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Executives

Alexander M. Cutler - Executive Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Richard H. Fearon - Vice Chairman and Chief Financial & Planning Officer

Donald H. Bullock - Senior Vice President of Investor Relations

Analysts

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Ingrid Aja - JP Morgan Chase & Co, Research Division

Jamie L. Cook - Crédit Suisse AG, Research Division

Joshua C. Pokrzywinski - MKM Partners LLC, Research Division

Eli S. Lustgarten - Longbow Research LLC

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Andy Kaplowitz - Barclays Capital, Research Division

Jeffrey T. Sprague - Vertical Research Partners Inc.

Terry Darling - Goldman Sachs Group Inc., Research Division

David Raso - ISI Group Inc., Research Division

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Eaton (ETN) Q4 2011 Earnings Call January 26, 2012 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Eaton Corporation Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. And I would now like to turn the conference over to our host, Mr. Don Bullock. Please go ahead.

Donald H. Bullock

Good morning. I'm Don Bullock, Senior Vice President, Investor Relations. Welcome to Eaton's Fourth Quarter and Full Year 2011 Earnings Conference Call. Joining me this morning are Sandy Cutler, Chairman and CEO; and Rick Fearon, Vice Chairman and CFO. As has been our practice, we'll begin today's call with comments from Sandy, followed by a question-and-answer session.

The information provided on our conference call today will include forward-looking statements concerning the first quarter 2012, full year 2012 net income per share and operating earnings per share; full year 2012 revenues; our worldwide markets; our growth in relation to end markets; and our growth from acquisitions. Those statements should be used with caution and are subject to various risks and uncertainties, many of which are outside the company's control.

Factors that could cause actual results to differ materially from those in the forward-looking statements are set forth in today's press release and related Form 8-K filing.

As a reminder, we've included a presentation on the fourth quarter results, which can be accessed on the Investor Relations page. We've placed our earnings presentation and released the materials out early this morning, earlier than normal, since many of you have a number of calls today. We want to be mindful of that, and we will conduct the call concluding at 11 p.m. Additional information is available today in today's press release, which is located on Eaton's homepage, www.eaton.com.

At this point, I'll turn it over to Sandy.

Alexander M. Cutler

Great. Thanks, Don, and welcome, everybody. Thanks for joining us. I'm going to work from the document that Don mentioned, and I'm on Page 3 to start, labeled Highlights of Fourth Quarter Results. And we had a very strong quarter filled with a number of records, although we did fall just short of the midpoint of our guidance.

Just to highlight a couple of the points that are on the chart that you see, our sales were up some 10%. Our operating profits, $1.08, per share. We're up 27% from last year. Net income per share, $1.07, was up 30% from last year. So I'm really delighted with that performance.

Emerging markets were about 26% of our sales. And as you saw in our press release, they were about 27% for the full year. That really reflects -- a theme we'll talk about a little later when we talk about end markets that we saw, emerging markets continued to weaken through the fourth quarter.

You put all that together, and we had a record year in 2011, our 100th year. It was our first time we had revenues over $16 billion. Our sales were actually up 17% from 2010. Our earnings per share were up 44% from 2010 and 19% above our all-time previous record, which was in 2007. And importantly, our segment operating margins at 14.2% were up 1.5 points, and obviously great progress toward that goal we've discussed with you of 16%.

All of this sets the foundation for, we believe, another record year in 2012. And that gave us the confidence to increase our dividend by 12%. You saw as part of our press release this morning, from $0.34 per share to $0.38 per share.

Moving to Chart 4. This is a reconciliation to the midpoint of our guidance for the fourth quarter. You'll recall that, that midpoint guidance was $1.11, which was a 31% increase over last year. We actually ended up achieving $1.08 at the bottom of the chart, which was 27%.

We did encounter lower market growth than we had anticipated in the fourth quarter. It's approximately $200 million of volume. We outlined in the press release, so I won't spend time on it right now. Where it occurred was primarily in our Electrical business.

We had higher corporate expenses in the quarter. We indicated that they came in about $0.05 higher than we thought. If you recall the quarterly progression of our corporate expenses were about $45 million in the first quarter, $54 million in the second quarter, $56 million in the third quarter, and we had provided full year guidance that we thought we'd be close to about $260 million when we started the year.

We had anticipated it would be on the order of about $80 million from the fourth quarter. As you saw, it came in at $102 million. And really, that's primarily the result of the fact that as shipments were a little lower than we anticipated, our inventories ended up being a little higher. And that incremental $20-plus million dollars of expense was primarily driven by the higher LIFO expense, as I mentioned with our inventories remaining a little higher than we had estimated.

The lack of the commodity hedge recovery that we note on this chart, you'll recall in the third quarter, we had taken mark-to-market adjustments for our commodity hedges of approximately $22 million. And that had been about $0.06. And if you recall in that reconciliation, we said we would not repeat -- or we did not expect that we would have another mark-to-market in the fourth quarter. We did not. But we had expected that we might get about $0.02 of recovery. And with commodity prices not really changing fundamentally from where they were at the end of the third quarter, we did not realize that additional income. So that was about a negative $0.02.

We had a lower tax rate, about 7.2% versus the 19% we'd used in our guidance for the quarter. That accounts for a positive $0.14. And then a very good news that I mentioned on the first page about our operating segments, margins came in at record levels, 15.1% all-time record for a quarter for us. Really great balance performance. And that contributed about a plus 7. So all in all, $1.08, up 27% versus a year ago. A very solid quarter.

If we move to Page 5, this is simply the financial summary at the corporate level. I think most of this is pretty self-explanatory, so I'm not going to spend a lot of time on this chart except to note that the sales were, as is normally true in the fourth quarter, off just slightly from where they are in the third quarter.

As we move to the individual segments, perhaps a little bit more color is helpful here. If we move to Chart 6, which is labeled Electrical Americas Segment, a really terrific quarter performance here in our Electrical Americas business. That sales level is actually a record for the quarter, quite pleased about it.

And as we noted in our press release, we'd hoped it might be even a little bit better because our bookings have been very, very strong, up again 11%. This has been a great year of bookings, and that's why that backlog continues to be so strong. We did experience some lower sales than we had hoped we might have in the quarter, really due to push-outs from a number of customers that -- right at the end of the month, frankly, were just hoping to delay shipment of some fairly large projects. I expect we'll recover that in the next weeks and months. So we don't really see this as any fundamental issue. It's much more of a timing issue, and that large backlog is really what gives us that confidence.

Underlying all of this is the continued rebound now in the non-residential markets. And you'll recall that we had made the call that we would see this turn by the middle of 2011. We saw it turn actually in the second quarter 2011. The fourth quarter posted some pretty attractive numbers, and we think we will see continued recovery into 2012.

Residential construction is starting to show a heartbeat. Numbers are still kind of low, but at least they're positive. And then we were very pleased to complete the acquisition of the switchgear manufacturer, Pedersen, which puts us with increased content into the utility marketplace, which is really an important marketplace for the utilization of much of our medium voltage switchgears.

So a really great quarter. Back to over 15% margins, 15.5% margins. So this business is performing really well.

If we move to Chart 7, Electrical Rest of World segment. We noted in our press release that we saw continued weakness in China, and that really has to do with the credit tightening that has affected really all portions of the marketplace. We'll talk about it again a little bit in the hydraulics marketplace as well. But we saw tightening affect both power quality and power distribution projects in China.

And then as you can well appreciate, Europe has been on a slow weakening pace really through the back half of the year, and that continued in the fourth quarter. So as you can see, numbers down about 7% from the third quarter in the fourth quarter, if you look at our third quarter shipments of $755 million compared to the $699 million that occurred in the fourth quarter.

Bookings, also down. And as we talk a little bit about guidance for 2012, you'll see that we're anticipating, not only in this segment but in other segments that have business participation in Europe and Asia, that the beginning of the year, we'll start slower. And then we think that recovery, if and when it really starts to manifest itself, is more likely to happen later in the year.

If we turn to Chart 8, the Hydraulics segment, another outstanding quarter. Sales, up 23%; margins, 15%; overall bookings, up 5%. Again, really reflecting our strength in the mobile segment. And as we've shared with you, we continue to see the mobile side of this marketplace leading in strength.

Our bookings were up far more than the 5% in the Americas. The weakness really continues over in Asia-Pacific at this point. And then Europe has really flattened out at this time.

We do expect the China mobile hydraulics marketplace, which is an important one for us, to expect to begin to recover in the second half. But we're not forecasting that in the first or the second quarter of this year.

If we move to Chart 9, the Aerospace segment. We had told you that we would see margins rebound significantly during the second half. You saw in the third quarter, they were at 16.9%, 18.1% now in the fourth quarter. Really pleased with the performance here.

The market outlook is really the tale of 2 cities that you all well appreciate, with commercial markets very strong and defense markets softening quickly. And you'll hear that again as we talk about our guidance for 2012.

Our aftermarket bookings, same sort of profile, much stronger on the commercial side than on the defense side, but we're very pleased obviously with performance and the margin performance in this segment during the quarter.

Turning to the Truck segment. It came in pretty much as we expected, with the exception of South America. And many of you had questions about what could the pre-buy look like in South America. Actually, a little weaker than we had thought, and we think that some of that carryover of the inventory that piled up in South America will affect the early part of 2012 as well. Nonetheless, a really great quarter. Sales, up 31%. 20.1% operating margins.

We saw the fourth quarter in NAFTA come in, pretty much in line with our expectation. We're leaving the year at sort of the 75,000-unit production level, which obviously, if you annualize it, you're going to come right to what our view is of what the market will be in 2012.

Moving to Chart 11, the Automotive segment. A very strong quarter again. You'll notice on the acquisition line, that's in the green box on the lower left-hand corner of this slide, there's a negative number, and that is indeed the divestiture of a small, small business we divested this year. It was involved in blow molding. It was something we didn't feel was a good place to keep our investment. We'll redeploy those dollars elsewhere. That's the negative, if you will. It also affected, obviously, the shipment volumes this quarter.

But a solid quarter. The margins a little lower than what we described in the third quarter, the 14% margin. You recall in the third quarter, we described as having the moon and the stars and the sun all aligned, everything went perfectly well. We're very pleased with this 10.6%. It does reflect a slightly lower margin because we are bringing up additional capacity in China right now for a very good reason, that we've had a number of very exciting new program wins in China. We've got to increase our capacity there.

If we move to Slide 12, now kind of transferring over to our guidance for 2012. I think the overall context I would set these specific numbers is that we're expecting a year of slow global growth, on the order of 2% GDP. If you'd ask us how we're feeling now versus how we felt 3 months ago, we would tell you the U.S. looks a little better than we thought it was going to look, that Europe looks a little weaker than perhaps we thought it would be, and that developing nations are a little weaker at this point than we had thought they might be 3 months ago.

And so as you think about how the year might layout, we think it's starts a little slower, and it recovers toward the end of the year. And that is really the impact of how long it takes for Europe to start to cure itself, as well as the time for some of the easing policies in the emerging nations to get traction and orders to be created in our marketplaces.

So that is the background -- if you simply look at our overall weighted average growth for our end markets. We think it will grow at about 5%. About 6% in the U.S., about 4% outside of the U.S. And as I just step through these quickly, in the Americas business, Electrical Americas, we think the non-residential market be up about 5%. Residential will be stronger than that, but it's not that big an item. And the Power Quality will be slightly less than that. And overall, that averages about 5%.

In Rest of World, if you look at -- for Electrical, we think Europe will be negative 1 to 0, and Asia-Pacific about 3. And that's how we come to the 1% forecast. In Hydraulics, continued strength is in the U.S. A big strong year again, this next year is 6%. And as we look outside the U.S., we think Europe is probably flat. Asia-Pacific, about 3%.

Aerospace, again a big year in terms of commercial in the U.S. We think up on the order of 15%, with defense down on the order of 6% to 7%. And our number outside the U.S. is primarily a commercial number.

In the Truck market, a 16% increase here in the U.S. And that's really anchored by our forecast of 300,000 production for heavy-duty truck. Outside of the U.S., it's really a mixed picture with Asia-Pacific being up about 6%. We think Brazil will be down about 5%, and we think Europe's up about 8%. And of course, that's a little smaller factor for us in Europe.

Automotive, a strong year in the U.S. This is anchored by expectations of just over 14 million retail sales in the U.S. in terms of our forecast. In terms of North America -- excuse me, non-U.S. growth, we think Europe is basically flat, and Asia-Pacific up about 11%. That's the background that I hope will give you some context for our thinking about the likely economic scenario.

If you move to Chart 13, this is labeled Margin Expectation. The very good news here is after a record year in 2011, as I mentioned earlier, the 14.2% segment margins, 2012 we believe will be another year of further margin expansion on our way to the 16% goal that we articulated last year in February at our New York Analyst Meeting.

You'll see here that we're expecting margin expansion in virtually every one of our segments here, although Automotive stays the same. And you put that together and it's somewhere between 14.5% and 15%. We think handsome margins, particularly in this period of some economic volatility.

If we move to Chart 14, it gives you just a quick look at our EPS guidance. Let me just address the column operating earnings here for a moment, the $4.15 to $4.55 guidance with a midpoint of $4.33. So we're talking of 5% to 15% low end of the range to the high end of the range in terms of year-over-year improvement, with the midpoint being approximately a 10% increase.

Now to give that a little bit more of a dimension, if you'll turn to Chart 15, we'll give you a quick look at the bridge between 2011 and 2012. Overall, this is revenue up 4%. Operating EPS midpoint would be up 10%. As I mentioned earlier, when we talk about the markets, we expect our market improvement of about 5% at a 28% margin, because that margin's a little over this next year than it has been the last year. Consistent with what we've said is that as you go through the cycle, the incremental margin tends to get a little lower.

Market outgrowth of about $320 million. A decrease in the number of shares outstanding. You remember that we made some repurchases in the third quarter. So on a weighted average basis, you're going to have slightly lower shares next year.

Net acquisitions and divestitures. These are the net of the acquisitions we completed during 2011 minus the divestiture I mentioned of the one automotive business, about $0.02. Net other corporate expenses, and a portion of this is lower intangibles as we had some assets roll off, of about $0.02. So about $0.90 of pluses, offset by the higher tax rate.

You saw in our notes that it averaged 12.9% for the full year 2011. Our guidance is between 17% and 19%, so 18% is what we've used here.

ForEx, a very significant item for us, and one we suspect that not everyone has had the opportunity to really fully value at this point. We think it will deduct about 3.5% from sales this year, about $550 million. And that's a negative $0.14. Obviously, we've seen quite a change since the mid to early part of last year to where these valuations are now.

And then increased pension expense. We had told you at the end of the third quarter, we thought it would be on the order of $40 million, with the even lower discount rates at the end of the year. It's on the order of $45 million. So negative $0.51, and that's what gets you to the $4.35 reconciliation.

If I can ask you then to quickly turn to Page 16 labeled Q1 2011 to Q1 2012 Reconciliation. You will recall that first quarter is always our seasonally weakest quarter. In 2012, it will not be any different in that regard. And so if we look a year ago, we were $0.84 operating earnings per share. We expect we will have higher volumes in 2012 than we had in 2011 in the first quarter by $200 million to $300 million.

We'll have lower shares, slightly lower shares, the reason I mentioned before. That contributes about $0.02. We'll have a higher tax rate. That again is at 18% versus the average of last year of being -- or excuse me, the first quarter number being about 14.5%.

We'll have higher corporate expenses than we had last year when we were $45 million. And so this is anticipating about a $65 million corporate expense in the first quarter. We'll have higher pension expense. This is about $15 million of that $45 million I talked about occurs in the first quarter. And then about $150 million of this $550 million impact that we think will occur in negative ForEx, and that throws off a negative $0.04. That's how we get to $0.85. So obviously higher volumes, better operating performance, higher tax, with ForEx offsetting it.

So if you move to the last chart in the packet, Chart 17, just a quick recap of some of the key elements for underpinning our 2012 guidance. I mentioned the market growth of 5%; the market outgrowth of 2%; the net acquisition revenue, which is about 0.5%, and the sales decrease from ForEx of $550 million is a negative 3.5. So that's how you get the 4%. 5 plus 2 plus 1/2 minus 3.5, that's the 4% growth.

Incremental margin, I mentioned 27% -- 28%. Tax rate, 17% to 19%. I already talked about the operating and fully diluted EPS projections.

Let me just spend a moment on operating cash flow and free cash flow. We didn't put a box on this chart but obviously, the difference between the 2 is a $600 million plan for CapEx. And I think that completes the key elements of our guidance for this year. So with that, Don, we'd be delighted to address questions.

Donald H. Bullock

If you would please instruct the participants on the question process, please?

Question-and-Answer Session

Operator

[Operator Instructions]

Donald H. Bullock

Our first question is from Andy Kaplowitz from Barclays.

Andy Kaplowitz - Barclays Capital, Research Division

Sandy, you talked about Electrical Rest of the World, but your orders were down 10% in 4Q and maybe down a couple of quarters in a row, and your guide to 1% growth in 2012. So I guess I'm just wondering, what's your conviction that you'd be able to get there given your weak solar inverter market? Maybe if you could just give us more color on how we're going to get to that up 1%?

Alexander M. Cutler

Yes. And again, I think it's a very good question because I think maybe one of the hardest calls from an economic perspective right now is how long does the European weakness go on? And then how long does it take for the response for the easing that we're seeing in China, seeing in Brazil and people are talking about in India. How long will that take to actually have an impact? And generally, what we've seen in our markets is these are sort of 6- to 9-month lags between when you see easing and when it materializes. That's what we've tried to use in this respect. So these forecasts for stabilization of these markets. We think that we've been seeing a weak third quarter. We saw a weaker fourth quarter. We don't think Europe gets any better till you get into the second half of next year. And that's our view also on a number of these emerging nations. So that is the underpinning at this point. What we're pleased about is that from a bookings point of view in Asia in the Electrical business, we actually saw it improve in the last month of the quarter versus the earlier month of the quarters. I would note, however, that's one month, and I'd love to see it for 3 or 4 months to declare a trend. But those are the assumptions we're using at this point. We do think in China there will be an attempt to accelerate the economy. We feel fairly confident about that. It's just a question what that lead lag is going to be. What we're describing in Europe is a more mild recession, not a dramatic deep adjustment. And that indeed seems to be what's coming out of some of the data that's more recent in the last month. It's still down though.

Andy Kaplowitz - Barclays Capital, Research Division

Okay, Sandy, that's helpful. So one thing I didn't really understand is you talked about Eaton production shutdowns in the U.S. and Europe in Auto. And so I'm just trying to figure out, usually, we have some holiday shutdowns I would assume. Was this more than usual and why? And then also, maybe is it possible to quantify the start-up cost with the Chinese capacity expansion in Auto?

Alexander M. Cutler

Yes, let me address the first part of that question. Initially here is that what we saw were really 2 different issues happen. In Europe, there were some part shortages from other vendors, not ourselves, that didn't allow people to complete their production schedules and affected some of our important products that are involved there. That will come back because the demand is there and they're backordered for us. So we don't think that's a permanent. Here in the U.S., you may be aware there were a couple of light truck plants that took some time off in mid-December. That turned out to be maybe the wrong direction because their inventories got stripped down even lower, and that's part of why you're seeing the production build up again here in the first quarter. So that's why we thought those were really timing issues -- non-Eaton specific. The demand is there for the product, and we think we'll be fine in that regard. On the issue of start-up costs, it's on the order of 0.5 to 1 point, is kind of what we were encountering. And we're comfortable that -- we're really pleased to have the opportunity to put in the capacity, and so we'll be ramping that up as we get through '12.

Donald H. Bullock

Our next question comes from Jamie Cook with Credit Suisse.

Jamie L. Cook - Crédit Suisse AG, Research Division

Two quick questions. One, Sandy, could you just comment, when we look at the Hydraulics business and in light of what Parker reported last week, I mean, if we look at your bookings, they were up in the fourth quarter 5%. But it's finally hitting the single-digit range relative to where we've been. So I'm just trying to get a feel for what areas have weakened, what's still staying strong, and how did the orders look throughout the quarter? Did it get worse throughout the quarter and improve? My second question is just a follow-up on the Electrical Rest of World. Revenue again up a modest 1%, but you're suggesting margin should improve in 2012. So I'm just trying to get comfort around that or how I should think about, is it more of a second half improvement? If you could just provide color there.

Alexander M. Cutler

On the first question in terms of the Hydraulics bookings, globally, you're exactly right. We're up some 5%. What we saw is a multiple of that in the Americas, continuing to have extremely strong bookings here, really delighted. And that hasn't backed off much. Where the weakness is, is Asia-Pacific. It's the same issue that we described in our Electrical business is that with the China construction market down, we've seen many of those firms -- we started talking about this really at the end of the second quarter, that we've seen a pretty full pullback. That has not gotten better at this point. And we again anticipate that we are not likely to see their demand come back till the second half. There's still a fair amount of inventory around, and some of you have traveled those regions and seen them all on the roads. Europe has gotten weaker but is still a positive in the quarter. But it's not quite the boomer that it was earlier this year. And so that's the sort of Hydraulics feel.

Jamie L. Cook - Crédit Suisse AG, Research Division

Just a follow-up on Europe, did it get worse each quarter, or was October the best? And can you just talk about in Europe how you saw things?

Alexander M. Cutler

No, it didn't substantially change month-to-month for us in the fourth quarter. It's been weaker, but it wasn't falling off. I know people's concern is this falling off the table. It actually was not. And that is also true in our Electrical business in Europe. It was relatively flat through the quarter. It didn't fall off. I think Asia has been the area where you've seeing a little higher beta, if you will, in terms of the degree of change.

Jamie L. Cook - Crédit Suisse AG, Research Division

Okay. And then sorry, last, just a follow-up on the margins in Electrical Rest of World?

Alexander M. Cutler

Yes, the margins in Electrical Rest of World is -- we've obviously been -- while the volumes have been coming down, we've been working on adjusting our cost structure, and that is an element of us being able to obviously deliver better margins at a slightly lower volume. And so that's the benefit. In fact, we've been adjusting down for a period of time, and that's how we got a good level of confidence on this profitability projection.

Donald H. Bullock

Our next question is from David Raso with ISI Group.

David Raso - ISI Group Inc., Research Division

Quick question. The way the guidance is playing out the first quarter relative to the full year, it's representing a little bit lower than normal, like the last 10 years or so, if you get rid of '09 which was an anomaly. The first quarter is usually, say, 23% of the full year. The guidance is saying first quarter is only 20%. So it's a little back half-loaded. What I'm trying to think through is let's say I want to take a more conservative tact on the EM's reaccelerating. Let's say the European weakness is a little bit beyond just a shallow couple of quarters of weakness. What are the offsets that you see that could make up for that? Because even just run the numbers on Electrical Rest of World and let's say instead of up 1% for revs, it's down 5 and your margins are flattish, not up. It trims about $0.10 to $0.15 from the guidance. What are the areas we could offset that? I mean, I see maybe Electrical Americas, the mix. So what kind of mix do you have? Is there some maybe top line upside to give some maybe comfort around that as an offset? Or the Truck business, you said domestic up 16. Now how would you bogey that? Is that something where, given the orders trends lately, maybe there's a little upside there. I'm just trying to see the buffer we'd have if you just...

Alexander M. Cutler

Sure, I understand the question. Yes. And all of these, I'd like to tell you are to a third decimal place of precision, but they're not quite that way in this kind of a volume. I'd say a couple of issues to think about though. Our view -- let me just start on ForEx. Our view on ForEx is that we've built in here $550 million, roughly 3.5%. That gets anchored by an expectation that we could see the euro in the $1.25 to $1.27 on average this year. Some people are more pessimistic on that. Some people are more optimistic. That's our view at this point. We've obviously seen a large adjustment in terms of the value of the Brazilian currency versus the early part of last year. That is where it is right now, and we think it's likely to stay in this range. Others have different views on that, and we're trying to be kind of explicit here about what our assumptions are. I'd say the third is one of the ones you just mentioned, and that's the issue of the North American heavy-duty truck build. We came out of the fourth quarter at 75,000 unit production. We're forecasting 300,000. You saw one of the single largest monthly freight increases just reported in the month of December that's in recent years history -- 5.9% if I recall. So I think some people are looking at it and saying wow, "That trade issue is even stronger than we thought it might be." Then I'd say the fourth one is probably in and around the non-residential construction market, where I think the mood is changing now. And if you listen to many people who are forecasting the market, whereas the middle of last year they thought they'd never see another building built, now there seems to be a feeling where people are starting to move forecasts up toward high-single digits. That's not where our forecast is, but there are some people who believe there. So I'd say those are just a couple of examples. And I would state just one more, David, which is the Hydraulics business has sort of been defying gravity to some degree over the last 1.5 years. And as I've shared with a number of you, we were looking at this very hard in the first half of last year. Because typically, these cycles don't go as long as they have been, and we think there's been a fundamental shift in the global hydraulics market toward the mobile side being a little larger portion than the stationary side through the cycle, as a result of the fact that there's been great strength in emerging nations. And here in the U.S., you've been seeing a lot of this replacement demand that's been going on. The U.S. is still booming in this marketplace. And so those are some of the factors we're trying to weigh that I think perhaps help offset it if we're incorrect on a couple of the others.

David Raso - ISI Group Inc., Research Division

That's helpful. So you'd throw domestic hydraulic on top of my domestic truck?

Alexander M. Cutler

Yes.

David Raso - ISI Group Inc., Research Division

And last thing you didn't address, my comment about Electrical Americas, the mix. When you think of non-resi up, I think you mentioned maybe EPS not as strong relatively, residential obviously not as big a piece, what's the mix of your backlog in Electrical America when I try to think through that 15.5% margin guidance?

Alexander M. Cutler

Generally, when we have backlog, David, if you think about our business, there's an assemblies business you tend to book and then it is shipped within a month or out to maybe 6 to 9 months. Then there's the flow business, which is pretty much in and out same day or same week. So our backlog are these project activities. And what's in the backlog is very much, what I would call, it's not a plus or a minus to the overall margin. So it's very representative. So that very big backlog we're carrying into the year is part of what gives us a lot of confidence in terms of our volume capability.

Donald H. Bullock

Our next question comes from Ann Duignan with JPMorgan.

Ingrid Aja - JP Morgan Chase & Co, Research Division

It's Ingrid Aja standing in for Ann. Can you talk a little bit about your outlook for Brazil truck demand versus Brazil agricultural equipment?

Alexander M. Cutler

Sure. One of the big speculations I think that we've all been -- we're trying to observe in the fourth quarter was the degree to which the pre-buy, which is occasioned by the emissions change after the first of the year of 2012, what kind of big pre-buy would there be? And there was a fair amount of inventory built in Brazil. The actual pre-buy turned out to not be as big as we and many others thought. And so you're carrying some inventory over, I'm talking at the OEM level, into the first quarter next year. As a result, our expectation for Brazilian truck and bus is that it'll be down about 5% from the 2011 number. And on the agricultural side, we think it'll be up about 5%.

Ingrid Aja - JP Morgan Chase & Co, Research Division

Okay, that's helpful. And then can you talk about input cost, what's built into your guidance? Input costs obviously are not what they were last year. Aluminum is down, copper is down, steel is up. So on average, can you talk about what's you've built into your expectations?

Alexander M. Cutler

We believe the commodity cost -- and of course this is always a very challenging one to estimate, 12 months out ahead of you, but our thinking is they're likely to be more stable than they were in 2011. And of course that's a pretty low bar in terms of comparison with all the volatility we dealt with last year. But we've assumed that the cost will be about the same as they were in the average prices in the fourth quarter of 2011. So if you then kind of transfer that to our margin guidance where we're saying we're going to expand margins, that's primarily the result of all the productivity and cost work we've been doing, as well as the significant new product launches we have, which is always a source of potential margin improvement for us.

Donald H. Bullock

Our next question comes from Stephen Volkmann with Jefferies.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

I wonder, Sandy, if you could just give us a little more sort of comfort I guess on some of these projects that you were talking about being pushed out past the end of the year? I mean, we're kind of through January now. Are they happening now? Or what do you think your visibility is on those? And...

Alexander M. Cutler

Yes, I've been around this business for over 30 years, Steve, and the classic issue that occurs in December of the year is that if you have a large project that's going to be shipped, normally what's required is that an inspector from the customer has to come to your plant and sign off after the full electrical test. And if they just don't get there the last week for one reason or another, it obviously slops over into the next month. And that's not the full reason that we didn't have some of these things shipped. Some people gave us a little bit more notice than that, but we had a number of projects that we had scheduled and we're working to produce in the fourth quarter. That's why our inventories went up a little bit, and people ask us to hold them for a period of time. This isn't hold them for 6 months, this isn't hold them for 3 months. So I'm pretty confident we see this during the first quarter kind of wash out.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

Okay, all right. That's helpful. And then I wonder if, as we think about your margin guidance for 2012, if we can kind of go back and if you change your view about sort of what the margin potential for each of these businesses is, it seems like a couple of them are kind of getting pretty close to where we've talked historically about the upside of where they can go. And I guess I'm just curious if you have any comments in that regard.

Alexander M. Cutler

I think it's a theme, Steve, we'll revisit in our February meeting in New York. But you're right, because when we've talked about historically where we thought these were -- so we talked about Electrical Americas is having the potential to kind of get to that 17% range and Rest of World a 14%; Hydraulics, 16%; Aerospace, 17%; Truck, 20%; Automotive, 12%; that's what supported the 16% targets that we have. We are ahead of schedule as we noted earlier this year in terms of getting to that 2015 goal. I think that's very good news. On the other side though, I would be candid in saying that none of us anticipated a 4.7% discount rate used for U.S. qualified pension plans. And so you recall, our game plan was that we were going to get 4.5 points of EBIT improvement by 2015. 3 points were going to come from the segment margins, and we're well on our way there. And 1.5 was going to come out of our corporate expenses through 2 items, one was that as we continued to contribute money, and that's kind of been on the order of $300 million the last couple of years to our U.S.-qualified pension plan. And we saw hopefully the recovery of these discount rates to something that makes a little bit more sense to all of us with a calculator, that we would then see our plan no longer be underfunded and then obviously reduces expense for us. That's looking like that's pushed out probably a year, I would guess. And anybody's guess is probably the right guess on the discount rate at this point. So a little bit of trade-off between the 2. But you're exactly right, the good news is we're getting there faster on the margin improvement.

Stephen E. Volkmann - Jefferies & Company, Inc., Research Division

I guess what I'm thinking about, and maybe I'm just jumping the gun here, but Truck is almost there and yet you have some volume built-in, some significant volume built-in going forward. And Hydraulics seem to be relatively strong based on your comments here today, and yet we've already kind of achieved the goal there. Is there an opportunity that even though some of this corporate stuff might be a little headwind, that there's actually some ceiling room on some of these other numbers?

Alexander M. Cutler

Well, I think you may be right. What we're going to try to do is just get obviously a month under our belt here and have the advantage of being able to chat a little bit more about those with you in the February meeting. Clearly, I think there is a mix issue that is one that's worth just chatting about here for a moment that's beneficial, is that we've been increasing our Filtration business obviously, and that is part of our Hydraulics segment. We're delighted with the 2 acquisitions we made in that business that have significantly enlarged our business there. And that's really allowing us to continue to help move those margins up in addition to all the operating improvements we've had in that business as well. So we're very pleased with our margin. I think you're on the right track.

Donald H. Bullock

Our next question comes from Jeff Sprague with Vertical Research.

Jeffrey T. Sprague - Vertical Research Partners Inc.

Sandy, I was wondering if you could also address capital deployment, maybe to David Raso's question about possible offsets. Kind of what the plan is for 2012 between M&A and share repurchase, if there's a placeholder on share repurchase? And if you can also tell us how you ended the year in '11 on cash?

Alexander M. Cutler

Okay. Maybe a couple of broad comments, and then I'll ask Rick to add to them. Looking at our balance sheet, you probably noticed we ended the year with a fair sum of marketable securities and cash. And I think a reasonable question is exactly the one you're asking, what are you planning to do with it. We contributed about $304 million to the U.S.-qualified pension plan early in January. That was pretty much per our plan that we'd communicated last year that we would be on that order. You saw that we just increased your dividend by 12% from $0.34 to $0.38, effective in February of this year. And so that will be a full year increase of that. And that's on the order of roughly $50 million increase there. We talked about a $600 million CapEx plan. And as we talked at the end of the second and third quarter, we've raised our activity in the acquisition investigation market again. You saw us, we closed 9 deals during 2011, albeit that they were relatively small. And we are hopeful that we will have some good opportunities to deploy some of that cash into additional value-creating activities for the company. And so we're returning to, what I would call, a more normal level of acquisition levels for our company. I do want to assure you though that the fact that we think end market -- excuse me, that our total growth this year of revenues will be on the order of 4%, because it's being decreased or depressed by the 3.5% negative ForEx, is not a reason that Eaton then goes out and does a bunch of acquisitions. We are looking at the acquisition strategy the same way we have in terms of the areas we want to do it and the type of return over our cost of capital that we intend to make. We're pleased that we were making very good progress on whatever version of this statistic you would like, our net debt-to-capital ratio. However, if you look at our balance sheet, you obviously see that by the pension, using a discount rate of only 4.7% versus about 5.5% last year, that our pension liability has gone up about $600 million on the balance sheet. So we're aware of that as well. And, Rick, you want to add any other comments to that?

Richard H. Fearon

I would just add, Jeff, that we're right in the middle of our capital ratios because of that increase in debt, or at least the pension liability going up. We have not billed repurchases into the plan other than small amounts to offset option exercises. But to the extent that we don't end up doing as much in the acquisition arena, it's certainly something we will revisit. We've said that we do not intend to remain over capitalized for any sustained period of time. But it happens right now, we do have a lot of activities underway in the acquisition arena. It's just hard to know what gets done ultimately.

Jeffrey T. Sprague - Vertical Research Partners Inc.

Right. And, Sandy, can you just give us a little more granularity on what you're seeing in U.S. non-resi? And is it moving into kind of commercial non-resi? Or is it still industrially focused? And yes, I mean, just any change in tone there over the last 3 or 4 months?

Alexander M. Cutler

I think the very good news is in the fourth quarter, if you've had a chance to look at some of the private non-resi put in place statistics, you saw a number of statistics that the other commercial segment went positive. You're seeing office was down to a very low single-digit negative, which is one of the ones people have been concerned about. We are seeing new office and new apartment activity. You've been seeing leases that have obviously been going up in many of the major urban areas. For this whole time, we've seen mining. We've seen the power side. We've seen areas in and around manufacturing structures being very strong. And interestingly, the last 2 quarters: amusement and recreation sectors have gone positive as well. So you're starting to see a much more broad-based kind of deployment happening in this area, and we're seeing that in our orders as well. And again, we're doing quite well in the fourth quarter again that allow these large projects.

Donald H. Bullock

Our next question comes from Terry Darling with Goldman Sachs.

Terry Darling - Goldman Sachs Group Inc., Research Division

Sandy, wondering if you could maybe give us a view on what's going in the Power Quality business, both kind of how 2011 ended up? And then in your assumptions within the Electrical segments for next year, how you're seeing growth there?

Alexander M. Cutler

Our view, Terry, is that in this -- often what happens when you're in a period of a little bit more uncertainty about economic growth rates, we've seen the power quality market go into weaker years. So our assumption is that we will see it -- here only speak to the U.S. first, grow more on the order of 4%. So it's a little bit below the average of our Electrical businesses this year. Through the cycle, we think that business is sort of a 6% to 7% grower. So a little different if you go to the different elements of it, and if I could split it into 3 pieces. And all of this, remember, is really dealing with what we call power quality. I'm not addressing the telecommunications market, I'm not addressing embedded computing when I make these comments. So if you go to the low end of the market, the single-phase market, we've all been seeing server sales being fairly weak. And that parallels what happens in terms of the single phase. The mid-flow, which is the flow or midsize, which is more of what would go into the smaller data centers, quite busy. And that has continued to be a strong area. The very large data centers has been slower, and we've commented on that a couple of times, and we think it will be slower this year for a variety of kind of technical considerations where people are trying to figure out where they stand and whether they want to do things in-house or whether they want to move things toward the cloud. We don't think this is a fundamental change. We think this is more a reflection of the, "Can I push something off right now." You may recall a statistic that we quoted when we had everyone together at our data centers, that 38% of all the data centers in the U.S. are going to run out of power here within 18 months. And so you can't put this off too long. And so we think it will come back, but we've built in a little slower growth this year.

Terry Darling - Goldman Sachs Group Inc., Research Division

Okay. And then just a couple of follow-ups on the margins. First on the Electrical Americas margin guidance implies incremental, substantially better than 2011. Is that just you're expecting price cost to be more benign for you? Or what else would be driving your view for better incrementals there?

Alexander M. Cutler

The incrementals. You may recall that in the first quarter of 2011, we had about $50 million of uncovered commodity cost. Really our pricing versus commodities was really in line by the time we got to the third and fourth quarters. So we think the results look more like the third and fourth quarter than they did the first and second. So you're exactly on point of that.

Terry Darling - Goldman Sachs Group Inc., Research Division

I mean incrementals in the fourth quarter were much below the range as well, right? So what kind of flipped the switch here?

Alexander M. Cutler

Well, part of what affected the fourth quarter -- and you are correct. Part of what affected the fourth quarter were some orders in the backlog that were taken back to the time when the pricing and commodities were not in alignment. We're washing most of that out at this point.

Terry Darling - Goldman Sachs Group Inc., Research Division

Okay. And then on the Electrical Rest of World margins for next year. Sandy, I just wonder if you can clarify how much cost you've taken out there? And presumably, the FX impact on the revenue line is much greater than those 3.5 points for the company overall. Are you -- or should we expect total revenues off of this 1% end market growth outlook -- should we expect all in Eaton Rest of World Electrical revenues to be down as a result of currency? Or do you think you got enough outgrowth to offset that?

Alexander M. Cutler

We'll have to look that one up. Give us a moment. It's a good question.

Terry Darling - Goldman Sachs Group Inc., Research Division

If you want to then just talk about the amount of cost out that you have right now, calibrate it for us?

Alexander M. Cutler

We're not going to put a specific number on the cost, Terry, for competitive reasons. But that is an area we control, and we're quite comfortable that the cost work we've done during these last 3 quarters puts us in a position where we can get the margin expansion. And of course, this is both our EMEA and our Asia-Pacific regions when we do this. So I think sometimes, there's kind of over concentration on the Asia-Pacific region in that regard. But we're comfortable the cost price situation is in good shape, because again, cost price was affected also in the first and second quarter by the same issues we just talked about in North America.

Richard H. Fearon

And Terry, I would just add to your earlier question, our current thinking is that when you factor in FX and growth and outgrowth, that you'll end up with a bit of revenue growth in that sector -- in that segment in 2012.

Donald H. Bullock

Our next question comes from Jeff Hammond with KeyBanc.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Can you just talk about any restructuring that you're contemplating or you're taking? Is that impacting any of the slower first half earnings? And maybe just talk about the benefits on the back end.

Alexander M. Cutler

Jeff, we don't break anything out because we think it's part of running the business, if you will. And so there typically are actions that we'll get going early in the year, because we want to be able to realize some of the benefits towards the back end, but I'd say there's nothing material here really to break out.

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

Okay. And then just real quick on the corporate. I mean, it doesn't look like a huge jump versus last year, but you had a big tax settlement. So I'm just trying to understand a little bit better what the moving pieces were in the corporate line, maybe year-over-year? You explained some of the LIFO dynamic.

Alexander M. Cutler

Maybe if I heard, you had 2 questions. One question was on taxes, one was on corporate expense? Is that right?

Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division

No, just on the corporate expense, I mean...

Alexander M. Cutler

Okay. Again, in terms of -- as you mentioned, we ran below -- when we started the year, we said we thought it would be about 260. It ended up being 257. And really what we've got is sort of a misbalance between quarters, if you will, and that we started off with 45 then went to 54 then to 56 then to 102. We actually thought the fourth quarter would be in the range of about 80, and that was the result of truing up -- what we expected would be the result of truing up a number year end reserves and what we had originally anticipated in terms of LIFO expense. On top of that, as I mentioned then, when our sales came in a little lower, our shipments came in a little lower than we thought, we had higher inventories. And as a result of that then we had an additional $22 million of expense beyond what we had anticipated, primarily caused by the LIFO adjustment. So those are really the kind of comparisons. I think as you think about 2012, we again think corporate expense will be about $260 million. And we think we will start the first quarter closer to about $65 million. So our best view at this point is we're going to see these quarters be a little flatter as we go through the year end corporate expense than they were here in 2011.

Donald H. Bullock

Our next question is from Andy Casey.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

First, just a clarification, and I've got a question again on Electrical Rest of World, and I apologize for the second one. The first, on the capital allocation, when you say you're looking at increasing acquisition activity, is it more like what you experienced in 2011 bolt-ons or their properties that are coming available for larger inorganic growth opportunities?

Alexander M. Cutler

I think, Andy, you know our history in this regard is most of what we end up doing are singles and doubles. And I think that's always the best bet, is that that's sort of -- we'll play baseball, if you will. The opportunities for the triples and home runs are fewer. We do a lot fewer of them, and they're just not as likely. So I think you can anticipate we're going to stay more in that singles and doubles, and hopefully we won't have to slide.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay. And that's somewhat implied by your dividend increase as well. Then on Electrical Rest of World, and I may have missed this, I apologize, how truncated is your view to back half growth versus first, given the regional comments about China and then some of the easing comparisons for, albeit a small revenue contributor, the solar markets as the year progresses?

Alexander M. Cutler

Yes. I think that from a -- as I tried to mention upfront, Andy, and it's a good question, is we think the hardest economic calls right now are trying to approximate when these easing actions that are being taken by very different governments by governments, when they will be finalized, when they'll reach the market and how quickly they'll start to loosen the market. And so we've tried to use this sort of 6- to 9-month guideline as a way to think about that. That's generally been helpful in the past. We can't certify to you that that's exactly going to be right, but that's been our planning scenario. So we're seeing those actions being taken -- they were being taken in the fourth quarter, they're being taken now in the first quarter, and that's why we believe we will start to see effect in the second quarter. But we can't tell you right now. That's for sure. I mean, that's our economic scenario we're trying to plan against at this point. Equally true for Europe as well is that I think last fall, many people felt the recession in Europe might be a fourth quarter, first quarter -- fourth quarter 2011, first quarter 2012 phenomena. I think most people are thinking now it's fourth, first and second. And you can debate whether it includes a third quarter. And our view is that this thing will start to stabilize, and we'll start to see things not grow quickly, but stabilize by the second quarter -- second half, excuse me.

Andrew M. Casey - Wells Fargo Securities, LLC, Research Division

Okay, so not much out of Europe supporting it. It would be more other regions. Is that the correct...

Alexander M. Cutler

Yes. And generally, our order patterns, they don't go out that far in these businesses. So we're having to plan against an economic scenario versus saying that we've got hard orders in hand. We do not in that regard, and nor will we expect to at this time.

Donald H. Bullock

Our next question comes from Josh Pokrzywinski from MKM Partners.

Joshua C. Pokrzywinski - MKM Partners LLC, Research Division

Sandy, just maybe to help understand, going back to an earlier question on kind of the commercial side versus your more traditional non-res electrical markets in North America, what are you really baking in on more commercial construction markets in the guidance? And I guess, maybe thinking about non-res since that has been up nicely for you in 2011, how much more room do we have to run on that? And I guess, given the relative importance of retrofit versus maybe new construction, is that a market that is more mature in its cycle than it is on the front end as people get more excited about non-res momentum in '12?

Alexander M. Cutler

We think there's quite a ways to go here, Josh. So you think about it, we're in probably the 2.5 year of recovery here in North America. I'm talking broad geographic recovery across all the different market segments, not just this area. And we're just beginning to see commercial construction coming back. So you've got almost a 4-year down before you're starting to get up. And normally, we think these up cycles go several years. So we think '12 is the first of several years of build, if you will, on the commercial side. And when you look through -- and someone asked the question earlier, when you look through all those different segments of office, healthcare, power, communication, petroleum, mining, education, vocational, amusement, recreation, they're not all in at this point growing, and they will begin to as we come back. So we have a 5% overall non-residential construction increase in our number at this point. Could be low, could be high, but we think this thing is going to grow during '12. And we think it'll grow again, and as we get into '13. And the reason that that's important for Eaton is it does drive a very significant portion of our Electrical Americas segment. And I know you've all noticed this, but even when this market was coming down, we were growing. So we've been growing our share, and we think that just sets up an even bigger opportunity as the market now starts to grow. We think our growth can accelerate further.

Joshua C. Pokrzywinski - MKM Partners LLC, Research Division

Okay, that's helpful. And then just on the shipment delays in the fourth quarter, does that set up some sort of destock that's implied in first quarter guidance? Or is that kind of a smaller non-event?

Alexander M. Cutler

No, it's not a destock because these delays are -- we have standard product, which goes into distributors that stock. These project businesses don't go into stock. They tend to be shipped to a job site per se. So not a distributor or stocking or destocking comment.

Donald H. Bullock

And our last question for the day comes from Eli Lustgarten.

Eli S. Lustgarten - Longbow Research LLC

Just a couple of clarifications quickly. One, what's your order forecast in the U.S. and Europe for '12?

Alexander M. Cutler

In the U.S., we're talking about -- it's based on retail sales that are just over 14 million units. And we know we're seeing forecasts out there between 13.9 million and 14.5 million, and we're sort of in the low 14 million.

Richard H. Fearon

In Europe, we're really plus 1. Relatively flat. Whereas in APAC, Eli, we're about 10% positive. 10%, 11% positive.

Eli S. Lustgarten - Longbow Research LLC

And you made [ph] acquisitions about $320 million I think. How much revenue carry over is there in '12 versus '11?

Alexander M. Cutler

The net number is the $90 million, and that deletes the -- excuse me, the divestiture that we made in the Automotive segment. A net of 90.

Eli S. Lustgarten - Longbow Research LLC

And you talked about inventories. Are you planning inventory liquidations in any of the divisions as you go through the year and how that will affect margins?

Richard H. Fearon

We are expecting, Eli, that we should be able to take DOH down 1 to 2 days this coming year, particularly given where we ended up the year. And so we expect inventory efficiency to improve. But of course, the business is going to grow as well. And so those 2 factors will cause probably just a very small increase in the absolute amount of inventory.

Eli S. Lustgarten - Longbow Research LLC

So there is a bit of margin impact going on from the restraint of production and that's across most divisions at this point?

Richard H. Fearon

Can you repeat that? I'm not sure I heard you.

Eli S. Lustgarten - Longbow Research LLC

Well, inventories are going to be taken down, of course. You had some margin impact. The question is...

Richard H. Fearon

Not material. A day or two isn't enough to really cause substantial burden changes one way or the other.

Eli S. Lustgarten - Longbow Research LLC

Well, it's pretty well spread out across the company as opposed to any one division at this point.

Richard H. Fearon

Correct. Yes, correct.

Eli S. Lustgarten - Longbow Research LLC

And your truck number, you said it had -- 16%, about 295. Are you using 300 this year domestically?

Richard H. Fearon

We're using 300, yes, for NAFTA. Yes.

Eli S. Lustgarten - Longbow Research LLC

You're expecting that you'll be able to sustain production pretty closely for the rest of the year at this point?

Richard H. Fearon

Yes. Basically, almost flatlines for the 75 per quarter. So it's really, at this date, more a question of demand than production. The industry is already producing at a run rate of 300,000. And recent orders have been supportive of this 300,000 outlook.

Eli S. Lustgarten - Longbow Research LLC

And are you having -- still having extended lead time problems in some of the divisions? Particularly, Hydraulics is one we keep hearing.

Alexander M. Cutler

I'd say that the -- I don't know that we're having problems per se. We're glad to see that distributors are really starting to stock at this point now. And I think that's what you would hope would happen as you get through this part of the cycle. But we think we've made real progress on some of the areas where there were supply disruptions back really in the first quarter of this year.

Eli S. Lustgarten - Longbow Research LLC

So at this point, the lead times are holding at this point and they're still extended?

Alexander M. Cutler

I'd say they are consistent lead times at this point.

Donald H. Bullock

Well, thank you all for participating in today's call. As always, I will be available to speak with you and answer any questions as follow-up. We did want to be mindful of the earnings calls that are going on after this, so we will close here at 11:00. For any of you -- we do have additional financial information available in the press release and located on our homepage at www.eaton.com. Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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