Oct 15, 2007
Executives
William C. Hartman - IR Alexander M.
Cutler - Chairman, CEO and President Richard H. Fearon - EVP and Chief Financial and Planning Officer
Analysts
Ann Duignan - Bear Stearns Stephen Volkmann - Morgan Stanley Dean Witter Andrew Casey - Wachovia Securities Robert LaGaipa - CIBC World Markets Jeffrey Hammond - KeyBanc Capital Markets David Raso - Citigroup Smith Barney Jamie Cook - Credit Suisse Terry Darling - Goldman Sachs Mark Koznarek - Cleveland Research Company Joel Tiss - Lehman Brothers Eli Lustgarten - Longbow Research Andrew Obin - Merrill Lynch
Operator
Ladies and gentlemen, thank you for standing by and welcome to the Eaton Corporation Third Quarter 2007 Earnings Conference Call. At this time all participants are in a listen-only mode.
Later, we will conduct a question and answer session and instructions will be given at that time. [Operator Instructions].
As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Vice President, Investor Relations, Bill Hartman.
Please go ahead.
William C. Hartman - Investor Relations
Thank you and good morning everyone. Welcome to Eaton's third quarter of 2007 earnings conference call.
Joining me this morning are Sandy Cutler, Chairman and CEO; Rich Fearon, Executive Vice President and CFO. And as you all know, our practice has been we'll begin today's call with some comments from Sandy and then it'll be followed by a question and answer session.
As a reminder, the information that will be provided on our call today will include some forward-looking statements concerning the fourth quarter full year 2007 net income per share, operating earnings per share, statements on our worldwide markets, our growth in relation to those markets and our growth from acquisitions and joint ventures. Those statements need to be used with caution as they are subject to the various risks and uncertainties, many of which are outside of the company's control.
Factors that could cause these actual results to differ materially from those in the forward-looking statements are set forth in today's press release and our related Form 8-K filing. Additional information is available in today's press release which is located on our Corporate News heading on Eaton's homepage at www.eaton.com.
And with that, I would like to turn the meeting over to Sandy. Sandy?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Great. Thanks Bill and good morning everyone and welcome.
I would like to start with just a couple of comments about the quarter, perhaps highlight a couple of the achievements and then talk a little bit about our guidance for the fourth quarter and perhaps even more importantly our early thoughts on 2008. First to the quarter.
We had a very strong quarter, some $0.14 above the midpoint of our guidance, and we think once again a confirmation that our diversification strategy is working. As you recall when we met with you after our second quarter where we had very strong earnings there as well, the change in our business mix and our nearly 50% international exposure is really coming through in our ability to increase earnings at a time when the North American heavy-duty market is down by now some 55% here in the third quarter.
Looking within the results for the third quarter, as we outlined in our press release, about $0.12 came from the divestiture gain on mirror controls. And in terms of our operating earnings per share, we deducted that $0.12 and then looked at kind of our results from operations as being $1.67.
And if you look within that $1.67, about $0.02 came from better truck margins, slightly offsetting lower margins in our Fluid Power business compared to the midpoint of our guidance which had been $1.65. If you had the chance to read through our financial statements, you'll also see that our $16 million contribution to our charitable fund fully offset the lower taxes in the quarter, and so one doesn't stand by itself.
We made the contribution really in terms of offsetting that in terms of not changing from our guidance, our actual operating earnings versus the midpoint of our operating earnings guidance. Record sales for the third quarter, up about 7% from last year, seventh quarter in a row over $3 billion.
We have finished the quarter strongly with record sales in August and September. And end markets turned out about as we had expected here in the third quarter, down about 4% from a year ago.
We had very solid market outgrowth, up some 5 points and broadly spread across each of our segments. We are very pleased with that progress.
Our fully diluted EPS was a record for the third quarter as was our operating EPS. And I think importantly, if you look through the results in terms of the operating EPS in the quarter up some 18% if you deduct the gains from discontinued operations both last year and last year's third quarter as well as this year's third quarter.
Looking within the segments, our 13.4% segment profit excluding acquisition integration costs is a new record and that balance of earnings is noteworthy with nearly 70% of the total segment's earnings occurring in our Electrical and Fluid Power business and new profit records being achieved in both of those segments. All segments over 11%.
We did comment in the earnings release that in terms of an update on our Excel 07 and our acquisition integration that we have got three sites out of the many, many, many sites that we introduced changes in during 2006 and 2007 as part of both of our acquisition integration and our Excel 07 activities. Three sites that are running are a little slower than our overall program, but we are confident they'll be back on track by the first quarter.
And those were in the Fluid Power segment, and that's really the reason for the slightly lower margins than we had expected in the third quarter, which were, as I said, more than fully offset by the higher margins in our Truck segment. As we look to cash flow, really, obviously, a booming quarter in terms of operating cash flow, $495 million.
We are also delighted that we reached agreement with the IRS regarding our 2003 and 2004 tax years, and we really think that speaks to the sustainability of our tax rate. Strong bookings in Electrical, up 12% at a new record level and in our aerospace business, up some 14%.
So particularly in the long cycle businesses, we are continuing to see great strength, and I'll talk more about that as we look into 2008. We expect the acquisition, our acquisition of the MGE small systems business to close here in the fourth quarter.
We were delighted to have completed the divestiture of our mirror controls business in the third quarter. And now as we talk a little bit about what's going on in our end markets.
And frankly, I think that's really the big news in terms of today's discussion is what has happened coming out of the slowdown or the turmoil that was caused in credit and financial markets really in the August-September time period and how do we think that plays into our guidance for the fourth quarter and, as I said before, more importantly 2008. Again, I think the big news is strength outside of the U.S.
and some weakness in the U.S., and I would say that's the big bold headline. If you get down underneath that, we think the weakness in the U.S.
is reflected in our slightly revised guidance for how we think about four primary markets. We think this credit market turmoil, and have mentioned this before, that occurred in the August-September timeframe, has a couple of fundamental implications.
First, that the North American residential housing market, the trough will be extended by approximately a year. When we talked back in the June-July time period, our feeling had been that you'd see the lowest point of that market occur in the mid summer of 2008.
We think that's now more likely to be a 2009 impact now and... excuse me, I am off one year...
we thought it would bottom this summer and then be flat and start to increase next year. We now think it bottoms in the summer of 2008; does not strengthen through the back end of 2008 and it begins to strengthen in 2009.
So a one year push out and that the bottom of that market is probably 10% lower than we had originally thought it would be. We think that has a knock-off effect into the light vehicle markets here in North America, and somewhere between 300 and 500,000 could come out of that market next year, and then we obviously are seeing some of that weakness here, we believe, in the fourth quarter this year.
And then third, the construction market here in North America where we have been expecting an increase on the order of a high single-digit number in 2008. We think that's more likely to be something that's a mid or low single-digit increase in 2008, all of those really stemming off of the residential weakness.
Now the last piece that we spoke about in our earnings release is that we have seen truck orders here in the North American markets and aftermarket coming back more slowly than we had thought might occur this fall. And if you'll recall our discussion of this area in our second quarter conference call, we had said we thought we would need to see orders approaching the 18,000 per month unit level here in the August and September time period.
Clearly, they have not; they stayed more in this 11 to 12 level. As a result, we think the likelihood is that the fourth quarter of 2007 remains pretty much like we saw in the third quarter of 2007, just a very modest increase.
And that would mean that we would get off to a slightly slower start in 2008 as well. As a result, I think the way you think about all this is we that we have taken a nickel out of our full year guidance after having raised it by $0.45 if we added up our increases that we made at the end of the first quarter, which you'll recall was $0.15.
At the end of the second quarter, we raised an additional $0.30. We are now taking that increase of $0.45 down by $0.05.
So versus our initial guidance, this year we are up some $0.40. We believe our operating earnings will be up about 6% year-to-year 2007 over 2006.
That really converts upon our long-term strategic goal, and that's why I say our diversification strategy is working for the very first time at higher earnings in a year in which the North American heavy-duty market turned down, and we do believe that will happen this year. If you think about the elements that contribute to the roughly nickel lower in terms of operating earnings for the full year, I think the way to think about this is it's on the order of about $80 million of less volume in the fourth quarter.
And that comes out of each of those markets that I talked about because we don't think markets are now increasing; we think they basically are flattening as this level; it's not that they are going down. You know that our original guidance this year talked about a year in which they would start pouring in the first quarter, build in the second quarter, build in the third quarter and continue to accelerate in the fourth quarter.
We now think that shape is more likely a flatter force after a reasonably good third and that a slower start in the first quarter before the economy than begins to pick up, much like we all saw last year in the fourth and first quarter when we saw the impact of Fed tightening six months later have about a two quarter impact that very much the way that we are thinking about this. We think that the turmoil this summer is likely to have about a two quarter impact and that actually the first quarter would be slightly weaker than the fourth quarter in that regard, which is also a seasonal issue.
We had about $0.09 that is due to the three facilities that I mentioned in the Fluid Power business that comes out of earnings with, say, $0.05 of that in the third quarter and $0.04 in the fourth quarter. And then about $0.08 of better truck margins and other improvements in third quarter in our earnings and then about $0.12 of lower taxes, about $0.10 there in the third quarter and about $0.02 in the fourth quarter, and Rick will comment on our expected tax rate in the fourth quarter.
Now as we look ahead, I think the big message here really is what does this all mean for 2008? You'll recall that our previous guidance for 2008 was we expected to see the weighted average of Eaton end markets increase about 5%.
And built within that was a NAFTA heavy-duty truck market of about 275,000 units. We still believe, sitting here today, we will see our markets next year rebound by about 5%, but the mix will be slightly different.
So we think the truck market is more likely to be in the order of about 260,000 exiting the year at a 300,000 rate, but entering the year at a rate that's more akin to what we are seeing currently. We are continuing to see very strong non-residential construction market, very broadly based not just from individual segments but also from a geography point of view across for the country.
And I'd be more than pleased to ask questions about that. And so a little stronger electrical market, a little weaker truck market, the rest of it pretty much as we had seen it.
So we are comfortable with a 5% growth. Our tax rate.
We had provided you guidance that we thought it would be on the order of 17% to 18% next year. Our adjusted tax rate guidance for next year is 16% to 17%.
And then the third item that we have provided you some guidance on next year, and a number of you have been following this closely, has been what is the perspective change in our pension costs. And many of you recall earlier this year we had indicated that we felt that 2008 would be the first year in which we would see our pension year...
pension costs begin to decrease after a number of years of consistent year-to-year increases. Our forecast had been our guidance that we would see that come down by about $10 million.
We now think it's likely to come down on the order of $25 million in 2008. And last but not the least confirmation of what we told you before in terms of likely increased revenues from acquisitions we have completed during 2007 where we'll have a full year benefit of those acquisition dollars in 2008.
And we still think that that guidance in the order of $250 million to $300 million makes sense. So briefly recapping 2008, 5% markets, 50% market outgrowth, $250 million to $300 million of additional acquisition.
And so we think it's going to be a strong year obviously with also a rebound coming in our Truck business, one of our, obviously, clearly, most profitable businesses. So if you wrap up, I guess what we have tried to share with you in our earnings release, a very strong quarter.
Chartable contributions offsetting the tax... lower taxes, a $0.12 gain from the divestiture gain which we identified that's the difference between the $1.79 and the $1.67, and we think a very well balanced quarter.
Fourth quarter is going to look more like the third quarter than we had originally thought it would because markets are flattening out, again, as a response to some of the turmoil we saw earlier this summer. We think the year may start a little slower next year, but we are still quite bullish on the outlook and the opportunity to really outsize performance for Eaton in 2008 is a year in which we see our markets relatively strong and our balance and our exposure to international markets better than it has ever been.
So with that, we'd be delighted to open up for questions and we can explore any of the areas you'd like to get into. Question And Answer
Operator
[Operator Instructions].
William C. Hartman - Investor Relations
Okay. A lot of names are popping up and first one on is Ann Duignan [Bear Stearns].
Are you there Ann?
Ann Duignan - Bear Stearns
Yes. Hi, good morning guys.
William C. Hartman - Investor Relations
Good morning.
Unidentified Company Representative
Good morning.
Ann Duignan - Bear Stearns
Maybe we could focus a little bit on the truck outlook. Sandy, how comfortable are you with the revised build for next year at 260 versus 275?
I mean orders right now would suggest that even 250 may be a stretch, and that that would still... that doesn't really support a 275 or a 260 number.
How comfortable are you with 260 at this point?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
It's our best modeling right now, Ann. And as you say, it's always I think the most difficult time to call the truck market is when you are kind of bottoming along or bouncing along the bottom.
We do think you still have to anchor your thinking about the truck market with the 2010 emission standards change. And while there have been a number of technology announcements recently where individual competitors are intimating that they have solutions for both engines and emissions elements.
We think there are always a couple of different issues that fleets appraise there. I mean one is the price risk, one is the warranty risk, one is the operator risk and other is the technology risk.
And we don't believe all of those have been dealt with at this point. So we are still anchoring our thinking that you will see a well over 300,000 market in 2009, the year of the pre buy, if you will.
And if you need to get up to a year that starts to get you that kind of ramp during 2006, which we think the industry has to be exiting 2008, it's somewhere close to a 300 rate to be able to satisfy that demand so that we need to start seeing obviously orders develop here late this fall. And we think it will be a very much late fall first quarter very significant ramp in volume.
We don't think we are going to get much more of an insight on this in the October or November numbers. We think this is much more likely to come at the very end of the year or during next winter.
Ann Duignan - Bear Stearns
You mean next spring... we'd have to see orders pick up early next spring, is that about what you are saying --
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Probably going to see orders start to pick in the winter for next year, yes.
Ann Duignan - Bear Stearns
Okay. And the tough margins were pretty impressive given the headwinds that that business is facing.
Can you give us some color on where the upside to the margins came from in that business? Was it mostly result of transmissions [ph] or was it better performance by the heavy-duty team?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, I would say Ann you've touched on a number of the key elements there. I think important to keep in mind is that we have been seeing with one of the benefits, and this is true across all of our businesses and I am sure you are seeing it in many manufacturers with the dollar being at its current value, we obviously have been seeing more orders for international markets and have traditionally been within the so-called kind of NAFTA mix, and so that has continued.
So there is strength there in the export market. Yes, we are continuing to do quite well outside of the U.S.
And while we've talked about Eaton's overall 50% balance in terms of being exposed to international markets, perhaps one of the underappreciated elements of our Truck business is it's not just a balance between our heavy-duty business now and our light medium business and our clutch and our aftermarket business and the big change in our manufacturing model, but the percentage of the business which is now influenced outside of the U.S. is up quite significantly.
And I would say that that theme is a very important one for us that those international businesses are larger and they are also quite profitable. Now I would also say I think our heavy-duty team here in North America has done an exceptional job of dealing with these very low volumes because this is the second quarter in a row of over 50% decrease in the end market and you are still seeing plus 50%...
15% margins in both quarters. So we too...
it was a little stronger than we thought, and I think the team's really done a great job there.
Ann Duignan - Bear Stearns
Okay. In the interest of time, I'll get back in queue and speak to you offline.
William C. Hartman - Investor Relations
Okay. Next we have Steve Volkmann [Morgan Stanley Dean Witter].
Good morning Steve.
Stephen Volkmann - Morgan Stanley Dean Witter
Good morning guys.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Good morning Steve.
Stephen Volkmann - Morgan Stanley Dean Witter
Just a quick follow up on that truck margin question. I have been surprised by how strong it's been on the down side, but can we expect sort of normal incremental, Sandy, next year as we start to get that volume back?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, that would be our expectation is that we ought to see it come back. Now I think what we need to be thinking of right now is we have obviously got very, very strong demand in Brazil.
The Brazilian economy is strong and virtually all classes of vehicles are doing quite well there, and that influences our automotive business as well. And then the ag business is continuing to be just booming in Brazil at this point.
And it's our expectation that that ag strength carries over into next year. But the only reason I make those comments is our Truck business is a little bit more complex than it once was when we simply all looked at the North American heavy number and said there is your insight.
I think you now have to kind of think about how that whole Brazilian piece in other international markets falls into it. But no reason to believe that we shouldn't be capable of producing very attractive profit levels from this business on an ongoing basis.
Stephen Volkmann - Morgan Stanley Dean Witter
Okay, good. That's helpful.
And then just with respect to I guess maybe kind of overall thinking about margins, you've given us some idea about the top line in 2008. But is it reasonable to expect that we are going to continue to have sort of the regular margin expansion that you guys have been driving in the, especially I guess in the Electrical and Fluid businesses?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, again, I think that's a reasonable expectation. We are very pleased with this 13.4% operating margin before acquisition integration charges here in the third quarter, and we would expect with volume that we can continue to build on that.
We are really quite pleased with the progress in our Electrical business. We've had a little bit of a disappointment, and again, I would put that in the, because it's up substantially from a year ago, in our Fluid Power business and we'll get these couple of sites pretty well ridden to ground in terms of the issues we are dealing with.
And frankly, part of them are being caused by the fact that our volumes were up. So we haven't been able to move some things as quickly as we would like, and that's good news.
I think that plays into strength for 2008.
Stephen Volkmann - Morgan Stanley Dean Witter
Okay, great. Then just real quick on the Electrical and the Fluid backlogs that you alluded to, obviously, '08 is going to be a little bit back-end loaded on the truck sector, but should we expect that in the rest of the business as well or will that be fairly stable through the year?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
I think seasonal is probably the most important thing to think about, and those two businesses had slightly different seasonality to them. The Electrical business, the weakest quarter seasonally is the first quarter and with residential not being as big a part of the business right now, that's one of the pieces that tends to bounce seasonally with not that much activity going on in the first quarter and then it strengthens through the year.
We are carrying very large backlog in our overall Electrical business; they are at all-time record levels right now. And so our expectation is we'll have a very strong year in 2008.
And I would come back to the non-res comment again because I've heard a lot of discussion over the last couple of months with people picking out individual data points and saying they think non-res is over. Non-res is everything except res.
So it's not simply retail, it's not simply strip stores, it's not simply office building. It is medical, it's institutional, it's all that's going on in oil and gas, it's manufacturing.
And there are areas I have just mentioned that are just very, very hot right now and we are doing quite well in them. So we would think both Electrical and Fluid Power, they may start a little slower because of seasonality, but we think the year is going to be strong here in both businesses.
Aerospace, I should call out. Probably not touched much by the seasonality because, again, it is a long cycle business and it's a great example of a long cycle business that's not likely to be touched much by some of the September and August issues that we saw hit a lot of markets.
And you all have seen the really big booking numbers that have been going on at the airframe level, and we are participating in that. And you obviously can see that in terms of our 14% booking here again in the third quarter.
Stephen Volkmann - Morgan Stanley Dean Witter
That's helpful. Thank you very much.
William C. Hartman - Investor Relations
Okay. Next we have Andy Casey [Wachovia Securities].
Good morning, Andy.
Andrew Casey - Wachovia Securities
Good morning, Bill, good morning everybody.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Good morning, Andy.
Unidentified Company Representative
Hi.
Andrew Casey - Wachovia Securities
A quick clarification on the Q4 guidance to bring it in a little bit short term. Does that include the $12 million tax settlement benefit described in the release?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Andy, no, that benefit was taken in the third quarter.
Andrew Casey - Wachovia Securities
Oh.
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
So maybe I should amplify on taxes in Q4. We think the rate in Q4 will be between 14% and 15%.
And we are not anticipating any one-off elements the way we had in the third quarter. In the third quarter once you...
since we reached agreement with the IRS, we took the accounting benefit of that in the third quarter.
Andrew Casey - Wachovia Securities
Okay. I must have read the back end of the release a little wrong.
Moving on, can you, Sandy, touch on the Electrical business, the margin there? The improvement really accelerated in the third quarter from the second quarter in terms of comparing year-over-year basis improvement.
What was behind that? Was that just pure leverage or are you seeing an acceleration in one higher profit piece of that mix?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Actually, at this time the... with a good question was the non-res business, which tends to be more intensively, let me call it, an assemblies business than the residential side, for example, tends to be more of a component business.
And the fact that we have generally some weakness in the industrial economy, and we comment on that both relative to our hydraulics business where the stationery portion of that markets has been a little weaker than mobile. And we have seen that industrial side or CapEx-related side, if you will, of the industrial side in the Electrical business being a little weaker.
We are quite pleased that we are getting the kind of leverage we are in our Electrical business without the additional muscle of the kind of component side of the business. So it's not coming from what I would call a more favorable product mix, but what it's coming from I think is the business that is being run better.
And we are obviously getting some more volume so that we are getting some leverage into some of our facilities. We are very pleased, however, and I have mentioned this at a couple of conferences that we've been at this year, that we continue to do very well on the power quality side of the business as well as the power distribution side.
And a number of our new product offerings, whether they be our industry leading efficiency ratings for our UPS equipment, whether they be our medium-voltage equipment, which is used in so many of these important markets that are expanding like oil, petrochem, mining and yes, datacenters. We have a very strong position in that area and we are getting some benefits from that.
Andrew Casey - Wachovia Securities
Okay, thank you very much.
William C. Hartman - Investor Relations
Next we have Bob LaGaipa [CIBC World Markets]. Bob, good morning.
Robert LaGaipa - CIBC World Markets
Hi, good morning everyone.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Hello.
Unidentified Company Representative
Hey Bob.
Robert LaGaipa - CIBC World Markets
A couple of questions. I guess one, just to focus in on the Automotive segment just for a moment.
You had mentioned I think earlier in the year, you talked about mix, the benefit from light trucks, SUVs etcetera. I was just curious, here in the third quarter and what you are expecting in the fourth quarter, does mix have anything to do with that or is it mix in combination with the weaker end markets?
I mean how should we think about that particular segment?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, Bob, you are right. You recall the comments from earlier in the year is because we were surprised frankly after a year ago having seen some reduction in the light truck, SUV and CUV segments as a percentage in the total North American retail sales.
We saw it come back up to these kind of 57% numbers for those same areas of light truck, SUV and CUVs here earlier this year, and it have stayed that way pretty well through the third quarter. You did see some big additional discounting on the full sized light trucks here in the third quarter.
I mean those numbers got pretty high; you've all seen some of those numbers. And they are trying to keep those vehicles at a higher production rate at this point.
We don't anticipate that's going to change much here in the fourth quarter. So, no, we aren't seeing much of a mix change in the third quarter from what we saw in the second and the first quarter.
However, the bigger dynamic continues obviously in terms of mix share in the Big Three versus others here in North America. And while there is some really great new product coming out out of the Big Three at this point in a number of new vehicles, the big trend hasn't changed much.
And so for us as a supplier, it's important that we continue to be able to supply a number of the people who are importing vehicles into the U.S. And that relative percentage of imported vehicles coming in is still higher than it was a year ago.
And that does not help us in that regard, but not a change from what we were seeing in the second quarter.
Robert LaGaipa - CIBC World Markets
Okay. So it's truly just the weaker end market then.
And second question is just the margin targets for each of the segments, what's the update on that? As of the second quarter, I think you were looking for 12 to 13 Electrical, 12.5 to 13.5 for Fluid Power, 15 to 16 in Truck and 12 to 13 for Auto.
Now obviously Truck's a lot higher. Looks like you are already at the bottom end of the Electrical range.
If you look at the 12.5 to 13.5 on Fluid Power, you are closing in on that bottom end, but you mentioned some of the weaker markets out there. And then lastly on Auto, you are already above the top end.
I wasn't sure what your adjustments might be to those margin targets.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
I think for the balance of this year, and of course with three quarters actuals at this point it's... much of it is kind of...
the cake is big. But for Fluid Power where we came into the year suggesting your memory is right that our return on sales targets before acquisition integration would be 13% to 14%.
We changed it to 12.5% to 13% at the end of the last quarter, and I think at this point, we would say 12.5 to 13.5% is probably the right way to... or excuse me, we changed it to 12.5% to 13%.
We had brought it down to 12.5% to 13.5% in the last quarter. So for the full year this year now, 12.5% to 13% versus the original 13% to 14%.
In the Electrical business, we still think that 12% to 13% is the right kind of range for this year 2007. For Truck, we entered the year suggesting 14% or better.
At the end of the last quarter, we had increased it to 15% to 16%, and we would now say we think 16% to 17% is probably the right full year range. Automotive, I wouldn't change it at this point.
We still think kind of that 12% to 13% range is the right spot. So I think that stepping back from it, a little weaker Fluid Power, a little stronger Truck.
Robert LaGaipa - CIBC World Markets
Terrific. And last question, if I could.
This is just with regard to the acquisition environment. As you look at the strong cash flows that you've had, as you look at the impact of the credit crunch.
I mean you mentioned the impact on your end markets being a little bit weaker, but certainly what we've heard from some other companies out there is, from an acquisition standpoint, maybe the multiples might be coming down or already have come down in some cases. How do you look at that market moving forward, especially with you splitting out some of the traditional segments and targeting those for growth as of the first quarter of next year?
What's your view of the market and your aggressiveness I guess going forward?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Well, we have obviously had a very successful year so far this year with the acquisitions we have either announced or closed. This has been a pretty busy year for Eaton with I think seven deals if I am recalling correctly.
We think we do have capacity to do more this year, but it's probably on the order of a couple of hundred million dollars that we've got room for this year, and obviously will be closing the MGE deal here in the fourth quarter. In terms of the overall pricing activity this year, there are a lots of speculation as to what will happen with pricing.
We have been consistently active right through this year. And as we have reminded a number of people over the years, an awful lot of the transactions we are involved in are deals that we negotiate privately.
And so we think we've been be able to do so on a very cost effective basis that really continues to create shareholder value. So with our strong...
coming back to the cash flow... we are delighted with the $495 million this quarter.
It really gets us on schedule for what we said we would do this year in terms of cash flow, and we do see and continue to see real opportunity to acquire primarily again in our Electrical and Fluid Power segment to expand those segments further. And so we look at this environment.
It's just probably gotten a little bit better since the turmoil of the August, September side for the strategic buyers.
Robert LaGaipa - CIBC World Markets
Terrific. Thanks very much.
William C. Hartman - Investor Relations
All right, next we have Jeff Hammond [KeyBanc Capital Markets]. Hello Jeff.
Jeffrey Hammond - KeyBanc Capital Markets
Hi, good morning.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Good morning Jeff.
Unidentified Company Representative
Hi.
Jeffrey Hammond - KeyBanc Capital Markets
Sandy, I was hoping you could maybe expand a little bit on the non-residential discussion, just in terms of maybe some sub-verticals where you are seeing particular strength or you're more bullish about and maybe conversely where you might be seeing some softening.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
I think, Jeff, the area that I think everyone has expected to see the softening would be this area that tends to tightly couple with a residential expansion. So anytime that you have a build out of a couple of hundred units in building a new neighborhood, normally, fairly close to that comes a strip store and some of the support issues, whether that be retail or fast food or other support type stores.
That has slowed a little, but frankly nowhere near as much as we thought. Now we think that's just a delay issue that kind of hangs in because at some point that does slow down.
And as I mentioned earlier, we think the whole residential side has moved out on the order of a year. Where we continue to see really great strength, though, is lodging, office.
We've seen a lot of activity around recreation, amusement, very strong activity in petrochem, mining, HVAC has been very warm, U.S. utilities up double digits this year.
So very broad strength. And in our experience, often what you have seen is a number of these industries be geographic in their focus that both stand in one geography of the U.S.
or Canada and maybe not others. But it's quite strong all across, and I think if you've been traveling various different cities and municipalities, you'd be seeing that now.
Education, I should mention, is another one that's spending very strongly. Medical is another one where you are seeing very large institutional expansion.
So we see a very broad-based activity, and, as I have mentioned before, we have got a pretty good window out ahead of us. It's not kind of a three to four month window and we are continuing to see very strong quotation, very strong design and build, a very strong early bid activity.
So we are quite bullish on what we see out ahead of us in terms of non-res.
Jeffrey Hammond - KeyBanc Capital Markets
Okay, great. And then just in terms of splitting the segments into '08, can you give us a sense of how the profitability variation is between the two segments within Electrical and Fluid Power?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, we will be providing all of that with history at the time that we actually provide guidance next year in January. And we'll provide guidance supply the six segments that we've talked about.
So at this point, it would just be premature to do so. We'll have all that data both with history and our guidance for it in our January conference call.
Jeffrey Hammond - KeyBanc Capital Markets
Okay. Thanks.
William C. Hartman - Investor Relations
Next is David Raso [Citigroup Smith Barney]. Good morning, David.
David Raso - Citigroup Smith Barney
Hi, good morning.
Unidentified Company Representative
Hey David.
David Raso - Citigroup Smith Barney
Not my original question, but can we just go back and make sure we all understand the third quarter. If you exclude the integration charges you cited 1.79.
There is a $0.12 gain on the sale of the auto mirror business, correct?
Unidentified Company Representative
Correct.
David Raso - Citigroup Smith Barney
Then there is --
Unidentified Company Representative
And it gets you to 1.67.
David Raso - Citigroup Smith Barney
Yes. But then Rick had mentioned while you get the cash in the fourth quarter for the tax refund, you recognized it in the third.
Unidentified Company Representative
Yes.
David Raso - Citigroup Smith Barney
That's why [ph] we heard that?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes, that's correct. And it totaled, David, it totaled $0.10 of tax benefits relative to the 15.5% rate that we had guided you to.
Of that, $0.08 were these one-off items that are mentioned in the tax footnote. And the what is offsetting that, though, is the charitable contribution.
David Raso - Citigroup Smith Barney
Let's go step by step. I just want to make sure.
1.79, let's back out the 12 gain on mirror sale, let's back out 8 --
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
8.
David Raso - Citigroup Smith Barney
And that tax gain... so we are down to 159, the charitable trust you add back about $0.07, correct?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Actually $0.09.
David Raso - Citigroup Smith Barney
$0.09. So we are 1.68, generally.
I mean viewed as you want, but it's kind of a cleaner number.
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes.
David Raso - Citigroup Smith Barney
Okay. So basically, we are trying of walk from third quarter guidance to fourth quarter where fourth quarter EPS is about the same.
Your Fluid Power hit in the third quarter at $0.05 is going to be similar in the fourth quarter. You said $0.04.
My tax rate goes up 30... 300, 300, 400 basis points; depends how you tax effect integration charges.
So my taxes are up. How am I offsetting the taxes up to keep the earnings essentially flat to up?
I mean your midpoint is 17, and essentially seasonality you usually get in the Electrical business and Truck doesn't go down much in the fourth quarter sequentially. I mean I am just trying to make sure we...
that the fourth quarter number... we do have a couple of headwinds with the tax rate offset by the Electrical I guess seasonal third to fourth.
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes, the way to think about it, David, you are right, the overall tax rate is higher because you don't have these one-off items. But you also don't have the charitable contribution.
And those two items offset each other. If you look at --
David Raso - Citigroup Smith Barney
I know. But that's why I backed it all out.
I am just going clean. You are 1.66, third quarter guiding to 1.70 mid point.
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes. So it's very, very close.
When you consider that you are 1.68 in the third quarter, the mid point is 1.70, it's really --
David Raso - Citigroup Smith Barney
Okay, that's fine. I'm not saying it's a big stretch, I just want to make sure I understand it.
A sequential slight tick up despite the tax rate --
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes.
David Raso - Citigroup Smith Barney
And I guess the Electrical seasonality.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Correct. And the one other thing we mentioned in our comments...
I know there are a lot of numbers going back and forth here is that Rick mentioned the slightly lower tax rate we are now anticipating in the fourth quarter versus the 15.5 that he was doing the reconciliation off of in the third quarter. And that throws about $0.02.
So if you took the 1.68, it's kind of a 1.68 to 1.68.
David Raso - Citigroup Smith Barney
Okay. Bigger picture, Fluid Power, the $0.05 hit in the third quarter, that's about roughly...
depends how you tax effect it... but about $12 million EBIT.
If we do view it, for argument take, as kind of one-time issues third and fourth quarter, the moves are done and we are off and running in '08. If you add back the $12 million of Fluid this quarter as well add back the integration charges, I am looking at a Fluid Power margin that's well over 13% with an incremental of 30%.
So I am just trying to understand the earnings power from this division looking out in '08, '09 and even your commentary seems a little more cautious about how it performed. Am I reading that properly where ex that $0.05 and ex the other integration charges, this business, this is a 30% incremental?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Well, no... and I think that's the right way to be thinking about it is that without these couple of items that didn't go as quickly as we thought, and, as I mentioned, part of that again is because we had some very good volumes that we would be, we believe, over 13% margins here in the third quarter.
And we think that's the right way to be thinking about the business.
David Raso - Citigroup Smith Barney
All right. I'll follow up with other questions later.
Thank you.
William C. Hartman - Investor Relations
All right, next we have Jamie Cook [Credit Suisse]. Jamie, good morning.
Jamie Cook - Credit Suisse
Good morning. One other clarification on Q4.
Are we still assuming $0.04 related to the MGE acquisition? I thought you said it --
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
No, the MGE acquisition will be broadly... yes, it will be very slight dilution in the fourth quarter, and it's simply due to the acquisition accounting that you have to employ, but it won't be very material, on the order of --
Jamie Cook - Credit Suisse
And so it will be less than the $0.04 that you guys sort of talked about last quarter?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
It would be on the order of $0.04 or a little less than that.
Jamie Cook - Credit Suisse
Okay. And then, Sandy, you talked a lot about commercial construction, and you guys are sort of contrary and relative to the Street.
I guess one, when do you see that market peaking and what data points would you be looking at that you'd say okay, maybe we are a little too optimistic? And then finally, if you could just touch on what you are seeing by country in Europe because there is also some data points to suggest that that's slowing too, which is a big part of your story.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, in our Electrical business for the non-residential construction market, that's not as big a play for us. Our Electrical business is not as large in Europe as some of our other businesses are.
So let me come back to the U.S. I think most people have anticipated that the non-res is strong through 2009.
And then remember, you tend to carry pretty big backlogs, and so you even after market starts to weaken, we are shipping into a sort of time period. I think our own thinking is that we'll see a pretty reasonable 9 and 10 at this point.
It's hard for us to look out too much beyond that at this point. You are right on Europe, though.
I think that's part of generally not simply whether it's non-res. There have been some indications in the last month or two that the very surprising in our mind rebound in European markets broadly.
There are some signs that it has begun to slow a little bit here in the last couple of months. Again, I think too early to announce it as a permanent trend, but it's something we are keeping our eye on on all of our businesses.
Jamie Cook - Credit Suisse
Okay, thank you. I will get back in queue.
William C. Hartman - Investor Relations
Next is Terry Darling [Goldman Sachs].
Terry Darling - Goldman Sachs
Thanks, good morning. A couple of points of clarification.
I guess first on the Truck margin outlook. I guess the takeaway is we can expect to see these kind of margins sustainable until we see the volumes in the Class 8 recover or do we see a downtick in between?
And/or whey you start to see those volumes come back, could we see a downtick again just based on mix with the strong ag Brazil margins getting diluted as that business starts to build back?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
I think, Terry, the one thing all of you have watched our Truck business over the years that Brazil has an interesting feature to it, somewhat like Europe does in August. December is not a particularly active month in Brazil.
And so we have generally tried to caution people to think about the fact that you end up with two stronger months in October, November and then a weaker month in December generally for businesses that have a large Brazilian quotient, which our Truck business does. So that would be the only modifier to what you just suggested that I would suggest.
Terry Darling - Goldman Sachs
Okay. And what about as the Class 8 North America market starts to come back on your forecast presumably in the back half of '08?
Do you margins come down for a period as you are adjusting to that change?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Historically, that might well had been true, Terry, when we had a very vertically integrated business model there that we have been able to ramp a couple of times now. This will be our third ramp in our new business model, and that has not been what's happened.
We have been able to ramp up and show attractive incrementals. And so that would be our expectation.
Terry Darling - Goldman Sachs
Okay. Sandy, wondering...
shifting gears to the Fluid Power business, wondering if you'd take us through what you see your construction equipment customers doing. I think based on what was said off of the June quarter calls and what's been said since then and what you have seen in terms of the residential market, incremental weakness, we might expect to see production in the fourth quarter take an incremental hit down to try to get inventories down further.
I guess I was anticipating that was part of your 4Q lower guidance, but it sounds like you're really more pointing towards the plant issues. Just wondering if you could sync us up on that one.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Well, I think if we think about global hydraulic markets, we entered this year feeling that they would be stronger than they've turned out to be. And the biggest single element in all that has been the construction equipment market has turned out to be weaker.
As we have commented on that in the second quarter, it's very similar to our outlook now. Those products which tend to be exported to the faster growing markets outside of the U.S.
are continuing to be quite strong, and a lot of that tends to be bigger equipment, if you will. Mining is continuing quite strong.
Where the weakness has been more pronounced has been where equipment is being used in the residential marketplace. And so there we have now lowered what we think what's happened in the North American construction market is down to kind of a 10% down number this year.
And I think you've seen that as it kind of rolled out over the years from others beyond ourselves. So that's really where we are seeing the bigger weakness in those markets.
And conversely, ag has been a little stronger, but recognize that the construction markets are approximately 3 to 4 times bigger than the ag market. So a dollar down on one place doesn't make up for it elsewhere.
That would be the big issue. And I would say that stationary or industrial has been a little softer this year as well.
And so we think that will continue to play out here in the fourth quarter and then slightly in the first quarter. And as I mentioned, next year, instead of expecting a high single-digit increase in the construction market, we think it's maybe a lower single-digit increase next year.
Terry Darling - Goldman Sachs
Okay, thanks. And lastly, can you, Rick, may be share with us what the impact, if any, on operating income was from currency in the quarter?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes. As we, Terry, as we indicated, we had a $0.03 benefit from FX in the quarter.
That was about $95 million of revenue in the quarter. And as I think we've said many times, typically, the margins that we earn on currency revenue is quite a bit lower than our typical margin.
So it was a little bit under 10% margin on that extra currency revenue.
Terry Darling - Goldman Sachs
And what are you assuming in the fourth quarter?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
You are probably going to see a pick up from currency that's roughly in the same neighborhood. We don't expect that we are likely to see a major shift in either the euro or the real...
the reais, and those have been the two currencies that have given us most of the benefit thus far.
Terry Darling - Goldman Sachs
Okay. Thanks very much.
William C. Hartman - Investor Relations
All right, next is Mark Koznarek [Cleveland Research Company]. Hello Mark.
Mark Koznarek - Cleveland Research Company
Hi, good morning.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Good morning.
Unidentified Company Representative
Hello.
Mark Koznarek - Cleveland Research Company
Could you clarify for me some of the comments on 2008, talking about less of a rebound and you mentioned at the construction outlook, instead of being high single digit now, mid to lower. And then Auto, I thought I heard we carved out 2 to 3 percentage points of production.
We get... I heard that you said that the total market outlook you still expecting up 5%.
Was it just a matter of rounding or did I just misunderstand something?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
No, I think maybe one other comment, Mark, there is that we see Electrical being a little stronger and aerospace, is just an element that's a little stronger. And those...
when we put all that together, it's still coming out to about 5%. The other piece to keep in mind is I think the international markets are continuing to perform a little better than we thought.
And so that overall trend of stronger international buffering, what happens here in the U.S. again with our balance being about 50:50, I think is the significant takeaway.
Often we all spend so much time talking about the U.S. economy.
We don't adjust this to what's really happening elsewhere, and that's driving 50% of our activity today.
Mark Koznarek - Cleveland Research Company
Maybe if Electrical is stronger but construction is weaker, does that imply that all on the power quality side that the outlook looks better?
Unidentified Company Representative
Well, not exactly. Remember that...
a good question... but the residential business for Eaton is about 10% of our overall Electrical business.
About half of that ties into new construction. So you are dealing with kind of 5% of the Electrical business there, whereas you have got kind of these twin towers in the Electrical business, so our power quality business being at roughly 40% and the non-res business being 40%.
And that's where the real action is, and both of those are continuing to be quite strong.
Mark Koznarek - Cleveland Research Company
Right. So when up in [ph] construction equipment [ph], that is more --
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Let me help out here, Mark. I think we are talking about construction equipment.
That construction equipment has been weak this year, it's going to rebound a little bit next year, but the non-residential construction, we forecast to stay strong next year and frankly, probably for the next few years to come.
Mark Koznarek - Cleveland Research Company
Okay. So non-res, you expect actually to grow next year?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes.
Mark Koznarek - Cleveland Research Company
Despite that kind of that connection between residential and --
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Right. Because big parts again of the non-residential construction are not in any way related to the residential construction.
I mean what's going on in the petrochemical industry has very little to do with home construction. And I think that's where often peoples models are anticipate...
or aren't reflecting the fact that non-residential construction is everything outside of residential. It's not simply the stuff that's tied to residential.
And we are seeing great strength in those areas Mark.
Mark Koznarek - Cleveland Research Company
Great. That's very helpful.
William C. Hartman - Investor Relations
Thank you. Next up we have Dan Doud [ph].
Good morning, Dan.
Unidentified Analyst
Good morning guys. How are you?
Unidentified Company Representative
Great.
Unidentified Company Representative
Fine.
Unidentified Analyst
Hey, a couple of questions. First of all, can you provide a little more context on the three areas in the Fluid Power business that had some problems on the supply chain side?
Can you also just spend a little bit of time... you can sort of look at your margin trend over time and see that you've also had some successes in that area.
Can you also provide some context on where things would be going particularly well?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Our overall Excel 07 program that we had shared with everybody in our January conference call, we delivered about $0.60 of after-tax earnings this year, are still very much on track to do that. We are a little bit ahead of where we expect it to be in our Truck business.
We are just a tiny bit behind where we are in our Fluid Power business, but that overall $0.60 is very much intact, and we are delighted by it. As we had outlined all through last year and early this year, it affected a great number of different facilities and with a very substantial undertaking.
And one of the reasons we did that is the same reason that we have lowered our fourth quarter guidance. But we feel very strongly, you run a business within an economic context, and that's really the reason for the 1% reduction this year in our full year guidance is that we think the fourth quarter is going to be a little weaker in terms of the top line.
What I was outlining in Fluid Power, Dan, is that we had three sites out of the many, many, many, many sites that are running a little later than we would have liked in completing all this restructuring activity. And part of it's because our volumes are higher, so we aren't able to move things quite as quickly.
And we are confident that we'll have those back to our original schedule in the first quarter next year. So there are three individual production sites.
Unidentified Analyst
And were those in the U.S. or were they overseas?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
We are not going to go into exactly which sites they are. Our people will know it and we are working on at this point.
I think the significance is that we are trying to provide some transparency around a big program that we were doing business on, and we have got three sites out of the many, many, many tens of sites that aren't going to be exactly on schedule. We think the achievement of the $0.60 that we had talked, approximately [ph] $75 million benefit in the segments this year, we are going to hit that overall number.
And that's a big part of our... being able to increase earnings this year for the first time in a year in which the heavy-truck business has gone down.
Unidentified Analyst
Terrific. One comment on a question on the tax rate.
Is the... are the tax strategies that were being employed in 2003 and 2004 essentially substantively similar to the kind of things you are doing today and so the inference would be that the 2003 and 2004 audits really suggest that all the strategies you have employed are likely to be good to go for the future?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes. That's correct.
I mean we, over the last several years, have embarked on a strategy principally related to how we run our international businesses that has allowed us to bring the rate to these levels. And I would point out that our overall tax rate in '04 was 16.7%, so a rate that's very much in line with the rate that we are looking at for next year.
Unidentified Analyst
Okay. Thank you.
William C. Hartman - Investor Relations
Next we have Joel Tiss [Lehman Brothers]. Hello Joel.
Joel Tiss - Lehman Brothers
How are you doing guys?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Hello.
Joel Tiss - Lehman Brothers
Almost everything has been answered, so I'll just make it quick. Can you give us a little bit of an early read on 2008 auto?
You didn't talk much about that. And maybe can you weave in there some comments about the mix as well or just what you are looking at?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
I think Joel our anticipation is that this issue that we have chatted about in terms of number of imported cars is not likely to be changed particularly in terms of imports of engines. So we think we'll phase that vexing situation, because the lead times are not substantial [ph], and it doesn't appear that that's going to change in this time period.
We believe that we are going to continue to see this kind of mix that we've seen this year. We have been a little bit surprised it's come back, but it seems to be what the American consumer is saying and the CUV market is being so successful that it seems that being stopping [ph] up whatever weakness was in the SUV side.
In terms of the overall market, we are not anticipating that you are going to see a lot of growth in market, and we'll get into that in some more depth next year. Part of the reasons in our January guidance, part of the reason that we feel you are likely to see a little core growth there than we might have thought would have occurred if we...
taking us back to our forecast of last June is with residential markets being down longer, with the pressure because of equity and their homes, we think it's prudent to assume that you will see some modest backlog on a base of 16 million units. Even [ph] 300 to 500,000 units at the top end is not a big number and so that's what had kind of impacted our own thinking.
So the likelihood as we go into next year without growth instead of you go into next year flatter or maybe just a tiny bit of down. But we'll tune that up once we get into January.
Joel Tiss - Lehman Brothers
Okay. And just a quick clarification too.
You mentioned 50% of your company comes from international, is that sales or is that operating profits? Thank you.
Unidentified Company Representative
We don't... we have not broken the second piece out to your question, but what we were really trying to share is that so much of our product is serving international markets, about 50% of the top line is driving that.
And we don't see, I guess I would say, I don't see substantially bigger differences one place or the other, whether it's here in North America or elsewhere in terms of our profitability. So I think you can take that implication.
William C. Hartman - Investor Relations
Okay. Next we have Eli Lustgarten [Longbow Research].
Eli?
Eli Lustgarten - Longbow Research
Good morning.
Unidentified Company Representative
Good morning, Eli.
Eli Lustgarten - Longbow Research
A couple of quick questions. If they have been asked [ph].
One, Fluid Power the implication what you are saying for the fourth quarter is that you again would be over 13% margin unless the $0.04 impact of the postponed or delayed restructuring?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
We think you will see and you are quoting the right number, about $0.04 again in the fourth quarter. It's getting better and we improve through the third quarter at those three sites.
And I think the big question in term of the industry in Fluid Power right now is where do we see the kind of industrial side of shipments here in North America? The pattern has continued through this year of international being strong, U.S.
being a little weaker. We were pleased we had positive, very solidly positive bookings in the third quarter.
And then the other side would be the aerospace, the ramp up in aerospace because production is ramping up on the aerospace side. And we have talked several times about all the various different programs in aerospace that we are still very bullish on.
And so our hope is we can continue to ramp that up. But I think the general kind of profitability you are thinking about is probably about right, Eli.
Eli Lustgarten - Longbow Research
So structurally, there is nothing stopping... thinking of '08 in the 13 to 13.5 of this year is 12.5 to 13 as a reasonable target for next year?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, we would expect to continue to improve the profitability in the segment, that's correct.
Eli Lustgarten - Longbow Research
And in the truck sector, last February, you introduced a solution for 2010 emission that they've talked with you [ph]. Anything ever happen to your work in that area to give you any insight as to whether you have any business or anybody working on that?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, it's quite a bit of work in here. Your memory is actually right on that.
Our thinking at this point is that there really are a couple of different segments for opportunity. There is the heavy-duty, there is the some medium-duty and there is the off highway.
And for Eaton, our best guess at this point is that a number of the off highway and perhaps even some of the medium-duty applications may turn out to be a bigger opportunity for us. It's still early in that respect, but you know that the off highway regulations require many of the same technologies that will be required on the on highway in 2010, but they occur on kind of a 1 to 2 year delay after that.
And it would appear that additional time may be needed to qualify some of our technology solutions for our various different customers.
Eli Lustgarten - Longbow Research
And I guess your expectations on... last question...
on the Electrical side for '08 is that you'll break the 13% margin next year at this point given the trends that you're talking about.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
And again, Eli, there without trying to get ahead of our guidance next January, we would expect to continue, yes, to improve our profitability. And I'll be having the opportunity to review those expectations during our profit plans with everyone this fall.
Eli Lustgarten - Longbow Research
And one final question then. Have you been...
it sounds like you've been taking a lot of market share on the Electrical side because the non-res markets that you site strong and you talked to education and you talked about lodging, recreational. Are all markets that are having sub prime spill off, the new activity actually is much slower and therefore [ph], those are markets that are leading you to forecast a 0 to 5% gain in non-res next year.
But while there is a lot of activity and you are seeing the end of projects coming on. The new stuff going on has been much sort of dragged out, and most of the funding for those markets on sub prime are that people would book for sub prime.
So I was wondering whether you have any comment. You've been taking a lot of market share and that's what's giving you the strength you are talking about rather than the overall market.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
I would say we are continuing to grow share, but as you can see from the numbers, it wasn't as big in this quarter as it was back in some other quarters. We would slightly disagree in your comment that the sub prime financing is all the financing...
petrochem --
Eli Lustgarten - Longbow Research
Not with [ph] petrochem; I was talking lodging and educational.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
In some of those areas, but the big parts of this market that happen to be over in these other areas I was talking about. And that's where a lot of the big activity is.
It frankly is not backing off; it's actually accelerating at this point in terms of the capital that's being committed into some of these kind of long cycle applications.
Eli Lustgarten - Longbow Research
Great. Thank you.
Unidentified Company Representative
Yes.
William C. Hartman - Investor Relations
All right, next we have Andrew Obin [Merrill Lynch]. Good morning, Andrew.
Andrew Obin - Merrill Lynch
Yes, good morning. Just going back to international markets, you sort of noted that Europe is starting slow a little bit.
Could you also provide a little bit more color on other markets and also what's happening in Eastern Europe?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, I would be glad to Andrew. I think broadly in Asia, the picture has not changed substantially.
Now you are hearing many different people prognosticate on what the 2009-2010 time period will look like. But we are seeing continued strength in each of our businesses in China and India, and those have been the two big lead markets we have talked quite a bit about.
Western Europe... well, let me start with Eastern Europe.
Eastern Europe continues to be very strong for us, and I think for many others as well. The infrastructure buildout parallels much of what we are seeing in the Far East frankly.
Western Europe, which had been a surprise to us, particularly the kind of German/France corridor. While there are some hopeful structural changes being talked about in those marketplaces, we know the export markets are helping a lot, and they are being fed off Eastern Europe as well.
And I think the start of the slowdown that we have seen people talking about in Europe hasn't really manifested itself in our business yet. We are just being prudent I guess about trying to keep an eye on us.
Brazil continues to be very strong, as I mentioned before, and virtually across each of our businesses we are continuing to see very strong activity there. So I think the big theme again, the headline is that international markets continue to be strong.
The fact that we have got about 50% of our resource now exposed to those markets is providing us the additional propellant this year at a time when the U.S market is slowing a bit and we think will flatten out here in the fourth quarter.
Andrew Obin - Merrill Lynch
Thank you very much.
William C. Hartman - Investor Relations
Next is Ted Wheeler [ph]. Are you there Ted?
Unidentified Analyst
Yes, I am, good morning everyone.
Unidentified Company Representative
Good morning Ted.
Unidentified Analyst
A couple of quick... just quick questions.
You mentioned some momentum in August and September just overall. Do you see...
it sounds as though you are seeing the same thing here even though you took your fourth quarter down a shade, that the same momentum in... that you saw in September maybe continued in October?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Well, I think what we really need to fully appraise, and it's a little early for us to be able to say yes or no to that, because we haven't October is that we think it's always prudent when you see a major change in interest rates or a major change in credit markets to assume that there will be some impact. And industrial markets particularly lag but whether [ph] think slower month so where they are slower and think of 6 to 7 months, you do get an adjustment.
We do not think is a recession case, and I want to be clear about that. We think this is a...
what you get is a prudent adjustment. Short cycle businesses more likely to be impacted than long cycle businesses.
It normally doesn't occur in a month or two, which is why we don't think it hit the third quarter. But our own expectation based off the model I just mentioned to you is that it would tend to have some minor impact in the fourth quarter, and that's what we see instead of the markets growing, they probably flatten at this very attractive level here in the U.S.
that we have right now. And in the first quarter, we might see a first quarter that looks a little bit more like the first quarter of 2007 and then come back to fairly attractive growth for the balance of 2008.
And so that's kind of our view, Ted, to your specific question. Do we see short cycle businesses flowing in the fourth quarter?
We think there will be a little bit of that that we won't get the growth that we expected, but it's too early for us to say we have gotten data yet.
Unidentified Analyst
Okay. Okay.
Just shifting a little bit on MGE. I guess it comes in middle of the quarter, towards the end of the quarter?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, I think the middle of the quarter is probably a good place say, so.
Unidentified Analyst
You've had some... maybe some market feedback in the time that you are going to be the owner of the business.
Wonder if you just have any update on the momentum you expect from them and how that fit's going to work for the power market.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes, I would say we haven't closed the business, so we really can't comment on it. It's short-term business outlook per se, but in terms of where it fits, in terms of the product array, the geographic channels and the assets its brings to us are every bit as high as they at the time that we announced the deal.
It's a great fill-in in terms of the low end of the business where we have not had as large an IT resaler channel as we would like. And we frankly haven't had the full breadth of product there.
We think it greatly complements our current business and is a very cost effective way for us to continue to expand our power quality business.
Unidentified Analyst
I guess just lastly, that acquisition accounting, will the inventory, I guess, step up and then run through? Will that be completed by the end of the year or will there be some carryover next year?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
We anticipate, Ted, it will be competed by the end of the year.
Unidentified Analyst
Terrific, thank you.
William C. Hartman - Investor Relations
Okay. We have two more which are follow-up questions and we'll try to get them fairly quickly.
So the first one's Steve Volkmann. Are you there, Steve?
Stephen Volkmann - Morgan Stanley Dean Witter
Yes, I am here. Rick, tax rate for '08?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
Yes, the rate we anticipate, Steve, would be between 16% and 17% and to put it in a little bit of context because some folks have asked with heavy-duty truck growing in the U.S. And of course that's a very profitable market.
Why won't create some upward pressure on the rate. And it will.
But if you look at our fundamental tax rate this year, excluding one-off items, it's going to be around 15%. And so we think that that upward pressure will cause the rate to rise a little bit next year into the 16% to 17% range, which is almost identical to what it was in 2004.
And 2004 was a year of 269,000 heavy-duty market. So virtually an identical sized heavy-duty market is what we anticipate in '08.
Stephen Volkmann - Morgan Stanley Dean Witter
Okay, great. And then incremental Excel 07 benefits, should we still be expecting that in '08?
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
We said that we believe there will be some, because as we mentioned, we were not set at a fully calendarized rate in the first quarter. But we've not yet, Steve, provided a specific number, but we'll do that in the first quarter conference call.
Stephen Volkmann - Morgan Stanley Dean Witter
Great. Thank you.
William C. Hartman - Investor Relations
All right. And lastly, Andy Casey.
You still there Andy?
Andrew Casey - Wachovia Securities
I am. Can you hear me?
William C. Hartman - Investor Relations
Yes
Unidentified Company Representative
Yes.
Andrew Casey - Wachovia Securities
Just a follow up. I am trying to reconcile this truck forecast at the end of '08 where you are ramping up to 300,000.
Specifically, if I look at some of your other forecasts versus Northern American markets, it sounds like there is some further downside in housing until mid '08 and then kind of flattish auto. So does this really suggest no fundamental freight demand improvement in '08 first?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
That's generally correct. Yes.
Andrew Casey - Wachovia Securities
Okay. So the assumption going into 2009 is totally pre-buy driven?
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Well, I think two things Andy. One, you've probably given...
I know you have been, so in the truck market there is a lot of question around the freight number today in terms of whether it's as good a predictor as not. And we thought we ought to do that offline.
They'll do it offline with you because there has been quite a growth in elements that are not in that index. But I think generally what you are seeing is, yes, the way to think about it is a slower first half, second half really starting to feel the pace or the key of the pre-buy necessity because you would only have six quarters left at that point.
And we do need to see some improvement in orders here to start get ourselves to move in the first half next year. I think that's probably the right way to think about it.
Andrew Casey - Wachovia Securities
Just to be clear, Sandy, the reason I am asking is basically the pre-buy was no great environment. Demand improvement really suggest a huge replacement as opposed to capacity addition.
Alexander M. Cutler - Chairman, Chief Executive Officer and President
Yes. But you are prob...
yes, fair enough.
Richard H. Fearon - Executive Vice President and Chief Financial and Planning Officer
But Andy, I guess I would add that in general it's our belief and it's certainly Jim Niels [ph] belief that the usage of trucks grows roughly in line with GDP, maybe a little bit in between industrial production and GDP, you sort of average those two together. And so longer term, we do believe you are going to have more truck usage.
Looking at the ATA Truck Tonnage Index, we think it's a little misleading and it only represents about 50% of the market, and namely the compact haulers. And so our belief is that fundamentally you will see increased truck usage next year.
Andrew Casey - Wachovia Securities
Okay, thanks. I'll follow up offline.
William C. Hartman - Investor Relations
Okay. Thank you.
I thank all of you for participating and as always, I'll be in the office all afternoon to continue to field your calls. Thanks again.