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Executives

Jon Safran - Director, Investor Relations

Kirk S. Hachigian - Chairman, President and Chief Executive Officer

Terry A. Klebe - Senior Vice President and Chief Financial Officer

Analysts

Bob Cornell - Lehman Brothers

Jeff Sprague - Citigroup Investments

Deane Dray - Goldman Sachs

Nicole Parent - Credit Suisse

Joe Herrick - Diamond Research

Steve Gambuzza - Longbow Capital

Cooper Industries Ltd. (CBE) Q4 2007 Earnings Call January 24, 2008 12:00 PM ET

Operator

Welcome to the fourth quarter 2007 Cooper Industries Ltd. earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today, Mr. Jon Safran, Director of Investor Relations. Please proceed, sir.

Jon Safran

Thank you, Stacey. Welcome to the Cooper Industries fourth quarter earnings conference call. With me today is Kirk Hachigian, Chairman and Chief Executive Officer; and Terry Klebe, Senior Vice President and Chief Financial Officer.

As mentioned in our press release, we have posted a presentation on our website related to the fourth quarter and full-year results. We’ll refer to this presentation throughout the call. If you would like to view or download the presentation, please go to the investor center section of our website, www.CooperIndustries.com and click on the hyperlink for management presentations.

Before we proceed, let me remind everyone that 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 as a result, 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 may include non-GAAP financial measures. To the extent that these have been anticipated, reconciliations of those measures to the most directly comparable GAAP measures are included in the press release.

Now, let me turn the call over to Kirk.

Kirk S. Hachigian

Thank you, John. Good morning. I assume everybody has had a chance to read our earnings release and access the exhibits we’ve posted on our website. If you turn to slide 2 , we delivered record revenue, earnings and cash flow in 2007 and we exited 2007 with good momentum on both core and acquired revenue growth, margin expansion and cash generation.

For the full year, we delivered 8% core growth with an incremental 6% from acquisitions and foreign exchange and earnings per share of $3.14, up 22% from 2006. As we enter 2008, our 175th year anniversary, we are extremely well-positioned to continue to deliver a balance of growth, earnings improvement and strong cash flow. I want to thank all of our employees around the world for an outstanding performance in 2007.

If you now turn to page 3 for more details on the fourth quarter, our total revenues in the quarter were up 15%, with very strong core growth of 8%. Electrical Products was up 17% with core growth over 9% and Tools up 7% with core growth of 2%. We continue to see strong growth in industrial, utility and non-residential construction and continue to see the housing and residential market soft as anticipated.

We saw very strong international growth, up 30% in the quarter and on a full year basis, we crossed $2 billion for the first time and achieved 34% of our sales outside of the US. Earnings per share were $0.83, up 22% from the fourth quarter of last year. We had favorable pricing and strong operating leverage.

Electrical Products return on sales were 16.4%, with 20% leverage on incremental sales. Tools return on sales was 13%, up 120 basis points, delivering 31% leverage on incremental sales.

For the full year, cash flow was $682 million, up 27% over last year, our seventh consecutive year where free cash flow is in excess of income from continued operations.

We completed six acquisitions and the tender offer for MTL Instruments. We have great complementary businesses now that add to Crouse-Hinds, B-Line, Lighting, Bussmann and Cooper Safety. We continue to build the size and scale around these faster-growing, higher-margin, less cyclical businesses.

If you turn to page 4 for the Electrical Products segment, which is now 87% of our total company’s sales, the drivers in the quarter were strong utility demand, particularly in CNI, reliability products and international; solid industrial demand with factory utilization near 80%; very strong international demand for industrial and infrastructure projects, particularly in developing economies, which was up over 40%.

We had firm commercial construction spending with strength in architectural and energy efficient products. We had four of seven businesses delivering double-digit sales growth and the total electrical orders were slightly ahead of shipments in the quarter. We had solid execution in our pricing discipline and productivity which drove electrical margins up 60 basis points to 16.4%.

Issues or challenges facing the electrical segment during the quarter were continued slowness in residential and retail -- down double-digits -- volatile credit markets with vacancy rates creeping up for the first time in four years and continued pressure from the metals and energy costs.

In summary, our electrical products grew at 17% with over 9% being from the core. We had solid incremental leverage of 20% to the bottom line and we delivered a very strong close to an outstanding year.

If you’d now turn to page 5 of the handout, for the tools group, we saw growth in Weller, aerospace and managed a slight growth in a difficult retail channel. Overall, the business was negatively impacted by the severe housing slump and depressed motor vehicle sales. Margins and free cash flow were up nicely due to solid execution on productivity programs and lean practices.

Now let me turn the call over to Terry to provide you with additional details on the quarter and update you on our 2008 outlook.

Terry A. Klebe

Thanks, Kirk. As Kirk mentioned, we had an outstanding fourth quarter. Before turning to the core earnings for the quarter, I will provide some highlights on our free cash flow and balance sheet.

In the fourth quarter, we completed six acquisitions, four of which were completed in December. We also initiated the tender offer for MTL Instruments. The acquisitions and the tender offer have a significant impact on certain balance sheet, cash flow and income statement items which I will comment on as I discuss our results for the quarter and the year.

On slide 6, as Kirk noted, our free cash flow for 2007 increased 27% to $682 million compared to $535 million for 2006. Cooper’s strategic initiatives continued to drive performance, resulting in the seventh year in a row that free cash flow has exceeded income from continuing operations, excluding the $84 million in tax accrual reversals we had for the year.

Our balance sheet remains in great shape with our debt to total capitalization net of cash at 24.8% on December 31, 2007 compared to 19.1% on December 31, 2006. This was after spending $276 million on common stock purchases net of proceeds and $336 million on acquisitions during the year and funding $290 million for the tender offer of MTL.

Now you may have noticed on our balance sheet and cash flow statement $94 million in investments. During the fourth quarter, our primary U.S. money market fund froze accounts and began liquidating the fund. As a result, we were required to reclassify the cash as an investment on our balance sheet and cash flow statement. The fund is making monthly distributions as it liquidates the investments and we expect to have approximately 90% of the funds distributed by mid-year. The fund did break the dollar net asset value and we recognized a small loss during the fourth quarter. Our debt and capital structure are in great shape and provide us outstanding flexibility in 2008 and the future.

Turning to slide 7, our inventory turns in 2007 were 6.3 turns, up from 6.1 turns in 2006. The dollar investment in inventory is impacted by the increased material costs compared to a year ago as well as the acquisitions completed during the year. We continue to focus on customer service and improving processes and should see continued improvement in 2008. For example, we still have several divisions with inventory turns below 5.

On receivables, our days sales outstanding in 2007 increased by two days to 65 days. The acquisitions we made late in the year drove the increase in DSOs. The improvement we are making in DSOs is also offset somewhat by the impact of the stronger international growth, where commercial terms tend to be longer.

We also improved our payables performance in 2007 and we continue to move suppliers to terms closer to the terms our customers demand. As a result, our operating working capital turns improved to 5.4 turns, compared to 5.2 turns in 2006. Overall, a good performance in 2007 on operating working capital considering our initiatives to improve customer service and acquisitions.

On slide 8, our capital expenditures were up 35% in 2007 to $115.5 million. Capital expenditures in 2007 included capacity additions in our power systems division and ongoing implementation of our global enterprise business system. We now have approximately $5 billion of our revenues on the new business systems.

In the 2007 fourth quarter, we purchased 1.3 million shares of our common stock, spending $69 million against proceeds from issuance of 14 million. For the year, we purchased 6.9 million shares and issued 4.1 million shares for stock option exercise, matches to our 401K and other stock program. As a result, our outstanding shares decreased by approximately 2.8 million shares in 2007. Under existing board of directors authorizations, we can purchase an additional 4.4 million shares plus the shares issued for stock option exercises and other stock programs each year.

In February of 2007 we increased our dividends 14% and based on our strong results and confidence in the future, will recommend to the board of directors a strong double-digit increase at our board meeting in February.

We have also recently been aggressively taking advantage of our balance sheet strength and the weakness in the stock market to purchase our common stock and so far in January have purchased 2 million additional shares. Our balance sheet is in great shape and we consistently generate very strong cash flow and as a result we have tremendous flexibility to fund growth, pay a competitive dividend and purchase our common stock.

Turning to the results for the fourth quarter in slide 9. First, there are a few items that impacted our results in both the fourth quarter of 2007 and the fourth quarter of 2006. In the fourth quarter of 2007, we recognized $6.3 million of Belden income and reversed $20.3 million in tax reserve as a result of the statute of limitation expiring on potential issues and other favorable results. These items combined increased our reported earnings per share by $0.15.

Our results for the fourth quarter of 2006 included a $0.01 per share benefit from the extension of the R&D credit. There was no R&D tax credit benefit recognized in prior quarters of 2006 therefore the full benefit flowed into the fourth quarter.

During the 2006 fourth quarter we also recognized Belden income of $5.1 million for the first time in several years. We also incurred legal and environmental for businesses that were disposed of years ago. As a result, there was no bottom line impact from these two items.

Excluding unusual items, fourth quarter 2007 earnings per share was $0.83 compared to $0.68 in the prior year fourth quarter, an increase of 22%.

For those of you that may not be familiar with the Belden agreement, this relates to the IPO of Belden in ‘93. As part of the Belden IPO transaction, we stepped up the basis in Belden with the agreement that Cooper would receive 90% of the benefit of the step up in years when Belden recognized the benefit in their tax reserves. We have somewhere in the $40 million to $45 million range of remaining that could be received from Belden under the agreement, but it’s all contingent on Belden’s future tax position and whether they can realize and utilize the benefits to reduce their federal and state income tax payments.

Turing to slide 10 on 2007 full year unusual items, for the year Belden income partially offset by legal and environmental reserves on disposed of businesses and tax reserve reversals totaled $0.59 per share. Excluding unusual items, our earnings per share from continuing operations increased 22% to $3.14 from $2.58 in the prior year.

Turning to slide 11, back three months ago we forecasted fourth quarter revenues to increase 12% to 14% and today we reported a revenue increase of 15.1% with electrical performing very well and tools coming in at the lower end of the forecast. The top line growth was aided by the significant appreciation of the euro and the pound sterling against the dollar in the quarter which added 2.9% to the revenue growth. Acquisitions contributed 4.1% to the revenue growth in the quarter.

As Kirk mentioned, we reported $0.83 in earnings per share versus our forecast of $0.79 to $0.83 exclusive of the Belden income and tax accrued reversals. Another great quarter with 22% comparable earnings per share growth and this is up against a tough comparison where we had 25% earnings per share growth in last year’s fourth quarter.

On slide 12, our overall cost of sales as a percentage of revenue was 66.9%, an improvement of 150 basis points from the fourth quarter of 2006. As a result, gross margins increased to 33.1% from 31.6% in last year’s fourth quarter. Great execution on productivity and the increased volume drove the improvement.

Our overall price realization was slightly over one-third of the core revenue growth in the quarter as we continued to drive price realization, especially in utility products where electrical grade steel and transformer oil have increased substantially from one year ago. Overall, we’ve been very successful in achieving price to stay at least even with material cost inflation and the fourth quarter was once again no exception.

Recently, prices of many of the metals we consume have been mixed but have been less volatile. Electrical grade steel and transformer oil are an exception, where the costs have continued to escalate.

While recent acquisitions have not had a significant impact on gross margins, they are having an impact on reported improvement in selling, general and administration, leverage, and return on sales. With purchase accounting and the amortization of intangibles, acquisitions have lower earnings on our base business in the early periods after consummation of the acquisition. Overall, acquisitions contributed 4.1% to revenue growth with the incremental revenue contributing an average return on sales slightly below 10%.

Selling, general and administrative expense for the quarter as a percentage of sales was 18.6%, compared to 18.4% in the prior year fourth quarter. However, excluding the $5 million in unusual items in the 2006 fourth quarter, our selling, general and administrative costs increased 60 basis points. Acquisition-related costs and the higher selling, general, and administrative costs on international sales growth drove the increase in the SG&A cost as a percentage of sales.

General corporate in the segment income statement decreased from $25.9 million to $21.3 million. But excluding the $5 million in legal charge in the fourth quarter of 2006, general corporate increased slightly. We continued to invest in our global growth and other initiatives and at the same time, realize a benefit from those investments, leveraging the revenue growth into earnings and cash flow.

Turning to slide 13, solid execution on cost initiatives, while continuing to invest in our company-wide growth initiatives and great execution across our businesses on price realization drove a 23% increase in operating income and our operating margin is up 90 basis points to 14.5%.

Continuing to slide 14 on net interest expense our tax rate and net income. Our net interest expense was essentially flat compared to the 2006 fourth quarter. Our effective income tax rate for the fourth quarter excluding the Belden income and tax accrual reversals was 27.6% versus the 27.2% for the first nine months of 2007.

Excluding the R&D credit, the income tax rate for the fourth quarter of 2006 was 25.6%. The increase in the tax rate is primarily from the incremental income being taxed at the statutory U.S. federal and state income tax rate. Despite the higher tax rate in the quarter, our net income excluding the unusual items increased 21% on a 15% revenue increase.

Turning to the segments in slide 15, for the quarter electrical products segment revenues increased 16.7% with very strong core revenue growth of 9.4%. Currency translation added 2.5 points and acquisitions contributed 4.8%. Price realization was close to 4% in the fourth quarter with both Bussmann and power systems needing and realizing the price increases to cover the increases in material and energy costs.

Core revenue growth for electrical products was strong in all regions of the world with Asia Pacific, Eastern Europe, and the Middle East having the strongest growth. Global electrical distribution and our utility revenues were up double-digits again this quarter with strong growth in North America and Europe. We experienced continued growth in industrial and utility markets and non-residential construction markets.

Our softest channel was the retail channel where revenues, as expected, declined in the electrical segment. Electrical retail sales declined in the low double-digits in the fourth quarter of 2007 compared to the fourth quarter of last year. Overall, electrical products segment earnings increased 21% and return on sales increased 60 basis points to 16.4% from 15.8% in the fourth quarter of 2006.

Our incremental earnings leveraged at 20%, slightly below the leverage in the first three quarters of 2007 on a higher contribution to the revenue line from acquisitions. Incremental revenues from acquisitions, diluted return on sales approximately 30 basis points and incremental earnings leverage by over 400 basis points. When you consider the currency translation and price that recovers material cost inflation dilutes earnings leverage, and the acquisitions take a couple years to achieve segment margins, we continue to have terrific leverage to the bottom line.

Turning to the tools segment on slide 16, in our tools business sales increased 6.6% with currency translation adding 5.2% to the sales increase. We continue to see solid revenue and earnings in aerospace and electronics, but weak sales to motor vehicle end markets. Retail sales were up slightly compared to the prior year quarter as a result of new products and new customers offsetting softness in the residential markets.

Tools operating earnings increased 17% on a sales increase of 7% and our reported tools’ operating margin as a percentage of sales increased 120 basis points to 13%.

Now turning to the full year results and slide 17. Our outlook for the year started at $2.90 to $2.98 per share and ended the year with earnings per share from continuing operations of $3.14 excluding the unusual items. In other words, we beat the top end of our February 2000 forecast by $0.16 per share.

As we told everyone in our 2007 outlook meeting, the markets could be stronger than we anticipated and overall, they were. Our February 2007 outlook was for our utility markets to grow 10% to 15% and industrial to grow 5% to 7% and with our exposure in energy for us to be up over 10%. Growth considerably exceeded our 2007 outlook in these two markets.

For non-residential, we thought the market would be up 3% to 5% with Cooper adding another 2% growth from regaining market share. While non-residential started the year slow, the second half of the year was strong. Residential construction we forecast to be down over 10% with our revenues down 3% to 6%. While we said at the outlook meeting that the residential forecast had the greatest risk in 2007, we underestimated how bad it could get and how fast.

That being said, our teams performed extremely well with sales in retail which primarily serves residential, down mid single-digits for the year, a very good performance in a difficult market.

So overall, we saw stronger utility and energy markets and delivered above expected growth in the developing markets where we grew revenues 32% in 2007.

Turning to slide 18 on a summary for the 2007 full year. For the year, revenues increased 15.4% in electrical products and our tools business increased revenues 4.8%. There was great leverage execution to the bottom line with the electrical segment earnings increasing 21% and tools segment operating earnings increasing 10%. Return on sales increased 70 basis points in electrical and 50 basis points in tools. Earnings per share from continuing operations were up a strong 22%. Our free cash flow conversion excluding the tax accrual reversals was 112% of continuing earnings, our seventh year in a row that free cash flow exceeded earnings.

Before turning the call back to Kirk, I will provide brief comments on our 2008 outlook. We will be providing a detailed 2008 outlook at our meeting on February 21 in New York City.

Turning to slide 19. First for the year we are forecasting a top line growth of 10% to 13%. Acquisitions including MTL Instruments should add close to 6% to the revenue growth and currency translation is a very nominal amount. Electrical 2008 revenues are forecast to increase 12% to 14% and tools revenues are forecast to increase zero to 5%.

At this point, with the weakness in the residential and motor vehicle markets and tough comparables in aerospace and electronics we are hesitant to forecast much revenue growth in the tools segment in 2008.

Earnings per share for the year are forecast to be in the range of $3.45 to $3.61 per share, an increase of 10% to 15%. With the integration cost of acquisitions and the economic uncertainties in the market, we believe it is prudent to be cautious in our forecast and have a wider range than in the past.

In the first quarter, we are forecasting revenues to increase 11% to 14% with electrical up 12% to 15% and tools up low single-digits. Earnings per share is forecasted to be in the range of $0.78 to $0.82 per share, an increase of 10% to 15% against a very strong first quarter of 2007 where earnings per share were up 25%.

First quarter revenues will be impacted by the timing of the MTL Instruments acquisition closing. Earnings also will be somewhat impacted by acquisition integration costs and anticipated reorganization costs in the tools group that total a few million dollars.

Kirk will provide a wrap up on 2007 results and comments on the 2008 outlook.

Kirk S. Hachigian

Thank you, Terry. If you turn to page 20, in summary, 2007 results demonstrate again the quality, breadth and resilience of our portfolio as well as our team’s ability to execute on our five business initiatives: driving total customer satisfaction, continuing to innovate to improve our products and services, expanding our penetration into existing and new emerging markets around the world; acquiring, assessing, developing, and deploying talent and a mindset of continuous improvement in everything we do including safety, quality and service.

As we enter 2008, we expect the global economy to be much more challenging with the tightening credit market slowing North American job growth and concerns regarding North American manufacturing activity. That being said, we still see strong opportunities for growth in the oil and gas and metals markets, in the international markets, on utility spending and in energy efficient and technology spending.

We are very fortunate to have purchased 13 terrific businesses plus MTL to complement our existing portfolios and allowing us to continue to build our specialty connector platform, utility automation platform, lighting controls, LEDs, notification and safety, Bussmann transportation, and to improve our presence in Asia particularly in China and in Korea.

Despite our recent stock buybacks and these acquisitions we continued to maintain excellent financial flexibility to invest in growth, repurchase our shares at a very attractive price and reevaluate our dividend policy.

Net net net we expect 2008, our 175th year anniversary, to be another record performance for Cooper Industries. Now, let me turn the call back to Jon for your questions.

Jon Safran

Thanks, Kirk. At this point, I’d like to open up the call for questions.

Question-and-Answer Session

Operator

Your first question comes from Bob Cornell - Lehman Brothers.

Bob Cornell - Lehman Brothers

Kirk, you intrigued me right off the bat when you said you exited ‘07 with good momentum both in the core and in the acquired businesses, I’m wondering if you can just expand on that and then maybe talk about visibility into the year?

Kirk S. Hachigian

Let me take it on a couple different levels. If you look at the industrial space, if you look at the organic growth rate, if you look at the way we finished on the international sales, all of it felt pretty good, even the non-residential primarily served by lighting. Pretty solid numbers, backlog did not deteriorate at all in the fourth quarter. So, we would be a lot more confident if it wasn’t for everything else you sort of read in the paper and you see going on in the macroeconomic effect, Bob.

I think that’s trying to be a little bit more prudent, I guess.

Bob Cornell - Lehman Brothers

I understand. You didn’t give your usual wrap up of the asbestos situation and it keeps changing. If you could just tell us whether we are in plan A or plan B or what we should really expect and what the financial impact would be in ‘08?

Terry A. Klebe

The next hearing is the last week in February. We expect to know more at that time. Federal-Mogul has emerged from bankruptcy, they funded the plan B $140 million into a escrow account, the judge, we are hopeful in the end of February meeting that she will express a view on the plan A on it. We feel somewhat optimistic yet that the plan A will proceed and we’ll know more then.

Bob Cornell - Lehman Brothers

So plan B is the one that’s been approved at this point?

Terry A. Klebe

Plan B, Bob, was always part of the main bankruptcy and bolted on with the main bankruptcy so it was easy for the judge to approve that side of it. In order to get Federal-Mogul out of bankruptcy by the end of the year she chose to segregate plan A for additional hearings right after the first of the year.

Bob Cornell - Lehman Brothers

Well, I don’t know if you want to take time on this call, but under plan B do you get money back?

Kirk S. Hachigian

Why don’t you explain the difference between them?

Terry A. Klebe

Under plan B, we will net Cooper Industries $138 million on it. If we go into plan A, we pay around $250 million and then $20 million a year for 25 years which all of that will be net of insurance, obviously. So there is a big swing between what we would pay out in 2008 being in plan A versus plan B.

Bob Cornell - Lehman Brothers

So plan B is a net positive financially under the current state of the asbestos litigation?

Terry A. Klebe

Correct.

Kirk S. Hachigian

But the $138 million is not in our books, it’s in an escrow account right now.

Operator

Your next question comes from Jeff Sprague - Citigroup Investments.

Jeff Sprague - Citigroup Investments

Kirk, could you give us your big picture view of how or if Phillips GENLite changes its competitive landscape in your view?

Kirk S. Hachigian

Net-net I saw it as a real positive. I mean, I think it sheds a very positive light on the space over the next ten, 15, 20 years. I know Phillips well from the old GE Lighting days. For them to make that type of an investment in this space would again lead you to believe that there is going to be great growth in investment in these energy efficient and architectural products.

I think the team at GENLite did a terrific job, always competed on design and aesthetics and innovation. Phillips is the same type of a company. We buy from Phillips on the ballast side and on the component side, so we’ll continue to maintain that relationship with them. But net-net I see it as a positive and another indication that space is going to be very attractive for years to come, Jeff.

Jeff Sprague - Citigroup Investments

What do you think about the need or the idea that the fixture and the lamp manufacturer need to be under the same roof? Any channel issues there, anything that you see arising?

Kirk S. Hachigian

I am not as convinced. You’ve got multiple spaces there, right? You’ve got the actual people who produce the dies, companies like Kree and Lucia and people that are in the fabrication of the dies specifically. Then you have packagers or integrators, and then you work yourself all the way up to the fixture.

For whatever reason, they saw it as being synergistic to what they wanted to do. You can still buy the dies and such and figure out where you want to play in those different intermediate steps along that continuum of value-added.

So no, we think it’s interesting, it’s certainly a perspective, but we don’t see it as being probably the most efficient way for us to go after that space.

We made two acquisitions in that space this year: that small company in the U.K.; we bought a company out in Chicago. Obviously we are stepping up our activities. We’ve always seen the change of source whether it’s ceramic metal halide, whether it’s T5 fluorescent, whether it’s compact fluorescent, always creates great demand because of the optics and the ballast and the energy efficiency and it’s going to be an exciting time and a very interesting space for us over the next multiple years.

Jeff Sprague - Citigroup Investments

Are those two little acquisitions a sign of more to come? Are there is things you want to do to better position or increasingly position the lighting business for what you see coming?

Kirk S. Hachigian

We are going to do a bunch of it organically. We continue to look at architectural type businesses, the lighting controls area, anything that has to do with light management and the LED space is right in that architectural, higher end specification package. So the answer to your question is yes.

But anything that has to do with specification, energy efficiency that helps you wrap up and tie up large quotation-type jobs will be where we invest in the lighting business. But I would tell you we are investing as much or if not more in core growth as well in that space.

Jeff Sprague - Citigroup Investments

Terry, how should we think about FX in terms of an earnings or margin fall through and did I hear you correctly that there is no FX in the ‘08 guidance?

Terry A. Klebe

Right. We have nothing in the ‘08 guidance at all on FX. Currently we get some fall through on the FX on the top line but it’s not very much because we have a 300 and something million dollar euro debt issuance so we get higher interest expense on it, but it does help our operating margins a bit.

Jeff Sprague - Citigroup Investments

Your operating profit dollars, but not your margins?

Terry A. Klebe

Right.

Operator

Your next question comes from Deane Dray - Goldman Sachs.

Deane Dray - Goldman Sachs

Could we revisit the 2008 guidance range that you gave back in November? I know that was early November, but it does look like you lowered the low end of the range by a couple of percentage points?

Kirk S. Hachigian

Deane we gave that guidance to be very specific. We are four months back and our take on the economy was chances of a recession in the U.S., maybe no better than 20%, 30%. So you fast forward, you will take you where you are today and I think even the best forecasts are talking 50-50. There are some people who are even suggesting that we are in a recession where we sit right now.

We don’t see it. We are not seeing it in our order rates. We are not seeing it in our end markets. But I think to reflect the risk of a recession even be it slight in 2008, we decided to take down the low end and leave the high end where it was. And I think it was basically more of a risk adjustment type of a decision than anything that we are seeing in the businesses or in our markets today.

Deane Dray - Goldman Sachs

Got it. I don’t think it was four months ago, but early November, but either way the macro environment has changed. If I heard Terry correctly in terms of how you are looking at the range and what the additional risks are, two data points.

One, you said the additional deals and how the integration might change in bringing you towards the lower-end and also economic uncertainty. But just in terms of the deals, how did the deals that you’ve announced so far recently, how does that impact margins and your earnings outlook for ‘08?

Terry A. Klebe

Well, it will impact the margins in the sense that the acquisitions come on at generally 10% or below return on sales. So our margins on our electrical side will not increase as rapidly as they have in the past. It will mute that increase somewhat on it. So you have that impact on it. They are all accretive as we move into ‘08 so they will help the earnings on it but of course we have got to finance that growth.

Deane Dray - Goldman Sachs

Is there anything tricky about closing the MTL transaction? I know it’s a London-based company, which means you have to go through the takeover panel?

Terry A. Klebe

We are at well over 90% shares tendered on that deal. At this point I believe we are only waiting for German and U.S. regulatory approval which we hopefully will have in the next couple of weeks.

Operator

Your next question comes from Nicole Parent - Credit Suisse. .

Nicole Parent - Credit Suisse

Kirk, you mentioned in your discussion on electrical products four out of seven businesses were up double-digits. Could you give us a sense of, I think we can probably point to power in a couple of them. Of the three businesses that weren’t up double-digits, what went on there? And then of the electrical product businesses, which would you expect to see turn down first?

Kirk S. Hachigian

The only negative business we had was the wiring devices which you would expect. The other businesses were all positive; actually a very good performance out of the lighting business. The competitors that have announced already had some pretty good numbers and we were very happy with the top line at lighting. It wasn’t double-digits, especially when you consider the downside to the residential and some of the retail business there, but we were happy overall there.

I think if you look out, Nicole, and you try to look for early indicators, it’s not going to be the Crouses or the power systems. The power systems is seeing some weakness on the piece of the construction single phase stuff that goes into the housing segment, but I think the lighting business is where you probably begin to see some things tightening up, if you were to see some downturn.

The international piece though, again if you look at the momentum we finished the year with, you would be believing that we are going to continue to continue that momentum in the first quarter.

Now with that said, again, you have seen the overseas exchanges reacting to the U.S. news over the last week. I don’t know how all that rolls through to absolute demand in those end markets, but I imagine the momentum that’s been generated in infrastructure projects, in oil and gas, in building out the export economies of places like India, China and the Middle East, I think that momentum is going to continue.

Nicole Parent - Credit Suisse

On that last point, you noted developing markets were up 40% in the quarter. Could you just talk about Western Europe and if you’ve seen any signs of sluggishness over there?

Kirk S. Hachigian

No, we had a big kiss from FX. If you take out the FX, it was still solid growth over there as well. We are still relatively a small player in those markets but we still think that we have significant opportunity to continue to grow. Crouse is a big part of that business in Europe and then you’ve got the non-residential. We don’t play on a big way on the retail space in Western Europe. So the Middle East non-residential construction continues to boom and then the Western Europe non-residential construction was strong as well -- I mean single-digit type of strong.

Nicole Parent - Credit Suisse

You just had your leadership retreat, could you talk a little bit about how much of the focus was on contingency planning and cost versus growth and innovation?

Kirk S. Hachigian

There was one page on contingency planning and cost and a couple other comments and then we had a staff meeting. The majority of the meeting was around the initiatives. We had a lot of presenters from the businesses. We had Larry Bossey this year as our guest speaker talking about execution. It was a pretty upbeat, I think a lot of international people there, 25% of the population was international, 25% were there for the first time.

So I would say it was pretty much focused on growth, new products, customer service, all of the growth initiatives and we of course made the point about being careful on SG&A and being careful on being close to your end markets and your customers as we go through these more turbulent times.

Operator

Your next question comes from Christopher Glynn - Oppenheimer.

Christopher Glynn - Oppenheimer

You talked about the margins from the acquisitions coming in just under 10%, what were they, excluding the acquisition related costs and accounting?

Terry A. Klebe

Chris, I don’t have those numbers handy here. I just look at it all in and how it impacts us and we manage that every month compared to our plans.

Christopher Glynn - Oppenheimer

On the tools business for ‘08, we have the re-org and exiting some business lines there or some approaches to the business. What kind of an impact on the margins should that see and when do we start to see it?

Terry A. Klebe

Well, the tools business in the first quarter we expect it could end up being below 10%. It depends on how much of it we get accomplished in the first quarter. We have some reductions in headcount going on there right now but it won’t be that significant. We are talking $1 million to $2 million, max.

Christopher Glynn - Oppenheimer

Just on the margin trends throughout the year. The EPS guidance is roughly inline with the revenue guidance, so really not implying any or at least very, very minimal operating leverage for both the first quarter and year. For the first quarter, we have the re-org costs and presumably higher acquisition and integration costs. So I am just wondering why the guidance would not imply a little bit more of a delta between the revenue guidance and the EPS guidance for the year versus the first quarter?

Terry A. Klebe

Well, we show leverage when we are building out our 2008 plan. I think one of the items is we will have higher interest expense in 2008 because we have to fund all these acquisitions, plus we’ve had quite a few share buybacks. So our interest expense takes the earnings per share down, but on operating margin line, we are still expecting pretty good leverage on it now.

It does on a ROSS perspective, we won’t see as big of improvement, Chris, because of having 6, 7% acquisition revenue growth in the year.

Kirk S. Hachigian

The core growth for the ‘08 outlook is still 4 %to 7%. So if you look at the guidance on the earnings off the core growth rate, it’s a pretty good match.

Christopher Glynn - Oppenheimer

In November and just in general we talked about a very rich acquisition pipeline; maybe that’s been depleted a little bit, just comment please?

Kirk S. Hachigian

No, we continue to be dedicated to finding the right properties. We did close quite a bit of course in the fourth quarter, there were six deals in the fourth quarter. Tom has built out a nice process. We’ve identified a lot of properties out there. We will certainly be a little bit more patient in trying to properly integrate the 13 deals that we’ve done. We will talk to you more about that in February when we are in New York, but we still have a number of nice properties that we would like to bring into the Cooper family over the next six months.

We are going to continue to press and we like what we’ve bought and we continue to find these properties that were tracking very exciting. I would say, you will continue to see a good mix of what we have been doing, which is driving the core growth, acquiring and as Terry said, being aggressive on the share buyback and we will talk to you about the dividend in the next few weeks.

Operator

Your next question comes from Joe Herrick - Diamond Research.

Joe Herrick - Diamond Research

A couple of questions regarding your operational initiative. What are you guys doing regarding lean manufacturing, TPM and SixSigma and how is that impacting your bottom line?

Kirk S. Hachigian

We launched what we called MVP in 2002, which was our productivity program and it has a bunch of different elements into it. We’ve emerged from that program into more lean practices and more lean training as you go forward.

The impact is pretty clear, right? I mean for the last four years, we’ve gotten at least 2.5% to 3% variable cost productivity on our total cost of goods sold. Our margins have gone on electrical from a low of about 12% to 16% plus, which you saw for the last quarter, and our tools margins went from a low of about 4% up into the double-digits and so forth.

The other area of impact of course is the cash flow. If you go back prior to 2000, 2001 the company very randomly had cash in excess of its income from continued operations. If you go back and look as in the last seven years as Terry pointed out, pretty consistent now being able to generate cash in excess of the earnings, which of course means that we are leveraging up on the working capital efficiency.

We still think that we have a significant way to go. We’ve looked at benchmarking best-in-class on working capital efficiency. We continue to drive improvements in the majority of our businesses. We went backwards a little bit in a couple of businesses last year, but that’s still a big area of focus for us.

Of course as you do the lean, you free up factory space, you free up lead times, you free up equipment capacity, you free up inventory, you reduce your cycle times, you improve your quality, you improve your safety. So, I would say on the lean journey, we are no more than maybe 25% down the path at the company.

Joe Herrick - Diamond Research

Regarding metrics like OE and RONA, how important are those to you within your company?

Kirk S. Hachigian

I’m not familiar with the terms that you are using, or the acronyms that you are using.

Joe Herrick - Diamond Research

RONA, return on net assets, how are you utilizing your assets to improve more throughput throughout your plans?

Terry A. Klebe

Clearly we measure everything on return on invested capital and we’ve improved significantly on return on invested capital. It improved significantly again in ‘07 and we expect to do exactly the same thing in ‘08.

Kirk S. Hachigian

Our bonus system has got two big metrics to it. I mean one is earnings, of course, and the other is cash flow and then the businesses have another measure of working capital percent of sales. So, we look at how much working capital is tied up on the balance sheet of a business in order to generate a dollar of sales. I think that’s a pretty consistent measure across the industry.

Joe Herrick - Diamond Research

Regarding both your divisions you have concern over with one division over the other, are they both of equal concern to you going forward regarding throughput and cycle times?

Kirk S. Hachigian

Well, they are certainly not equal in size when you say two divisions. I mean electrical is 87% of the company and the tools is now 13%. But, no I would say there is significant opportunity still on the electrical. You have seven different operating divisions there and you can imagine we’ve got some that are in the teens and some that are in the high 20s working capital percent of sales.

As we have said, while the tools made great progress on cash flow in 2007, they still have a significant way to go to be anywhere near the top quartile even of the Cooper businesses. So we’ve got a wide distribution even within the eight operating divisions that we have in the company.

Joe Herrick - Diamond Research

Going forward for the remainder of this year, it can be a very challenging year for a lot of companies in the manufacturing sector. What systems and solutions are you guys putting in place to accelerate your CI or continuous improvement initiatives and how you see them impacting your overall bottom line?

Kirk S. Hachigian

It’s just what we do every day. There is nothing additional. I mean again, if you look at the performance over the last five or six years, these guys all submit budgets that are aggressive improvement year over year and we drive our business initiatives. We are continually using the EBS, Enterprise Business System to become more efficient in back office processes and a lot of different things that we do.

We’ve got a CRM package rolling out on the front-end of the business. We continue to leverage our international infrastructures. We make those investments and we build out our revenue in sales in those economies.

I mean nothing special; we run the company for the long haul. We are not really responding other than trying to be a little bit more diligent with regard to SG&A and such in the short term, but we run the company for the long haul.

Joe Herrick - Diamond Research

Good luck down the road, congratulations on a great quarter.

Operator

Your next question comes from Steve Gambuzza - Longbow Capital.

Steve Gambuzza - Longbow Capital

Just a question on the revenue guidance. It looks like for electrical products is 12% to 14%. I believe you mentioned that 6% of that comes from acquisitions, is that correct?

Terry A. Klebe

That’s right, 6% plus.

Steve Gambuzza - Longbow Capital

So on the 6% to 8% organic growth, I was wondering if you could perhaps give some discussion of how that might be different for the 70% domestic versus the 30% international and if you also might comment on how price actions you have taken in the middle of 2007, what the full year impact of those might be on that organic growth or anticipated price actions?

Terry A. Klebe

Let me start with the price. On average, we are looking at a 1% to 2% price increase overall for the year and of course we monitor that continuously through the year, so that can change depending on what happens with the commodity prices during the year.

But if we look at our businesses today, if I look at the third and fourth quarter performance indications through it we have very, very strong growth across the world. The U.S. was very strong in the third and fourth quarter. If we could duplicate and keep at that momentum going into 2008 and throughout the year, we would be past the top end of our range on the earnings side, clearly.

We are a little more cautious because of all the economic uncertainty in the U.S. as well as the rest of the world. But, the U.S. growth in ‘08 will still be very respectable. It will be clearly below the international growth, where we would expect that to be growing probably at 2X what the U.S. does.

Kirk S. Hachigian

Potentially, as Terry said, with some upside to it.

Steve Gambuzza - Longbow Capital

You gave a number for the international revenue growth for 2007 that was very high, just earlier in the script. I was just wondering on an organic basis for the portfolio of international businesses that were there at the beginning of 2007, what did those businesses grow at during 2007?

Terry A. Klebe

I don’t have that handy, but it is clearly double-digit. Low double-digit.

Steve Gambuzza - Longbow Capital

Roughly you can expect 2X the growth internationally if we look at domestic organically, is that a good rule of thumb for ‘08?

Kirk S. Hachigian

At a minimum.

Terry A. Klebe

For ‘08, yes.

Steve Gambuzza - Longbow Capital

In terms of share repurchases contemplated in ‘08, is there any incremental share repurchase included in guidance in excess of those to offset options?

Terry A. Klebe

At this point, no although I did mention we’ve already purchased 2 million shares in January. We would expect our option exercises to be significantly lower than they were in 2007. So depending on what the market does, we are going to take advantage of it. We think that $45 a stock is very reasonable buy.

Steve Gambuzza - Longbow Capital

What was the tax rate that the 2008 guidance is based on?

Terry A. Klebe

The tax rate will probably be in the 28% to 28.25%.

Operator

There are no further questions at this time. I would now like to turn the presentation back over to your host, Mr. Jon Safran, for closing remarks.

Jon Safran

As we conclude this call, I would like to invite everyone to join us for Cooper’s 2008 investor outlook meeting, which will be held at the New York Mandarin Oriental Hotel on Thursday, February 21st. We will begin presentations around 8.30 am and conclude by 11 am.

As we did last year, we will have presentations by both Cooper senior executives from the corporate office and also division management. A formal announcement for this event will arrive shortly.

With that, thank you for joining us today.

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Source: Cooper Industries Ltd. Q4 2007 Earnings Call Transcript
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