Eaton Corporation plc (ETN) Q1 2009 Earnings Report, Transcript and Summary

Good morning, everyone. Welcome to Eaton's first quarter 2009 earnings conference call. Joining me this morning are Sandy Cutler, Chairman and CEO, and Rick Fearon, Vice Chairman and Chief Financial and Planning Officer. As been our practice, we will begin today's call with comments from Sandy, followed by a questionandanswer session. We would like to remind everyone that the information provided in our conference call today will include forwardlooking statements concerning the second quarter 2009 and full year 2009 and income per share and operating earnings per share, second quarter full year revenues, our worldwide markets, our growth in relation to end markets, and our growth from acquisitions. Those statements should be used with caution and are subject to the various risks and uncertainties, many of which are outside the company's control. Factors that may cause actual results to differ materially from those in these forwardlooking statements are set forth in today's press release and related Form 8K filing. As a reminder, we have included this presentation on our first quarter results which can be accessed on Eaton's investor relations page. Additional information is available in today's press release, which is located on Eaton's home page at www.eaton.com. With that, I would like to turn the session over to Sandy Cutler.

Thanks, Bill. Welcome everybody. Thank you for joining us this morning. I hope by now you have had the chance to pull down or access the several charts that we've provided that provide the backdrop for my comments this morning, both on the first quarter and then our revised full year guidance for this year. I will simply call out the chart number just to be sure that we're on the same page as we walk through my comments this morning. I will start on chart 3, highlights of the first quarter results. As noted in our press release and as you'll see on the next chart, we did have improved performance in the first quarter, about $0.08 better than the midpoint of our guidance for operating earnings per share. A couple of important elements in understanding that performance are sales for the first quarter were down by 20% from a year ago. Within that, our end markets were down some 21%. That actually is higher than the original 13% decline that we had expected. We were able to offset that 21% market decline by 1 point of market outgrowth; and, as you can see, acquisition growth helped to offset the ForEx impact. Our electrical and aerospace businesses are standing up best at this point through this very severe recession. Our hydraulics truck and automotive businesses have faced really steep market declines, and we'll comment more upon each of those as we walk through those individual charts. We're very pleased with our performance over the last 6 months and again in the last 3 months in terms of our operating cash flow, $107 million of operating cash flow within the first quarter, $59 million of free cash flow, and as you can see the points below this really rates quite well historically for us. As you can see, over the last 6 months from $731 million of operating cash flow. We move to chart 4. Just a couple points to understand, our first quarter guidance is up on the top line as you can see which was a negative $0.25 to negative $0.35 of operating earnings per share. How did we do against that? Our midpoint of that guidance obviously is some negative $0.30. The lower reductioninforce expenses in the first quarter of approximately $65 million versus $110 million we provided you guidance for in the first quarter. That contributed about a $0.23 improvement. We actually were able to achieve higher savings from all of our activities of about $0.02. And then the impact of our markets being a negative 21% versus the originally anticipated negative $0.13 actually impacted us for a negative $0.48. Now that leaves our improved performance of $0.31 and what I would leave you with on that last point is we are being successful in operating the franchise at a much lower overall cost level which I think is a good reflection of the cost management capabilities within the company. All of that netting to the $0.22 operating earnings per share loss in the first quarter. If we turn to chart 5, this is a quick look at our financial summary. I am not going to walk through each of the numbers on this chart. I think they're fairly self explanatory; but if you look in the light green box in the lower left hand corner, I think that gives you a good synopsis of the items that contributed to our lower 20% sales numbers. Again highlighting that market contraction of 21 points. If you look obviously on the bottom line of the white up above, you will see our loss of some $50 million in the quarter. It really takes us back to 1991, the last time that we had this kind of performance, obviously reflecting the depth of this recession. As we move to chart 6, let's talk a little bit about our individual segments. This first chart is on our electrical segment for the Americas. You can see sales off some 6%, operating profit dropping some 25%. If you look at the lower left hand corner, you will see that the market was down about 10%. And the way to think about it, we think the market at this point is, the big project business, whether you're talking on the power distribution side or the power quality side has held up quite well. Where the real weakness is is in the flow businesses, that would obviously be attached to residential, industrial control, power quality, those areas where you have a heavy activity in terms of distributor or dealer destocking and that activity has been quite pronounced. That's our comment about the steep decline in the short cycle components of businesses. We have seen that throughout the first quarter, and it's our expectation that we will continue to see some of that activity in the second quarter. Bookings suggested for ForEx and acquisitions were down about 11%. I would characterize the bookings the same way I did the sales continued strength on the project side of the business, both in the power quality business and the power distribution business, and weak on the short cycle flowtype business through distribution channels. If we move to this next chart, chart 7, this is the electrical segment for the rest of the world. Top line, obviously a 38% growth, but I would urge you to look down to the left hand corner, the light green box again, market growth off even more strongly than in the U.S. We did achieve some outgrowth. Remember, you have got a very strong impact of acquisition, primarily from the Moeller and the Phoenixtec acquisition, and a whopping impact from ForEx. Your net organic growth in this business hit quite hard during this quarter. Bookings in Europe and Asia Pacific declined by 20%. We really saw vicious destocking activity, particularly in Asia early in the quarter, very strong destocking in Europe. We believe we are beginning to see the end of that destocking activity in Asia. But that's not yet true, we believe, in Europe. We think we probably have another quarter ahead of us in that regard. As you can see, a real drop in the operating margins as a result of this enormous drop in terms of physical activity here during the quarter. We move to chart 8, the hydraulics business. Top line down 35%. Our global near term hydraulic orders down on the order of about 30%. We've seen really massive order cancellations from OEMs, particularly in the mobile segments out beyond that 3month window. We think what it's a real reflection of the fact is the uncertainty in this market place that major buyers or customers are really trying to operate on a 3month window at this point. So there's been a real rejuggling of back orders over this fourth quarter and first quarter. A dramatic downturn in the operating profits. A 29% end market growth contraction. And it real doesn't matter what region of the world you look at, it's been quite consistent as we've seen machine OEMs and mobile OEMs pull back hard. And you can see ForEx, again, another major impact in this particular segment. If there is a bright spot within the hydraulics segment, we would point to China, where we are beginning to see some impact of higher order activity that may be somewhat aligned with some of the stimulus activity there within China. On the aerospace segment, this is chart 9, slightly down on the top line, very attractive margin performance again. We have seen, as everyone has seen in the public data, real declines in commercial passenger traffic. Business jet production has dropped very significantly; and we are now forecasting, as I will come to in a couple of pages, a 5% fullyear decline in these markets. In first quarter down about 4%. A very strong backlog off of all of the wins that we've had over the last couple of years is propelling our shipments, so that we had outgrowth during this quarter; and we would expect to see this business continue to perform pretty well through 2009. Next chart, chart 10, truck business. Top line down nearly 50%. As you can see, market down about 27%. Our market indicators in this particular segment are really built around production numbers for number of vehicles. We think that actually understates the weakness in this marketplace. That's clearly what we've seen in our own shipment activity is aftermarket has contracted significantly and OEMs are working to drive their purchases underneath their production levels, so we've seen an enormous contraction in this business. The one bright spot in this area is, in the midst of all of this doom and gloom, there is a real premium being placed upon more environmentally friendly vehicles; and we've seen a pop in our hybrid programs in terms of customers being interested in really reupping their commitments to hybrid technologies. Last, but not least, on page 11, our automotive segment, 50% drop in volumes on the top line, market growth down some 40%. You can see the note about the U.S. market in terms of the contraction and the relative level of nonU.S. market contraction really no easy places to hide right now with this marketplace. You can see quite a drop in terms of the bottom line yeartoyear, but not a lot different than what we were experiencing in the fourth quarter of this past year. So, if we turn to chart 12 in terms of just a quick summary of the first quarter, our acquisition integrations of Moeller and Phoenixtec and MGE and Argo-Tech, very much on schedule. We're very pleased with the strong cash generation, not only in the first quarter, but also during the fourth quarter. That sets up really what we've been able to achieve in terms of both also issuing $550 million of term debt, but then being able to reduce our CP to $172 million we think very prudent during this period of time. Then our cost management has more than offset the lower market impact during the first quarter and obviously will be critical as we go into the remainder of this year. If we turn to chart 13, and I am sure most of you have had the chance to read the press release in which we changed our overall end market growth expectations from 10% to 11%, which was the guidance we provided at the end of February, to now down 15% to 16% obviously, an enormous change. Clearly when you start the year down 21%, that sets a new lower baseline than we'd anticipated for this year. We think this is a confirmation of the really deep severity of this recession, not simply in the U.S. but around the world. It's our expectation that the potential for recovery has moved out by at least a quarter; that means it's moved out of 2009 into 2010. As you look at these numbers just to give you some reference, the electrical Americas index which you see here which we expect to be down 12%, in New York we had said it would be down 9%. The rest of the world, down 9%. Our expectation at the end of February would be down 7%. Our hydraulic worldwide number of down 24% now compares to down 18% at the end of February. Our aerospace index of down 5% compares to down 1% as of the end of February. The truck index of down 22% compares to our earlier forecast of down 20%. And the automotive index of down 23% compares to our earlier forecast of down 16%. So, again, a broadbased continuation of weakness; and we don't expect the second quarter markets to be substantially stronger. There will be some minor seasonal strengthening, but on the order if we were down 21% maybe we'd see these markets being down 19% to 20% in the second quarter. We do expect that in the second half, we'll see markets be down more on the order of 10% with it starting on a weaker end and then getting slightly better during the fourth quarter. But this is obviously a major reset of market expectations for this year. If we turn to page 14, we are continuing strong cost abatement activities. We think it's critical from both a cash point of view and from an earnings point of view and, of course, insuring that the corporation is in a very strong position once the marketplaces begin to strengthen again, which we think is a 2010 event not a 2009 event. What you will see on this particular chart is a recasting of the yeartoyear pretax income improvements that come from the employee reduction activity that we initiated in the second half of 2008. We took action obviously that we shared with you in January. And we've also taken additional actions here in April. As you will see, this number is now, the pretax income increase yeartoyear in 2009 is now $205 million. What we shared with you in February was $165 million. So that's an additional $40 million of yeartoyear improvement. Looking to 2010, the number is now $210 million; and what we had shared with you in February was that it was $125 million, so up some $85 million. Now most of the savings, as you can see, is occurring in the second half of this year, which is why, again, when you look at our guidance for the second quarter and you look at our actual achievement of operating earnings per share in the first quarter, you come up with a first half which is approximately breakeven. And come up with the majority or all of our remainder of our earnings being in the second half of this year propelled by, you can see, the net $100 million of savings in the third quarter and the net $125 million of savings in the fourth quarter. Turning to page 15, we have not only taken actions in terms of the painful actions in terms of reducing fulltime employment and you can see that on this chart. That's the additional $40 million you see listed under the category of additional actions that adds to the $165 million that gives you the total of $205 million on the previous page. We've also undertaken another round of significant actions to reduce nonemployment related savings. And this is everything from what we shared in February to now having asked our employees around the world to be taking an additional week off without pay in the second, third, and fourth quarters as we did in the first quarter, to reducing bonuses, to having no merit increases, to eliminating 401K matches a long string of activities and this adds up to $170 million. So that while we're dealing with these 15% to 16% reductions in end markets, we've been able to take out, we believe, about $375 million of pretax expenses this year. That leads us to page 16. On page 16, I hope you're familiar, this is the same bridge that we have shared with you on several occasions. As you can see, the market decline number of the 15% to 16%, which is the top line in the yellow category, has gotten larger. You will see if you go up to the top of the green is the yeartoyear RIF numbers and the other savings actions have also gotten larger, netting out to the midpoint of our revised guidance of $2.75 per operating earnings per share. If you move to page 17, what we've tried to provide you with is a quick summary of our operating earnings per share as well as our fully diluted earnings per share for the second quarter and for the full year. You will note the asterisk that's on the second quarter line, which is the second line on the page. There we're trying to give you some calibration as to really earnings forecast in this current environment are increasingly challenging, obviously. We're not backing away from providing it, but we are trying to provide you with some calibration in and around volume levels. Assuming that our second quarter sales which tie into the economic forecasts I provided to you will be somewhere between $3 billion and $3.1 billion, this is the range we believe is appropriate for operating earnings per share and net income with the savings programs that I also shared with you. If we turn to page 18, just to give you a quick update on a couple other elements that are within our guidance, our 2009 guidance for market outgrowth is $200 million; it was $300 million. Our incremental sales from acquisitions as these markets have decreased was $400 million; it is now $300 million. Our operating EPS guidance had been $4 to $4.60. It's now $2.50 to $3. Fully diluted EPS guidance had been $3.60 to $4.20. It's now $2.10 to $2.60. Our operating cash flow guidance had been $1.4 billion to $1.5 billion. There may be an error on the chart that you have; we'll be reissuing it today. It should be $1.3 billion to $1.4 billion. And the free cash flow was $1.1 billion to $1.2 billion; the guidance now is $1.0 billion to $1.1 billion. If we flip to chart 19, just a very quick summary, obviously it is still difficult to forecast in this environment. We are maintaining our practice of tying our earnings per share forecast to our economic forecast. Again, we think that's the really big news today is that the first quarter we performed better than we had expected through both different timing on some of our RIF expenses that was occasioned by some of the laws in different countries that make it more difficult to get those programs implemented as quickly as we had hoped. But then, secondly, the big issue really surrounds the economic forecast starting out much lower this year than we had anticipated and we think recovering in a much flatter fashion than we had originally forecast. That leads us to this market decline of 15% to 16%. Foreign currency declined the same number we had talked to you before, about 6%. We have increased our pretax yeartoyear earnings improvement from all of our cost actions to $375 million. And we still think the 14% to 16% tax rate is appropriate for the second quarter and for the full year. Hopefully that provides you with a quick overview of obviously a complicated economic situation worldwide, as well as obviously complex the actions we're taking that we think very effectively to deal with this downturn. With that, we'd be glad to open things up for questions.

John, could you pull everyone on the Q and A portion of the meeting, please?

Certainly. (Operator Instructions)

First in line is Eli Lustgarten.

Good morning. It's going to be an interesting couple of quarters, I guess. One, can we sort of start an overview that in order to get towards your guidance, we're going to have earnings in the second half of the year have to be $2.75. It's got to be because the first quarter is actually offsetting the loss. You forecast the second quarter offsetting the first quarter. Can you give us some guidance of either you are going to get, all of a sudden we're getting a dollar a share plus increase in the second half of the year per quarter. That's an enormous change with not much change in the economic environment. Can you sort of break down how much of that is coming from what you think your market profitability or sector profitability looks like and how much is coming from, is it all coming from the improvements that you expect to put in the bottom line or get some idea how do we get a dollar a share swing per quarter?

I think there are maybe three elements to think about in that regard. First, I would say were the employment reductions and what we called other actions that we detailed for you that give you quite a different quarterly perspective. You are going to have $100 million of pretax employment reduction benefits in the third quarter, $125 million in the fourth quarter. And that compares to the net of the severance and the benefits of a $12 million cost in the first quarter and $8 million cost in the second quarter. So, right there you have got a pretty good base in terms of what's going to happen. From an economic point of view, first quarter end markets were down about 21%. The best we can estimate is the second quarter, that number is likely to look like a negative 19 to negative 20. Believe me, there's no decimal point on these estimates. Then we think that the third and fourth quarter are likely to be more on the order of a 10% reduction. So you do get some market improvement. And I would put it really under the category of primarily of the end of destocking. So that you get yourself to a more of a production run rate. Then hopefully we start to see this economy begin to stabilize a little bit from this massive wave of cumulative stimulus activities. The third issue I would mention is that you can defer our businesses have a seasonal, which is stronger out there at the back end of the end of the year. I would say those are the three factors we would be looking at.

Can you talk a little bit about two specific sectors? I am sure everybody is going to know one in particular, the electrical sector and the truck sector. One, the electrical sector, you've got especially in the Americas you're talking down I think 12% and you're down 10% in the first quarter, you don't have much weakness unfolding for the rest of the year in the electrical market compared to what we see in the macro data. Can we talk a little bit about the electrical both North America and in Europe? And then the truck sector, I see you have 135,000 units forecast and that's probably down from what a lot of us thought. If you look at the latest data, which is running 25,000 to 30,000 production per quarter through the nine months, that's an awful lot, it's a hard number to get to in the fourth quarter without a big prebuy all of a sudden shaping up at the end of the year.

Let me just start with truck real quickly. I think the key variable, because it's hard to call anyone's forecast better than someone else's forecast right now, is that we've been through just a massive destocking activity. So when we look at what's sitting out there in terms of in dealer's lots, we're on the side of the road that's coming into better adjustment as we go through this. We've also seen a massive aftermarket slow down or abrupt stoppage. We again think part of this is toward trying to get economy and demand somewhere rightsized. We've been going through that for quite some time, and we believe that we'll start to stabilize. But, again, you have to believe that the overall economy is going to go through its biggest portions of destocking during the fourth quarter of last year than the first two halves of this year. That's really critical. When all that destocking is going on, there's not a lot of freight being carried, either. Once you stop doing that and get back to more production level, you are going to start to get some level of freight activity. I would say it's tied into that assumption about inventory destocking across the economy here in the first half versus the second half. On the electrical side, we also have seen really a lot of the flow goods activities go through very large destocking as distributors have been working hard to get their inventories down. OEMs have, as well. We think that after six months of that what tends to happen in industrial markets is people are able to cut back, normally, their A and B goods really fast; and what they get left with in their inventories are the C goods. At some point, you have to start putting back in the A and B goods and you can't stay down at the levels you are. We think after the economy goes through six or nine months of that, you do start to get some rebuilding of that. You didn't ask about hydraulics, but I would say if there's any good news on bookings here in North America right now, and I would be careful about extrapolating on this, is that we have not seen the destocking activity in April that we saw in the January, February, and March time period. Actually, we have seen some hopeful signs, if you can take a half a month of data in that regard. That's what we're going to need to start to see across the economy. We think that by the time we have gone through, as I mentioned, another quarter of this, we should be pretty well burned through that.

One final question. Are you expecting profitability to hold relatively close to current levels in electrical? And do you expect truck and auto to return to profitability by the second half of the year?

I would say yes. If I could just tune in a little bit on the second quarter as well. I think the pattern as you see in the first quarter are likely to be similar to what we see in the second quarter lifted just by a little bit of seasonal volume you had mentioned and that's that kind of 19% to 20% down versus the 21%. I think a fair assumption is that the first half is rugged half. We expect to see the benefits of a lot of these cost reductions we've been working on and a slight slowdown in the rate of decline from a year ago in the second half.

I will let somebody else ask a question.

Next we have Bob Cornell. Good morning, Bob.

Just following on some of Eli's questions, go back to electrical and power quality, for example. How sensitive do you think those businesses are to global trends in CapEx and nonres spending?

I think, let me start on the low end and go to the high end. I would say there's no question people have been pulling back their CapEx quite hard. Where we believe that had the biggest impact has been at the low end of the markets where you are just seeing the discretionary small stuff just getting chopped out, whether that's in the hydraulics or whether it's in electrical. We think at some point you can't go a lot further on that. You've seen the low end on the power quality business affected at singlephase type of equipment. Of course part of that goes consumer as well. You have certainly seen the flow businesses, whether that be industrial control or power distribution, that type of equipment in the PD side of things. The larger project business has continued for us to be quite strong as people are looking at whether a major energy plays or major efficiently plays, we're continuing to see spending on that. I know a lot of people are probably surprised to hear that, but we're continuing to see pretty good results in those arenas at this point. I think the piece that we're having the hardest time putting our hands on is that a lot of people have questions about the stimulus bills and how quickly will those dollars come through and while we are seeing quotations of projects that are allegedly shovelready. I use that term with some guidance around it. I think it's too early to say that there's concrete examples broadly based through the economy that we can put our finger on. We can put our finger on some small items here. I would say where we have seen some impact in that regard is actually in China and that appears to be the first market where we really can string things through to government stimulus bill activity.

I think a lot of people would say in the electrical business and power quality as well you have a very likely significant fall in nonres coming in the second half of this year and in 2010. I understand the point you make about flow and destocking, but some of these larger projects are just getting finished and you're looking at a dearth of new large projects, unless you can shed some light on that.

I know a lot of you follow the ABI index. If you actually looked at it this month, you saw a fairly significant jump up. I wouldn't put it into happy halo category yet, but it did jump up. We believe what that is telling you is that a fair amount of this quotation activity is beginning to go on on some of these additional projects that come through the stimulus bills. Our forecast has been, as I think you know, we thought that nonres would come down. It would come down fairly hard this year. It would be much harder in what I call the commercial side versus the power side. That's still our forecast. We're carrying a pretty hefty backlog into this year. And I think that's why our performance is remaining quite strong. On the power quality side, our energy efficiency story is still one that is selling quite hard to areas of the economy that are really looking at these major data center activities. As you know, one of the major pushes of the stimulus bill happens to be data centers for medical activity as an example for the whole information technology electrification of records.

One final thought from me. Pricing, Sandy, we haven't heard much of companies talking price cutting yet in this cycle, in this quarter. How do you see the competition in that regard?

I can't comment on the competition per se, but in terms of our relationships between cost and pricing, they're still very much within the bands that we had in our original guidance and continue to have in our guidance at this point.

Next is Ann Duignan. Ann Duignan JP Morgan: Good morning. Sandy, could you comment on capital allocation and what you called for on the dividend at this point? Just looking at all of the complexities that you're facing. If you could give us some color on what you might be thinking about?

I think from a capital allocation point of view, let me start with just on the issue of acquisitions which often gets asked and where exactly where we have been over the last six months, that we do not expect to be closing any material acquisitions. We just think this is not the environment for that and we're really focused upon being sure that we have a strong balance sheet and that we get our debt ratios in a range that we feel very comfortable with. Don't look for us to be involved in major activity in that regard. From a dividend point of view, we feel very good about our dividend, both policy and where we are positioned. We have not made a formal announcement about our second quarter dividend at this point. We will do that following upcoming board meetings. We feel that the dividend policy is very much in place.

That's helpful. Then, I just want to take a step back to something you mentioned earlier. You said that hydraulics, you were seeing some hopeful signs. Could you expand a little bit on that, Sandy, whether it's mobile, industrial, if you could just give us a little bit more color there, it would be helpful.

I think the comments I'm making are hopefully helpful more broadly because it underpins our broader economic thinking as well. We've been through a sixmonth time period, fourth quarter and first quarter of major customers really trying to think through forward demand. They were coming off a period of expanding demand. As a result, many had put long lead-time orders out ahead of them that had increased many manufacturers' backlog. The fourth quarter and first quarter were a period of time when you saw much of that long lead time stuff all get canceled out of people's backlogs. It has kind of netted out of orders and people are, I think the message is uncertainty, not willing to make longterm commitments, pull in your horns, and do everything on a quick reaction period and there's been a huge adjustment, not only around confidence, but around what's happened to backlogs. We have seen in our hydraulics business most of that activity took place during our first quarter, end of the fourth quarter and so far, I say that so far, through April, we are not seeing anywhere near that degree of kind of cancellation and pulling back in. So, we actually have seen some slight uptick on both sides, the mobile and the industrial. Again, I would say this is a very short piece of information. We're all searching for good news in this economy, so I wouldn't overreact. But what we're hoping that it does signify is that perhaps this all of industry is coming to a more realistic calibration of 2009 activity and, as a result, it starts to make it an easier environment to manage in. Then inventories start to get managed correctly. You start to get the right kind of cash flows. People have their head counts and their manning established correctly, and that is one of the necessary ingredients of a bottom. We're not Polly Annish about it, we think there's probably a second quarter of some additional challenging times. But it starts to set the basis for a 2010 recovery.

In other words, stabilization might be more appropriate rather than ...

I think that's a better way to think about. It instead of continued erosion, maybe the beginning of stabilization.

Next we have Rob Wertheimer.

Let me try a different, Sandy, what I wanted to ask is how you're approaching the sort of cost savings initiatives. You know the weeks of vacation and I guess that totals four, I'm not sure, is a good way to share the pain and keep people poised for recovery, I guess in some ways, presupposes a recovery. Are there any business end segments or end markets where you're assuming a lower level activity for the next couple of years and you're making more permanent cuts? Or are you more or less in your plan trying to struggle through the low period and then assume it sort of comes back in 2010?

Very good question. Let me take you back to end of last year. We announced that we were taking out over 3,000 fulltime equivalent positions in the company then announced in January over another 5,000. We have not assumed that economic conditions come back and look just like they had been. We have taken additional actions to reduce employment further. All those are aimed at being sure that the company is capable of competing profitable and effectively as the markets come back. We are not assuming that they come back to 2007 and 2008 levels. We think that was an extraordinary period of growth, not likely to be duplicated in the immediate near term. Then what we're doing with the more temporary reductions now is ensuring that we keep the right kind of capabilities in the company to assure us that we do well on the upside as well. We're really trying, we adjusted the total fixed costs of the company and now we're taking actions that are addressed at more variable adjustments to enable ourselves to kind of tune ourselves to an economic outlook that is clearly challenging to predict.

I agree. That makes a lot of sense. I guess if I can just follow up very quickly. The sort of fulltime positions that you have eliminated to date, have you hit a point where you have taken out all the fulltime that are easy to do and you would have to cut more of the bone to do that? Is there a step function where you took them out or is there continued more actions to do if you wanted to do more?

It's obviously a question that every one of us who work within the company want to understand fully as well. There what we've said is that with this 15% to 16% market forecast down this year, we think the actions that we've undertaken and the additional ones we're in the process of taking right now will size us correctly. The $55 question, if you will, for growth rates here, Europe, Asia, South America, do we have them calibrated correctly? We have spent a lot of time obviously on this forecast and I think as all of you know, forecasting is really a key part of our business model in terms of being able to set the right level of resources. Our best estimation at this point is this negative 15% to 16%, which, let's recognize again, that's another five points worse than where we thought it was at the end of February, is a major downward adjustment. We think having adjusted costs correctly at that level, we think we're at the right level now.

Just a quick one. The signs of stabilization you might have been seeing in Asia. I know it's obviously a volatile market. What sort of things were those in the electrical segment?

We really saw just massive destocking in Asia, even to a larger degree than we've seen in the U.S. We also have seen quite a bit of destocking obviously in Europe. What has started to change in Asia is that we're starting to see in selected countries some of the projects that can be traced fairly specifically to stimulus bills happening. We're starting to see the absence of cancellation and in some selected lines of business, some significant upturns in order patterns. Again, we would like to sit here and have three months of data to tell you we have seen three months of consistency, we're trying to watch these things week-to-week and month-to-month. That's our best judgment at this point. I think it's too early to go to print to say that we have a recovery underway in Asia. We think what it's starting to tell us is that we're seeing all the characteristics of a bottom. We're starting to see potentially that we may start to be building very slowly off that bottom. And the reason we try to monitor in every one of our businesses is you have to hit a bottom before you can have a recovery. That's what we keep looking for in each of these businesses. That's a region where that appears to be starting to show in the electrical business as well as in the hydraulics business.

I'll stop, but that's not just China, that's exChina, Asia?

There are other elements as well. I would say it gets led by China, but there are other elements. Certainly not Japan, but there are some other countries where we are starting to see some activity as well.

Next in the queue is David Raso.

Good morning. Just to clarify, if I am stating it incorrectly, but the revenue guidance for year. You kind of backed into roughly about $12.5 billion, is that a fair assumption? $12.5 billion, $12.55 billion? Is that the thought for the full year sales?

Again, we don't give specific revenue guidance for the full year, but the pieces I think to look at there again is this down 15% to 16%. You are going to lose about 6% from ForEx. You are going to get about $200 million back from outgrowth, and you are going to get about $300 million from acquisition growth. That would be the model to build it off of.

It's about correct. Can you help us with the core margins, [inaudible] savings, you were helpful in outlining the employment reductions in the third and fourth quarter, the $100 million of savings and the 125. Can you break out the other actions, how you see that playing out in the third and fourth quarter?

The other actions, and it's on that chart 15. If you take them, they will be pretty ratable over the second, third, and fourth.

So that roughly is 40 a quarter because we're 170 for the full year?

I would say they're fairly ratable. They're a little higher in second, third, and fourth because they weren't really implemented until we got halfway through the first quarter.

That leads me to my question. It looks like if you back out those savings, you are looking at a fourth quarter with a decremental margin, still down sales, a decremental of only 10%. That's even pre-savings, that seems like a very aggressive operating assumption. Maybe I am missing something about the mix in the fourth quarter. I am just trying to think through, is there something about price versus cost or am I missing, it just seems that the incremental margins pre the savings also get better in the second half. Is it a mix or a price versus cost something I’m missing?

I don’t think you’re going to find definitives. There are always small, across the broad franchise, there’s always some mix issues. I don’t think the mix and the price/cost relationships are big elements here that would move your analysis a lot in one direction. David Raso – Isi Group: In savings for ’10, you highlight the employment savings in ’10. Can you help us with? There’s 220 for employment savings in ’10 versus that ’09. How about the other actions?

Can you repeat your question once more? David Raso – Isi Group: You mentioned full year ’10 pre-tax savings for the incremental from the employment reductions. That’s $220 million?

$210 million. David Raso – Isi Group: I am looking at slide 14; it says full-year ’10 at $220 million. But $10 million is not a big difference. I am just trying to think for the other cost savings on top of it, obviously everybody is just hoping for ’10 EPS growth and I am just trying to think through a decline in the electrical profits and a decline in aerospace potentially, how much does that chew up of the cost savings?

David, we have, although it’s tempting and everyone would like us to do so, in terms of 2010, we have not provide either market guidance or margin guidance for 2010. It’s one bridge too far at this point. David Raso – Isi Group: At least the other actions taken are fairly permanent savings. We should expect to have some savings in 2010 from those ’09 other actions, correct?

I think the questions are on the other actions and many of those are going to be what the economic conditions are in 2010 and whether we elect on some of those to restore some of those elements or not. Those are future decisions we have got to address when we get into 2010. David Raso – Isi Group: One quick follow-up on the pension. I noticed the higher expense from pension and health care went up from $0.25 to, I believe, $0.32. Can you give us an update on where that is on an EPS basis, but also cash contribution?

The cash contribution is not expected to change. We think the cash contribution will be about $270 million to the collective pension plans, of which about $80 million of that will be outside the states. The rest will be inside the states. You’re right; we do believe that the expense for pension and health care will increase just slightly and you see that on our slide 16 where we previously said it was going to be a higher pension and health care and other was going to be about $0.25. Now it’s gone up to $0.33. You’re looking at an increase something on the order of $15 million. And that’s really a function of in this kind of an environment where you’re doing reductions of staff, you tend to incur slightly higher both health care and settlement expenses for pensions. David Raso – Isi Group: So the uptick is more the curtailment charges. Okay, I appreciate the help.

Next is Jeff Hammond. Jeff Hammond – Keybanc Capital Markets: Could you give me a bridge or a sense 1Q to 2Q you have about a $0.47 swing versus what you reported in the guidance. I understand seasonality, but if you could just help me bridge between those two.

I think two pieces. One as we mentioned our markets were down about 21% in the first quarter. We think they will be down more on the order of 19% to 20% in the second quarter. Remember second quarter is always a seasonally slightly larger quarter. Actually three pieces, a seasonally larger piece than the second quarter; and that’s true in many of our businesses. The third piece would be on chart 14, which would be the employment reductions where you can see there’s a slight improvement in the negative. Then I guess you would also have to take a look at, to David’s earlier question, on page 15 the ratable rate, if you will, of other actions will be stronger in the second quarter than it will be in the first quarter, because they really only impact about half of the first quarter. Jeff Hammond – Keybanc Capital Markets: Okay, then secondly, just given the further downtick in demand trends, have you revisited goodwill impairment testing?

We normally do that every July to September. That’s the time period that we do our impairment test. We last did the impairment test in December of last year. So we’ll be revisiting that at the normal cycle. Jeff Hammond – Keybanc Capital Markets: Thanks.

Next we have Terry Darling. Terry Darling – Goldman Sachs: Sandy, I wonder if you can help break down the changes in the aerospace index, minus one to minus five, between commercial and military? Is that something you can help us with?

I would say maybe a third piece, too, in terms of the aftermarket, Terry, within. When we look into the aerospace business, I would say that the biggest decline that we’ve seen that we think is impacting this year is on the commercial outside of the U.S. And that area has come down, if you go back to the chart on 13. We’ve seen a more precipitous drop there. If you look at what we had been thinking in end of February, we had thought the non-U.S. growth would be down by about 6%. We now believe it will be down about 14%. Whereas the U.S. change went from a plus 1% to roughly flat, if you will. Now, within the U.S., clearly the biz jet segment has been hit really, really hard. That’s probably you’re biggest change. You’ve got people with different forecasts out there about number of planes going to be delivered and all of it. That number doesn’t seem to be moving quite as much as what happened to biz jet, what happened to regional jet. Those areas got hit quite hard. Our defense outlook is pretty similar to where we were originally. Not a big move in that particular area where we had been forecasting, hang on for a second. Internally, though, as I mentioned is where we felt the really big change was. I will give you the aerospace rest of world piece here. In the defense in the U.S. we still had been looking at something growing on the order of about 5%, whereas the commercial contraction is on the order of about 6%. That commercial contraction has the biz jet and the regional jet within it. I would really point you to the bigger change has been the international side. Terry Darling – Goldman Sachs: And you have not seen a step up in your defense orders here, too, as part of the recalibration. You did not take defense for the full year up the way some others did.

We have not taken it up substantially. We will think 5% is about the right number. A lot of people are looking at the recast of what’s been proposed at this point in terms of which platforms. Clearly having a bigger joint strike fighter allocation is good for Eaton. A lot of that impact we won’t feel until we get out a year from now because remember you’re always building six months, seven months ahead of these delivery numbers. So you go to kind of leave lags and stuff. But from we’ve seen, it’s going to be good news for Eaton. Terry Darling – Goldman Sachs: Then two kind of how might this cycle be different kind of questions. The first kind of coming back to your earlier comments on pricing, that you’re really not seeing a whole lot of pressure there. I think obviously everyone is looking at history saying maybe we ought to look for some of that. Is it too early in the process in your mind? Have we just had a lot of consolidation? Is the sort of shift to a solutions-based model for a lot of people? Why would that be different this go-around, particularly given kind of the severity of the recession this go-around, and how low capacity utilization is at the plant level? How do you see the kind of balance of risks here on the pricing issue as we move forward?

Terry, when we talk pricing, we always talk kind of margin preservation, the difference between cost and pricing. What we think has happened here is that you actually got a lead into this recession by the cave-in of commodity prices. So we’ve not seen an acceleration of commodity prices significantly at this point. So the adjustment on the top line has been offset by the input side of things. That’s why we think you aren’t seeing the price/cost margin pressure at this point. That’s not to say that as things re-accelerate and we get out at some time in ’10 and ’11 into healthier markets that you may not start to see some pressure on commodities and then have pressure on the top line. But we’re not seeing that as a big issue at this point. I would say to your broader question about what’s different in this downturn than the other is the fact that it’s simultaneous around the world. We’ve all heard this overused now phrase of this simultaneous global recession. But it really is worth thinking about because what’s happened is that the very fast-growing underdeveloped nations have been hit as hard or harder than many of the developed nations; and that’s this double-barreled impact of FDI flows being so constrained out of the developed nations they’re sucking the cash out of the fuel that’s really helped many of these underdeveloped nations grow quickly. Then those underdeveloped nations that were exporting very heavily to the developed nations lost their customers as well. You saw not only the big downturns in Europe, U.S., and Japan; then you saw these export markets just dry up and die for many Eastern Europe and parts of South America and parts of Asia. So you’ve gotten this real double-clubbing that’s gone on. That has so flattened confidence around the world that I think it explains what you’re seeing with capital spending from companies where people have just pulled back their horns, and it’s going to take a couple of quarters before people start to see some degree of confidence come back and people will start to ease up those purse strings. As a result, we’ve seen both in the fourth quarter, and we believe again in the first quarter, extraordinary deceleration of demand. And beyond production levels, people are really trying to get at inventory levels; and that’s what has led to this enormous multiple of manufacturing production downturns versus simply the GDP numbers. Terry Darling – Goldman Sachs: Lastly, just on your cash flow guidance. I guess I would have expected that it would have been down a little bit more given the degradation in earnings so you’re getting some sort of an offset with even better working capital performance. Are there any other moving pieces there we should be aware of?

I would say the other one is capital expenditures where we now think that our CapEx is going to be around 250 this year. We, too, have turned it down hard. We’ve made real progress in just days on hand to give you an example. We’ve taken six days out of our days on hand since yearend. That’s not an easy thing to do when volumes are decelerating on you. Real progress in that area as well. Terry Darling – Goldman Sachs: And the CapEx previously, can you remind us there?

Previously we were in the 250 to 275 range. We’re now under 250, probably slightly under 250. But really, Terry, the thing to focus on is our working capital. We believe that we will be able to generate improved working capital performance based on the progress we made in the first quarter. Terry Darling – Goldman Sachs: And that’s on the inventory receivables side or on the payables side?

It’s on all three actually.

Next we have Andy Casey. Andy Casey – Wachovia Capital Markets: Couple detailed questions on truck. Within that number, you know it was down more than what the NAFTA production was and you clearly delineated that. Could you help us understand what the NAFTA aftermarket year decline was?

It’s hard for us because part of this gets mixed in to how the orders come in. If you’re looking at the overall market let’s say in the U.S. or NAFTA being down on this order of 40-some percent in the first quarter. We think the aftermarket activity is every bit of that. We have just seen people just halt their orders. For the first time that I can recall, and many times we’re seeing the cannibalization off of existing trucks. I think that gives you some feel for how rough things are. If you just drive by dealer service bays and all, you will see how quiet they are currently. Andy Casey – Wachovia Capital Markets: When you, kind of skipping to that point, when you see the cannibalization, Sandy, and we’ve seen that as well; and it’s highly unusual. Does that indicate that given the recalibration from kind of the big macro change of credit issues kind of clamping down on spending everywhere? Does that indicate that there’s a lot of excess capacity out there in truck, and it may have an unusual down period relative to past cycles?

I think two things to think about. I think one is what was the wisdom about 2009 and 2010 of six months ago it anticipated there would be some form of a prebuy in the fourth quarter of 2009, and then you’d see this enormous downturn in 2010 after the emissions change. We think that is not the right way to think about this. We think that you have a first half depressed by this confidence issue and lack of freight, a little bit of an upturn in the second half that comes from some more freight being carried, but that you don’t get the typical 40% downturn in 2010 that you would have following three years of an emission year. While this year is rough, we think that next year is likely to be a year where you will get some benefit as the economy comes up where that would not have been in any previous forecast for Eaton where you would have been thinking we’re going to have another 40% downturn. So, if there’s a silver lining in the way that this thing lays out, we think it comes back in a fashion that you wouldn’t have expected in 2010 using the old forecast. Andy Casey – Wachovia Capital Markets: Then, lastly, you mentioned it in hydraulics in April, are you seeing any improvement anywhere in NAFTA class 8 in April?

No.

Next we have Mark Koznarek. Mark Koznarek – Cleveland Research Company: Couple clarifications on the cost reduction actions. The additional employment actions where you’re looking at $40 million of benefit, the original $165 million was going to be on staff reduction of 8,000, is that correct?

It was 3,400 plus 5,200, so 8,600. Mark Koznarek – Cleveland Research Company: So then we’re looking at this additional $40 million is probably proportional to that, so it’s another 2,000 or 2,500?

We’ve not announced an employee number at this point. Mark Koznarek – Cleveland Research Company: But that wouldn’t be an unreasonable expectation to just use the proportion?

I think the critical number is the $40 million. Mark Koznarek – Cleveland Research Company: Then the other actions, that’s a week of furlough per quarter coming up for the rest of the year? So three more weeks of furlough?

That plus have impacted a few other internal plans as well. Mark Koznarek – Cleveland Research Company: Then the key question I have is on the international electrical outlook. Because as you just walk through the 2Q to 1Q bridge, talking about how volumes are not going to be that different in 2Q, maybe a point or two better, so I’m kind of guessing that international electrical might be down 14% or 15% rather than 16%. But that implies the second half has to be down only 2% or 3% to get to the down 9% for the full year. So I am wondering if you can explain the dynamics there, how that appears to snap back in the second half?

I think maybe two other comments that we made, if you kind of roll them into your thinking, it may be helpful. The numbers of the 19% to 20% that we mentioned are kind of total company numbers. We did mention that in electrical that it is the region we saw one of the steepest or more vicious de-stocking going on and that has abated significantly; and we’ve seen some encouraging signs there. So we believe that’s one that actually has bottomed, and we’re starting to see a level of improvement in those areas. To your thinking, I think we are seeing some improvement and it is our expectation that one will improve. Mark Koznarek – Cleveland Research Company: So in the second quarter you expect to see a material improvement from the down 16% already?

Yea, and I think the word material obviously is advised for all of us. But we do expect to see an improvement in the second quarter. Mark Koznarek – Cleveland Research Company: But then what about the second half? I mean it still seems like it’s going to be close to neutral.

It should build from there. We think we’ve been through a really vicious fourth quarter and first quarter adjustment. As a result, we think from what we are seeing right now that it’s reasonable to assume that it builds. Mark Koznarek – Cleveland Research Company: Can you quantify the electrical backlog at this point, either in dollars or compared to where it was at yearend or a year ago?

It’s different in terms of how we collect it around the world, so we really can’t quite give you a uniform. I think an indication, though, is that the major project business, which is usually where the backlog is, and the flow business kind of comes in and goes the same week. Our major project business here in the Americas where I feel most comfortable about the data accuracy at this point actually has held up really well all the way through the first quarter, and we had a very strong March again in terms of building backlog. Mark Koznarek – Cleveland Research Company: And then, finally, on electrical is the international March at one point 8%, is there a significant piece of intangible amortization in there based on purchase accounting that rolls off at some point during the year?

That’s not really the cause of the issue, Mark. No, there isn’t a big piece that rolls off, either. It really was the nature of the implosion that we had in terms of the volume and how fast it hit. Mark Koznarek – Cleveland Research Company: So we don’t get any sort of technical pickup at any point later this year as intangibles come off?

That’s correct.

Next we have Nigel Coe. Nigel Coe – Deutsche Bank Securities: A question on inventories. Obviously, the [OCF] guidance for the full year bakes in a fair contribution from inventory reduction. I think this quarter we didn’t really see that coming through. I just wondered if you could maybe comment on where you think the most work needs to be done on inventory reductions and when we might expect to start to see inventories starting to fall.

Nigel, if you looked, you did see the dollars come down a little. If you look looking out, because obviously your inventory is really a function of what you think your future sales are. As we measure that from the end of last year to where we were at the end of March, we were down about six days. So we do believe that we have made significant improvements in our efficiencies, which of course will help us as the markets begin to improve some. Nigel Coe – Deutsche Bank Securities: Just in terms of after inventory levels are down 4% Q on Q, that was my comment.

No, it’s all a function of what the outlook is in terms of sales and the ensuing next quarter. Nigel Coe – Deutsche Bank Securities: Then maybe switching to inventories in the channel. You’ve made a number of comments about the headwind, obviously, from the stock. Maybe you can try and quantify that and maybe toss that by segment if possible?

We don’t share that kind of detail, Nigel. It is very different by segment. But it’s in terms of the specific numbers. I think our sense is that as I mentioned Asia is a little closer to getting through that de-stocking than we see here, particularly in Europe and in the U.S. That’s what we said we think some of this de-stocking continues into the second quarter ex-Asia and by the time we get into the second half of this year, that we’ve largely exhausted the de-stocking activity which then starts to get demand for our products to start to resemble production in these end markets to a greater degree than it has in the first half. Nigel Coe – Deutsche Bank Securities: Do you think industrial production declines of say global IP down maybe say 12% in 1Q, is that a good proxy for end markets and then the balance of the inventories?

You’re on an important point in terms that we generally think the industrial production numbers are three to four times what the GDP numbers are in terms of declines. If you look at the industrial production numbers, we think there has been, because that’s a composite up and down the chain. It should include some portion of this inventory de-stocking in it. We may be more severe or less severe in individual segments, but it’s supposed to be picking up, those numbers are supposed to pick up not only the top of the chain, but right down the chain. So it theoretically should pick up inventory de-stocking. Nigel Coe – Deutsche Bank Securities: Just a final one on the dividends. Sandy, you made a big commitment to dividends on the call. At the low end of the guidance for the full year, we were getting up to, I think [80%] payout ratio. Is there any reason why you wouldn’t be prepared to let the dividend payout ratio go up 100% if we do see some slippage in the guidance?

I think the real question around the whole cash strategy is tied to our market forecast. At this point with the market forecast being down 15% to 16%, we think our dividend policy is in tact at this point. That’s not to say that if something happened significantly worse, which we don’t foresee at this point, that we wouldn’t revisit our overall cash strategy, but we feel very comfortable with it right now. Nigel Coe – Deutsche Bank Securities: Thank you.

Next we have Dan Dowd. Dan Dowd – Sanford Bernstein: Can you just talk about the electrical segment in the Americas? First of all, did I hear you say correctly that in March your backlog was up? Did I hear that correctly?

Correct. Now I’m talking projects, so please be careful with the data. We don’t have a backlog for flow business. Dan Dowd – Sanford Bernstein: But compared to the way you’ve traditionally talked about backlog,

That’s correct. Dan Dowd – Sanford Bernstein: You are actually up in March, whereas January and February were down significantly.

We didn’t comment that January and February were down significantly.

In fact, it’s held up very well all throughout the first quarter in the large project business. Dan Dowd – Sanford Bernstein: Can you just comment on the decrementals in electrical Americas? Was that what you were shooting for in Q1 or was there something special going on about you mentioned the steep decline in short cycle components.

I think if you think about electrical again, maybe three pieces to think about in terms of the mix in the first quarter. Big projects have held up well, both on the bookings and the shipment side. Flow business has been down significantly, and flow business tends to be generally a little bit more profitable than singular big projects. Then the engineering service activity has been simply terrific. That’s a piece that people tend to miss that during this type of an economy, what tends to happen is that many of our customers are reaching out for outside service organizations. You remember Eaton has got a very capable organization in that regard. So both our bookings and shipments up very strongly. Now the margin contributions of each of those are slightly different, but it’s that lower flow business that really contributed to the weaker margin in the quarter. Dan Dowd – Sanford Bernstein: Can I turn to the electrical rest of the world, then? At the risk of looking past the current macro economic pain, how do you think about normalized margins in the rest of world business?

Again, we’re not providing 2010. We came off a couple of years of very strong activity. I think you saw that in our second and third quarters of last year. Fourth quarter got impacted by this very heavy de-stocking. We think that’s happened here in the first quarter again. So I guess I would point you looking back more to the second and third quarter of margins as being more representative, of 2008, being more representative of recent expectations for that segment. Dan Dowd – Sanford Bernstein: So it should be better than first quarter of ’08 that you’re reporting here.

The first quarter of ’09. Absolutely.

Next up we have Ted Wheeler. And I am going to apologize for there are several other people that are on the line that we’re not going to be able to get to on a timing basis. As always, I will be available. We will field Ted’s questions, and that’s going to have to be it. Ted Wheeler – Buckingham Research Group: In your guidance, what is your assumption for the truck de-stocking issue as to when it stabilizes?

We think we’ve probably got another quarter ahead of us, Ted. It’s pretty similar to our thinking across, that’s a pretty good macro for us across all of our business, ex what I mentioned in terms of China. We think it’s reasonable. These things normally go on longer than everybody likes to think they will. I think it would be very easy to declare the de-stocking is over in the first quarter. Our experience says about the time you think it’s over, count on one more quarter. So that’s part our thinking, and that’s what we’ve got reflected. Ted Wheeler – Buckingham Research Group: So the trucking, this issue on timing for truck is pretty similar to the other sectors?

We believe so. Again, it’s going to be related very much to freight and confidence; and those things tend to take a little bit more time to turn than the pure economics do. Ted Wheeler – Buckingham Research Group: And your expression of market in this case undergrowth is a reflection of this de-stocking?

It is. Ted Wheeler – Buckingham Research Group: So you define the market as the build rates of your customers?

Correct.

The reason we do so, Ted, is that we don’t have any external data on actual flows of components. It’s the only objective available data that we can get our hands on. So it’s really just a proxy. Ted Wheeler – Buckingham Research Group: And another question. On aerospace, you talk about in your segment chart, number nine, you talk about a five-year reduction in aerospace sales. That’s for Eaton’s aerospace sales?

Five percent end market decline. Ted Wheeler – Buckingham Research Group: Because that’s on the other page. Okay. Now would you expect a similar pattern for your sales as occurred in the first quarter to continue in aerospace? Pretty significant outgrowth and a pretty heavy ForEx hit?

I think on the outgrowth it’s reasonable as coming out of our backlog, and I think the ForEx hit continues. Ted Wheeler – Buckingham Research Group: So kind of the same pattern that we saw in the first quarter on a relative basis?

Reasonable, yes.

Thanks everyone for participating and, as I said, we’ll be here all day answering your questions and look forward to it. Thank you very much.