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Executives

John Safran - Director of IR

Kirk Hachigian - Chairman and CEO

Terry Klebe - CFO

Analysts

Robert Cornell - Lehman Brothers

Nicole Parent - Credit Suisse

Jeff Sprague - Citi Investment Research

Alex Rygiel - FBR

Christopher Glynn - Oppenheimer

Deane Dray - Goldman Sachs

Eli Lustgarten - Longbow Securities

Cooper Industries Ltd. (CBE) Q2 2008 Earnings Call July 23, 2008 12:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the second Cooper Industries Limited Earnings Call. My name is Christie. I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's conference, Mr. John Safran, Director of Investor Relations. Sir, please proceed.

John Safran

Thank you, Christie. Welcome to the Cooper Industries' second quarter 2008 earnings conference call. With me today is Kirk Hachigian, Chairman and Chief Executive Officer, and Terry Klebe, Senior Vice President and Chief Financial Officer.

We have posted a presentation on our website that we will refer to throughout this call. If you would like to view this presentation, please go to the investor center section of our website, www.cooperIndustries.com, and click on the hyperlink for management presentations.

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

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

Now, let me turn the call over to, Kirk.

Kirk Hachigian

Good morning and thank you, John. I assume everyone has had a chance to access the exhibits posted on our website along with our second quarter earnings release. While the domestic economy is facing challenges, we continue to find attractive opportunities in many of our end markets with continued strength globally.

We entered the back half of 2008 extremely well positioned with the company posting an 18% overall growth, 7% from the core in the second quarter of 2008. Despite difficult comps of 8% core growth in the second quarter of last year. With the first six months of 2008 complete, we maintain strong momentum on all of our growth initiatives as we continue to manage cost and deliver strong productivity, leveraging into solid double-digit earnings per share growth.

If you turn to the second page of the handout I will give you some more details on the second quarter. As I mentioned, our overall revenue was up 18%, this is the best overall revenue growth we have had in over five years, 7% was core, Electrical Products was up 19% with 7% of that being core and Tools was up 12% with 6% of that being core.

We saw continued strong growth in industrial and energy markets. Utilities were solid, but up against some tough comps with last year. Our commercial performance is expected and residential continues to be soft. If you recap our end markets against the February outlooks, the first six months of this year, our industrial business is doing better, our utility business is slightly softer, our commercial business is about the same as anticipated and residential is slightly weaker.

We saw continued strong international growth in the quarter, up 38%. Our core was solid double-digit growth. Our total international business is 38% of sales in the second quarter. Earnings per share were $0.97, up 24% from the second quarter of '07, on top of 22% earnings per share growth last year.

Electrical Products return on sales was 17.2%, up 40 basis points, and we leveraged 30% on incremental sales excluding acquisitions. Tools return on sales was healthy at 10.4%, down 90 basis points from last year, but up versus the 9.3% loss in the first quarter and this excludes the $7.6 millions of severance that we booked in the quarter.

Our year-to-date cash flow was very strong at $208 million that is up over $154 million at this point last year, putting us on target to deliver our eighth consecutive year of free cash flow greater than net.

If you turn to page three, I will talk a little bit more about the end market conditions. Our industrial and utility businesses, which now account for 60% of our sales, are expected to remain strong. We continue to see solid growth in oil, gas, refining, petrochemical, mining, and international markets.

Factory utilization rates have fallen below 80%, but exports and capital spending are solid and our outlook is favorable. Utility markets remain strong in switch gear, regulators, and other reliability products. Our energy automation solutions sales were up over 50% and our international sales on the utility side continue to be strong.

Our outlook for this 60% of our portfolio tied to industrial utility is expected to look similar to what we saw in the first six months of this year, a very positive trend. For commercial construction, which was 26% of our business last year, we have seen solid domestic growth in the first six months, but we expect this pace to slow in the second half of this year.

We continue to see strength in hospitals, education, military and government spending as well as international markets. Energy retrofits continue to be a strong segment of growth as utility bills escalate and the recent energy bill requires higher efficient lighting sources.

Lastly, our residential business, which is roughly 10% of our sales, we expect to flatten out toward the back half of this year given the extremely depressed levels of housing starts. While the overall residential markets were weaker in the first half than anticipated, we hope this will accelerate finding a bottom to this cycle.

If you turn to page four of the handout, for the Electrical Products segment the quarterly performance, which is now 88% of our sales in the second quarter, we saw strong industrial demand again, particularly on oil, gas, and energy sectors. We saw very strong international sales for the Electrical group, up over 40%. We saw firm construction spending, particularly on new projects and energy demand retrofits.

Firm utility demand on CNI reliability products, lighting and international infrastructure, our residential and retail sales were down. Our total orders in Electrical exceeded shipments, and in the quarter where sales were up 19%, we consider this a very good indicator of our momentum into the second half of the year.

On the last call, we got a question with regard to year-over-year book-to-bill ratio and in the second quarter our book-to-bill ratio was almost equal to just about exactly equal to that of the previous year as it did in the first quarter as well. Lastly, mix, productivity, and pricing discipline drove Electrical margins to 17.2%, matching our best quarterly performance in over five years.

If you turn to page five of the handout for the Tools group, we saw core growth in every category with very strong growth overseas. Our order rates were greater than sales in the quarter and we continue to see stable revenue trends. Our margins were down over prior year, but up over 100 basis points compared to the first quarter. The timing of pricing actions, inventory level adjustments negatively affected margins in the quarter. Overall, the Tools business had a solid quarter delivering strong growth, and building backlog while adjusting their inventory levels and spending to the new market conditions.

Now, let me turn the call over to Terry to provide you with additional details on the quarter and update you on our guidance for the remainder of 2008. Terry?

Terry Klebe

Thanks, Kirk. As Kirk mentioned, we had an outstanding second quarter and a more challenging economic environment than a year ago. Before turning to the earnings for the quarter, I will provide some highlights on our free cash flow and balance sheet.

On slide 6, as Kirk mentioned our free cash flow for the first six months of 2008 was $208 million, compared to $154 million in the first half of 2007. In the first half of the year, annual customer and employee sills were paid and sequentially our revenues accelerate, requiring working capital funding. This year is no different than the past where we will generate disproportionate amount of our cash flow in the back half of the year.

Coopers' strategic initiatives continue to drive performance and we anticipate delivering the eighth year in a row where free cash flow exceeds recurring income. Our balance sheet remains in great shape with our debt to total capitalization net of cash and investment at 28% on June 30th, 2008. This compares to 19.7% a year ago, and 24.8% on December 31, 2007.

Over the last 12 months, we funded $435 million in acquisitions, $159 million in dividends, and $523 million in stock buybacks, net of proceeds, a total of over $1.1 billion while maintaining a conservative capital structure.

While our interest expense has increased over $5 million in the second quarter of 2008 compared to the second quarter of 2007, our share count is down over 10 million shares, and our net debt to EBITDA is only 1.1 times. Our debt and capital structure are in great shape and we have outstanding flexibility to capitalize on our opportunities.

Turning to slide 7, our inventory turns in the first half of 2008 improved to 6.2 turns compared to 6.0 turns in the first half of 2007. The dollar investment in inventories impacted by the increased material cost compared to a year ago as well as the MTL acquisition completed in February and the 13 acquisitions completed in 2007. MTL and number of the acquisitions have low inventory turns, which we believe provide significant opportunities for improvement. We expect to see continued improvement as 2008 progresses.

On receivables, days sales outstanding decreased by one day to 65 days. The improvements we are making on DSOs are partially offset by the impact of the strong international growth, where commercial terms tend to be longer.

Our operating working capital turns increased to 5.1 turns compared to 5 turns in the first half of 2007. We expect to see continued improvement as the year progresses and we integrate the acquisitions completed over the last year.

On slide 8, our capital expenditures increased $1.5 million in the first half of 2008, compared to the first half of 2007, to $57.9 million. For the year, we continue to expect capital expenditures of $120 million to $130 million.

In the 2008 second quarter, we purchased 389,000 shares of our common stock, spending $16.5 million against proceeds from issuance of 4.8 million. Through June, we have purchased 6.7 million shares, spending $283 million against proceeds from issuances of 11 million. We issued 1.2 million of shares for stock option exercises, matches to 401-K and other stock programs year-to-date. As a result, year-to-date our outstanding shares decreased by approximately 5.4 million shares.

Under existing Board of Directors authorization, we can purchase up to an additional 10.8 million shares. This month, in July, we purchased over 900,000 shares, capitalizing on the weak stock market in the first half of the month.

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 both organic and acquisition growth, pay a competitive dividend and purchase our common stock.

Turning to the results for the second quarter and slide 9, first there were items that impacted both the second quarter of 2008 and 2007. To be transparent and have comparability, we noted these items in our press release

In the second quarter, we recorded a currency loss of $5 million, which essentially offsets the $5 million gain recognized in the first quarter. By the end of the second quarter, we completed all but a relatively small amount of our project to establish permanent financing for the MTL acquisition and our tax restructurings and we do not expect significant gains or losses in the second half of the year.

As we stated in last quarter conference call, we anticipate a charge in the second quarter for downsizing a tools European facility where the majority of the tools assembly transfer lines that we have been exiting were built.

Normally we absorb downsizing over a period of time but due to German labor laws, in this case we had to do the reduction in one period. The charge totaled $7.6 million pre-tax or $0.03 per share. These two items decreased our earnings per share by $0.05 in the second quarter of 2008.

In the prior year second quarter, we recognized a discrete tax gain of $63.5 million or $0.34 per share. We also recognized $3.3 million of Belden income, which was essentially offset by a legal charge related to old discontinued operations. Excluding these items, our earnings per share would have been $0.97 in the second quarter of 2008 and $0.78 in the second quarter of 2007, a 24% increase.

Turning to slide 10, year-to-date in 2008, unusual items close to offset each other. Currency nets to a very small amount and the tools restructuring charge is close to offset by the discrete tax gains recognized in the first quarter.

During the 2008 second quarter, we did not recognize any Belden income and at this point based on information Belden has provided to us, it does not look like we will receive any payments until the third or fourth quarter. Year-to-date, excluding unusual items, earnings per share increased 20%.

Turning to slide 11, today we reported a revenue increase of 17.8%, aided by currency translation and acquisitions, which contributed slightly over 10%, leaving slightly higher than 7% core revenue growth.

At the EPG conference in mid-May, we indicated we are tracking to the high-end of the second quarter forecast of 15% revenue growth. The primary drivers to our exceeding the revenue forecast were continuation of the strength we saw early in the quarter throughout the quarter, higher currency translation and price realization. Growth in businesses serving energy markets and international infrastructure had another tremendous quarter. We delivered mid-single-digit to double-digit core growth in every division except one.

As Kirk mentioned, our orders remain strong in the quarter with orders exceeding shipments and the progression of sales by month was what I would characterize as normal. In the first quarter conference call, I pointed out that our revenue growth in the first quarter was impacted by certain naturally occurring and unusual items.

There were one to two less shipping days, depending on the Cooper business unit, the loss of a lighting distribution center and shipments ahead of the enterprise Business System go-live last year. The items that reduced the first quarter core revenue growth added to the second quarter core revenue growth.

Exclusive of the currency loss and the Tools restructuring, we reported $0.97 in earnings per share. If you recall, our forecast included $0.02 to $0.03 for the tools restructuring, and therefore our forecast was $0.89 to $0.92 excluding the Tools restructuring, a very solid $0.05 per share beat on the high end of the forecast.

Across the company, we are investing in businesses and geographies with strong growth prospects and in businesses and product lines in the current economic environment have slowed or are slowing we are taking out costs. Throughout the year, aside from the specific actions in the Tools Segment, we will be absorbing higher severance and other costs than the prior year.

The bottom line is that we feel very good about our second quarter and first half start to the year, and we will continue to drive out cost in slower markets in the back half of the year. I discussed in our February 2008 outlook meeting that reducing or share count would be a nice contributor to our earnings per share growth in 2008.

Simply taking the reported lower share count over 6% of our earnings per share growth was from stock buybacks. Of course this is more like 4% when you consider the additional interest expense incurred to finance the share buybacks.

On slide 12, both our balance sheet and income statement were impacted by the incremental impact of acquisitions. As I mentioned earlier acquisitions contributed close to 8% to our revenue growth. Incremental revenue from acquisitions contributed slightly over a 10% return on sale with a lower cost of goods sold than the base business and higher selling and administrative costs.

Excluding unusual items our gross margin improved 40 basis points, resulting in gross margins increasing to 33.1% from 32.7% in last year's second quarter. The incremental impact of acquisitions accounted for about 10 basis points of this improvement. Gross margins improvement reflected our continuing pricing actions, realization of the benefits from our strategic initiatives, favorable sales mix and higher growth rate in our international sales, where we have a higher gross margin offset by higher selling and administrative costs than in the US.

Steel, copper, Electrical grade steel, transformer oil and certain other metals and energy have increased significantly, creating a challenging environment. In the second quarter, material inflation alone was $22 million in excess of our forecast at the beginning of the year. As I said before, our operating practice is always to look ahead and drive pricing to offset material inflation as it occurs and not play catch-up.

With the rapid increases we have and continue to implement and announce price increases across all of our businesses. Overall, we have been very successful in achieving price to stay at least even with material cost inflation and even with the challenges in the first half of the year, the second quarter was no exception.

Importantly, we expect to continue to achieve price at least equal to material cost inflation over the balance of the year. Now, that is not to say that when costs rapidly spike up that we can always stay ahead in every business, especially the portions of the business that use LIFO inventory accounting.

In these cases, under our accounting, the full brunt of the cost increase hits income immediately. As I will talk to in a minute, this did impact Tools in the quarter. Excluding currency losses, selling, general, and administrative expenses for the quarter as a percent of sales were 18.1%, compared to 18.2% in the prior year's second quarter.

The incremental impact of acquisitions added over 30 basis points to selling and administrative costs as a percentage of sales. While overall a nice improvement on adjusted basis, the leverage could be higher except that growth platforms we are building out tend to have much higher selling and administrative costs than our base business and the higher growth rate of international revenues where most case selling and administrative costs are higher than in the US.

Our strategy has and continues to be unabated to aggressively invest in businesses in international markets where we have strong growth. From a segment reporting perspective for the second quarter of 2008, we reported $27.3 million in general corporate and other expense, compared to $25.5 million in the comparable quarter of 2007.

General corporate expense includes $5 million in currency exchange losses in 2008, and legal charges of $2.4 million in 2007 excluding unusual items, general corporate decreased $1.2 million primarily from lower spending.

Turning to slide 13, solid execution on cost initiatives while continuing to invest in our companywide growth initiatives and great execution across our businesses on price you realization drove a 22% increase in operating income and our operating margin up 50 basis points to 15%, exclusive of the unusual items.

Continuing to slide 14, our net interest expense, our tax rate and net income. Our net interest expense was up $5.4 million, compared to the 2007 second quarter driven primarily by the acquisitions and stock buybacks. Exclusive of unusual items, our effective income tax rate for the second quarter was 29% versus the 27.3% for the second quarter of 2007.

Our tax rate was higher than the 28% to 28.5% we forecast for the quarter as a result of earnings exceeding the forecast and our raising of guidance for the year, which requires a catch-up from the first quarter to flow into the second quarter and from slightly higher taxes in certain jurisdictions.

Currently, we are forecasting around a 28.5 to 28.75 tax rate for the remainder of the year, excluding unusual items. Despite the higher interest expense and higher tax rate in the quarter, our net income increased 18% on an 18% revenue increase, exclusive of unusual items.

Turning to the segments on slide 15. For the quarter, our Electrical Products segment revenues increased 18.7%, excluding currency translation of 2.4% and incremental revenue from acquisitions of 8.9%, revenues grew 7.4%.

Price realization represented close to 3% of the growth. The businesses serving the energy market continued to excel with corn revenue up double-digits against tough comparables as did our international operations.

Retail sales were down mid single-digits, driven by the continued weakness in residential unlike commercial. Our lighting business more than offset the retail channel weaknesses with solid sales increase in the commercial/industrial market and delivered mid single-digit core revenue growth in a challenging market.

Our Power Systems business was up against some very tough comparables in the second quarter of 2007, where revenues increased close to 24% exclusive of acquisitions, but still managed to grow core revenues mid single-digits. Comparables get easier as the year progresses, and the long-term growth drivers remain intact so we remain very positive for the year on the utility side.

Revenue growth for Electrical Products was very strong internationally. Developing country revenue growth was 33%, with Asia-Pacific, Eastern Europe and the Middle East continuing to have the strongest growth.

Electrical distribution revenues were up double-digits with very strong growth outside of North America, and mid single-digit growth in North America. As I mentioned previously, our softest channel was the retail channel where revenues declined mid single-digits in the Electrical segment. The residential market continues to be weak, partially offset by new customers and products.

Overall, Electrical Products segment earnings increased 21% and the return on sales increased 40 basis points to 17.2% from 16.8% in the second quarter of 2007. We had a terrific performance in Electrical with return on sales excluding the incremental impact from acquisitions at 17.7%. The sales mix in the quarter was positive with sales of lower margin Power Systems, lighting and other products that serve the residential market are sold through the retail channel offset by higher margin products sold in energy, infrastructure and industrial markets.

We also have continued to execute on price realization and productivities and the acquisitions completed in prior years are delivering consistently, improving margins. This is why absent a significant global or U.S. economic downturn, we continue to remain confident that we can deliver solid double-digit earnings increase in these tougher economic times.

Turning to the Tools segment on slide 16. In our tools business, sales increased 12% with currency translation contributing 6% of the growth. We had solid revenue and earnings growth in aerospace and in an industrial power tools. We have a tough motor vehicle end market, a great performance by the tools team in delivering new products and customers to more than offset the decline in this end market. Hand tools sales in the US were aided by $1 million to $2 million of sales pull-forward prior to the go-live in the US in our enterprise business system. Reported retail sales were up slightly, but down slightly excluding the sales pull-forward in a very tough market.

Tools operating earnings increased 3%, excluding the severance charge on the sales increase of 12%. Our tools operating margin, as a percentage of sales excluding the severance charges, decreased 90 basis points to 10.4%. The results were impacted by strong lower margin chain and accessory sales in the US, and being hit by material cost increases.

With the US hand tools business on LIFO, we incurred the material costs inflation immediately, which reduced the operating margin by over 100 basis points in the quarter. We have price increases implemented that are being realized so this is more of an accounting timing issue. Before turning the call back to Kirk for his final comments, I will provide comments on our forecast for the third quarter and year.

Turning to slide 17. In the third quarter, we are forecasting revenues to increase 12% to 15% with Electrical up 13% to 16%, and Tools up 4 to 8%. Core revenue growth is forecast at 4% to 6%. Earnings per share are forecast to be in the range of $0.92 to $0.97 per share, an increase of 11% to 17% from the $0.83 we reported in the third quarter of last year, exclusive of unusual items. We currently anticipate a non-recurring tax gain in the third quarter, not reflected in our forecast.

For the full year, we are increasing our top-line forecasted growth to 12% to 14%, primarily from strength in the energy and infrastructure global markets and from a higher contribution from currency translation and price realization. We are increasing our earnings per share forecast to $3.61 to $3.71, from $3.51 to $3.65. Our prior forecast did not include the currency loss in the second quarter of $0.02, so we effectively have increased the forecast for the year by $0.08 per share on the high-end.

Let me turn the call back to Kirk for his final comments.

Kirk Hachigian

Thank you, Terry. In summary, we delivered a very solid first half and we are on track for another record year, despite a challenging economy. Our portfolio is proving resilient. We are focused on the right initiatives. Our teams are executing extremely well.

We are also benefiting from the investments we have made over the last five years. Our new products and globalization are accelerating our core growth; sourcing and productivity programs are driving solid leverage and free cash flow. EBS is giving us information to make better, smarter, faster decisions and eliminating waste and our talented teams are increasing their execution, we are increasing our internal promotion rates and doing everything in a very ethical and energized way.

The key long-term growth trends are still intact. Oil and gas and the metal investments the outlook remains very favorable with strong capital spending expected to exceed 20%. Energy efficiency and technology spending is in the very early stages with wind, solar and LEDs getting a lot of attention. Our international infrastructure investments are paying dividends with strong demand in emerging markets and utility upgrades and investments are on a very positive long-term trend with automation efficiency reliability being the key themes.

Our order patterns remain strong heading into the second half. We built backlog in Q2. July is off to a good start. Our acquisition integrations remain on track. We purchased $600 million of faster growing, less cyclical more technical and potentially higher margin businesses once integrated and our balance sheet remains extremely strong, providing outstanding flexibility for us to continue to fund the core with new products, global expansion, our new Tech Center and our talented teams. Support our competitive dividend and again repurchase our shares at attractive prices. All in, a very, very strong first half in a tougher economic environment.

Now, let me turn the call back to John to take your questions.

John Safran

Thanks, Kirk. I'd like to open up the call for questions. I just want to remind our listeners to please enter the queue using our own name. And respect for others waiting to ask the question, we will not take questions from people who entered the call using someone else's name.

Christie, first question please?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Your first question comes from Robert Cornell of Lehman Brothers. Sir, please proceed.

Robert Cornell - Lehman Brothers

Hi, everybody. Good looking quarter. Terry mentioned the strength of Electrical and the operating profit, and talked about a double-digit outlook. I mean, how far out would you see that double-digit growth outlook? Is that second half of this year? Would that continue into '09 potentially, as well?

Kirk Hachigian

Well, Bob, as we sort of back into the back half of this year, it's hard for us to say much about '09, because we don't do that until late in the year. We take our budgets and we roll it up. We're just finishing the strategy sessions now. Given where utility spending is, given where oil and gas and energy spending, looking at the capital expenditure numbers that we foresee out there, looking at the international market, I don't see much of a reason that our business is going to change substantially into '09, as it's coming out of '08.

When we look at these book-to-bill ratios, we look at July. Every indicator that we have, we still feel pretty good about the outlook. Does housing bottom out? Yes. Sometime late this year, probably early next year, commercial construction will continue to weaken.

Does it weaken by a couple percent, or does it go into a free-fall? That's what we'll know by the fourth quarter of this year. And my guess is that we'll be able to navigate the business around those soft spots, as we have for the first half of this year.

Terry, do you have anything else?

Terry Klebe

No, I think as we look forward, clearly most of our industrial and utility business, at this point, we look for that to be very strong going into '09. And as Kirk said, the residential will bottom out at some point. And the commercial construction, we have a big piece of that business in international, going into the Middle East, other developing countries.

We see no reason why that should be slowing down. Plus, with the energy efficiency kickoff becoming more economic call in the US that should give us some additional growth there.

Robert Cornell - Lehman Brothers

Maybe, just my last question would be to expand on the energy retrofit and how that market is expanding. How is your front log, as some people like to say in that market?

Terry Klebe

Well, on the lighting side in particular, there's a lot of noise and energy. We've talked about before that 80% of the lighting systems installed in this country are over 20 years old. We have talked about the energy legislation. First, they start with 100-watt incandescent and start outlawing a progressively larger and larger pool of the probably most popular lighting sources.

We've gotten into the control business. We've made several acquisitions around LEDs. We talked about the payback now driving the economics of this, versus the idea of being just green for green's sake. And so, we continue to drive that with our lighting agents and our sales force many. We continue to introduce new products that are solely dedicated to that segment of the market.

It's always hard to quantify exactly what is being redone for retrofit or cosmetic purposes, versus energy efficient purposes. But we still think there is great growth in that segment of the market. We're seeing all of the international business really around the energy efficiency side as well.

Robert Cornell - Lehman Brothers

Okay. Thanks, guys.

Terry Klebe

Okay, Bob. Thank you.

Operator

And your next question comes from Nicole Parent of Credit Suisse. Please proceed.

Nicole Parent - Credit Suisse

Good afternoon.

Kirk Hachigian

Hey, Nicole.

Nicole Parent - Credit Suisse

I guess, could you just maybe give us a sense of how much the North American commercial business slowed in the second quarter versus the first? And maybe, give us an update on the non-res project business.

Kirk Hachigian

Yeah, so we picked our comments very carefully. If you look at the first half of the year, even the second quarter, the commercial North American business, in fact, didn't slow. We had built backlog in the quarter, quotation rate was good, shipping was good. But as we look out into the back half of the year, we read the newspapers and watch the news, it's just our expectation. The ABI numbers somewhat shades our thinking on this, although I'm not sure how accurate that index will be or has been.

But we anticipate seeing some slowness in the back half of the year. The particular part of the business that's been slow in the first half is the stocking business, and you can relate that to light commercial, so Starbucks closing 600 stores, retail, and certainly the residential side, which would normally be a stocking type of a business. So that's where we've seen the slowness through the first half.

Nicole Parent - Credit Suisse

Thanks. That's helpful. And just one last one on order rates, you said order rates still remain strong. Could you give us a sense, both domestically and internationally, how they proceeded May, June, and then month-to-date in July?

Kirk Hachigian

There was nothing unusual about the trending over the quarter. In fact, Terry stood up in May and kind of gave the outlook at the higher end. Even at that point, we felt pretty good that our business was trending more to a higher end core growth than overall growth rate.

I can't separate the orders per se on the international side, but we just finished the call, in fact, the other day. And I tell you, Nicole, still in Asia, Southeast Asia, Middle East and South America, you know, 38% overall up, very strong core growth there. Don't feel anything slowing down on a momentum side there at all yet. So still anticipate that that will play out very well in the back half of the year and into '09.

Nicole Parent - Credit Suisse

What about Western Europe in June?

Kirk Hachigian

Again, we're reading all the stuff that you guys are seeing and we peel that back a couple different times. We're more nichey over there than we are in the mainstream, and we're not seeing anything yet. In fact, if you looked at our core growth in the second quarter, it accelerated, and it was one of our best core growths in Europe, when you take out acquisitions and FX.

So we play a little heavier on the energy side. We play a little heavier on some of the security fire side of the business and have not seen anything slowdown there yet, and the order rate was good.

Nicole Parent - Credit Suisse

That's helpful. Thank you.

Kirk Hachigian

Wish I could be more negative for you, huh?

Operator

And your next question comes from Jeff Sprague with Citi Investment Research. Please proceed.

Jeff Sprague - Citi Investment Research

Thanks, good afternoon.

Kirk Hachigian

I figured I would answer your question before you asked it this time, Jeff.

Jeff Sprague - Citi Investment Research

Well, thank you very much. So what was the book-to-bill?

Kirk Hachigian

It was good. It was above one, and again on a year-over-year basis, was about equal and same as the first quarter, Jeff. First quarter, we said 110%. We were less than that in the second quarter, but with shipments out the door up 18, that's north of 20% order rates in the quarter. So felt very, very good.

Jeff Sprague - Citi Investment Research

Yeah, that sounds solid. Hey, just one point of clarification. The guidance is all in for everything, right, all the restructuring, all of the discrete items, everything except this Q3 one-off that you're calling out, Terry?

Terry Klebe

Yes. Absolutely, it's all in.

Jeff Sprague - Citi Investment Research

Okay. Kirk or Terry, could you just elaborate a little bit more on utility? It sounds very strong. You did say it's actually coming in a little weaker than you thought. Terry mentioned the comps. Is there something with mix or reliability projects, or some other dynamic that's just making the year play out a little bit different than you thought?

Kirk Hachigian

It's the residential piece, Jeff. Because residential was weaker, we saw a little bit more weakness on the pool amount side of the transformer business. Starting to think that that may be stabilizing a little bit. Saw better trending and better order rates in the second quarter, albeit maybe a little early to call a bottom there. But as you look at the comps in the back half of the year and look at the strength of the reliability, the EAS business and international business feel very good about the back half of the year, and expect the comps to look a lot better.

Jeff Sprague - Citi Investment Research

You mentioned the acquisitions and it sounds like they're getting good traction, but a little bit of color of where they are, relative to margin targets and integration?

Terry Klebe

Sure. On all the acquisitions we've completed, we are at or above where we expected to be on them. In fact, a little bit of the contribution in the second quarter was over performance on three of the acquisitions that we completed late last year and early this year, so very positive on every one of them. Integration side, of course, takes some time. I mentioned that our return on sales on the incremental was about 10% ROSS. That's a big improvement from the first quarter, but the first quarter takes in some inventory accounting, those types of things. So, I would expect them to be north of 10, growing as we progress through the year.

Jeff Sprague - Citi Investment Research

And then just finally, Terry, could you actually just tell us what realized price was in the quarter, as a percent of revenues?

Terry Klebe

It was just about 3%. Actually, the total, I believe, was between 2.5% and 3%. Tools had a little less realization than Electrical group which was closer to 3.

Jeff Sprague - Citi Investment Research

Great. Thanks.

Operator

And your next question comes from Alex Rygiel of FBR. Please proceed.

Alex Rygiel - FBR

Good morning, gentlemen.

Kirk Hachigian

Hey, Alex.

Alex Rygiel - FBR

Two quick questions. Could you quantify the favorable impact in the second quarter that, Terry, I believe you quoted as saying was from naturally occurring weather events, which I think you're referring to the tornadoes. So could you quantify that? And then, I have a follow-up.

Terry Klebe

In the first quarter, we talked about core growth which was not as strong as we would have liked to see. It's added probably a little bit over 1% to the core growth rate in the second quarter, just a number of days in the quarter, in each of the two quarters, which for the first half of the year, of course, were right on.

Alex Rygiel - FBR

Perfect. And then, you've obviously made a lot of acquisitions over the last year. Kirk, this is probably more for you. Could you highlight maybe one or two of our most successful, and tell us exactly the end market? Is it the product? Is it cost synergies? And the follow up on that, could you talk a little bit about your acquisition backlog, and whether or not you're seeing private equity out there these days?

Kirk Hachigian

That's a good question, Alex. When you step back from it, I think Cannon was a game changer for us at the end of the day. We were selling discrete components. We were having discussions with the utilities about product, and it's completely changed the conversation and the sophistication of that business. You know, interestingly in the quarter, that utility business for us actually eclipsed lighting on a revenue basis for the first time ever. Today if you look at one quarter, the Power Systems business is the largest business in Cooper Industries.

When you think about six, seven years ago when I joined the company, that business was about $550 million of sales. So I think that, one, from an entire new segment and just timing on where the economy is going and the infrastructure build and the whole reliability game, there is a big one.

The other ones I would say are all equally as important. I mean, even if you look at GS Metals within B-Line, and if you look at what's that doing for the top-line and getting them more to the oil and gas space, if you look at what Bussmann did on the (inaudible) fuse business over in China, you look at what we did on transportation, you look at MTL getting us into instrumentation for Crouse-Hinds.

We had a discussion the other day, is there any one of the deals that we've done over the last 15 that we wouldn't have done, knowing what we know now, and the answer was not a one of them. They're all tracking at a revenue rate equal to or higher than what we anticipated. So I tell you, we do a pretty good job, as Tom had showed a couple different times. You start with 800, write purchase and sales agreements, you make offers, you get it down to about 15 deals, you probably have a pretty good idea of what you're buying and why you want it.

On the go-forward, we're still busy with the 15. But I would say that, again, seeing less competition out in the field, trying to lock and load on a couple bigger deals, that would probably be more meaningful from a revenue perspective. But the couple that we're looking at now a little harder are very, very early in the cycle, so I don't want to get too optimistic, because again you could run into a whole lot of different things in the due diligence process that would change your thinking on it.

So we'll see. But pretty comfortable with where we are in the process and we've got good teams of people out there, not a shortage of opportunities certainly in this environment.

Alex Rygiel - FBR

That's great. Thank you.

Operator

And your next question comes from Christopher Glynn of Oppenheimer. Please proceed.

Christopher Glynn - Oppenheimer

Thanks, good afternoon.

Kirk Hachigian

Hey, Chris.

Christopher Glynn - Oppenheimer

So, just a little question about the top-line guidance for the next quarter. Had 3% from price, might be going to 5% or 6% in the back half, and then the book-to-bill. Looks like the top-line guidance could be a little light.

Terry Klebe

Well, we do not expect price to go to those types of levels in the third and fourth quarter. It may tick up a little bit, but it's not going to tick up at that type of rate. What you will see in the back half of the year is the impact of FX declining, especially when you get toward the fourth quarter. So, I think if you peel it back. And the other piece of it is, of course, is acquisitions, which we start anniversarying some of those acquisitions as we move into the third and fourth quarter. You peel back our forecasts; I think you'd find that we're looking at probably about the same core growth as we started the year at 4% to 6%, maybe a little bit more price in there, clearly.

Kirk Hachigian

And, I think commercial could be slower in the back half as we talked to, right? I mean, we had a pretty good first half commercial still through the first six months, and our anticipation is that we'll probably slow a little bit more than we saw in the first six months.

Christopher Glynn - Oppenheimer

Yeah. On the commercial, you mentioned you have to wait a little while before you can tell if it will be down a couple percent or something more cataclysmic. How open minded are you about something really kind of bad resembling, sort of, the residential markets in that area?

Kirk Hachigian

At this point, not probable, because if you go back and you look at the last time this all happened was the dot-com bubble, and it drops or peaks the trough about 5%. You didn't have energy retrofit and you had office vacancies at a significantly higher rate than you're clipping at now. We still see really good spending on the institutional side, the government side, lot of schools, municipalities. So, it doesn't feel that way at all to us at this point. And again, we'll keep talking about it quarter-to-quarter, and give you our latest thinking as the year unfolds.

Christopher Glynn - Oppenheimer

Okay. And then just lastly on the retrofit legislation, what are you hearing on renewal of the tax rebates and how much does it matter at this point just from perspective? Is the marketing and the consciousness taken on a life of its own around that?

Kirk Hachigian

I don't hear anything about it. I'm not up to speed on the tax piece of it. But I don't hear that as a driver at all. I hear cents per kilowatt hour, and I hear paybacks now that are down to about a year, so economically very, very attractive.

And again, of course, people generally have a tone of wanting to get more independent of foreign oil and the green effects. So everywhere I go, that's what we're hearing and that's the buzz that's driving the demand side there.

Christopher Glynn - Oppenheimer

Thank you very much.

Kirk Hachigian

Great, thank you.

Operator

And your next question comes from Deane Dray of Goldman Sachs. Please proceed.

Deane Dray - Goldman Sachs

I wanted to clarify the '08 guidance, if I could. And just to make sure I'm not being dense on this, for operating results this quarter you're using $0.97; is that right?

Terry Klebe

Deane, all we did was break out the unusual items that would impact it, just like we did in the first quarter. For the year, our 2008 guidance includes all-in, everything that's happened that we've broken out in the first and second quarter.

Deane Dray - Goldman Sachs

All right, so that includes a $0.97 operating result this quarter?

Terry Klebe

It actually includes a $0.92 operating result this quarter.

Deane Dray - Goldman Sachs

Okay. That's what I was looking for, because you had previously included both that severance and the foreign exchange items in previous guidance.

Terry Klebe

The currency, we had not in the second quarter, but the severance or the closing of the facility or down-sizing of the facility, we had.

Kirk Hachigian

And again, I think that the tools piece of it, Deane, because of German law and such, you had to take it all in one pop. And normally, what we do is we're continuously perpetual restructurers, right? That's how we get productivity.

And we generally don't call it out. This one happened to be all in one quarter, because of the way the union negotiations work over there. And so we just wanted to call it out, not to show what was going on in the business, frankly, on a level load I guess.

Deane Dray - Goldman Sachs

Okay. And then just on that vein, with regard to restructuring, we are seeing a lot of the companies this quarter talking about accelerated restructuring in the second half as a way to linear organization and potentially create some cost savings into '09. Is this a strategy that you all are looking at and is there an opportunity for more restructuring in the second half?

Kirk Hachigian

You know, I would say, Deane, that's the beauty of what we've been doing with the productivity program, in that we've been driving this 3% now for over five years, and so we've got our plants and our physical footprint in very, very good shape.

And the core growth and the volume that we're still generating through the factories, we've got a terrific footprint in Mexico, we've talked about over 50% of our headcount is already outside of North America. We've been doing much more sourcing in from Asia.

We're very comfortable with our footprint. You looked at the margins in the quarter on electrical. If you took out acquisitions, near record highs and so we don't have anything on the drawing board for large physical restructuring right now.

Terry Klebe

And Deane, we started taking some extra costs, I'd say, in the latter part of last year. That's continued through the first couple quarters, especially in businesses that we see slower growth or anticipate slower growth, taking the costs out ahead of the game and we'll continue that through the fourth quarter. But all that's built into the guidance, and we at this point don't see anything big on the horizon.

Deane Dray - Goldman Sachs

Thank you.

Kirk Hachigian

Okay, Deane.

Operator

Your next question comes from Eli Lustgarten of Longbow Securities. Please proceed.

Eli Lustgarten - Longbow Securities

Good afternoon.

Kirk Hachigian

Hi, Eli?

Eli Lustgarten - Longbow Securities

Quite impressive. I must say. Couple of questions, one, what are actual shares outstanding at the end of the quarter, because 6% of the gain, I think we need to know more precisely on that.

Kirk Hachigian

We're looking at for the third quarter probably around $176 million, could be a little bit plus or minus, depending on the share buybacks, the remainder of the quarter.

Eli Lustgarten - Longbow Securities

Okay. Secondly, you said 38% of your business was international. How much of that is Europe versus emerging markets?

Kirk Hachigian

It's almost about 50/50, the last time I specifically pulled it up. You've got the safety business out there in Europe, Crouse-Hinds is big in Europe. Then we call, say, Mexico emerging, Southeast Asia, rest of South America, and all of the Middle East emerging. I think it was close to 50/50 if I'm not mistaken. Terry is trying to pull it up here real quick.

Eli Lustgarten - Longbow Securities

Is Germany a big piece of that.

Kirk Hachigian

Germany would be the Western Europe. Germany, France and the UK are three biggest countries in Europe.

Terry Klebe

Germany, we manufacture Electrical there, primarily Crouse-Hinds and some of the tools business. Tools has a pretty good presence. Now, a big piece of what we do in Europe is export into export markets, into the Middle East and other countries where on the Electrical side you have IEC standards.

Eli Lustgarten - Longbow Securities

And I guess the question, in Europe, because you're talking how you haven't seen much slowing, but U.K. has been weak, France has been weak, and now Germany. The data that came out this morning said that's starting to turn down. You haven't seen any of that hit you at this point, is that fair?

Terry Klebe

It depends on the product line. We're kind of a niche player in Europe on the products we have over there. It's not like the U.S. where we have a huge presence on across broad Electrical lines. But the U.K., clearly has been slower for the last six months, although our export business out of the U.K. has been pretty good. So from a factory side of it, pretty good. France has been pretty good, pieces of it a little softer than others. But outlook when we talk to our businesses overall is still pretty good, at least in the markets we play in.

Kirk Hachigian

There's a lot of MRO business over there. The Crouse business is MRO, the Bussmann business over there is MRO, and like John just pulled the numbers up, it is 50-50 split between developing and Western Europe markets.

Eli Lustgarten - Longbow Securities

Okay. And then a final question, we've had a big step up in profitability in the Electrical business this quarter, it's exceptionally impressive, particularly with the (inaudible) acquisition. Can you talk about, with a lot your international business on FIFO, can you talk about the sustainability, or profitability at core and should we expect that to moderate a bit because this was a little better than we deserved and we get back to a decent level but not quite the same level the rest of the year, is that what we're expecting?

Terry Klebe

As we talked about, a lot of our growth, our industrial-type businesses, especially the energy side of it are performing very, very well in very good markets and so we get good product mix because when we have growth going in a lot faster in those markets than in our more commercial residential market, that helps us on the margin side.

A big piece of that has been very disciplined on the price side of it, on the productivity side of it, the new product. Can I exactly say that margins will be as high next quarter as this quarter? They probably will not change dramatically, that depends somewhat on mix.

Eli Lustgarten - Longbow Securities

But this was quite impressive quarter, just wonder. But thank you.

Terry Klebe

Thank you, Eli.

John Safran

Thank you for joining us on the call today. As always, please feel free to follow up with me with questions or clarifications that you may have. And Christie, you can end the call now. Thank you.

Operator

This concludes today's conference call. You may now disconnect. Have a good day.

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Source: Cooper Industries Ltd. Q2 2008 Earnings Call Transcript
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