Eaton Corporation plc (ETN) Q2 2011 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Cooper Industries plc Earnings Conference Call. My name is Crystal, and I will be your operator for today. [Operator Instructions] As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Dan Swenson, Vice President, Investor Relations. Please proceed, sir.

Thank you, Crystal. Welcome to the Cooper Industries Second Quarter 2011 Earnings Conference Call. With me today is Kirk Hachigian, Chairman and Chief Executive Officer; and Dave Barta, Senior Vice President and Chief Financial Officer. We've posted a presentation on our website that we'll refer to throughout this call. If you'd like to view this presentation, please go to the Investors section of our website at www.cooperindustries.com. As a reminder, comments made during this call may include forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are subject to various risks and uncertainties, many of which are outside the control of the company, and therefore, actual results may differ materially from those anticipated by Cooper. A discussion of these factors may be found in the company's annual report on Form 10-K and other recent SEC filings. In addition, comments made here may include non-GAAP financial measures. To the extent they have been anticipated, reconciliations of those measures to the most directly comparable GAAP measures are included in the press release and the web presentation. Now let me turn the call over to Kirk.

Thanks, Dan. Good morning. We're very pleased to report this morning that we have continued the momentum we discussed in the first quarter of this year. Our results today continue to demonstrate the dedication of our 26,000 employees worldwide, the breadth of our portfolio and the effectiveness of our business model. Despite continued global economic challenges, federal debt, high unemployment, budget crises, commodity inflation and uncertain tax and regulatory environments, we continue to deliver highest mix of core growth and improved operating margins, which allow us to continue to make significant investments in our future. If you turn to Page 2 of the webpages. For the second quarter, Electrical revenues were up 16.8% at $1.37 billion. The core was up 17 -- or excuse me, 12.7%. The Energy & Safety Solutions division was up 22%, with its core up 15%; and Electrical Products Group was up 11%, with its core up 10%. We had record second quarter earnings per share of $0.96. The previous record was in the second quarter of 2008, and that's up 20% from the second quarter last year. Consolidating operating margins came at 15.8%, up only 20 basis points due to some higher legal and some environmental costs. But we had terrific segment margins. At Energy & Safety Solutions, the operating margins were 17.8%, up 90 basis points; and EPG was 15.1%, up 30 basis points, and some nice sequential improvement from the first quarter as well. The Tools equity income was $14.4 million, $0.07 per share down from last year, but up a bit from our forecast. And our free cash flow came in at $217 million despite the significant growth and our ramp-up in SG&, R&D and capital spending, a terrific result. So again, solid, solid core growth and margin improvement and record EPS for the second quarter. If you turn to Page 3, core growth trends are the 3 key points, again, I want to point out. The total Electrical revenues now are still down 10% or $140 million off the peak revenues of the second quarter 2008, where we recorded $1.5 billion in Electrical sales. Again, 1/3 of our portfolio is still tied to construction, which are still at recession lows, so a terrific result on the core growth side with 4 out of our 6 cylinders firing there. And our year-over-year comps now begin to get more difficult when you go out to the third and fourth quarter, and again, you can see that clearly on Page 3. So clearly, the front-end investments that we've made have had a significant impact on our growth -- our core growth rates and our profitability. If you turn to Page 4, the end markets, I'll make a few comments now. The Industrial and MRO markets continue to remain strong. Solid exports, improved factory utilization, auto, truck, machine tool production rates are all up, and strong demand in metals, mining and oil and gas sectors. On the utilities side, very strong demand globally in nearly all the product lines around the world. EAS was up in all product lines, except for the AMI Power Line Carrier technology, which continues to shift from PLC to the Eka RF solutions. And we're quoting aggressively some new projects there, and expect those quotes to turn into orders shortly. On commercial construction, we continue to see it flat, while office vacancies improved modestly and low interest rates are helping, a weak banking sector, insurance industries, high unemployment, federal and state and local budget constraints will continue to weigh on advancing new construction. The good news is we continue to see strong demand in energy efficiency products. As technology improves, costs are coming down and we continue to improve our product offering. Lastly, on the residential side, still pretty tough. Very depressed, tough pricing environment, no evidence of a near-term recovery, high unemployment, a stalled foreclosure process and excess inventory of homes for sale. As we said in the first quarter, maybe an improvement in 2012, 2013 somewhere around the 2% to 4% range. In summary, our heavy investments in our industrial and utility businesses, plus our focus on energy efficiency, safety and globalization, have more than offset the continued weakness in construction. We're very, very pleased with our ability to reposition our portfolio into the right corners of the global economy to continue to realize double-digit core growth in the second quarter. If you turn to Page 5, let me make some comments now on the 2 business segments. Energy & Safety Solutions, again, which is our Power Systems, Crouse-Hinds and Safety businesses. During the quarter, we had very strong core growth at Cooper Power Systems and Cooper Crouse-Hinds, with our European division, Cooper Safety, up high single digits. Developing markets were up over 20%, with total international growth up mid-teens. Our book-to-bill was right at 1. And again, given the core growth rate of 15%, pretty good, and our margins were 17.8%, driven by good mix, disciplined pricing actions and productivity. Our leverage, excluding acquisitions, was at 24%. We continue our positive outlook on ESS, given the strength in our emerging markets, increased oil and gas investments, utility demand on grid upgrades and real -- and reliability and our solid backlog. For our Electrical Products Group, Page 6, again, our shorter-cycle more construction-related businesses still had a pretty good quarter, with the core up 10%. 2 divisions, Bussman and Lighting, were both up double digits. B-Line up high-single digits, and wiring devices only up modestly due to their heavy exposure to the residential construction. Lighting had a solid quarter, driven by renovation retrofit, new products, pricing and growth in lighting controls. There've been a lot of questions around margins and mix and LED penetrations that Dave added to the chart, that he'll discuss with you in a second. I'll just try to give you some clarity on how we see all these playing out. Our total international business was up strong double digits, retail was flat and our book-to-bill for this segment was also at 1. Our margins were 15.1%, driven by, again, good mix, pricing, productivity, and our leverage was at 18%, a little bit soft because of the construction and our inability to fully offset material inflation in some of those markets. We continue to be very pleased with the overall performance of EPG and our ability to continue to sidestep the overall weakness in construction. Industrial MRO, new products, energy efficiency and international continue to allow us to achieve solid results. Now let me turn the call over to Dave to provide you additional details on the quarter and update you on our full year guidance.

Thanks, Kirk. Again, before I begin my comments, as in, I guess, the last year, the prior quarters, many of the slides have been adjusted to include the Tools business from the prior-year comparability, so we've noted that on the impacted slides. Let's first turn to Slide 7, covering some of the highlights. Revenue for the second quarter, as Kirk said, was $1.37 billion, which is a 16.8% increase over the second quarter of 2010. Core revenue increase was a strong 12.7%. Revenue increased 2.5%, as a result of the impact of currency translation, and acquisitions increased sales by another 1.6%. For the quarter, prices were a little over 1% positive, and I'll add at this time, as we expected and included in our guidance, as a result of the pricing actions and material cost stability during the quarter, the net price inflation gap was neutral to margins on a year-over-year basis. So we think that's an exceptional accomplishment as we've been fighting that battle over the last year. I'll talk more about the outlook for the price inflation dynamic when I discuss our Q3 and full-year guidance. Our book-to-bill in total was 100% on a strong revenue base for the quarter. Both groups ended up in exactly 100%. Sales outside the U.S. were 40.3% of total sales in the second quarter. The core U.S. sales were up approximately 11%, and we really saw the nice core increase internationally where sales -- our core sales were up 16%, led by Latin America, Russia and Eastern Europe and Asia. And another positive, we also saw improving sales in North Africa and the Middle East off of the first quarter difficulties in those regions. As shown on this morning's release, we reported $0.96 in earnings per share from continuing operations as compared to $0.80 per share in last year's second quarter. And as Kirk mentioned, the $0.96 is a Q2 record for Cooper and were, again, still not back to record revenue level. Now Turning to Slide 8. Gross margin was 33.7% in the second quarter as compared to 32.6% last year. We saw an incremental base, as the $73 million of additional gross margin dollars on $197 million sales increase resulted in 37% incremental leverage as a result of the pricing actions, the productivity, of course, the sales volume, positive absorption benefit in the factories, and all that despite a continued material inflation drag, and substantial step-up in spending for new product development. The gross margin results also included $4 million of cost related to restructuring and relocation of facilities, which is slightly above last year's Q2 of $3 million. SG&A expense for the quarter as a percent of sales was 19%, which was consistent with last year's second quarter. And again, we continue to support investments in new product development and marketing, and commercial resources being added as we step up the organic growth profile of the company, which, again, we continue to view as extremely prudent in this period. Corporate expense was $24.5 million as compared to $21.3 million a year ago. This increase is also primary a result of growth initiatives and costs related to legal and M&A matters. Now turning to Slide 9. Operating earnings increased 18% to $216.5 million. Our operating margin increased 20 basis points to 15.8 from the adjusted second quarter 2010 operating margin of 15.6% due to the drivers I mentioned previously. I do think it's important to look at the leverage in further detail. While the total leverage of the company was not in the 25% to 30% zone that we've been targeting, 4 of our 7 divisions did preacquisition and restructuring cost impact leveraging that range, so we do have 4 of our 7 divisions leveraging in that 25% to 30% range. The 3 that did not, and obviously levered below 20%, are the more residential- and commercial-facing businesses where, as Kirk said, volume and pricing still a difficult situation, and my expectation is we'll continue to hold back our overall leverage a bit until that volume picture improves. In addition, we're continuing to invest some of the incremental margins, as I mentioned, back into organic growth initiatives. Continuing to Slide 10. Interest expense increased to $17.1 million as a result of debt issued in the fourth quarter of 2010. Also, this quarter, interest expense included the write-off of approximately $700,000 of unamortized cost related to the renewal of our bank credit facility. As a reminder, during the quarter, we established a new bank credit facility. This facility is a 5-year, $500 million facility that was established with extremely attractive terms and rates, and replaces the $350 million facility, which would have otherwise expired in August of 2012. Our effective income tax rate for the second quarter was 19.1% versus 21.2% for the second quarter of 2010. Turning to Slide 11. From a segment standpoint, sales for the Energy and Safety segment, or ESS segment, were $751.1 million, which is an increase of 22% as compared to the second quarter of 2010. In this segment, currency positively impacted the sales by 3.9%, and acquisitions positively impacting sales by 2.9%. This performance, as Kirk mentioned, was driven by extremely strong results at Power Systems and very encouraging strong results at Crouse-Hinds. The segment operating margin increased 90 basis points to 17.8%. Margins for this segment were positively impacted by the strong volume, strong pricing discipline and productivity and, again, still covering material inflation. Additionally, in this segment, of the $4 million of restructuring facility rationalization cost, $1.9 million of that appeared in this segment. Turning to Electrical Products Group on Slide 12. Segment core sales increased 9.6% for the quarter. Currency translation increased revenue 1% and acquisitions added 0.2%. This segment continues to benefit from strong demand for MRO and industrial products and strong demand for energy-efficient lighting products. However, our more residential and commercial businesses continue to see a tough end market environment. The Electrical Products Group operating margin increased 30 basis points to 15.1%. The story, again, was basically the same as with the ESS group, as volume price and productivity were a nice lift to margins with a headwind of material inflation. Additionally, in this segment, there was $2.1 million of facility rationalization costs included in their operating results. Again, we don't have a page on Tools that's worth mentioning, that the business was slightly result -- slightly above our expectations. Sales were strong for the Power and Professional Tools business, strong in the international hand tools, offset a little bit with softer sales in the North American hand tools business. I would add as well the integration and synergy we're seeing very, very well. The business is executing on all cylinders in terms of our initial plans that were established a little over a year ago. On Slide 13, certainly a much better quarter than our first quarter for cash. Free cash flow for the quarter was $217.3 million. The growth in sales especially international continues to put pressure on our cash generation due to the working capital requirement. You'll see on the next page, we continue to make progress on improving our working capital returns. Capital spending for the quarter was an increase of $8 million over last year's Q2. During the quarter, we also funded the asbestos trust, and we talked about that extensively in our Q1 call. This was a cash flow -- cash outflow of $250 million, which is excluded from this free cash flow calculation. So in summary, our balance sheet continues to be in great shape, with our net debt to total cap at 12.5% at the end of the quarter. We ended the quarter with $900 million of cash, so we continue to be in fantastic shape to fund the core, pursue attractive M&A opportunities and return cash to shareholders. Turning to Slide 14. As I mentioned with the previous slides, the team is continuing to work diligently on improving our working capital metrics to offset the cash we use resulting from a strong top line growth. Inventory turns were 7.3 as compared to 7.1 a year ago, and with -- our DSO increased slightly from prior year from 60 to 61 due in part to the international sales mix and timing of the collections. DPO improved to 49 days, as compared to 48 days a year ago. So all these results in working capital turns of 6 compared to 5.9 in the second quarter last year. On Slide 15, capital allocation. As I mentioned, CapEx did increase $8 million over last year, as we spent $23.2 million compared to the $15.5 million in the second quarter of 2010. We also repurchased approximately 500,000 shares of our stock during the quarter with issuance of almost $500,000 for option exercises 401(k) and other programs. On Slide 16, it summarizes our Q3 and full-year outlook. For the third quarter, we are forecasting revenue to increase 9% to 12% with the ESS segment, up 12% to 15%, reflecting the continuing strong utility and industrial end markets; and the EPG segment up 6% to 9%, reflecting strength -- the continued strength in industrial products and energy-efficient lighting. We're projecting GAAP earnings per share to be in the range of $0.98 a share to $1.03. At the midpoint, this will be the first time in our history where we've exceeded dollar share from a continuing operations basis. The second quarter tax rates used in developing this guidance is a range of 16% to 18%. We're expecting the income for the Tools equity investment to be approximately $18 million for the quarter. For the year, we're increasing our revenue forecast to reflect the full year increase of 10% to 13%. This is an increase from the prior guidance of 8% to 11%, and we're narrowing the earnings per share outlook for continuing operations including restructuring to $3.80 to $3.90 per share. We expect the price inflation gap to be neutral to earnings in each of the third and fourth quarters. Based on our projections for input cost, we're continuing to implement further price increases in certain divisions to achieve this neutral outcome. We expect the income from the Tools investment now to increase our prior guidance of $60 million now and increasing that to $65 million for the full year. We expect the full year tax rate to be 16% to 17%, as I mentioned, with the third quarter of 16% to 18%, and therefore, the fourth quarter in the 14% to 15% range. We're also adjusting our CapEx guidance slightly today from -- due to the expected timing of certain large projects from the prior guidance of $120 million to $140 million to a current guidance of $110 million to $130 million. So we're continuing to push for the target of 100% cash conversion, although, as we've mentioned, a difficult goal given this year's growth in CapEx. Before I turn the call back over to Kirk, as he mentioned, I'm going to provide a little commentary on the topic since I got a fair amount of airtime, that being the impact of LED component cost decreases on our Lighting business. So we've included the Slide #17 as an illustration of the impact. The slide assumes a static volume index of 100 and projects the LED mix change and resulting impact on sales and margins. The end summary is that given the expected cost deflation in LED component cost, this will all end up with a net positive in terms of sales and margins. The reduction of component cost will assist as retail prices will come down in the conversion to LED products. But given the ASP difference that exists today and that will be maintained, albeit to a lesser degree, it will end up being a positive impact to the sales line. And assuming we pass only the actual cost deflation through neutrals on the margin percent. So on a higher sales base, growing sales in a static volume environment, maintaining neutral margin percent, it will be accretive to earnings in an absolute sense. So we see this as just a tremendous opportunity as the world moves at a faster pace to more LED products. So now I'll turn the call back over to Kirk for concluding comments before the questions.

Great. Thanks, Dave. Page 18 is also new to our traditional deck. A lot of activity going on, on the M&A side. As you know, back in June, we announced the possible cash offer for Laird plc, which is a U.K.-traded company, but with its operating headquarters in St. Louis for 185p per share, approximately a 35% premium to its then existing share price. Laird had over about $900 million in revenue in 2010. It has 2 primary businesses, almost split equally, plus or minus 5%, between the performance materials business, which is EMI shielding, thermal management and signal integrity products, and wireless systems made up of handset antennas, industrial controls and wireless infrastructure antennas. The combination of Bussmann and Laird would create a compelling global suite of protection components, radio devices, wireless controls and power management products. Because this is ongoing -- an ongoing process, and the U.K. has very strict rules regarding ongoing transactions, we'll not make any further comments regarding this pending opportunity or take any questions. As you'd also imagine, there are many other activities going on, on the M&A side. Last week, we announced the purchase of Gitiesse. Gitiesse manufactures an integrated communication system, which is the central communication system for ships and offshore platforms in oil and gas. And it enables the communication systems of these vessels and platforms around fire alarms, public address systems, radio, televisions, surveillance CCTV, intercoms, telephones and computer data network systems. The Gitiesse solution provides major savings in cabling, labor installation, maintenance and power management, by laying multiple network systems into an open architecture, very flexible Ethernet system. This is a perfect fit to our MEDC and Hernis businesses, and will provide a platform for future acquisitions. If you turn to Page 19, this is a slide that we've used for many years, reminding you of our 12 strategic growth platforms. Gitiesse, of course, fits nicely with Crouse-Hinds instrumentation and our Cooper Safety business, and Laird fits nicely with the Bussmann electronics and transportation businesses. Again, we're looking at many other acquisitions that would fit nicely into these existing 12 platforms. It's also probably a good time for me to remind you of our acquisition criteria. We buy what we know that strengthen the core of these existing platforms. We focus on technology and high-specification businesses, and we look for businesses that expand our international footprint. Many different deals in the pipeline. As we talked about our outlook, we serve $140 billion total available market. We stay disciplined on price, and we will focus on returns for our shareholders. If you turn to the last page, Page 20, in summary, terrific second quarter. Our core growth rates reflect the investments that we've made in the portfolio over the past several years. There's improving global markets, and our bigger focus on industrial and utility are paying off nicely. We're seeing accelerated growth from new products and acceleration of the growth on these new platforms and we've improved our exposure to the international markets. Again, about 40% of our sales now are outside the United States, $1 billion of that were 20% from developing economies now growing over at 20%. Productivity and cost structure are aligned. We're bumping up against record margins from 2008 on, as Dave said, significantly less revenue. And we had finally caught up on the material inflation pricing issue and, again, probably took us a quarter or 2 too long, but we are at parity, and we'll have some more actions in the back half of this year to make sure we stay at parity throughout the year. And again, we have exceptional balance sheet with strong cash flow that provides us great flexibility. We talked about the M&A. We continue to fund the core, customer loyalty, innovation and globalization. Again, our SG&A and R&D are both up commensurate with our revenue, so that's about a 16% load year-over-year. And again, we continue -- we will continue to focus on our shareholders, with our dividend up 7% at our stock buybacks. Also, as Dave said, we expect to be in the $3.80 to $3.90 a share this year, which exceeds our record of 2008 of $3.59 and, again, expect the third quarter to exceed $1 a share for the first time in the company's history. With that, I'll turn it back to Dan to take your questions.

Thank you, Kirk. [Operator Instructions] Operator, we're now ready to open the lines for our first question.

[Operator Instructions] And our first question comes from the line of Jeffrey Sprague with Vertical Research.

Kirk, could you spend a little bit more time on the spending on new products and how that's influencing your organic growth rate? And I've got kind of a subtext to that question. Your price realization in the quarter actually seems to be kind of below the industry. Wesco and Grainger are saying they've got 3% price this quarter and the electrical products guys that reported today are saying they are 2%. And you guys are at 1, and appeared to be investing more in new products. I don't know why that wouldn't materialize in a little bit better pricing or pricing on par with what they're seeing elsewhere in the industry.

Yes. So let me take the first piece. About 5 years ago, we started measuring our vitality index. And as a company, we were down around that 7% number, which was horribly low. And so for a company that had these businesses and this breadth of scale, and acquiring these higher-growth platforms, we felt it was important for us to get the vitality business -- index up significantly. So that starts with people. So many of our businesses didn't even have VP of Engineering, a responsibility that reported in some marketing or had just diminished those responsibilities in the organization. So now all the businesses have VPs of Engineering. The second piece you focus on is process, and so we went out and rolled out a very disciplined tollgate process, using marketing on voice of the customer and different tollgates for different stages. And then lastly, significant funding. And so more junior engineering resources in the company and a lot more innovation around local markets, local economies for the penetration in those local markets. So that's where the money has been spent, and we've seen terrific results, where our vitality index has gone from 7 to 24. We'll bump up against 30%. We have significantly higher core growth in the company, Jeff, than we've ever seen in our history, and we want to make sure we can maintain that level of organic growth. We certainly have the money. The best IRR projects in this company are always the organic projects, and so that's where we get our best return. We measure ourselves and we get the money back out of it. You want to take the price?

Just remind you, I did say it was over 1, so not to imply it was 1. So we were north of 1, but rounded to 1, not rounded to 2. As always, we're a little thoughtful about helping our competitors do much on what we're doing in pricing. But you can imagine it does vary significantly by division. I've got some divisions whose price realization was actually closer to 3% to 4%. On a SKU basis, there were increases that probably range from low-single digits to high-single digits. So that's the diversity of the business we have around the world, a lot of different results, and again, the overall average between 1 and 2. And how we measure that, I think, is important as well. We measure that based on SKUs sold today versus the price of the same SKU sold a year ago. So a new product would actually not factor in to that price equation. We don't look at it in terms of like an average selling price movement year-over-year. So that had to be a SKU that was in the business a year ago and how that compares to that same SKU currently. So new products would actually be excluded from the calculation, and you're right. You're obviously designing those products in mind of trying to improve your overall margin mix with the new products. So -- and then as you look at the mix of our businesses, there are certainly some situations where you have long lead times. Some of the lighting projects, some of the power system projects where you may or may not be able to adjust your price once you've got an initial quote. So it's got a mixed bag. But overall, again, we were -- we recovered by the inflation. Again, it's nice to see material cost somewhat stable in the quarter. As we look forward, we've seen copper already move back up in the more mid $4.40, $4.50 range, up from the $4 range. And as I said earlier, we're going to continue to push, and we do have some increases that have just gone in for certain businesses that will impact the second half of the year, but I've been very resolved to offsetting and neutralizing commodity inflation as we move forward.

And, Jeff, also I know Wesco particularly well. Their business is more industrial, and so it will be Crouse, Bussmann, B-Line. They are not very big in residential. I think they have a small piece in commercial construction, but they've always been a more industrial utility type. I don't know about Grainger is in market exposure as well.

I mean, that's even further off the mark. And then just one other question kind of thinking about this. So everyone is getting some pricing in varying degrees, and there's more coming. I guess there's some risks to demand destruction at some point that we all have to think about. But switching to Lighting actually, with the deflationary impacts on LEDs, I'm wondering how you're seeing kind of the payback balance play out in favor of the customer looking at a retrofit in that market? And appreciating the slide you gave us is just an illustration, but can you give us some sense of the scale of that chart in terms of kind of the speed of the ramp that you see this transition taking place?

There's certainly a lot of different, I guess, estimates out in what LED component costs will do. And again, it's important for us to realize that a reduction in LED chips and drivers and other LED components is actually, it's a good thing for us. So we're not selling those things. We're selling part of their input cost, and input costs are going down. We're going to pass that through because that's probably what the industry will look for. So again, we'll bring retail prices down, our end-user prices down, help that adoption of LED products. And today, depending on the product, it's hard, as we struggle to put together that slide, we had to do a fairly generic slide because there's all kinds of different products and relationships. But the fact is today, the average selling price of an LED versus an equivalent incandescent can be 3, 4, 5 to 1. So as those costs are coming down, and I think we used 15% type deflation on just the LED components alone, pass that through and looked at it in terms of whether it's 15 or 20 or again different industry views on that. That cost decrease passing that through with the adoption rate improving, we still maintain a pretty significant ASP difference at the end of that 5-year period. So average selling price overall in the Lighting portfolio will be up, and we're passing through just the cost decrease to maintain the margin percent. So in a static volume environment, ASP differential still stays at a multiple, whether that goes from 4 or 5 to 1 to 2 or 3, it's still significant increase, and again, revenue increase, margin dollar increase, maintain the margin percent.

And as your average selling price, Jeff, keeps coming down, the benefit, the net benefit payback on energy efficiency continues to cross over and gets to a shorter and shorter period, which drives more adoption. So I think you're kind of getting at that cusp now. You saw this early on in just automotive dashboards and stoplight intersections, and now you're seeing it penetrate much more wider applications, still not overly economical for residential, but again, you're going to cross over those points. You're going to see the adoption rate accelerate.

Our next question comes from the line of Deane Dray with Citi.

Just to clarify on the price question again. I'm sorry to keep coming back to this. There, you talked previously about a 3% to 7% list price increases that we're beginning to take effect. Have those all been implemented? And what has been the realization?

I would say -- what we talked about earlier this year, obviously, has all been implemented, and I think the reception was pretty well. And in fact, as I mentioned, in couple of our businesses, another round going in the back half of the year, those being situations where their exposure to certain commodities is greater. So we were seeing more inflation or potential for more inflation or have more difficult time passing those through. The realization across our businesses has ranged from good where volume is strong and demand is strong to, as I mentioned earlier, some of our more residential and commercial construction-facing businesses obviously a little tougher environment. So I think overall, the realization, the reception has been as good as one could expect any time you're out raising prices to your customers. And I did mention that you don't get that 100%. I wish it were a case where if you go out with 4%, you get 4% across $5 billion. It doesn't work that way because of every product is different, every business is different, the competitive set is different. You've got some situations, as I mentioned, where you quoted something sometime ago that you maybe locked into that, so you may be delayed in raising your price. You certainly have customers that have lead time notifications. So it's not as clean as you go out with a number in 20 days or 30 days, you see that number pop up. It actually gets blended a lot more. But I would say, overall, pretty successful given what still certainly a weak environment in certain end markets.

Great. And then on the third quarter guidance, how much restructuring projects are you anticipating and including in that guidance?

I would say it's probably similar, probably in the $4 million range.

So similar to what we saw in the second quarter?

Right, similar to this quarter.

And then just last question, on that M&A update, which was very helpful. And, Kirk, you went through the objectives and the strategies and the thresholds that you look for. Is it safe to say that you don't pursue an investment if you can't get full due diligence access?

Yes, I'd rather not comment, Deane. I mean I think we're sort of in a process now, and it's sort of an ongoing fluid process, and I'd rather just sort of stand down on that.

Okay. And then it was interesting on the slide on Laird, it does referenced a wireless and antenna business, but we also saw an announcement that, that business was being divested. Is that accurate?

That's correct.

Our next question comes from the line of Christopher Glynn with Oppenheimer. Christopher Glynn - Oppenheimer & Co. Inc.: I appreciate the book-to-bills in the segments, but pre-ESS, I was wondering if you could comment or disclose what the backlog is and also how you think about what sort of visibility longer term you have at Power Systems into 2012, or at least some qualitative thoughts there?

So these guys are going look up the backlog real quick. But I would tell you that the oil and gas large projects globally is doing very well, and so we're beginning to, not only participate in the MRO, the upgrade side of the Crouse side of it, but also the exposure we have on the international with the 4. We've made now 10 acquisitions in that oil and gas space, so getting our fair share of all that. On the utility side, I had dinner with one of our large customers last night who was in town. But the way they get a return on investment, of course, is to put more capital deployment. So his view of the world was cheap cost to borrow, old grid, not easy justification through the regulatory commissions and such, but most of the utilities are aggressively repairing and fixing old grid. Reliability still seems to be a critical theme, and we expect that trend. And everything that we saw in the quarter for Power Systems would indicate that, that trend continues. So the only issue where we had was the Safety business, a little softness in some of their commercial construction markets in Europe. But as I sort of said, the growth there, the core growth in Europe were still up kind of high-single digit, so not too bad of a core growth rate there. Dave, you want to comment on the backlog?

Sure. The backlog for ESS was over $500 million, so around $530 million, which is pretty close to 100% and consistent with the first quarter ending and, again, more weighted, as you might imagine, with the Power Systems business. So pretty strong backlog given the kind of sales we're seeing at the door as well.

Our next question comes from the line of Rick Kwas with Wells Fargo Securities.

Just a quick question, Dave, on R&D. What's the dollars spend here year-to-date and for the quarter? And how does that compare to a year ago?

I have to look for the absolute total dollars. I think the first quarter, we were -- the increase was around $7 million year-over-year, and I think similar type number as well, but let's see, the year-to-date, $44 million -- sorry, that was first quarter and $47 million, so actually a little bit of a step-up, so $44 million, $45 million in the first quarter, $47 million in the second quarter and, again, probably a step-up of $15 million or so year-over-year.

And then, Kirk, just longer term on outlook, you talked about a 30% vitality rate. I think you were at 24% last year. What's the progression to get to the 30% level? How long did that take? And with the portfolio where it is, any gaps there, whether it's through M&A or where you're making internal investments that are going to either slow or enhance that pace to get to that level?

Well, the Lighting business, because of its transformation of the source, of course, just drives the hell out of it. The Crouse business has historically been a little slower because of just the nature of the beast. But I expect -- we've put a lot of investment on the Crouse side in engineering and marketing, so I'd expect you're going to see a higher number there. We're seeing it trend up already over the course of this year, so we'd be maybe even closer to sort of somewhere between 25% and 30% midpoint as we kind of get through this year. It's the nature of the beast; right? The businesses that you buy, the ones that you look at on the electronics side and on the instrumentation side, on the Ethernet side, just have a higher vitality index to them. And that's sort of our focus in our strategies. Actually, that's one of the key themes that we've been driving. And then also on the international. We're trying to develop much more of a local product portfolio in those local markets. So it's not shipping designs over from the U.S. for China but trying to do more local designs for the local Chinese market, et cetera, around the world. So I think in the next 2 years, probably you're going to get to the 30%. There's not a sort of an absolute number that we look for. But of course, more is better in this case for us.

And then just lastly, does that 30% assume acquisitions? Or is that an organic number for you?

No, it's an organic number. We don't count the acquisitions in that. I think we have to be in a portfolio a year. And then we match them up against previous year and then they become an organic piece to us. It's a pretty pure metric.

Our next question comes from the line of Julian Mitchell with Credit Suisse.

I was just wondering on the sort of the year-on-year progression in profit growth, and what's implied in your guidance for Q3. If you look at the gross margin, that grew x Tools about 30 bps year-on-year in Q1 and over 100 bps year-on-year in Q2. Your comments suggest I guess that sort of progression in gross margin year-on-year should continue into Q3 and Q4. Is that right? But your earnings guidance suggest a slightly lower increase?

Yes, I think your -- as we progress forward, we're seeing a lit bit of a business mix change that kind of softens that a bit. So if you go back 6 quarters, we saw some of our higher-margin, earlier-cycle businesses take off. You're now seeing the utility strong for a year, so its impact on the top line growth is still strong but not as strong. Our later-cycle Industrial business like Crouse-Hinds coming on have been strong now for several quarters. And as we look forward, some of the, I just call it later-cycle type businesses, which I think we've said in the past are fleet average to some of the cases below get a little bit stronger, so that softens a little bit of that impact though. The top line type growth, the business mix underneath changing impacts that a bit as we see some of these settle in a more normalized pace.

Okay. And then just secondly on utility. You touched on it I think in response to an earlier question. But ABB was saying today that their Power Products business in the U.S., the sort of the order growth intake is accelerating. I think on the previous call of Q1, you said that you think because of comps, your own utility business starts to slow down or decelerate somewhat towards the end of the year. Do you still see that? Or you think the order pickup is sufficient to drive very strong utility growth sort of through well into next year?

Well, we saw the momentum, Julian, just stay kind of where it had been. And if you look at my comments on the end market, I did use the word "continues very strong." So I would say that maybe we were a little bit cautious but don't see any reason to be cautious yet. Order intake was still very strong. And if you look at that by product line, really strong around the world. So I don't see any softness at this point in the momentum that we have down at the Power Systems business.

And if you look at fourth quarter of last year, I think one of the reasons we made that comment, the utility business, Power Systems business, was up over 20%. So to think that they'll have a headline of up another 20% is not really realistic, that this is getting dropped in the zone of 30%, the downturn. So they've got back 20% of that. It is continuing to climb back, and certain products probably will be more prerecession levels. So they won't print a 20% on top of a 20%. It will obviously look like a much more modest headline than what we saw in the fourth quarter of '10.

Our next question comes from the line of Anthony Kure with KeyBanc.

I just had a question on how Bussmann performed during the quarter, and I guess what's factored into the guidance as it relates to the electronics market? Just saw some negative sentiments from some of the electronic manufacturers. I'm just interested in your take in that market?

Yes, so 3 segments . There's the Electrical segment, which is the traditional fuse segment. There's the electronics, as you mentioned. And there's what we call transportation, and for us transportation is not so much automotive. It's more large Class A. And so the electronics was the softest of the 3 segments, up high-single digits. The other 2 were up exceptionally well, both double digits. Now again, I'd be a little bit careful because we've been seeing and experiencing tremendous growth there now for the better part of a year. So you're starting to get up against some tougher comps, but I'd still characterize high single digits as being reasonable core growth around the world.

Okay. That's helpful. And then just to maybe review the restructuring impact. I know that's factored into your numbers, but you said it was $4 million here in the second quarter about and that's sort of what's factored into the third quarter another $4 million. Could you just remind me what's factored in? What was the first quarter number on that?

I think it was around $3 million, $ 3.5 million.

And then would that be -- would that $3.5 million to $4 million be reasonable to expect for the fourth quarter also?

Probably in that zone. I'd say $4 million is, again, is a guess at this point.

Our next question comes from the line of Shannon O'Callaghan with Nomura Securities.

So in terms of just the leverage you're getting at this point, I mean your organic growth is really strong and the mix looks pretty good. So what is it, I mean, when you think about that high end of the 25 to 30 versus something now at about 20, what needs to happen to make that leap?

So what I'd tell you, the first couple of quarters of the last was price. And what I'll tell you that's different now, Shannon, is a direct investment back into the core. So we're getting 0 leverage on SG&A in revenue. So if you look at the last 3 quarters, I see no reason at all to mitigate or constrain our investment back into the core. So we're letting the SG&A percent stay flat. And if you look at the core growth rate over the last 3 or 4 quarters, that is the most aggressive core investments we've poured back into the company. We're doing absolutely nothing to drive productivity on what we call sort of the fixed cost or the overhead structure of the company. We're building new companies in Brazil, building new factories in China. We are ramping up R&D. We're adding people to the global oil and gas sales team. We're going after with a vengeance, trying to get into all these corners of the world simultaneously. We're hiring national executives around the world, and I think that's the right thing to do. It's not going to pay off this year, but when I look out over the next couple of years, we will hope not to starve the core. We're doing a whole new relaunch on the website. We've done C3. Just a number of different activities going on around the company that we're not saying no to. And I just think it's a great environment right now to be adding a lot more to the core growth of the company. And you said that the core growth rate has never been stronger. And frankly, when I read all the other peer comparisons, and segmentation comparisons of all the industrials and our peers, I'm pretty happy with where we are.

So when do you think you'll cross that point of -- not necessarily taking a foot off the pedal but at least letting a little bit more of that SG&A leverage flow through. Is that a 2-year event?

I think when you run out of good ideas, because everything we look at, Dave and I look at each other and say why wouldn't you do this, why wouldn't you fund this. And so I think it's a different company, and it's got -- because of these acquisitions, because of the global nature, because of the leadership that we've got out there, we -- our guys are banging down our door to go do more. And I don't know that you center that back anytime soon. If you look back at some of my lessons learned in my career, it's because you do pull back on it. Had we not built that LED lab 2 years ago, where would we be today? If we had not done all the wireless work that we did with Cannon in the Power Systems business, where would we be today? And so every time we do it, we're very happy 2, 3 years later that we did it. So I'd tell you that the new business model is to continue to pump that money back into the core, and give our teams the ability to go back and reinvigorate their own businesses organically.

Okay. And then just for a second one, just kind of a tax question. It seems like you're tracking a little better this year. As you're thinking next year, are we still thinking about mixing up at a 35% incremental? Or is there more that's been done on a tax planning standpoint that we might get a better tax rate than that?

Until we get our business plan done and I really get to see the distribution of income worldwide, hard for me to give you anything other than that type of a view. So I would use that for now. So there's been nothing really structurally changed in a significant way. But again, as we've talked about, we continue to really try to drive our operations outside of the U.S., and that may end up being a help, but I think you'd be safe with that view on incrementals at that point.

And is that what made it better this year, just sort of mix of where things were earned? Or was there something different?

No, nothing really structurally different. It comes down to the mix of income probably as much as anything.

Our next question comes from the line of Terry Darling with Goldman Sachs.

I guess question on the second half organic, Kirk. Have you actually lowered expectations in the second half? Did I miss something earlier in that regard? I'm just clarifying that, first off.

No. If you go to Page 3, we just come off against tougher comps, Terry. So no, I don't think that we -- the businesses that have been -- I just don't think we see a dramatic improvement, and I may be wrong here, but in commercial, non-res construction, and I certainly don't believe you see any dramatic improvement or any improvement in resi. I think it just sort of comes along. So I'm not suggesting that either of those get worse, but we're not counting on either of those getting better. Now again, UTX had some terrific number out of Otis and Carrier, which would suggest that maybe we're being conservative there, but I don't know.

And that's kind of where I was going. I mean the comp is about 300 basis points tougher, which would take you to 9, which is the high end of your 6 to 9 core there. And I guess that's what I'm wondering. What are the elements of the scenario that would take you to 6 if you fell off that much, basically cutting core in half sequentially if that happens? So that's just construction markets? I think getting worse, it's going to...

Yes, I think because the Crouse oil and gas energy stuff, we had pretty good visibility. The order rates are good. The utility business has a little bit better visibility, the order rates, the backlog. It would be Europe -- uncertainty in Europe -- I understand they cut out a deal of refinancing the Greek debt again, but it would be Europe where we had some more of a commercial construction, central battery, emergency lighting. There's a piece of that there, and then I would say it would flop all over to the U.S. construction markets would be other piece of it.

Okay. And as you think about the non-res landscape for 2012, are you thinking a little bit more cautiously on that front? Or is it too early category? Or where are you with that?

No, we're being conservative. I mean, again, I see -- I'm looking at the HVAC guys for numbers. I'm looking at Otis for numbers. I'm looking at every indicator so I can try to figure out what's going on out there. Interest rates are cheap. Vacancies are getting better. Some real estate prices are going up. But boy, I struggle with all the other headwinds you see on the federal deficit, state problems, local municipalities, the insurance business, the banking business. It's just tough to figure out how it gets significantly better from here on the short term.

On the investment -- incremental investment that's weighing down the incrementals, is there an annual all-in number that you can help us with on that to try to get a sense for what that step-up has been? And I know it's a lot of little things, but some sort of an aggregation would be helpful.

The first quarter I think we said from an incremental kind of SG&A and engineering investment, we are around the $15 million mark, and I would say it's a similar number this quarter where we haven't really continued to accelerate, but maybe modestly. So I would say in probably for this year we'll be in the neighborhood of $60 million, $65 million in terms of what we would -- could point out as being more incremental decisions we made to invest.

And just if I could squeeze last one in. David, I think you just called out Tools profit contribution 3Q at $18 million. And I guess I had a sense that there was a whole bunch of restructuring going off that would kind of scale back in steps. Is that what's happening in the third quarter? Are you starting that process of scaling back the restructuring to where there's visibility and continued improvement even if the underlying is flattish you move into the fourth quarter?

Well, I think that the restructuring that we laid out when we put these businesses together was a 3-year plan. So you really got a lot of things going on over a 3-year period. Certainly, there are some things starting rolling off, some of the earlier projects they had. So we are seeing some of that roll off. At the same time, they're rolling on some of the projects that we have later in the plan. So the business is performing well. As I said, the sales have been up nicely over the last 12 months since we put these businesses together. The restructuring to date have been impactful and helpful. But again, they're going to continue to do more, but you are seeing the benefit of some what they started a year ago when we put these together.

Our next question comes from the line of Josh Pokrzywinski with MKM Partners.

I just wanted to dig in here on some of the comments on Europe, for Safety. I mean more caution on the ground there? Or are you guys getting a sense of we're just kind of in an air pocket wall? I guess what are you hearing from your customers there?

Yes, I'd say more caution. There's pieces of this business, the oil and gas piece of this business. The Middle East had a good quarter. We're probably seeing some double-digit growth out of the Middle East, anything to do with the energy, mining. But the other piece of this business, you had a piece in Greece and Italy, and construction-related businesses in the Mediterranean markets, very difficult. Germany is doing well. France is doing reasonably well. U.K. is slow, and Ireland is slow, of course. So it's a mixed bag, especially if you're on the construction side. But yes, with all the financial issues around Europe right now, anything related with construction right now is a little bit more difficult.

And again, we're more weighted to kind of north part of Europe than the South. So Spain and Greece, not overly troublesome, but obviously overshadows the rest of Europe, as you can tell this by watching CNBC in the morning. So again, it's a nice pocket of the business, but again, it's very slow. They were still positive x acquisitions, x currency. So they're somewhat positive in a very, very tough environment.

Overall, high-single digits for the overall business core growth.

I guess are you hearing any concerns from your customers or any feedback that financing has gotten more difficult in some of those Northern markets which have held up better?

I couldn't answer that.

Yes, nothing that's been brought up by our guys over there, so it doesn't appear to be an issue at this point.

Okay, and if I could just squeeze in one last one here on price cost. Typically, you guys are kind of net beneficiaries there, and you seem to be more couching it toward kind of flat here in the back half. When do we get back to the point where you're ahead of the curve on price cost? Is that in 2012, or kind of as soon as commodity has flatten out?

Well, you got to get demand back on construction. I think Jeff asked the question at some point, how hard can you push pricing to sort of demand; right? And I start and Dave made a point a couple of different times. We're getting price in oil and gas. We're getting price in utility. We're getting price in some of those spots where the demand is up. We're back to '08 revenues. But in housing and in commercial construction, I just think it's going to take a little bit of a demand curve to reappear before you can get positive impact, of net impact positive price. But certainly, that would be something in the back of our minds is trying to get net accretive to margins. I think your question's a good one. I'll ask the division president.

That concludes our question-and-answer session for today. I would like to hand it back to Dan Swenson for closing remarks.

We will be filing our Form 10-Q with the SEC sometime in the first week of August, so keep an eye out for that document. Thank you, everyone, for participating in today's conference call.

Ladies and gentlemen, that concludes today's conference. Thank you so much for your participation. You may now disconnect, and have a great day.