned joint venture. We acquired an additional 20% for $500,000 and had to adjust our carrying value of the investment, resulting in a $9.1 million non-cash charge. This was the only joint venture we did not control and manage, and other than very small equity positions in two companies, we now control and manage all entities where we do not own 100%.

In the fourth quarter of 2007, we recognized $6.3 million of Belden income and reversed $20.3 million in tax reserve as a result of the statute of limitations expiring on potential issues and other favorable results. These items combined increased our reported earnings per share for the fourth quarter of 2007 by $0.15 per share. So excluding these items fourth quarter [2000] earnings per share were $0.84 compared to $0.83 in the prior year fourth quarter.

Turning to Slide 12, as there were a number of items in the quarter that impacted the results in addition to the restructuring impairment charge of $0.19 per share, I thought it'd be helpful to provide a view of the earnings per share for the quarter as we would view it. Our reduced guidance for the quarter was $0.70 to $0.80 per share and we reported $0.84 per share excluding the restructuring impairment.

It's very easy to just say we beat the top end of our forecast and explain the items that helped third quarter results. As we have proven in the past, this is not Cooper's style. We beat the top end of the forecast primarily as a result of the dollar appreciation abating somewhat in December, a lower annual tax rate, and the reduction in long-term stock incentive accruals by more than we anticipated due to the deteriorating economic situation.

For presentation purposes we thought it would be more meaningful and transparent to provide our internal view of what I'll refer to as normalized earnings for the fourth quarter. Slide 12 is actually the identical slide I went through with our division and corporate management team during a recent two-day executive meeting. Now the purpose is not to explain what was in or out of our forecast, but to look at the quarter on a normalized basis.

In the quarter we incurred a settlement and related legal fees on a patent issue, recognized a loss on investments, and were required to write-off all M&A costs incurred on pending transactions to comply with the new accounting requirements. These items reduced earnings per share by $0.03 in the quarter.

We also reduced stock compensation and other compensation that had been recorded in prior quarters to reflect the year end result and the outlook for 2009 and 2010. This added $0.06 to earnings per share.

Our tax rate for the year was 26.6% and the fourth quarter rate was 21.8%, excluding restructuring impairment. The fourth quarter tax rate reflects the reversal of the higher rate in the prior quarters and the R&D credit enacted by Congress in the fourth quarter. The lower tax rate added close to $0.06 per share in the quarter. Therefore, all in, we'd consider $0.75 per share a more normalized earnings per share for the quarter.

Turning to Slide 13 on 2008 full year unusual items, for the year restructuring totaled $52.4 million or $0.21 per share and tax accrual benefits totaled $23 million or $0.13 per share for a net $0.08 per share charge. For the most part the [$0.09] and items to normalize the fourth quarter to $0.75 per share did not impact the full year as they only adjusted timing on which quarter in 2008 they were recorded. In the prior year unusual items added a net gain of $0.59 per share. Excluding these items, our earnings per share from continuing operations increased 14% to $3.59 from $3.14 in the prior year.

Turning to Slide 14 on revenues and earnings per share, the global economy rapidly deteriorated as the quarter progressed as the unprecedented volatility and credit crisis spread throughout the world, impacting every one of our businesses. As we communicated during the quarter, we aggressively curtailed production to reduce inventory and, as I discussed earlier, had outstanding execution. It's always tough to sacrifice earnings, but we run the company looking to the future, not one, two or three quarters of short-term results.

Today we reported a revenue decline of 1.4%, with Electrical revenues increasing 2.6% and an unprecedented revenue decline in Tools of 25.1%. The top line was hurt by the significant depreciation of the euro, the pound sterling, and other currencies against the dollar in the quarter, which subtracted 3.7% from revenues. Acquisitions contributed 5.4% to revenue in the quarter.

Revenue started the quarter pretty close to our forecast, but orders and revenues deteriorated as the quarter developed. We saw the reactionary effect of the credit crisis accelerate during the quarter, with utilities curtailing spending and customers across the globe conserving cash, delaying orders and shipments, and destocking inventory.

Businesses serving energy markets managed to achieve core growth. Our Utility business also achieved modest core growth, but experienced a deterioration in orders as the quarter progressed. Industrial, Commercial and Residential all had significant core revenue declines. Our orders deteriorated in the quarter, with shipments exceeding orders in both the Electrical Products and Tools segments.

As I covered earlier, we reported $0.84 in earnings per share exclusive of the restructuring impairment. On a normalized basis, results were more like $0.75 per share.

In the fourth quarter, the lower share count provided a $0.06 earnings per share improvement before financing costs and approximately $0.04 after financing costs.

Turning to Slide 15, as I mentioned earlier, acquisitions contributed over 5% to revenues. The incremental revenue from acquisitions contributed slightly over a 10% return on sales, with higher selling and administrative costs as a percentage of sales. Gross margins in the quarter declined to 31.2% from 33.1% in last year's fourth quarter.

While we had great execution on productivity, the lower volume, factory production curtailments, and increased commodity costs in our Lighting and Power Systems business negatively impacted margins. Our overall price realization was approximately 2.5% of revenue in the quarter as we continued to drive price realization to cover the significant inflation we incurred on certain commodities during most of the year.

Most types of steel and energy related costs have reversed the significant year-over-year inflation we incurred in the first nine months of the year; however, it will remain a very challenging pricing environment until we work the high input costs from earlier in the year through the manufacturing and sales cycles. In the fourth quarter, material inflation alone was $56 million in excess of our forecast at the beginning of the year.

In addition, as a normal practice we hedge commodities through derivatives and supply agreements. In the fourth quarter, our marked-to-market on commodity hedges went from a few million negative at the beginning of the quarter to over $30 million negative at the end of the quarter. Absent increased commodity costs, this will continue to impact margins for several quarters.

As I mentioned, most type of steel costs have reversed the significant year-over-year inflation experienced in the first nine months of the year. The exception is electrical grade core steel, where the cost has continued to escalate. Both Lighting and Power Systems, due to their backlog and hedged material positions, will continue to have challenges that negatively impact margins into the first half of 2009, and unless electrical grade core steel prices begin to decline, this will be an added challenge in Power Systems.

Selling, general and administrative expense for the quarter as a percent of sales was 17.8% compared to 18.6% in the prior year fourth quarter; however, excluding the reduction in compensation accruals and other items, our selling, general and administrative expenses would have been 18.4%, an improvement of 20 basis points. Acquisitions with higher selling, general and administrative costs added 20 basis points, therefore on a comparative, normalized basis, SG&A as a percentage of sales declined 40 basis points.

General corporate in the segment income statement decreased from $21 million to $12 million. General corporate expense for the quarter was impacted by the reduction in stock and other compensation by close to $7 million.

Turning to Slide 16, solid execution on stepping in to the deteriorating economic environment minimized the decline in operating earnings to 9% and resulted in an operating margin of 13.4%, a 110 basis point decline from 14.5% in the fourth quarter of 2007. On a normalized basis, excluding stock compensation and other items, the operating margin would have been slightly below 13%, reflecting the impact of our production curtailments in the quarter and material inflation.

Continuing to Slide 17, our net interest expense increased $7 million, which includes a $4 million charge on investments to reflect the decline in the net asset value. Year end pressure drove market values down significantly and hopefully we'll see some recover in 2009. Funding the MTL acquisition and stock purchases also increased interest expense.

Our effective income tax rate for the fourth quarter excluding the restructuring impairment was 21.8%, as I mentioned earlier, versus 28% for the first nine months of 2008. The 2008 annual was 26.6%, as the impact of the R&D credit and the reduction of the first nine months drove this rate down in the fourth quarter.

Our fourth quarter continuing income excluding the restructuring impairment charge and unusual items in the prior year decreased 6% on the 1% revenue decline. On a normalized basis, continuing income declined approximately 16%.

Turning to the segments and Slide 18, for the quarter our Electrical Products segment revenues increased 2.6%, with a core revenue decline of 0.3%. Currency translation reduced revenue 3.3% and acquisitions contributed 6.2%.

Demand for electrical products weakened in all regions of the world as the financial crisis rippled across the globe. As I mentioned earlier, utility and products serving the energy industry managed to post year-over-year core revenue growth. Global electrical distribution increased revenues low single digits for the quarter, but the U.S. and Canada posted high single-digit declines as customers destocked inventory and the end markets contracted.

The retail channel was very weak, with revenues declining in the Electrical segment high single digits. Sales mix was negatively impacted by the double-digit declines in certain higher margin industrial product lines served through electrical distribution. Overall, Electrical Product segment earnings decreased 9% and return on sales decreased 180 basis points to 14.6% from 16.4% in the fourth quarter of 2007. Absent compensation and other adjustments, segment earnings declined approximately 11% and return on sales would have been approximately 14%.

The incremental impact from acquisitions diluted return on sales about 20 basis points.

Turning to the Tools segment on Slide 19, in our Tools business sales declined 25.1%, with currency translation reducing revenues 5.8%. We had a rough quarter on the top line for tools. The tough global motor vehicle end market and industrial customers destocking inventory and end customers curtailing production drove unprecedented revenue declines. Retail sales were very weak as retailers did not place the usual Christmas orders, with sales down over 30% in this channel.

Tools operating earnings declined 39% on a sales decline of 25%. Our reported Tools operating margin as a percentage of sales decreased 240 basis points to 10.6%; however, absent compensation and other adjustments, segments earnings as a percentage of revenue would have been approximately 9%.

Turning to Slide 20 and a summary of the 2008 full year, while it may not feel like it with the credit freeze and unprecedented volatility in the last four months, the full year 2008 was a record-breaking year for Cooper by just about any measure. For the year revenues increased 10.5%, with Electrical Products up 12.7% and our Tools business revenues declining 3.7%. Core revenue growth was 3.2%, with Electrical 4.6% core revenue and Tools at a negative 6.2%.

Excluding the restructuring impairment and tax discrete items and 2007 unusual items, earnings per share from continuing operations was up a strong 14%. Free cash flow conversion was 121% of continuing earnings, our eighth year in a row that free cash flow exceeded earnings.

Before turning the call back to Kirk, I'll provide brief comments on our 2009 outlook. We will be providing a detailed 2009 outlook at our investor meeting on February 19th in New York City.

Turning to Slide 21, with the volatility and economies around the world searching for direction, it's very difficult to forecast the revenue line for a quarter, let alone the year, therefore you'll see a much broader range in our forecast than in the past.

We currently anticipate that our Utility business and most of our businesses serving industrial markets will decline in 2009 versus our view a few months ago that these markets would show low single-digit growth. It is now likely that commercial and residential market conditions will even be more depressed than we were forecasting a few months ago. Even developing markets, which we thought would have reasonable growth, are seeing slower growth.

So for the year we're forecasting a top line revenue decline of 10% to 15%. Acquisitions are less than one-half of 1% of revenue, and currency translation is forecasted to be a negative 4% to 6%. Electrical 2009 revenues are forecasted to decline 9% to 14%, and Tools revenues are forecasted to decline 18% to 23%.

Pension expense will be a significant headwind, considerably higher than we thought a few months ago. By year end the discount rate dropped significantly, eliminating some of the offset to the decline in asset values. This will impact earnings per share by slightly over 7% in 2009. However, lower shares will more than offset this headwind.

And we are forecasting the ninth year in a row where free cash flow will exceed continuing earnings.

Earnings per share for the year are forecasted to be in the range of $2.45 to $2.80 per share, a decline of 22% to 32%.

In the first quarter we're forecasting revenues to decline 10% to 15%, with Electrical down 8% to 12% and Tools down 28% to 33%.

Earnings per share is forecast to be in the range of $0.45 to $0.65 per share, a decrease of 20% to 44% in the first quarter.

Now I will turn the call back to Kirk for a wrap up.

Kirk S. Hachigian

Thank you, Terry.

In summary, we're extremely well positioned to tackle the challenges of 2009 and beyond. Our portfolio is in terrific shape, with lighting, construction, energy, utility all being markets or industries that the world requires with attractive long-term trends around global energy demand, energy efficiency, reliability, global infrastructure, and safety and protection.

We've expanded the breadth and global footprint of our portfolio as well as entered into new technologies and attacked emerging markets through bolt-on acquisitions and internal development.

Our five business initiatives are alive and well. During the last five years we've delivered top quartile core growth. In addition, on a down cycle we're able to navigate a challenging fourth quarter with the new systems and core processes built into our strategy over the past several years. Over $700 million of free cash flow with eight consecutive years of cash flow greater than continuing income is the true measure of our capability.

Our cash flow now becomes a strategic asset, allowing us exceptional flexibility, funding continued expansion overseas, development of new technologies, strategic acquisitions and returning cash to our shareholders. We will as we have in the past maintain a conservative capital structure. And lastly, talent development is now a way of life at Cooper. After many years of external recruiting and internal development, we have a solid team and an exceptional strong bench.

While 2009 is expected to be extremely difficult, we have and will continue to right-size the company and look for ways to continue to improve the efficiency of our balance sheet, focusing on strong cash flow but at the same time continuing to fund the core and be opportunistic on acquisitions.

Thank you and now I'd like to turn the call back to Mark to take your questions.

Mark Doheny

Thanks, Kirk.

At this point I would like to open up the call for the questions. I would like to remind our listeners to please enter the queue using your own name. Out of respect for others waiting to ask a question, we will not take questions from people who've entered the call queue using someone else's name.

Katrina, first question, please.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeff Sprague - Citigroup Investments.

Jeff Sprague - Citigroup Investments

One question, part one for you, Kirk, and then really the details on Terry.

I'm a little surprised, I mean, the cash does look solid. I'm surprised inventories and receivables didn't come down more given currency and also given that sales were actually decent, but you had widespread plant closures. Terry, could you just give us a little color on how currency may have impacted the working capital items and any editorial thought on that part of the question?

Terry A. Klebe

Well, year-over-year on the currency, Jeff, if you look at our balance sheet, it had a very nominal impact on operating working capital. We had a significant currency increase for the first nine months and gave most of that back in the fourth quarter, so dollar on dollar, 2007 versus 2008, very little currency in there. There's about, as I mentioned, $25 million from just pure consolidation of a joint venture and an acquisition at year end on inventory for the year.

So all of our metrics, when you look at them, if you look at them by month, by quarter or by year, improved significantly in the fourth quarter, so we feel we took out probably more than we ever could have anticipated as the quarter progressed.

Jeff Sprague - Citigroup Investments

And then, Kirk, there's been a pretty clear playbook here on, you know, a healthy drumbeat of small deals and a healthy level of share repurchase. Does that change in this environment? Is the appetite to do something bigger greater here or how do you play it?

Kirk S. Hachigian

I was watching CNBC this morning when I got up and the Chairman of Dow Chemical was on as a guest host, so no, I think you get a little bit more conservative, Jeff, in that it's hard to tell where these capital markets are and it's very hard to tell where this economy's going.

So I think we probably, as Terry sort of said, keep the $280 million in cash that we have on the balance sheet capable of paying down that note in November of this year. As we generate additional capital, we'll keep a pretty healthy CapEx budget for the year. We've got some things around the world. We're putting in capacity, still a bit shy in the Middle East. We've got a Tech Center in Lighting we're building out. We've got a bunch of new products that are still in the pipeline, so we want to continue to fund a healthy CapEx budget, which we can afford to do.

And then I think beyond that we've got a good pipeline of small deals, but I think that more traditionally it looks like what we've done in the past and not deviate too far away from what we've done in the past, I think, at this point.

Jeff Sprague - Citigroup Investments

And then there's one other one and I'll pass it on. I'm sure you're going to get a lot of other questions on price, cost. It certainly sounds like kind of a complicated path to navigate here. But in particular, Terry, you noted price was 2.5%. I think that's a Q4 number year-over-year. Is price actually declining sequentially? Did you see that anywhere? It just kind of seems given what happened with the margins there must have been some price pressure.

Terry A. Klebe

Yes, the 2.5% is, I'd say, just about 100% carryover from actions earlier in the year. Pricing pressure to date has primarily been on the Power Systems side, transformers, regulators. And the dilemma there is that the input costs have not come down, even if you forget about or don't consider the manufacturing sales cycle, you know, core steel's still going up, so we're seeing unanticipated pressures.

But the biggest thing that hit us is how rapidly the commodity prices came down in the fourth quarter. I've never seen it happen that fast and, of course, we have to go out and renegotiate our supply agreements and items we have hedged, that continues to hit us for a period of time.

So you're absolutely right, probably the toughest environment I've ever seen because of how rapid the commodity price has changed.

Kirk S. Hachigian

But I think at the end of the day, Jeff, the plan was clear to our guys, which is shut the factories off, take out the higher-cost inventory because of this deflation that Terry was alluding to, and drive the hell out of cash flow. And so we took a hit, a big hit, on the absorption levels, of course, as we focused on cash flow, but in a deflationary environment like that, I mean, you do want to delever your balance sheet as fast as you can.

Operator

Your next question comes from [Bob Cornell] - Barclays Capital.

Bob Cornell - Barclays Capital

When you look at the guidance, it is a little interesting that in the Electrical Products you're forecasting revenues in the first quarter down 8% to 12%, but the full year is down 9% to 14%. Often managements have said the first half is worse than the second half, but you seem to have a different profile. Maybe you could expand on that point.

Terry A. Klebe

Well, the first quarter we do get a bigger impact from acquisitions because we acquired MTL in the middle of the - February, I believe it was. So there's about 1.5% plus just from the MTL carryover impact.

Plus we are still filling some orders that were earlier in the fourth quarter, the October timeframe.

Kirk S. Hachigian

I think the order rate trend, Bob, as we looked at it, October was reasonable. November fell off and December fell off, and I think the first quarter's going to reflect a carryover of people not placing orders in that fourth quarter, which will reflect into the first quarter.

I think we've taken a - I'd like to say we've taken a conservative approach to '09. I hope it's conservative, right? I mean, trying to forecast this economy out into the third and fourth quarter's extremely difficult. But what we basically did is take the fourth quarter kind of run rates and extrapolated them out for the year and basically used that as our baseline. We'd rather be conservative on the top line and have a more cost-out cash-focused plan as we go into this kind of economy.

Bob Cornell - Barclays Capital

A couple of weeks ago one of the lighting guys announced results and talked about the beginning of price cutting and they talked about volume's down 17%. Maybe you could talk about your Lighting business in a little more detail.

Kirk S. Hachigian

Yes, I listened to their call, and I think that their guidance was probably in line with where we would be, you know, down mid to high teens. We haven't seen dramatic pricing, but we're starting to see minimum levels on freight come down and things like that in the marketplace. Of course, we'll be competitive.

I think the Energy side, Bob, still's got great legs to it. We've talked about this in the past. The stimulus package is out there. It talks a lot about government buildings and controls and lighting, and we've talked, you know, that 30% to 40% of the energy in a commercial building is lighting and that these buildings have very old and antiquated systems that are over 20 years old, and we've come up with over 40 new products on the energy efficiency side in the last year, and the primary focus of that has been around LEDs and halo. And again, you know, people being able to achieve now 50% savings with some of these new products on the lighting side.

So we think there's a great opportunity there. We think the stimulus package will help us there. But again, in the short term, Bob, you've got to work through some tough issues with credit and construction and unemployment and retail and state government budgets, I think, which is going to be tough to work through for the next 12 months.

Bob Cornell - Barclays Capital

And I guess the final question from me is on the Power side, I mean, your business typically splits between, you know, split to your [capacitor] or [closure], it's that kind of stuff that makes a lot of money pretty predictably and then transformer, which goes from nothing to something, and I think we're headed back towards nothing.

Kirk S. Hachigian

Unfortunately. I don't want to agree with you, but I'm going to have to. Yes, I think we got caught a little flat-footed in the fourth quarter, to be fair. I think there's more we can do on value engineering. There's more we can do on lean. You know, we've been pretty focused on expanding the product line globally. We've been focused on that new EAS business that we've built out. The pieces that we've wanted to get into - the [C&I] business and expand it - we've done a nice job on.

I would tell you that I think we fell short of expectations certainly in the fourth quarter on transformer margins and we've got some work ahead of us. And, you know, you'll see Mike back out with us in New York as well.

Operator

Your next question comes from Nicole Parent - Credit Suisse.

Nicole Parent - Credit Suisse

One question on restructuring actions. Could you give us a sense of which businesses and what you think the payback's going to be?

Terry A. Klebe

Nicole, it was every business, every region of the world had actions in it, so it was spread out pretty uniform. Even in the businesses where we expect revenues to be stronger in '09, we took actions in them, albeit a lesser extent.

But the biggest hit would be clearly in the businesses serving the commercial markets, you know, the lighting businesses, some of our European businesses. But it was spread across the universe because we made a decision back in October that we could see what was coming and every business had to rebudget, take costs out.

Nicole Parent - Credit Suisse

Any sense of payback?

Terry A. Klebe

Payback on just all of the restructuring, the severance is very short. We have $60 million of benefit flowing into 2009. It will be a little bit skewed toward the back half, but not by that much, so you could pretty much spread it across the four quarters.

Nicole Parent - Credit Suisse

And I guess maybe, Kirk, a question for you. Given all that you've done at the company in terms of just changing out management, focusing on lean, driving continuous improvement across the businesses, which businesses do you think are best positioned to weather kind of the revenue deceleration from a cost or margin standpoint?

Kirk S. Hachigian

That's a good question. I mean, I think unfortunately where we're going to get the hardest is probably at Lighting, just because of the credit markets and the volume.

But I was just out visiting plants, Nicole. I mean, I can even take Tools where they've been hard hit on the top line, done a phenomenonal job - there's a UAW plant out in Dayton, Ohio where they've taken operations that were done by six people down to two and freed up 30% of the square footage on the floor, reduced cycle times, reduced inventory on the floor.

We still have a ton of work to do at the factory level and a huge opportunity. The Lighting guys are pretty far along doing a lot of VAVE, as we call it, redesigning existing products to take material out, improve the quality. And so while markets are going to be down, we're using that as a call to go back in and double our efforts on this engineering redesign and on re-laying out our factory floors because it's a lot easier to do that right now than it was six months ago.

You know, [Krause] will be fine. B-Line will be fine. I think those kinds of businesses, industrial businesses, will still be good. Bussmann will be fine; we've done a lot of work in the last downturn on rearranging the footprint for Bussmann.

But overall - and we'll talk about this in New York - we have not added a lot of square footage. We have not added a lot of high cost capacity. We're going to insource a lot more during this cycle because we would rather fill our factories than have that outsourced and get up the utilization rates, so stamping operations and machine shop operations, we'll be pulling a lot of that more back inside.

But again, I sort of don't feel that we're too far off. And we've got a little work to do on the Power side, but I think overall we've come a long way and we'll talk a little bit more about this in New York as well.

Nicole Parent - Credit Suisse

And just one last one. Lots of companies in the last few months announcing that they're redomiciling [inaudible]. Any update with your plans there?

Terry A. Klebe

What I'll tell you is that we have done a lot to restructure our international operations over the last two years. We feel that our position is very good if there's legislation passed and we've set up the legal structure so if we did have to redomicile we could accomplish that very, very quickly.

Nicole Parent - Credit Suisse

Okay, so we shouldn't expect anything unless we heard a change from the new administration?

Kirk S. Hachigian

Unless they pass some legislation we have to adjust to.

Operator

Your next question comes from Scott David - Morgan Stanley.

Scott David - Morgan Stanley

I want to talk a little bit about your customer inventory levels because it seems that they've probably been destocking now for I guess probably three months. How long does it typically take for inventory levels to right size? And given how much worse this has been, this cycle's been, so far, than what we saw last time, what do you anticipate your customers take  destock for much of '09 or is there a period where we can start to think about selling through some product again?

Kirk S. Hachigian

I've got to tell you, Scott, I think they're in pretty good shape. If you look at retail and you look at how bad retail was in the fourth quarter, I think they got it early that the traffic wasn't coming through the stores and really had begun - and I could give you specifics on low with a couple of our businesses - but their inventories are down significantly. In fact, if the economy picked up they would be caught, probably, with less inventory than they wanted.

Electrical distribution has been seeing this coming for some time. And normally we have these rebate programs and guys will order up a little bit to cross certain thresholds. We saw none of that in the fourth quarter; in fact, that's one of the most surprising pieces, that we just saw no activity there.

And on the Utility side, I've had a chance to see three of our largest utility customers in January, and it's not that their inventory levels are high, it's that their cost of capital has gone through the roof. And so if they have construction projects or other things going on they basically didn't take any inventory unless they had to take it, and I think that they are going to be at a level by midyear that you're going to see a pickup of demand because, again, the age of the grid and the MRO-type nature of what goes onto the distribution grid. They're going to just need product.

So from that keyhole I think you're sitting in a pretty good space. As liquidity opens up a little and there's a little bit more lending, the LIBOR rates coming down - and it depends on what day you're looking at this thing - and if there's more liquidity for industrial companies out there, I think this will soften up a little bit.

Scott David - Morgan Stanley

I hate to beat a dead horse. I know others have talked about price, but I don't think the answers have given much clarity yet. What kind of pricing pressure do we see in 2009? And I guess it goes a little bit hand-in-hand with inventories. How much are your customers asking for already to start reordering?

Kirk S. Hachigian

It's a good question. I think a lot of industrial companies, though, Scott, are in the same position, right? I don't know of many who don't hedge or didn't hedge at all. What hedging does for you, our position was never to try to predict the commodity prices. It was to smooth in these volatile markets and give our distributors time to bake in these price increases into their price books, because you have to go through literally thousands of SKUs and get this all loaded in their systems.

And so even if you were hedged out a quarter or two quarters and you have percentages that you normally look out, I think all the manufacturers both have raw materials sitting on their shop floors and they have some sort of contractual obligation.

So we don't see, other than in transformers, as we mentioned, and a little bit more on the project side on the lighting side, we're not seeing massive pricing pressure today. As people liquidate through this inventory, you will probably start to see some pressure, but again, I would imagine that on our P&L we would go to a purchase price deflation and start getting, you know, of course, some benefit rolling through our P&L.

Again, I'm looking at people's margins in the quarter and the rate they're delevering. I don't think we're unique at all. Now maybe we took it a little harder because we took down the production rates faster, but I don't think we're unique at all in the rate of deterioration of the margins on that side of it.

Scott David - Morgan Stanley

I'd agree with that. And just lastly, Terry, if you can give us a little bit of color into what goes on nowadays with the renegotiation of your revolver? You know, LIBOR has dropped, but at the same time spreads are widening. What holds up that negotiation? Are terms getting that - are they that challenging or is it just a function of just some final points to negotiate before you can announce a new deal?

Terry A. Klebe

I have to say the market overall, Scott, is getting a five-year revolver like we had before will be extremely difficult, so the revolver will be a shorter term and part of that revolver may end up being a 364 revolver.

As you well know, the banks out there don't want to allocate capital to revolvers, commercial credit, so it is a relationship game. It will cost us more to have a revolver in place than it did in the past, but we have great relationships with all the big banks. We already have commitments from several of them. But it is a much tougher, longer process to get done.

Operator

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

Christopher Glynn - Oppenheimer & Co.

A question on the Tools margins. You're kind of in line with the run rate you had all year and the revenue level was dramatically lower, almost at sort of the run rate you'd be at the middle of guidance range for next year. So just go into a little bit about what was holding those up in the quarter.

Terry A. Klebe

The Tools, if you look at what happened, I think I mentioned that their fourth quarter is the best quarter of the year, Chris, and so there's - retail was down over 30% in the quarter. Retail sales tend to have a lower margin than the rest of the business, so that helped prop up the margins just from the mix, even with that big of a decrease in sales.

But absent that, as you move into the first quarter, which is typically the weakest quarter of the year, you have very little retail sales generally in that quarter, a lot lower volume, and you lose a lot on the industrial. So you will see the margins come down as we move into the first quarter of 2009 and then increase as they typically do second, third and fourth quarter. Really a big piece of that was mix.

You know, our Tools guys, even with the reduced volume, I think a question was asked earlier on how far along are they on the lean. They are quite aways along on that side, which helps tremendously.

Kirk S. Hachigian

And adjusted their inventory very quickly in the quarter.

Christopher Glynn - Oppenheimer & Co.

And on the $60 million in savings in excess of the $5 million run rate you had in the fourth quarter and then ramping in the year, do you get up to a $20 million quarterly run rate ultimately?

Terry A. Klebe

Well, you know, the first quarter, the estimate's around $13 million and it ramps up to $17 million as it gets to the third quarter. So like I said, it's not a huge variance quarter to quarter.

Christopher Glynn - Oppenheimer & Co.

And then share repurchase, very strong, keeping cash on hand to pay down the debt later in the year. It'd be a little hiatus, it looks like, on the share repo?

Kirk S. Hachigian

Probably. It depends on how much cash we generate in the first half. As you know, the first quarter, because of some bonuses and distributor payouts and things like that, it's generally not a great quarter for us on cash flow. It depends on how we track through the year, but we'd probably be prefer to be conservative and keep that cash on the balance sheet, sure.

Terry A. Klebe

Yes, I'd say one of the big drivers is going to be where's the economy go or how comfortable are we because at the end of the day, it comes toward the end of the year, second half of the year, the markets remain depressed and it doesn't look like there's an uptick coming in the next six months, we may pay off that debt and just sit there for awhile.

Christopher Glynn - Oppenheimer & Co.

Okay, and it may factor into the revolver negotiations, too?

Terry A. Klebe

That's not really going to have much impact on our revolver negotiations. We want to get another $0.5 billion revolver put in place, which gives us flexibility on the commercial paper side, so even if we pay off the $275 million, we would have nice flexibility on the revolver side.

Mark Doheny

Okay, as we conclude this call I would like to invite the investment community to join us for Cooper's 2009 investor outlook meeting, which will held at the New York Mandarin Oriental Hotel on Thursday, February 19. We will begin presentations around 8:30 a.m. and conclude by 11:00 a.m. As we did last year, we will have presentations from both corporate senior executives and division management.

And with that, thanks for joining us today. Please feel free to contact me with any follow up questions that you may have.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day.

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Source: Cooper Industries, Ltd. Q4 2008 Earnings Call Transcript

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