Cooper Industries Plc (CBE) Q4 2009 Earnings Call January 26, 2010 12:00 PM ET
Mark Doheny – Director of Investor Relations
Kirk Hachigian – Chairman, Chief Executive Officer
Terry Klebe – Senior Vice President, Chief Financial Officer
Jeff Sprague – Citigroup
Robert Cornell – Barclays Capital
Rich Kwas – Wells Fargo
Scott Davis – Morgan Stanley
Terry Darling – Goldman Sachs
Welcome to the fourth quarter 2009 Cooper Industries earnings conference call. (Operator Instructions) I would now like to turn the call over to your host for today, Mark Doheny, Director of Investor Relations.
Welcome to the Cooper Industries fourth quarter 2009 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’ll refer to throughout this call. If you’d like to view this presentation, please go to the investors section of our website, www.cooperindustries.com.
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.
Thank you Mark. Good afternoon. Well I guess as they say what a difference a year can make. It was just one year ago that we were reporting record revenues of $6.5 billion, record earnings per share of $3.59 and record free cash flow of over $700 million. And while it’s been a difficult year by any measure, we’re very proud of the way our teams have navigated through this very difficult economy.
In fact, on this call last year as we saw further evidence of the dark clouds ahead, we commented about all the hard work that we had done over the last decade building a world class portfolio and refining our business processes so that we could not only survive such a crisis, but could prosper by adapting to changing market conditions and emerging technologies as we have over 175 years of our history, and most importantly, that our conservative capital structure gave us great confidence in our ability to manage Cooper through a very difficult cycle.
The results of this improved portfolio and streamlined business systems are shown on Page 2 of our handouts. While the S&P has delivered the worst 10 year performance in its history, Cooper shareholders have been rewarded with a 10.8% compound annual growth rate over the last decade. Cooper’s returns also compare very favorably with our proxy listed peer companies reported on our proxy.
As we enter 2010 we have position into new faster growing emerging technologies like Smart Grid, LED lighting and RF monitoring and signaling as well as new explosive growth economies like China, South America and the Middle East all while further strengthening our balance sheet and preserving our strategic options as we move into this new decade.
If you turn Page 3 of the handout, Terry and I will make some specific comments on the fourth quarter and the full year 2009. For the fourth quarter our total revenues came in down 18% to $1.26 billion. Electrical products was down 19% to $1.1 billion, down 4% from the third quarter and Tools was down 7% to $154 million but up 10% from the third quarter.
We continue to have intense cost management which led to overall operating earnings delivering at only 14.6% on an 18% revenue decline excluding restructuring.
Our operating margins were 13.1% up 80 basis points from the third quarter. Electrical products operating margins were 15.5%, up 40 basis points from the third quarter and Tools operating margins came in at a strong 8.3% up 340 basis points from the third quarter 2009.
Our full year free cash flow was $723 million excluding a one time German tax deposit for 170% cash conversion on recurring income excluding unusual items. That’s 14.3% of sales and a big part of that was working capital improvement from our inventories which were down $158 million or 25% year over year.
If you turn to Page 4, our end market conditions, industrial our biggest end market at 39% of sales last year has shown steady signs of recovery over the last two quarters. We see improving trends in MRO and OEM markets despite overall factory utilization still below 70%.
In commercial construction 24% of last year’s sales, we continue to see difficult market conditions into 2010 with vacancy rates climbing, rents falling and continued restrictive lending practices. We do see increased demand for energy efficient products and expect these sales to remain strong throughout 2010.
In the utility markets 22% of our sales, we continue to see the same trends we reported in the third quarter with transformers, regulators, down significantly with capacitors and smart grid solutions growing.
Our international markets were solid, essentially flat with last year. And lastly, residential or retail sales or 10% of our sales last year are flat with the third quarter and down mid teens with last year but again, beginning to see signs of a modest recovery.
If you turn to Page 5 of the handout for the Electrical Product results, were 89% of our sales last year. We saw improving trends in the fourth quarter. North America electrical distribution is improving, again particularly on the MRO side. OEM sales were up double digits with strong electronic sales.
International sales were flat or down just over 10% excluding the benefits of foreign exchange. We continue to see strong demand for energy efficiency products around the world and our book to bill for Electrical in the quarter continues to right at 100%.
Lastly, again we saw a great cost management which allowed our margins to expand to 15.5%, their best levels in over a year while generating exceptional strong cash flow.
If you turn to Page 6 of the handout for the Tools group, we are finally beginning to see the overall market conditions improve. We’re reporting our best revenue and margins all year. Revenues were up 10% from the third quarter and down only 7% from last year. ‘
Industrial and retail sales are steadily improving as global economies begin to revive. Our margins and cash flow were strong as a result of solid productivity and pricing disciplines.
Now let me turn the call over to Terry to provide you some additional details on the quarter, full year 2009 and 2010 outlook.
Thanks Kirk. Well today’s economic recovery that’s in progress has not translated to overall revenue growth across all of our portfolio, Cooper’s fourth quarter results demonstrate how well we are positioned to delivery very strong earnings growth as our markets do recover.
Our fourth quarter results increase our confidence that the changes we’ve implemented over the last decade on the way the company is managed, investments we’ve made in our enterprise business system, investments in new platforms and execution of our strategic initiatives will allow us to delivery superior returns to our shareholders.
I’ll cover the highlights of the fourth quarter in a minute but first some highlights on our free cash flow and balance sheet. Turning to Slide 7, in 2009 free cash flow was $633 million compared to $761 million in 2008, a 149% inversion of recurring income to free cash flow.
Excluding a $90 million discretionary tax deposit we made in late December, free cash flow would have been $723 million in 2009 or 14% of revenue. The $90 million tax deposit was probably have been made in 2010 to preserve our ability to appeal a German tax assessment. While we believe ultimately we will prevail, from a financial earnings perspective, there will be no net impact no matter how this is resolved and the cash flow impact is just a matter of the year the deposit and the foreign tax credits are recognized.
Our free cash flow in the fourth quarter of 2009 was $64 million as we made the $90 million tax deposit and purchased a warehouse and a factory for $14.5 million.
Our balance sheet remains in great shape with net debt to total capitalization at 15.7% on December 31, compared to 26.8% on December 31, 2008.
Turning to Slide 8, our net debt at December 31, 2009 was $553 million compared to $952 million a year ago. In November 2009 we paid of $275 million in notes and at December 31, 2009 we had no commercial paper outstanding.
With an under leverage debt position and $382 million in cash on the balance sheet we have tremendous liquidity. We’re very pleased with having our debt and capital structure in great shape and have been well positioned to use our balance sheet as a strategic asset to acquire businesses and to return capital to our shareholders.
Turning to Slide 9, our operations had another outstanding quarter executing on working capital. We reduced inventory a further $22 million from September 30. Our inventory was $484 million at December 31, 2009 compared to $642 million on December 31, 2008, a 24.6% decrease, an outstanding performance by all of our operations teams.
Our inventory turns were 6.8 equal to the record 2008 results, a year where revenues declined 22%. For receivables our day sales outstanding at December 31, decreased three days compared to the prior year and decreased four days from the third quarter. Receivables declined $214 million from December 31, 2008, a 21% decline.
Similar to inventory an outstanding performance by our businesses in a difficult credit environment, and as with the prior quarter, you can tell from our results that we are aggressively monitoring credit and collections and continue to make progress on collecting receivables within the terms granted to our customers.
Our payables declined $108 million or 22% from a year ago driven by the inventory reductions and our capturing discounts offered by our suppliers. From December 31, 2008 to December 31, 2009 our operating working capital declined 22.7% reflecting our resizing the balance sheet for the reduction of revenue experienced this year. We rapidly executed resizing the balance sheet in the first half of 2009 and then incrementally improved from there.
On Slide 10, our capital expenditures were $55.9 million in the fourth quarter of 2009 compared to $41.5 million in the fourth quarter of 2008. Full year capital expenditures were $127 million compared to $137 million last year.
I mentioned on last quarter’s conference call that we are in the process of capitalizing on the weak commercial real estate market and we’re close to purchasing a couple of facilities which could increase our capital expenditures if completed before year end. We completed the purchase of two facilities in the fourth quarter which resulted in our exceeding our forecast of $100 million to $110 million capital expenditures for the year.
We have consistently emphasized that during the economic downturn, that we have not cannibalized our core and continue to invest in technology, new products and our international infrastructure. A new factory in Saudi Arabia, a world class LED technology center and record new product introductions demonstrate our continued strong investment in the future.
In the fourth quarter of 2009 we purchased 295,000 shares. For the full year we purchased 1,557,000 shares of our common stock at an average price of $24.75, spending $38.5 million against proceeds from the issuance of $20 million for the two million shares we issued during the year. In the prior 2008, we purchased 14.4 million shares at an average price of $35.89.
Our outstanding average diluted shares for the fourth quarter increased by 1.4 million shares from a year ago but increased 1.1 million from the third quarter driven by option exercises and the inclusion of additional shares resulting from the increase of the stock price.
Under existing Board of Directors authorization, we can purchase an additional 12.5 million shares plus the estimated shares issued for stock option exercise and other programs each year.
In the fourth quarter we did complete one acquisition, [Paloon], a great addition to our hazardous Electrical Products portfolio.
As I said earlier, our balance sheet continues to be in great shape and we consistently generate very strong cash flow providing Cooper tremendous flexibility to fund organic and acquisition growth, pay a competitive dividend and purchase our common stock.
Turning to the results for the fourth quarter on Slide 11, a couple of items impact our results both for fourth quarter 2009 and fourth quarter 2008. In the fourth quarter this year and in 2009 we recorded a pre tax charge of $4.2 million or $0.02 per share. This was offset by a discrete tax benefit in the fourth quarter of $3.2 million or $0.02 a share.
In the prior year fourth quarter we recognized restructuring and an impairment of $44.8 million or $0.19 per share. So excluding the restructuring and impairment and discrete tax benefit for the fourth quarter of 2009 and 2008, we reported $0.76 per share compared to $0.84 per share in the fourth quarter of 2008.
You’ll note that excluding the discrete tax benefit that our expected tax rate was 14.3% for the fourth quarter compared to 18.2% for the first nine months of 2009.
We continue to realize additional benefits from our legal structure and lower State income tax realizing an effective rate of 17.1% for the year. The lower tax rate adds approximately $0.03 per share in the fourth quarter.
Now aside from the $0.03 earnings per share from the lower tax rate, our operations did an outstanding job on inventory reductions in the fourth quarter which resulted in inventory valuation income. For the year, we recognized LIFO income of $18.8 million, partially offset by $14.7 million in other inventory valuation expenses.
For the first nine months of the year, LIFO and other inventory valuation adjustments were a net expense. In the fourth quarter we’re expecting close to zero impact but due to the inventory reductions at Tools and at certain Electrical businesses, we ended up with a $0.03 per share benefit in the fourth quarter.
We offset $0.02 of this $0.03 net inventory valuation gain with reserves on government contract disputes and other items.
The bottom line is we had a net of approximately $0.04 per share of items of improved fourth quarter reported results, and absent these items we reported normalized earnings per share of $0.72 per share, so by any measure, a strong fourth quarter on what remains still a very weak top line.
I’m not going to get into all the details of the fourth quarter 2008 adjustments, but will remind everybody that the results include a lower tax rate adjustment and adjustments to stock and other compensation and other items that increased per share by $0.09.
Turning to Slide 12 on 2009 full year on usual items, in 2009 we recognized $29.9 million of restructuring charges or $0.14 per share partially offset by discrete tax benefits of $0.08 per share. In 2008 we recognized $52.4 million or $0.21 per share in restructuring charges and impairments and discrete tax benefits of $0.13 per share.
So excluding these items, 2009 earnings per share was $2.52 compared to $3.59 in 2008, a decline of 29.8% on a revenue decline of 22%, a very good execution on deleverage in the worst economic recession in over 50 years.
Turning to Slide 13, on a revenues and earnings per share, today we reported a revenue decline of 17.5% with Electrical revenues declining 18.8% and Tools revenues declining 7%. Currency translation increased revenues 2% and acquisitions contributed .3% to revenue in the quarter.
Looking at revenue from a product line perspective, we’re seeing improvement in product lines that declined early in the cycle, specifically electronics and MRO types of product lines. Overall, pretty much what we expected on the top line except for Tools where the power tool side of the business was stronger in December.
Core revenues declined 19.8% with Electrical core revenues down 20.6% and Tools 13.2%. Inventory destocking by our customers and end users appears to be substantially complete. More frequent, smaller quantity orders continue to be the norm. Activity on projects that were delayed due to higher commodity costs and credit conditions continue to show activity.
Continental Europe is mixed but improving in most countries and developing markets are improving, especially China and Latin America. The U.S. continues to be the weakest market. In total, international core revenues declined 12% as both China and Canada grew and most developing markets continue to improve. Our book to bill continues to be right around 100% indicating that we have stabilized albeit at a much lower revenue level.
As I covered earlier, we reported $0.75 in continuing earnings per share exclusive of restructuring and the discrete tax benefit. Normalized earnings per share that is, excluding tax rate adjustments and other adjustments in the fourth quarter declined $0.03 from the prior year to $0.72 per share.
We had excellent execution by our businesses in managing price, material economics and realizing the benefit of the cost actions that we’ve taken.
Turning to Slide 14, gross margins increased to 33.4% from 31.2% last year for a strong 220 basis point improvement. Both periods were impacted by inventory and other items and excluding these items in both periods, the improvement was approximately 160 basis points.
Sequentially from the third quarter of 2009 gross margins improved 150 basis points with about half of the improvement from inventory and other items. Great execution on productivity and continued execution on price versus material economics drove the sequential improvement from the third quarter of 2009.
As expected, we had consistent execution on price versus material economics. The results were very close to forecast with price declining slightly below 2% more than offset by material cost reductions.
As I said last quarter, we’re very disclipliined on price versus material economics and have successfully managed and measured our businesses for over six years on this critical component of profitability.
While each product line in our family has unique characteristics and dynamics that require a different strategy, it’s clearly in our DNA to effectively manage price and material economics and we’ve been extremely successful and see no reason why 2010 will be an exception.
Selling, general and administrative expense for the quarter as a percentage of sales was 20.2% compared to 17.8% in the prior year fourth quarter, and increased 70 basis points from the third quarter of 2009. The prior year SG&A percent was impacted by the stock compensation other adjustments and would have been around 18.5% absent these items.
Fourth quarter of 2009 the reserves on government contract disputes and other items increased SG&A as a percentage of sales by approximately 40 basis points.
So excluding these items in both years, SG&A as a percentage of sales increased approximately 140 basis points on a normalized basis from the prior year and sequentially from the third quarter approximately 40 basis points driven by lower revenues and modest increased spending.
General corporate expense on the segment income statement increased from $11.9 million in last year’s fourth quarter to $19.2 million. Prior year included stock comp and other adjustments and absent these items, general corporate was close to flat with the prior year.
Turning to Slide 15, fourth quarter operating earnings declined 15% from the fourth quarter of 2008 on a normalized basis. On a sequential basis from the third quarter operating earnings increased 2% on a normalized basis and a very nice improvement on sequential revenue decline of 2%.
Exclusive and restructuring, our operating margin was 13.1% in the fourth quarter of 2009 and 12.8% on a normalized basis, a solid sequential improvement from the 12.3% in the third quarter of 2009. Operating margin improved 20 basis points on a normalized basis from the fourth quarter of 2008.
Continuing to Slide 16, our net interest expense decreased $5.9 million from a year ago. Lower debt balances more than offset a slightly higher interest rate and lower interest earnings. As I went through earlier, our effective income tax rate for the fourth quarter was 14.3% which includes the adjustment to bring the rate to 17.1% for the year.
Our fourth quarter continuing income excluding the restructuring and discrete tax benefit decreased 5% on a normalized basis on an 18% revenue decline.
Turning to the segments in Slide 17, for the quarter our Electrical Products segment revenues declined 18.8% with core revenue decline of 20.6%. Currency translation contributed 1.5% to revenue and acquisitions .3%.
Price realization was close to two points negative in the fourth quarter and very close to what we expected. Demand for electrical products is starting to show some life in many regions of the world. Developing markets continue to hold up better than developed economies and have been the first to recovery.
Global electrical distribution sales declined approximately 16% from the fourth quarter of 2008. As Kirk mentioned, MRO activity is picking up and later cycle product lines have stabilized.
The retail channels continue to be soft with revenues decline in electrical segment mid teens from the fourth quarter of 2008. Utility demand continues to be very soft with sales declining greater than the overall segment decline. We currently are not seeing utilities stepping up spending in the U.S.
International has picked up and our energy automation businesses continue to have double digit growth, and the pricing environment is stable.
On the U.S. utility side, with the increase in economic activity, we anticipate over the next year to see higher order rates as infrastructure requirements have not changed from the double digit revenue growth we experienced prior to the U.S. credit markets freezing up last year.
Overall the Electrical Product segment earnings decreased 12% on a normalized basis in the fourth quarter of 2009 compared to the fourth quarter of 2008. Return on sales on a normalized basis increased 110 basis points to 15.4% from 14.3% in the fourth quarter of 2008.
We deleveraged 11%, a very solid performance in an environment where revenues declined 19%. On a normalized basis we deleveraged slightly less than 11%.
On Slide 18, our Electrical Products revenues declined 3.8% from the third quarter of 2009 reflecting normal seasonality. Sequentially, return on sales improved 40 basis points from the third quarter of 2009, 30 basis points on a normalized basis driven by realization of benefits from the cost actions taken in the fourth quarter of 2009 and throughout 2009, solid performances on managing price and material economics and stabilization of our factory performance.
You look at the last economic down turn, electrical return on sales bottomed in 2002 at 12% on single digit declines on revenue and it took four years to get back to 15%. In 2009 electrical revenues declined 22% and took us only two quarters to get our electrical margins back to 15% with return on sales now over 15% in both the third and fourth quarter, and a very solid 14.1% for the year and this is with operating working capital down greater than the decline in sales.
Cooper is a different company than it was seven years ago and we are very well positioned to deliver outstanding earnings leverage as the market recovers.
Turning to the Tools segment on Slide 19, in our Tools business sales decreased 7% from the fourth quarter of 2008 with currency translation increasing revenues 6.2%. The hand tools side of this business had stabilized with retail sales declining low single digits and the industrial side of the business has improved with aerospace and automotive showing some signs of life.
Tools operating earnings declined 30% exclusive of restructuring on a normalized basis from the fourth quarter of 2008. Return on sales declined 230 basis points on a reported and normalized basis.
On Slide 20, Tools sequential revenue increased 10.3% from the third quarter of 2009. It was nice to see the business stabilize and underlying volume increase, and Tools earnings continue to recover with a return on sales in the fourth quarter of 8.3% compared to 4.9% in the third quarter.
On a normalized basis return on sales was 7.2%, a 230 basis point improvement from the third quarter of 2009. It’s a nice recovery from where we started the year in the Tools business and very well positioned to leverage a revenue recovery.
Turning to Slide 21, while the fourth quarter continued to be difficult on the revenue side with revenues declining 17.5%, we continue to aggressively manage our cost structure and operating working capital.
If you normalize for acquisitions in both years from one year ago, operating working capital is down 23%, and inventory 25%. Our SG&A is down 16%, cost of sales 21% and our head count 10% from one year ago.
From before the economic recession and credit crisis hit us, that is from September 30, 2008 to December 31, 2009 operating capital is down 32% and head count 16%, a very dramatic adjustment that was extremely well executed by our businesses without damaging our new product development, our sales organization and international growth initiatives.
We continue to closely manage our cost structure and are very well positioned to leverage a recovery.
Turning to Slide 22 on restructuring actions, cumulative fourth quarter 2008 and full year 2009 restructuring totaled $65.6 million. In the fourth quarter we recognized $18.7 million in benefits from the restructuring. With the actions completed to date, we have approximately $25 million in incremental benefits that will be recognized in2010.
To date we’ve closed eight manufacturing and warehouse facilities and have approved closure of two additional facilities.
Turning to Slide 23, and a summary for the 2009 full year, I have to admit that I’m very happy to have 2009 behind us. It was not an enjoyable year with a lot of tough actions across our businesses to adjust to the worst economic decline since the Great Depression.
For the year, revenues deceased 22.3% with Electrical products down 21.6% and our Tools business revenue declined 27.2%. The results in core revenue declined 21% with Electrical down 2.4% and Tools at negative 24.4%.
While the impact of the economic crisis was unpredictable, we continued throughout the year to revise our assessment of revenue and earnings for the next quarter and year and while we were far from perfect on forecasting, we believed it was very important and more important than ever to provide the information.
It’s interesting to note that if you go back to a year ago we forecast revenues to decline 10% to 15% and earnings per share excluding unusual items of $2.45 to $2.80. As I look back on the year, I have to applaud our operations for quickly adjusting to a much worse revenue environment while delivering the commitment we provided a year ago on earnings for the year.
Excluding the unusual items, earnings per share from continuing operations declined 30% on a 22% revenue decline, not an easy metric to achieve. Free cash flow conversion was 149% on recurring income, our ninth year in a row that free cash flow exceeded earnings.
Now turning to Slide 14 and our 2010 outlook, for the first quarter of 2010 we are forecasting revenues to be in a range of a decline of 3% to an increase of 2%. The forecast includes a positive impact from currency translation and acquisitions of over 4%. In other words, year over year core revenues decline in the low to middle single digits.
Sequentially from the fourth quarter we expect Electrical revenues to be down low single digits to up a couple of percentage points and Tools revenues to be down mid to high single digits. Tools fourth quarter is traditionally the strongest quarter with the first quarter by far the weakest quarter.
We anticipate additional $0.01 to $0.02 per share restructuring in the first quarter. Excluding this charge our forecast is earnings per share of $0.65 to $0.70. For the year, we’re forecasting $2.70 to $2.90 per share exclusive of unusual items. We’re forecasting a revenue range of down 1% to up 4% for the year with currency translation contributing over 2% to revenue in 2020 and we expect free cash flow to exceed recurring income for the tenth year in a row.
From the preliminary thoughts we provided in the fourth quarter of last year, there’s not been much change in our thoughts on the market. A couple of items on the assumptions built into the forecast; pension and OHIP expense will be a positive of a couple of cents in 2010. Material costs have continued to escalate and we’re being a little more conservative on price versus material economics in 2010.
Our tax rate is expected to be between 19% and 21%. And importantly, as we said before, if we achieve volume above our forecast we expect to leverage that volume into significant earnings growth.
We’ll provide further details on our 2010 forecast at our Outlook meeting on February 23 in New York City.
Now I’ll turn the call back to Kirk for a wrap up.
Thank you Terry. As we end one decade and begin a new, we feel extremely confident in what it takes to be successful in this faster changing, more complex world. We’ve strengthened our global competiveness with a relentless focus on productivity, exiting 2009 with 15% plus Electrical margins and facing no headwinds in 2010 from furloughs, 401K cuts or pension funding, and our balance sheet has also been strengthened with a debt to total capital below 16% due to our aggressive reductions of working capital in 2009.
While 2009 was incredibly challenging from an operational perspective, we did not lose our focus on the future and continue to invest in emerging new technologies around energy efficiency, green and customer productivity exiting 2009 with a record vitality index of new product introductions.
We also continue to expand our global commercial footprint to improve our penetration in China, the Middle East and South America where auto sales, steel, chemical and oil and gas industries are flourishing.
We believe the diversity of our end market balance and our portfolio continues to be a real asset, especially after such a steep downwards decline we have just experienced. Our industrial and residential end markets are beginning to grow again. Utility will follow, then non residential construction in 2011 providing a solid core growth for the next four to five years.
And as we are all well aware, cash flow is the lifeblood of any company and for nine straight years, our cash flow has exceeded recurring income with the last five years being north of 10% of sales.
So in 2005, 2006, 2007 and 2008, while we were experiencing solid growth and in 2009 when our sales dove sharply, our business model was able to produce healthy and stable cash flow.
And lastly, we understand the expectations of our owners to communicate in a clear and transparent manner the performance of the company and conditions of our end markets and to produce long term steady returns by investing in the core of our company while returning excess cash to the owners avoiding excess leverage, giant buy backs at the market peaks and acquiring into industries where we have little or no expertise.
While none of this is easy, and the world economies seem more susceptible to violent gyrations as we experienced with dot com, housing and energy booms and busts, we feel confident we have the right leadership team, cultures and values and business model to continue to guide this 176 year old company to great prosperity.
(Operator Instructions) Your first question comes from Jeff Sprague – Citigroup.
Jeff Sprague – Citigroup
This whole idea of leverage on revenue growth and I think it’s probably for 2010 greatly intertwined and kind of the whole price/cost dynamic, but ’09 is interesting to watch. Every quarter for the year your sales have been actually in the $30 million band so you did basically $1.250 billion plus or minus all year long in the margins marched steadily upward.
I guess we understand what the restructuring variances are but I just wonder if you could put a little more color on the operating leverage question and maybe it’s even a two part answer like the leverage in the early days of growth versus where it settles out maybe several quarters down the road.
I think what you saw in the fourth quarter really of ’08 was a very steep decline in November/December and so as we said then, we shut off the production rates at the factories and started taking down the inventory and the working capital. So we really didn’t even get to significant restructuring until, we started it early but we didn’t get into in the big time until the first quarter.
So you’re absorption rates, your inventories coming down plus the steepness of the market fall really did impact the margins then quickly. As you streamline through the year then, you start getting to the sort of more normalized run rates. You get the benefit of the reductions, the restructuring reductions and some of the plant closings and such and start getting more efficiencies and I’d say by the fourth quarter obviously, you can see Electrical, I’ll talk to, on $1.1 billion to $1.2 billion, what kind of margin you can run.
Now our approach to ’10 was not let the businesses build a V shape recovery in any of their budgets and so conservatism would say that you can continue to run under the cost structure you have and so I would say as you get some volume, 30% incremental leverage in the early days will certainly be well within our grasp.
But as we said, we want to continue to invest. We’re going to continue to invest in international expansion and new products so over time, some of that will, we’ll chew up some of that to continue to reinvest in the core. But I think facing no headwinds out of one time, furloughs or 401.
So we don’t have anything coming back that will pollute those numbers as you run into the first and second quarters of ’10. So that would be my take on it.
The only thing I would add is clearly until we see the actual revenue and volume sustainably picking up at least from our vantage point we won’t be adding the cost in. So we’ll clearly leverage that much better in the very early end of the cycle versus from a normalized out and say later in the year into the next couple of years.
Jeff Sprague – Citigroup
Would you elaborate on what you’re seeing on cost? I’m sure you’ve got a variety of contracts that are protecting you a bit but at what point in the year do you think you’re seeing year over year raw material cost increases?
When I look at the 2010 forecast which we’ve been updating here, on the revenue side as far as price, pretty modest price increase built into our forecast, but net on the material costs, that is year over year, not a huge amount of material cost offset with price, and pretty consistent quarter to quarter.
So I really at this point don’t see damage to the margins if you will from price material economics.
Jeff Sprague – Citigroup
Obviously a great job on the working capital, I would suppose nominal dollars would have to go up as the company grows but do you think you can maintain or even improve on the turn over ratios in working capital as the revenues begin to turn?
Absolutely. We have a long ways to go in our view on the whole supply chain side of it, so inventory clearly. On receivables, you will build receivables because it’s much tougher to keep taking your DSO’s down. And then of course payables will grow.
But I think you’ll see a fairly modest build in operating working capital if we start growing revenues in the 5% to 10%. If it gets over 10% clearly then it’s tougher.
We saw some businesses that made some good progress on turns but still start with a four in front of the number, so I think there’s certainly some improvement. The ones that turn well are turning pretty well but there’s still a couple of them that turn below what we would consider good numbers.
Your next question comes from Robert Cornell – Barclays Capital.
Robert Cornell – Barclays Capital
There were some comments made about projects in the quarter on the non res side maybe you could expand that by talking about what you see in terms of the non res segment this year and just flush out that project comment with regard to inquiries, funnel, and also pricing on those projects. A company yesterday talked about pricing aggressively on projects, whether you’re seeing any of that, so non res in the aggregate and then projects.
Non res is still going to be tough I don’t care how you cut it. We’re still looking at a negative double digit decline. I think the market is somewhere around 14% to 15% down most likely. We think we can do a little bit better than that because of some new products and some energy efficiency products and things like that.
But that’s kind of what we’re budgeting. If you look at vacancies of offices and you just drive around the country and talk to some of our lighting agents and the architects, even the funding and the availability of capital, banks want to do 50% to equity types of loans on small projects.
It’s very, very difficult. So I think anything much better than that is going to be tough in this year. We are trying to follow a disciplined approach on the pricing. We have taken some price increases in several of our businesses heading into the fourth quarter. Lighting is one of those businesses.
There’s been increased copper, steel prices, so I think overall I wouldn’t suggest that all that we’re seeing more pressure on price for large projects than you’d expect over what we’ve seen over the last 12 months.
This has been down for some time now. The relief you’re going to get out of construction is going to come from housing. I think some of the big box guys are actually forecasting now same store sales up a couple percent next year. We’re coming off such low starts there but you can see some growth there.
And I don’t know if this stimulus money ever turns into some real construction projects which would be helpful as well. But we think that’s going to be a soft spot. We’ve anticipated what it’s going to be but I don’t think anything worse than we’ve seen in the fourth quarter already or the momentum we have going into 2010.
Robert Cornell – Barclays Capital
You once mentioned that you saw some building inquiry on the small to medium size projects. Is that still the case? Is that real?
We aren’t seeing anything deteriorating any more quickly. Our fourth quarter came in almost spot on where we think the market was and where we thought it would come. It’s not been a drag to us. It’s not been a business that calls up with a surprise every quarter. It’s been predictable and pretty steady in the way the guys have managed it.
Margins have been very good. Cash flow has been very good. We build this new LED center down there. We’re getting a lot of play on the technology side and so it’s a good time right now to reinvest in the core of that business with new product development.
This LED transition is going to be a huge tailwind for the next 10 years and so converting all your products over to this new technology and all that, it’s a good time to be doing it now. So we’re putting more engineering and more resources. The vitality in that business is probably one of the highest in total Cooper right now.
Robert Cornell – Barclays Capital
What is the Cooper capacity utilization right now? Do you have a feel for that?
It’s tough. Some of our businesses, Terry was talking about the MRO or the OEM business. Some of our businesses are actually struggling to keep up with some of the increased demand that we saw over the fourth quarter. So it’s a wide mix.
The Tools business for example, is modestly seeing things pick up but nowhere near where the volumes were a year ago. Same on the commercial side, and then we’re seeing our European businesses and some strength in our businesses and a couple of our smarter businesses. I’d say it’s mixed but we have plenty of ability to serve the market. There’s not an issue on capacity other than electronics and some of those key markets that we’ve been seeing some tremendous growth out of.
Robert Cornell – Barclays Capital
It looks like on your first quarter guidance you’re looking at margins for both Electrical and Tools comparable to fourth quarter levels. Is that right? Seasonally you expect the first quarter to be a little lighter than that. What’s the thinking there?
The first quarter on Electrical side at this point we’re thinking it will stay up pretty good at least close to the 15% and that’s driven, we have carry over benefits from the restructuring actions that we took and the revenues as I said are pretty close to the fourth quarter.
The Tools on the other side of the coin is a strong typical fourth quarter, much weaker first quarter so a lot less volume running through in the first quarter so their margins will come down; likely come down in the first quarter.
Your next question comes from Rich Kwas – Wells Fargo.
Rich Kwas – Wells Fargo
Following up on the pricing with utilities specifically, what are you seeing there? Are you seeing incremental pricing pressure on that end and for which products?
As we’ve talked about earlier, earlier in the year, water pressure especially on the transformer side of that business. From I’d say the last three to six months of the year, much less pressure on that side of it, so pretty stable pricing at this point albeit at a much lower profitability than it was a year, year and a half ago.
Rich Kwas – Wells Fargo
Is it fair to say that caution regarding pricing/materials is just concern about material economics? You get some kind of spike or how much of that is related to maybe some of the platforms, maybe lighting or something like that, the pricing quotient getting a little more challenging.
I’d say this. We’ve seen a lot of base materials inflate primarily because of the China demand and some of the global economics around copper and aluminum and steel. What we’d say is it’s probably going to harder to pull the traditional price in an economy in North America at least where you have excess capacity and still very weak demand.
So until you start seeing some absorption and demand picking up on some of these key end markets, we’re more cautious that we’ll be able to just match the equation between inflation and pricing and keep that at parity.
Historically we’ve been able to go in and get a little bit of an extra kiss on that and so as we start the year, we’re probably a little bit more conservative in our ability to pull that through given the weak demand that you’re still seeing or the weak overall economy you’re still seeing primarily in North America
Rich Kwas – Wells Fargo
In terms of the utility business overall, it seemed like a couple of quarters ago you were a little more bullish about utility for 2010. Last quarter you said you thought 2010 would end up being flattish in terms of your business and you kind of reiterated that here today. What are seeing as the drivers either way for 2010? What could move the needle either up or down on the utility side?
I think you caught my comments spot on. The steepness at which it fell off starting back in November of last year, they basically shut everything off. They weren’t ordering anything, and that was one of our first businesses, I couldn’t imagine how you could shut it off so fast and they were chewing up inventory and they had problems with access to the capital markets.
By the mid year I thought for sure we’d begin to see a recovery of the basic demands and needs of the aged grid in utilities, but they’ve been able to push that even longer than I had anticipated of the core products.
And so if you look at the demand patterns and the order patterns, they flattened out, but they cannot in my estimation hold at these reduced levels much longer. So I think their inventories are down. Capital markets have loosened up.
I understand that energy demand because of industrial factory utilization being down and construction being down, there’s actually a negative demand of energy right now, but eventually they’re going to have to come back to equilibrium or normal demand patterns and I think that’s probably not going to be until the back half of 10.
So the way we forecasted that business, and you’re going to see Mike who runs the power business at our Outlook meeting, probably stays very negative comps through the first half and begins to pick up on the order rate in the back half which almost makes for sort of a flat revenue year, and then a pretty good demand cycle as you get out into ’11 and ’12 and ’13.
So I think that’s going to be a turning point kind of midway. I’ll move my prediction out to midway through ’10 admitting that I was wrong there but I think we can get back to better demand patterns by mid year this year.
Your next question comes from Scott Davis – Morgan Stanley.
Scott Davis – Morgan Stanley
The one thing you mentioned, the supply chain; can you talk a little bit about the health of your supply chain? Coming off of this steep of a downturn and if we do have a sharper pick up in demand and an inventory recovery at the same time as some real demand out there, is the supply chain healthy enough to respond?
I’d say with the exception of a couple of product lines, I think we’re in very good shape and of course we watch that very closely. But one of our strengths clearly is we have very, hundreds of thousands of SKU’s in different product lines.
The exception is areas like electronics where you have very specialized material and that’s been a real struggle ramping back up. But we’ve gone through our businesses. There’s a couple other instances where we could see some shrug off and start growing 10%, 15%, 20%, but other than that, we should be in very good shape.
That’s exactly right. Your basic copper, steel aluminum, those kinds of things will be all right but when you get into these specialty materials, in the electronics industry, you look at the numbers of Apple and Intel and those kinds of guys, that’s exactly where you see it.
Scott Davis – Morgan Stanley
Moving to cash reinvestment, you have about a 4% of M&A in your 2010 outlook. Talk to us about the deal pipeline. What are the prospects for potentially having bigger numbers or anything even substantially larger that could be a little bit of a data mover.
First thing is we ‘ll go to our Board and we look at the dividend generally every February. We’ll go to the Board with a proposal on the dividend this February. I think we’ve got some room to go there to take the dividend up this year and so we’ll propose something to the Board. They’ll make the decision.
I think the buy back, if you think about being on the front end of a nice four to five year growth period on core growth, we know what we can do to earnings per share when you lever that out. So I still think the stock is very attractive at these levels and so we’ll continue to be in the market buying back the stock.
And, I think we’ve got a significant amount of cash on the balance sheet to continue to reinvest in these technologies. I’m particularly focused on expanding into new geographic markets and we use acquisition as you know to do that. That would include South America, continuing to look at things in Europe around our safety platform.
There are some interesting pieces around that Busman business like electronics. There’s the instrumentation business around Krauss. There’s the interconnect business. All these new platforms that we’ve been talking about, certainly a very good time to be exploring all of those and Tom has been very active in all those pieces.
Just to clarify, in the first quarter the 4% is primarily translation because all we build into our forecast is acquisitions that have actually been completed to date, so that’s like 30 bips in the first quarter.
Your next question comes from Terry Darling – Goldman Sachs.
Terry Darling – Goldman Sachs
I’m wondering if you might continue down or just focus on electrical products, kind of flattish top line. You’ve gone into some detail on utility kind of flattish for the year. You think you’ve got a nice trend in energy automation, you continue to grow that. But could you take us through the other pieces, distribution, MRO, retail, take us through where your assumptions are on those pieces.
We’ll get into this in more detail at Outlook of course but let me kind of give it to you. Industrial certainly grows. MRO, factory utilization improves from here. We saw some good progress in the fourth quarter. Busman electrical is a pretty typical indicator of early cycle MRO type of business.
The Tools business on the industrial side of course picked up so that will grow. Retail will grow. The OEM electronics will grow. Utility flattish, I think that’s an upside to the plan that we have thought. I think there’s an opportunity to do better than that. And then non res down double digit and we’ll have Neil who runs the lighting business at our Outlook meeting as well, so he’ll give you more details there.
International grows across the board as well. Europe was pretty good for us in ’09 overall, much better than the European market, and I think we can do more on the developing economies as well in 2010 so they’ll be up double digit.
Terry Darling – Goldman Sachs
It strikes me that there’s probably a favorable mix indication for margins in that context. Can you chat about that as well?
I think the answer is, if you look at Busman, Krauss, those kinds of businesses, they are better. The lighting project business, non res commercial construction businesses, yeah generally pretty tough. Our transformer business which is down are some of our lowest margins in the utility business and so that’s why I think you’re seeing the $2.70, $2.90 gives you pretty good EPS growth as we go into 2010 and I think a chunk of that is mix, of course.
Terry Darling – Goldman Sachs
I’m still a little confused on the price of raw material message as I try to tie together what happened in the fourth quarter and what your guidance is going forward. Maybe it’s just easier to talk about just the Electrical products business in this context, so maybe that’s where my confusion is, but I thought I heard you say that price was off two points in the fourth quarter but that the price of raw material spread actually got better, more favorable for you sequentially, yet I thought you said in the guidance, you’re assuming two points of positive price, and on the raw material side no inflation net year over year, yet you are seeing some inflation in the spot market. I’m still a little confused as to what’s baked into the guidance from the standpoint of price of raw material spread here. Can you put those pieces together?
If you look at the price material spread in the fourth quarter, very, very consistent to quarter one, quarter two and quarter three during the year even though price was down 2%. But remember, we’re always talking year over year on that and the same with material costs on it.
So very consistent in 2009. 2010, what you’ve seen in the last six months is a number of the commodities move up in cost, aluminum, nickel, copper has moved up during the year. So we know going into ’10 that we have some more inflation coming versus ’09 year over year there was a lot of deflation in the raw material costs.
So going into 10 as Kirk talked about earlier, we know pricing environment in some markets will be a little bit tougher, and some products. But taking a pretty conservative stance, but that being said, we still expect to have enough price in 10 to offset material economics.
The spread there will probably not be as great as it was in ’09 but we’ll still manage that very well.
Terry Darling – Goldman Sachs
I got the pieces of the puzzle I’m just trying to put them together. If you have negative 2% price in the fourth quarter and you’ve got a flattish top line I’m just thinking Electrical Products here, how do you swing that to a positive 2% for the year. Does that go back to the mix issue we talked about in the context of the pieces of the puzzle or am I missing something there?
We’re not estimating or forecasting 2% price in ’10. It’s going to be a very modest price increase in ’10.
Terry Darling – Goldman Sachs
Share account assumed in the guidance, can you help us with that?
Pretty flat with 2009 because we are buying enough shares to offset what we call creek shares.
At this time I’d like to turn the call back over to Mr. Mark Doheny for closing remarks.
As we conclude the call, I would like to invite the investment community to join us for Coopers 2010 investor Outlook meeting which will again be held at the New York Mandarin Oriental Hotel on Tuesday, February 23. We’ll begin presentations around 8:30 am and conclude by 11:00 am.
As we did last year, we’ll have presentations from both corporate senior executives and division management. With that, thanks for joining us today. Please feel free to contact me with any follow up questions that you may have.
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