Oct 20, 2008
Executives
William C. Hartman – Senior Vice President Investor Relations Alexander M.
Cutler - Chairman of the Board, President, Chief Executive Officer Richard H. Fearon - Chief Financial and Planning Officer, Executive Vice President
Analysts
Bob Cornell - Barclays Capital [Robert Rithheimer] Ann Duignan - J.P. Morgan Andrew Casey - Wachovia Capital Markets LLC Jamie Cook - Credit Suisse Terry Darling - Goldman Sachs Andrew Obin - Merrill Lynch Mark Koznarek - Cleveland Research Company Christopher Glynn - Oppenheimer & Co.
[Dan Doud] Brian Rayle - FTN Midwest Securities Corp. Jeffrey Hammond - Keybanc Capital Markets Eli Lustgarten - Longbow Research [Ted Wheeler]
Operator
Welcome to the Eaton Corporation’s third quarter earnings conference call. (Operator Instructions) I would now like to turn the conference over to our host, Bill Hartman.
William Hartman
Joining me this morning are Sandy Cutler, Chairman and CEO, and Rick Fearon, Executive Vice President and CFO. As has been our practice we will begin today’s call with comments from Sandy followed by a question and answer session.
The information provided on our call this morning will include some forward-looking statements concerning the fourth quarter of 2008 and full year of 2008 for net income per share and operating earnings per share, our worldwide markets, our growth in relation to those markets and growth from our acquisitions. These statements should be used with caution as they are subject to various risks and uncertainties, many of which are outside the company’s control.
Factors that could cause actual results to differ materially from those in the forward-looking statements are set forth in today’s press release and related Form 8-K filing. As a reminder to you also, this quarter we’ve included a presentation on third quarter results which can be accessed on the Investor Relations page.
Additional information is available in today’s press release which is located on Eaton’s home page at www.eaton.com. With those comments I’d like to turn the session over to Sandy.
Alexander M. Cutler
As Bill mentioned, we are going to take a little different approach this morning and utilize the presentation as sort of the backbone of our comments this morning. We hope you all had a chance to find that on our Investor Relations page and are able to pull it up there or download a copy.
I’m looking at page 3 in that presentation. It’s the first page following the forward-looking comments that Bill just mentioned.
We feel we had a very solid third quarter in spite of the decelerating growth of our end markets as the third quarter progressed. As you can see, our sales of some $4.1 billion were up 25% and a new third quarter record, and we think it’s significant in this period of time when we’re seeing growth rates come down around the world that over 20% of our revenues are still in a faster-growing countries, developing countries around the world.
Net income was up some 22%. Earnings per share up 9%.
Operating earnings per share up 9%. We think good cash flow in the quarter of $433 million of operating cash flow.
As we’ve commented in previous sessions our electrical, hydraulics and aerospace businesses now comprise about 79% of our segment earnings. Significantly our electrical margins before acquisition integration charges were a record 14.1%, we think a real confirmation of the increased depth and performance of our largest business.
We turn to the next chart, chart number four; just a quick reconciliation of our third quarter performance to our guidance. As you recall our operating earnings per share guidance was $1.95 and we actually came in at that $1.95.
We did have a lower tax rate which accounted for about $0.09 of benefit in the quarter and we bought back about 1.4 million shares during the quarter. That gave us $0.01 lower share count than we had anticipated when we started the quarter.
Offsetting those two positives were the downturn in the market that we commented on in our press release. From an overall point of view as you see, our end markets grew at about 2% in the quarter.
We had actually anticipated they would grow over 3%. Most of that contraction occurred in the US truck demand which you see hit us for about $0.05, lower hydraulics demand about $0.04, translation and you’ve all seen the volatility not only in the final days of the third quarter but you’ve seen it continue into October -$0.07, and as I mentioned we were really delighted with the really exceptional performance of our electrical business and that was about $0.06.
Those are the elements that really got us to midpoint of guidance. As you might expect during these periods of a lot of turmoil out there, there were a lot of moving pieces in the quarter.
We turn to the next chart, chart number five; just a quick recap for you of sales and segment operating profits last year versus this year third quarter. As you can see again, sales were up some 25%.
Segment operating profits were up some 22% as a result of weakness in a couple of our segments and I’ll go through those in a moment. Our segment operating margin as down by 30 basis points.
Acquisition integration charges in the segment were about $20 million versus $18 million last year. As you can see, our net income and segment operating profit were both up 22%.
Significantly when you think about the quarter’s 25% sales growth, about 2% points coming from market growth and outgrowth of about 2%. 19% from the acquisitions we completed over the last year.
Forex down to 2% as again I mentioned the Forex impact has now been weakening as we go through the back end of this year. Significantly if you think back to the second quarter, our end market growth was 6% so I think that gives you a sense for the nature of the deceleration in many of these markets as the credit crisis has really started to hit with some traction in a number of our end markets.
We move to chart 6, the one that’s labeled Electrical Segment. There you can see the very strong performance.
We’re delight with a 59% increase in the top line with 51% of those 59% really coming from acquisition. You can see the strong continued market growth of 4%, our own end growth of 4%.
Virtually no Forex impact. Operating profits were up a whopping 71% and the segment up to 14.1%, a new all-time record for the segment.
Integration charges of some $14 million and as we commented in our press release as well we will begin to be ramping up many of those integration activities for both the Phoenixtec and Moeller acquisitions now during the fourth quarter. Operating profit you can see was up some 66% after integration charges.
A couple of qualitative comments about the segment and market conditions and significant events within the quarter in the electrical segment. Our bookings were up a solid 6%.
Moeller and Phoenixtec continue to exceed plan in terms of revenues and profitability. We’re very pleased with those.
As I mentioned, we will be ramping up acquisition integration activities here in the fourth quarter. Our integration teams have been working with those businesses for some time and we’re beginning to announce a number of those actions that we’re taking.
Clearly its strong profitability reflects not only the better balance in terms of end markets and you’ll recall that this business was at one time primarily a North American business. Now it’s one that’s quite well balanced around the world but also much better performance in the base business.
The US non-res construction market segment we’ve been watching quite carefully obviously. We’ve talked a lot about it with you over the last six months.
The commercial segment is beginning to weaken. We see that more in the negotiations out ahead of us much as we had expected.
But the power segment continues very strong. Those are the larger projects that tend to be petrochem, mining, manufacturing structures, and we expect that to continue into next year as well.
European markets as we communicated with you at the end of the second quarter definitively have weakened as we’ve seen those economies back off but interestingly enough as we look through the US and our European channels, we’ve seen no evidence of overstocking in the distribution channel. Distributors are also being careful about inventories and we’re not seeing large pre-buys on price increases which tend to be a historic kind of monitoring point in the industry for overstocking by the distribution channels.
As we move to chart 7, the one that’s labeled Hydraulics Segment, it was a very solid quarter. The top line was up 7%, operating profit was up 14%, a 70 basis point expansion in our margins up to 11.3%.
You can see market growth was 3% in this quarter. It was 6% in the second quarter.
So again you get the feeling of deceleration. Outgrow was 1% and Forex was 3%.
Third quarter bookings were flat. That feels about what we’re seeing out there in terms of the environment at this point.
That’s a global number. The strong part of the markets tend to be agriculture, petrochem, wind power, oil and gas.
The weaker points as you would expect would be construction and areas like truck and bus. Again, in terms of our own surveys of distribution we do not see evidence of overstocking in the distribution channel.
In terms of a significant event that occurred actually just after the end of the quarter but since we’ve all last talked, we’re very pleased to have completed our acquisition of Integrated Hydraulics which really helps build out our valve product line again in this business. We move to the next chart, chart 8, labeled Aerospace Segment.
It had a very strong quarter again in this business of 12% on the top line and 10% on the bottom line. If you look at that sales mix again on the left-hand side of that chart, market growth was up 2% in this quarter.
That’s versus 7% in the second quarter and obviously it was impacted by the strike that’s going on at Boeing that impacted part of this quarter. Outgrowth was up by 11% reflecting the very strong bookings we’ve had over the last several years and the fact that a number of these important programs where we have much larger positions than in the preceding programs are now beginning to be built and shipped.
You saw a press release that we issued recently that we were very pleased to have booked an additional contract with Embraer. It’s got about $100 million of revenue value over its contract.
You’re all well aware of reading in the industry of the Boeing strike that is still ongoing at this point. We do anticipate it will have an impact on fourth quarter growth rates as well for the market place.
Last but not least, a lot of discussion in the industry around commercial aftermarket. It actually held up a little better in the third quarter than we had anticipated it would.
We do expect it will weaken through the first half of 2009. It may be a little different for every company in terms of the lead and lag effects in terms of how their aftermarket flow-through channels but that’s our best look at how we think that will impact, retiring about 500 planes by the end of this year other commercial fleets will have upon aftermarket.
We turn to the next chart, chart 9, labeled Truck Segment. You can see an attractive top line growth of some 15% but a big piece of that if you look down to the left-hand corner of this chart has to do with Forex.
Out of that 15%, 5% came from Forex; 6% from market growth and remember in the second quarter market growth was 16%, so again I think you get a feeling of the ramp up that we had expected in the second half is not occurring in this business versus a year ago. Outgrowth was very solid at 4%.
Many of you who recall our discussion of this segment in our second quarter conference call recall that we had expected the fourth quarter NAFTA heavy duty market to increase by about 16%. Our best expectation now is that it will be down about 2% as we’re just not seeing this market come back and we don’t expect to see any impact of a significant pre-buy in this business before the fourth quarter of 2009.
We are pleased however in light of that latter forecast for the business that that we booked some fairly significant new customer wins both in South America and Asia, and a number of those will begin to go into startup production in late 2009 and early 2010. As we move to the next chart, chart number 10, which is our Automotive Segment.
Obviously it was a pretty rugged end market condition. Overall market growth was down 6%.
Our own business was down some 14% and a very big drop obviously as you can see on the bottom line in terms of a 63% reduction in profitability. You’ll recall my comments at the end of our second quarter that my urging was that people think ahead to how tough the third quarter would be both as a result of downturns in the market place but also inventory pressure out in the dealer channels, and we expected that we would see a weak third quarter.
That’s indeed what we’ve seen with margins only 4.3%. A couple of comments as we think about where both the North American and European markets fit at this point.
We think the sales weakness that we’ve seen in the third quarter will lead and is leading to additional production cuts in the fourth quarter. Offsetting that we have two positives that really occurred during this quarter.
One is that we formed a stronger and more enduring partnership with our Nittan partner that we’ve been a minority owner of for many times. This gives us much better access into the Japanese and Korean OEMs for business both in the US and outside the US.
And secondly, you saw the announcement of the Kirloskar engine valve business that we announced in the quarter. That obviously gives us a real production base and engineering base there in India for really supporting not only that local market but OEMs around the world.
Last but not least, you’ll see an 8K that we will issue today which will detail our closing of a facility in Italy. This is a large facility that we are closing as part of the capacity rationalization in this market place and another step we’re taking to be sure that we don’t end up with over capacity at a time when the industry is going through significant changes.
Those charges which are detailed in that 8K in terms of the bottom line will be offset by the tax benefits when we move that production or the remainder of the production we have in that facility to an additional facility there in Europe. I’ll talk more about that when we come to our guidance.
If we go to the next chart, which is chart 11, this is our attempt to give you a summary of where we think our end markets are at this point. As you can see for 2008 we’ve arranged that in three columns, US growth where we’re saying we think the US will now actually contract by about 1% in terms of the weighted average or end markets.
Outside of the US we think growth will be on the order of 6% so we’ll see about 3% growth for the full year. Interesting enough here, recall we just came through a quarter with 2% growth in the third quarter and if you look to the right-hand side of that chart, you’ll see that our best forecast for the fourth quarter is zero.
Obviously what we’re seeing here is that we’ve seen two dramatic shocks to our original economic guidance for 2008. The first was the surge in oil prices in the second quarter and the second has been the meltdown really in the global credit markets.
While it appeared by June and July we were seeing some moderation of global oil prices and that has continued to the present time, in the late August to October time period and perhaps most punctuated by Lehman’s failure in the middle of September, we’ve really seen the banking credit markets render our early economic forecast almost irrelevant. We now believe instead of a fourth quarter resurgence in the US economy we’re entering a period of recession in the US, flat conditions in Europe and reduced growth in the emerging nations of the world.
We think the simplest way to think about that is that if you take almost any region of the world, growth has been reduced by 2% to 2.5%. We believe that the global credit crisis has and will have such a pervasive impact that the prudent assumptions we said in our overall press release is to assume a period of reduced growth.
While we talk about reduced growth, obviously you’re seeing a lot of pundits also speculating that perhaps people are becoming too negative in terms of the outline of economic downturn. We don’t think this goes on forever.
Our own thinking at this point is we think this period of time persists through the fourth quarter and the first and second quarter of 2009 and that we begin to see a mild sense of recovery occur in the second half of 2009. That really has to do with the strong stimulus that we think is already in the system in terms of a lot of the actions that have been taken to begin to buttress the international banking industry, but secondly the fact that it hasn’t been lost on us that oil prices have dropped from $147 down to the low $70s and that in itself is a form of stimulus.
While we think we are taking a prudent view for a fairly deep reduction in terms of world growth here for these next three quarters, we also believe there are some actions that have been taken that would lead us to believe that there’s a reasonable opportunity for some recovery, modest, at the end of next year. So we’re using outlined thinking in terms of US GDP that 2009 might be on the order of flat to down 0.1%; that in Europe you might see almost no growth, maybe just 0.1% or 0.2% of growth; and then in areas of the world like China and Brazil we’ve come down a couple points, so China’s more in the 8.5% range instead of the 10.5% range and Brazil instead of being in the over 5% will be just under 3%.
That’s the outlined thinking that sits behind all of our economics for both this year and next year. If we turn to chart 12, you’ll see what we are doing to have ourselves be well positioned during this time period.
We don’t have any one-time charges or massive restructuring plans to announce to you today because we believe that the actions are already in place within Eaton to deal with this kind of economic time period. You’ll recall that our Excel 07 program had almost $170 million of benefits come out of it.
That’s why we’re operating as well as we are through a period of reduced operation and we’ve not added back resources on top of that. The Moeller/Phoenixtec acquisitions were about $145 million of synergy value coming out of that.
The plant that I spoke to you about just earlier this morning in terms of our automotive business will have about $15 million of benefits in a mature year. Each of those actions sizes us very well for what we think is this period of about three quarters of weakness.
In addition to that we’ve also been trimming in our own businesses and it’s all been reflected in our third quarter results as well as our outlook for the fourth quarter. We’ve reduced our running employment beyond those three items I mentioned on the chart by about 2,000 people.
As you would expect we’ve been taking the prudent actions to assure that we’re sized correctly. If we move to chart 13, which is our EPS guidance, perhaps most significant on this and all these numbers were in our press release is that our fourth quarter operating earnings per share guidance has come down by $0.25 or just about 16%.
When you step back from that and say, “What could cause things to come off after a really very good third quarter? How could things come down that strongly on the fourth quarter?”
Perhaps that answer is best supplied on the next chart, chart 14, when you look at our fourth quarter guidance. You’ll see that versus our third quarter $1.95 operating earnings per share, the elements that we would expect that our share count will still be a little lower, our weighted share count.
Forex as I mentioned has been volatile and would understate the conditions I think we’ve seen here in October will impact profits by about $0.06. Our electrical business typically has a seasonal margin that’s lower in the fourth quarter than the third quarter, so you can see about $0.08.
We do expect the Boeing strike will continue for some time here. We think that’s likely to have a little larger impact in the fourth quarter than it did in the first quarter.
Very significantly we do not expect any pre-buy to occur in the North American heavier duty or medium duty markets. You can see that’s almost $0.06.
The net of the plant closing plus the offsetting tax benefits that I mentioned would hit us for about $0.01. So that’s the $0.20.
If you step back and try to think about it versus our previous guidance, it’s quite easy to think about where that reduction in about $0.35 between the $2.10 and the $1.75 guidance for the fourth quarter are. About $0.13 is in truck.
You’ll recall that we had anticipated that the market would grow by 16% in NAFTA heavy duty. It’s actually going to contract we think by 2%.
The automotive market has continued to move down for all the reasons we’re all familiar with. That’s worth about $0.13 as well.
And of these very volatile and declining Forex values, about $0.09. Three items that make up the $0.35 difference.
If we move to chart 15, it’s just a summary of our guidance. Our market outgrowth has been modified to $200 million, incremental sales from acquisitions about $2 billion, operating EPS numbers and fully diluted numbers were both in the press release, our operating cash flow of $1.4 billion to $1.5 billion, and our free cash flow estimate of $0.9 billion to $1 billion.
Last but not least before we open up for questions, if we just turn to chart 16 Outlook for 2009, I think the first bullet says it all. This is a pretty difficult environment right now to do forward-looking forecasting.
We think it will continue to be volatile and we’ll get good news on one day and then maybe some not good news the next day. Our best thinking at this point is that our markets in 2009, these are Eaton’s weighted average markets, will be flat to down 1%.
That compares with our earlier outlook of 4% to 5%. The Moeller/Phoenixtec synergy benefits will still be accretive by $0.25 to $0.35.
We’re quite comfortable and confident of that number. Pension costs are expected to be flat at this point.
That is versus our earlier guidance of 10% in terms of income. Tax rate instead of being the 16% to 17% that we had thought it might be in 2009, we now think it’ll be more on the order of 14.5% to 15.5%.
I’m sure there have been many questions in terms of our 2009 operating plan. I would tell you at this point we’re in the midst of putting that together.
Those points that I just shared with you are really the best insights we can provide you in terms of our thinking about 2009. With that Bill, why don’t we open things up for questions?
William Hartman
Can you give the instructions on the Q&A portion of the call please?
Operator
(Operator Instructions)
William Hartman
Our first question comes from Bob Cornell - Barclays Capital.
Bob Cornell - Barclays Capital
Sandy, you mentioned Moeller/Phoenixtec had a schedule. I see the synergy number’s still the same but maybe you can just give us a little more visibility and clarity into what’s going on there and how those are shaping up?
Alexander M. Cutler
We’re very pleased with both businesses. As I think you know, they were good businesses when we bought them so they were not fixer uppers.
That’s particularly important in this time period. Both their revenues and their profitability have been stronger than we had originally anticipated.
Clearly what’s beginning to change in Europe at this point is that you’ve seen the weakness move from UK to Spain and then on north, so most of Western Europe has been impacted in terms of slower growth rates. But Moeller’s got a really good footprint through Eastern Europe and while the growth rates aren’t as fast as they once were, they’re still quite positive.
Similarly Phoenixtec has continued to do very well in terms of its uninterruptible power supply capability not only in Asia but in terms of their shipments to elsewhere in the world. Those businesses are coming together well.
The synergy plans are coming together quite well at this point and we really look at both those acquisitions as being very successful albeit at this early stage.
Bob Cornell - Barclays Capital
A bigger comment too. Some companies are starting to talk about pricing compression and you didn’t mention that specifically.
If you look at your pricing outlook and also the potentially beneficial impact of commodity costs coming down in the context of how much you might have hedged, how is the price/cost combination look for Eaton in the fourth quarter and the first half of next year?
Alexander M. Cutler
I think your comment is on point. What we’ve seen now is almost 5.5 years of commodity inflation and with this so-called demand destruction that’s going on in many end markets currently, you have to believe that the rate of that increase starts to mitigate.
In some cases you’ve seen a number of commodities start to come down fairly strongly. We’ve been able to manage quite successfully over the last 5.5 years the increase side of this.
We are equally confident we’re going to be able to manage the downside on it. It has taken some pressure out which is helpful at a time when volumes are weakening up as we think they will over this next three quarter time period.
William Hartman
Our next question comes from [Robert Rithheimer].
[Robert Rithheimer]
Let me just start out with just a little bit of a detailed one. When you looked at the pension, you mentioned obviously it’s an uncertain environment.
Did you look at a range of probabilities and if it’s worse than flat, how bad could it get?
Richard H. Fearon
As you know the pension expense is a function of what the discount rate is, and the discount rate has come up quite a bit from the rate we used at the end of last year which was 6.0% for the US plan as well as the level of assets. Now the level of assets is a five-year weighted average so as the assets clearly have come down related to the decline in the world equity market, you see that decline only slowly factored in.
So our best guess is it’ll be flat. It might end up depending on how those two factors end up at the end of the year maybe +/- 10% or around that.
But that would be our anticipation right now.
[Robert Rithheimer]
I hate to be negative but on the oil patch, it’s one of the markets that’s holding up well for you and for a lot of folks. Have you seen any signs of weakness there and new quoting activity or otherwise?
Richard H. Fearon
No. I would split it in two.
I think the great majority of the investments in those areas are being made by fairly substantial firms that have very strong cash flow, and in that category I would say no, we’ve not and we’re quoting on new projects as well. As you can imagine, the cycle time for not only quoting but for building and putting into commission those new facilities is quite long.
I think there’s generally a feel that oil prices, energy prices are going to be higher than they’ve been on average over the last five years so it’s a time for expansion. I’d say those are very small firms that are perhaps a little bit less well financed and we think that’ll be an impact but that’s a very small portion of the total that’s really going out in that arena.
William Hartman
Our next question comes from Ann Duignan - J.P. Morgan.
Ann Duignan - J.P. Morgan
Sandy, can you talk a little bit about the progression of operating profits for the businesses as we roll forward? What kind of detrimentals would we expect from the businesses in the markets in that flat to down mixture?
Obviously you’re saying that the first half would be slow and the back half recovery. Can you actually grow earnings year-over-year in the first half ex Moeller and Phoenixtec?
Alexander M. Cutler
We are obviously right in the midst of putting our operating plan together right now so we don’t have a definitive answer for you on that. I think what we tried to suggest in those couple points that we tried to provide about 2009 is that the easiest piece to think through in that regard obviously is where we have acquisitions, where we’re bringing in both incremental revenues because we didn’t own those businesses for the whole year, and then secondly where we’ve got synergy activity going on.
I’d say those are the big ones we can put our hands on. The reason we’ve been cutting back resources as we provide you some detail on that one chart is that we want to be sure that we’re not carrying any higher expense rates in the next year.
We’ll be in a position really to comment in more detail on that in January.
Ann Duignan - J.P. Morgan
Have any of your end markets slowed much more rapidly than you might have expected where in the near term we might be looking for worse than normal detrimentals as going to Q4?
Alexander M. Cutler
I think I would suggest to take a look at what our guidance is for the fourth quarter because that ought to give you the run rate coming off the period of time of no growth if you will. We’re saying that you’ve got kind of $1.75 run rate coming out of the fourth quarter and obviously if you annualize that, you’re up at a $7 kind of rate leaving this year.
What you decide to do with your thinking through those acquisition integration benefits plus we’ll have some part year growth that comes from the acquisitions we didn’t own for the full year. I think those are some of the elements to kind of think your way through what a reasonable level of profitability is for us next year.
Ann Duignan - J.P. Morgan
So conspicuous by that sense is your earlier outlook for 15% to 20% earnings growth for next year or is it just too hard to forecast at this point?
Alexander M. Cutler
That’s a very relevant question. Clearly I think when we come off 4% to 5% market growth to now one where we think it could be flat to maybe down 1%, that takes obviously a 15% to 20% off the table.
We wouldn’t want to leave any misconception around that at this point. We think that what we’re facing is a pretty sharp downturn here into the fourth quarter/first quarter that clearly was not in any of our early thinking.
We surely did not see the magnitude of this credit crisis materializing as it did through August, September and now October. We think that however you want to express it, the damage is in or the concern is in in the markets.
There’s a period of hesitation and surely you can see that not only in the consumer sentiment but you can see it in purchasing managers’ indexes, you can see it in a variety of different entities. That’s why we feel that we really need to be taking the prudent actions to ensure that we don’t go into next year with any higher resource levels than we’ve been carrying this year.
In fact you’ve seen us take some of those resources out in the chart that I detailed for you.
William Hartman
Our next question comes from Andrew Casey - Wachovia Capital Markets LLC.
Andrew Casey - Wachovia Capital Markets LLC
A couple of clarifications before getting to the question. On the automotive margin performance in the quarter, the 570 basis point decrease, was that all mix and absorption or was most of the 2,000 headcount decrease in there?
Alexander M. Cutler
No. Our headcount reductions are really around the company.
Obviously you would expect a big piece is in automotive but I would say a lot of what you see there is normal third quarter seasonal weakness magnified by the fact that as we had tried to signal there in our second quarter guidance that we thought that quarter would begin to be impacted significantly by much weaker volumes as retail sales started to back up. We did see production cuts through the third quarter and they have now accelerated into the fourth quarter.
Andrew Casey - Wachovia Capital Markets LLC
Should we expect any sort of additional restructuring outside of the Italian plant closure?
Alexander M. Cutler
We think that that’s the major piece that you’ll really see hitting the fourth quarter. Again, the way I think to think about it is that you’ll have that charge in the segment and then we’ve got really what we believe will be an offsetting benefit that will manifest itself in our tax line.
Andrew Casey - Wachovia Capital Markets LLC
Could you give us some clarity on what you expect for all-in tax rate for Q4?
Richard H. Fearon
I would expect a tax credit of about 5%. The reason it will be a credit is you’ll have the incentives that are triggered by moving volume to this other European plant.
That’s based on an agreement with a government. Then you’ll also have the benefit of the newly passed R&E credits because if you’ll recall in the TARP bill, the R&E credit was renewed.
That entire really full-year benefit will show up in the fourth quarter rate.
Andrew Casey - Wachovia Capital Markets LLC
This is kind of a perennial question, but now that some of the end markets have taken a turn for the worse are you seeing any effect of the credit issue on your distributors and suppliers related to their ability to finance working capital?
Alexander M. Cutler
It’s clearly been a concern of ours and we’re great fans of watching what happens with regional bank loans in terms of how they prospectively forecast pressure in the channel. If you flip to the truck industry, you’ve obviously seen a lot of bankruptcies in terms of private operators’ small fleets.
We have not to date seen significant impact or feedback from our distributors and other businesses at this point about working capital. We just have had a series of fairly large customer meetings and have had the chance to ask that question because our expectation is that you would be seeing that occur.
I think what you’ve been seeing though is people have been very careful about not overstocking their inventories so they’re not stretching their lines, and perhaps that’s the reason we’re not hearing the pressure from them at this point.
Andrew Casey - Wachovia Capital Markets LLC
If I read into your ’09 preliminary outlook, are you pretty much banking on a flat North American build for Class 8?
Alexander M. Cutler
Yes. What we said on that one chart, the truck chart in our presentation, is that we think there’ll be some modest impact in the fourth quarter of 2009 that you could call a pre-buy but we would describe this much more as a sort of heartbeat in the patient than the patient jumping off the table and running out of the operating room.
William Hartman
Our next question comes from Jamie Cook - Credit Suisse.
Jamie Cook - Credit Suisse
Rick, what was the $17 million in other income in the quarter and how should we think about that for the remainder of the year? And then my follow up question, Sandy you gave order trends for total electrical but how should I think about what we’re seeing there in Moeller and Phoenixtec relative to the previous quarter?
And is there any way that you can help us with trough margins for those businesses? I’m just trying to figure out if that gets weaker, how that impacts my model?
Richard H. Fearon
Let me grab the first question. Other income and expense normally ranges in any given quarter between 0.5% income and 0.5% expense.
Included in other income importantly are things like royalties, commissions, rental income, and a variety of small categories. The way to think about the $17 million in ’08 is if you adjust the ’07 number for the fact that ’07 did have the charitable contribution, $16 million of expense, it’s virtually identical between the third quarter of ’07 and the third quarter of ’08.
Looking into the future it’s very hard to forecast this line in that it does bounce around because it’s a collection of small items, but my anticipation would be it’s likely to be modestly positive in Q4 if I were making an estimate right now.
Jamie Cook - Credit Suisse
And the question on the Moeller and Phoenixtec, whether you’re seeing a deterioration there in orders and how we should think about what were trough margins just so I can figure out the cyclicality of margins in that business in case that starts to weaken as well?
Alexander M. Cutler
The overall electrical bookings recorded at 6% do not include Moeller and Phoenixtec because we had not owned them a year ago. So when you look in the actual Phoenixtec and Moeller bookings, they’re very solid, they’re positive through this time period so we’ve not seen them back up if you will at this point.
Jamie Cook - Credit Suisse
They have not weakened at all?
Alexander M. Cutler
At this point we’ve not seen those bookings weaken although we anticipate you will see that happening in Europe at this point. I think the thing to think about here is that a fair amount of this kind of impact that we’re forecasting started to run fairly strongly in September, and - I’m not talking just to those businesses, I’m talking generally - as the quarter was a quarter with some different feelings.
July and August were better feeling months than September was and I think that’s kind of a general trend that you saw happen, so we think that trend continues into the October, November and December period which is why we’re forecasting zero end market growth for all of our markets in the fourth quarter. In terms of trying to give you any kind of margin impact through the cycle, it’s just too early for that.
We’re right in the middle of those operating plans and really trying to work through them. I’m not trying to give you any sense for concern.
I just can’t give you good numbers there until we have gone through our detailed operating planning with them, and that’s what we’re doing right now.
Jamie Cook - Credit Suisse
Is there any way you can give me a sense of what we think by segment, like what your visibility is by segment today versus what it would be a year ago? I’m just trying to see what your visibility is over the next three to six quarters?
A lot of the other industrial companies have said visibility, and it depends on if you’re long or short cycle, but it’s pretty limited at this point.
Alexander M. Cutler
I think if you think about the two businesses which are clearly the longer cycle business within Eaton, the longest cycle business is clearly our aerospace business and I think you see all the same numbers that we do that in the industry they’re up to kind of three-year backlogs that exist there. We continue to see those activities being quite strong and likely to be one of the stronger end markets as we march through 2009.
The next business that’s a good four to 4.5 month kind of visibility is what we’re carrying the backlog of the assembly side of our electrical business. Regardless of what one’s forecast is for US non-residential construction next year, we’ll enter the year with a very large backlog that even if not a single order was booked will carry us well into next year, and we do expect more than a single order to be booked.
Those would be the longest lead time businesses. Clearly within segments of hydraulics or you get a look at mining equipment; that tends to go out over a longer period of time.
But then a number of the rest of our businesses I would say are kind of industrial flow businesses where you aren’t looking out a lot beyond a couple months.
William Hartman
Our next question comes from Terry Darling - Goldman Sachs.
Terry Darling - Goldman Sachs
Rick, I’m wondering if you can finalize the translation to your comments on the fourth quarter tax rate with the 5% credit and the R&E 5% to 7%, something like that?
Richard H. Fearon
When I say a credit, what I mean is instead of the rate being an expense it’ll actually be income and it’ll be about 5% of the pre-tax.
Terry Darling - Goldman Sachs
If we start with a baseline of 14%, 15% or 16% or right around 15%, you’re down to 10% there and then the R&E credit brings you down further. In your guidance are you assuming essentially 5%, 7% or 8%, something like that?
Richard H. Fearon
We’re starting with a base rate that’s around 15% and then if you take out the impact of the R&E credit, you take out the impact of the tax incentives that will be triggered, that’s what gets you to this 5%.
Terry Darling - Goldman Sachs
On foreign currency in your guidance on a full-year basis ’08 versus ’09, what is the bottom line fx impact and presumably as we move into next year that’s going to be a headwind? I’m wondering if you can talk about Euro dollar today at $1.33, what kind of headwind that might be?
Richard H. Fearon
Obviously the fx benefit in ’08 is not going to be quite what we had expected in our last conference call. We thought it might be as much as 450 and now it looks like it’s going to be more on the order of 250.
So it has definitely come in. We’re still in the process of doing our planning for next year and as you know the rates are bouncing around a great deal.
So it’s pretty hard to have much of an outlook right now on the impact, but I wouldn’t expect it’s going to be enormous. If the rates just stabilize where they are today, there would be an impact of a certain negative magnitude but the reality is that I think as the markets settle out here we may see some gains for example in the [RAI] because in the [RAI] as I think you know the [RAI] did weaken and vary enormously in the middle of October and it has been strengthening ever since.
We’ll have to see where things like the [RAI] settle out. If you look at the total amount of income that we will have booked this year on the roughly $250 million of revenue, it’s on the order of about $30 million through three quarters.
Terry Darling - Goldman Sachs
On the Phoenixtec/Moeller accretion of $0.25 to $0.35 on the ’09 outlook, is that unchanged? If it is, given the deterioration in Europe, why would your expectations there not be scaling back unless you’re accelerating cost cutting?
Alexander M. Cutler
It is unchanged and it is largely because just what you mentioned there, that we feel very good about the cost synergies that we have in the business and our ability to accelerate them. As I’d mentioned at the end of the second quarter, it really was one of our levers that we had to pull if we thought the economy was going to come in weaker than our initial projections.
And because we think the economy is coming in weaker than our projections, we think it’s prudent to move ahead with some additional cost scaling and we can get to that kind of accretion through these synergy moves.
Terry Darling - Goldman Sachs
Any chance you can help us with the fourth quarter acquisition intregration costs? In the press release you mentioned they will be higher in the fourth quarter but can you quantify those for us?
Richard H. Fearon
Our anticipation is it’s going to be on the order of about $35 million. It will scale up as we start taking some of the actions that were in the integration plan in the fourth quarter.
Terry Darling - Goldman Sachs
That’s just electrical, right?
Alexander M. Cutler
No, that’s in total.
Richard H. Fearon
That’s in total but the great majority of it is electrical. As you know we do have integrated hydraulics, we do have some smaller transactions that are included, but the great majority of that’s electrical.
Alexander M. Cutler
And that $35 million is versus $21 million in the third quarter.
William Hartman
Our next question comes from Andrew Obin - Merrill Lynch.
Andrew Obin - Merrill Lynch
I’m just a little bit confused in terms of tax rates. The tax rate in 4Q will be a benefit of 5% so we’ll have a negative tax rate, is that correct?
Richard H. Fearon
Yes.
Andrew Obin - Merrill Lynch
What are your assumptions for GDP growth for the US and the world in 4Q and ’09, just because your forecast has to be reliant on the macro work that you guys are so good at?
Richard H. Fearon
Our current view is that the US GDP growth in 4Q we think will be -2.0% and with an industrial production number that’s more negative than that.
Alexander M. Cutler
I think that’s the real significance because I think as you’ll all recall, it’s generally when the US goes through a period of economic recession, manufacturing tends to cycle more or has a larger beta if you will so a -2% in the overall GDP means that you get a fairly severe drop in terms of manufacturing industrial production.
Andrew Obin - Merrill Lynch
What about ’09?
Richard H. Fearon
Our overall view is that GDP growth in ’09 for the US will be just about flat to perhaps slightly negative.
Alexander M. Cutler
You start off with probably a negative in the first quarter and then you start to fight your way to being more flat as you get out of the second quarter.
Andrew Obin - Merrill Lynch
What assumptions are you making about global growth? In particularly I’m very interested in your views on China?
Alexander M. Cutler
As I mentioned earlier, our general view is that this economic period of weakness really triggered or magnified by the global credit crunch takes 2% to 2.5% off of basically every region of the world. We think that still means that your kind of brick nations continue to be growing but they’re growing at lower numbers, so China comes down from a 10% to 10.5% to probably something closer to 8.5%.
Brazil comes down from kind of a 5% to 5.5% to something like 2.5% to 3%. We don’t think that there’s any area of the world that’s going to escape this.
Some will continue to grow; some will go to a flat or slightly negative status.
Andrew Obin - Merrill Lynch
On a slightly different topic, given that you guys raised equity back in the spring your balance sheet is in pretty good shape. What are you seeing in terms of acquisitions and if you could comment on any specific areas that you’re looking at?
And also, what about physical ability to do deals in this environment and in particular access to debt financing?
Alexander M. Cutler
Really no change in terms of what we said in this area. There are a number of areas we’re still anxious to add to our overall business balance and those continue to be in the electrical and the hydraulic and the aerospace areas.
We’ve said that we would not do large acquisitions in our automotive or truck area. We’ve got plenty of opportunities to grow those businesses internally.
We had a lot of speculation really starting last fall if pricing would change out of the market place for acquisitions. I think as we’ve seen, that manifest itself as a really good business state, fairly expensive.
The medium grade or low grade businesses pricing has caved in on those but we’re not particularly in those types of businesses. In terms of our capacity we define it two ways.
Obviously in terms of our financial capacity, there we’ve said that really we would not be doing transactions; didn’t expect to do any material transactions until we were exiting this year 2008. But the other is obviously the managerial capacity which we think is important as well.
Having concluded the large transactions we did in our electrical business and we had a couple smaller acquisitions in other businesses, we’re pretty busy currently in terms of integrating those activities. We’re on a lower scale here over this next six to nine months than we have been in terms of the acquisition market.
Andrew Obin - Merrill Lynch
What about just in terms of what you’re seeing on the debt market ability to refinance short-term debt? Can you comment there?
Richard H. Fearon
We ended the quarter with just over $1 billion of CP outstanding. That’s a very typical level for us.
We haven’t had any issue at all in placing commercial paper. We have actually over the course of the third quarter moved out the duration of our CP to where it’s approaching 40 cays, and historically we had kept it more in the 25 to 30 days.
We just did that as a prudent measure. In terms of rates, there has not been much impact.
If you look at what we’re paying right now for example compared to what we were paying in July, rates have gone up by about 10 to 15 basis points so not much of an impact. I guess my view on all of the turmoil in the CP markets is that it’s principally affected financial issuers and highly rated industrial insurers.
At least if you look at our experience as well as the experience of other large diversified industrial companies that there really hasn’t been much impact.
William Hartman
Our next question comes from Mark Koznarek - Cleveland Research Company.
Mark Koznarek - Cleveland Research Company
A question on a couple of the segments starting with electrical. When we look at the trend of the markets here for the first nine months, it’s averaging around 5% and your outlook in the fourth quarter is 2%.
What I’m wondering is whether that softness is across the board or is it primarily in the power distribution side and power quality is continuing to grow at its historic kind of rates of mid-single-digit numbers?
Alexander M. Cutler
At the second quarter we commented a little bit that in the power quality market where we had begun to see some weakness was in the IT reseller channel. That tends to be a channel through which a fair amount of the single phase product is moved and we had seen that start in Europe sort of paralleling areas where you had seen the weakness in the residential construction.
So it was in the UK and Spain. What we’ve seen is it has moved up if you will through France and Germany and into those market places, and here in the US also you’ve seen some slowing in the IT reseller market as well.
We think there are prospects of slowing both on the power quality side in that element and then on the power distribution side. On the high end of the power quality market we’re continuing to see a fair amount of activity in terms of large data centers, and they’re not all built by simply financial institutions.
A lot of the hosting sites continue to be quite busy in that regard and online storage continues to be a major driver in that arena. That’s sort of middle to high end continuing strong there.
Then if we get over to the power distribution side, not a tremendous amount of change in residential as you can imagine because it’s so weak already. You constantly see a kind of pushing out of forecasts as to how long the residential side will be weak.
What we think will be happening, and we’ve been commenting on this it seems like for almost a year and a half because we thought it would weaken and it hasn’t weakened, this commercial side of non-res will begin to weaken in response to the financing issues that are out there. We just think that’s the prudent view at this point.
It hasn’t really impacted our bookings to any large degree yet, but we just continue to believe that it will. That’s sort of our view from the power distribution side.
I’d say the one area within Europe to keep in mind that everyone seems to ignore though is when we talk here we talk Europe and Middle East, and the Middle East is continuing to be quite strong and you’re seeing quite strong construction activity through that area as well. Not all in that region is weak at this point.
Mark Koznarek - Cleveland Research Company
It sounds like to step back, the predominance of the weakness would be power distribution because some parts of power quality are still working for you.
Alexander M. Cutler
I would say that you’re continuing to see positive growth. We haven’t seen negative.
So I’d say you’re still seeing growth but the single phase power quality area is an important market as well. You remember we bought the MGE business and we bought the Phoenixtec business which are primarily single phase businesses.
Mark Koznarek - Cleveland Research Company
Actually that leads right into the next question I had which is the fourth quarter margin commentary that there’s seasonal weakness there. Just looking back at the last four years, only one of those years we saw margins soften in the fourth quarter when you adjusted for charges and some gain that was booked in one of those.
But is that cyclicality due to the recent acquisitions MGE, Moeller, and Ptec, because it didn’t seem to be very seasonally cyclical prior to this?
Alexander M. Cutler
They’ve magnified it but normally you do see a fourth that’s a little less in the third. We’ve had some different acceleration of markets going on the last couple years but if you had a year where you didn’t have a strong up or down in a market direction, you would generally find the fourth quarter is a little weaker than the third quarter.
Mark Koznarek - Cleveland Research Company
So it’s been becoming more pronounced because of these acquisitions?
Alexander M. Cutler
Yes.
Mark Koznarek - Cleveland Research Company
In ’09, granted you’re still pulling your plans together, but given the flat to slightly down total market outlook, could you at least prioritize the expectations for the major segments in terms of which categories might be actually growing next year and which ones are expected to be down in order to average to a flattish kind of number? In other words, are they all flat or is one or two up a little bit and the rest down a little bit?
Alexander M. Cutler
I think the best kind of calculation as I mentioned before were awfully early in this and it is maybe a more volatile time period now than we have faced collectively over the last number of years. I’d say the high end is likely to be aerospace for all the reasons of it being the long cycle type of business and backlogs pretty well in place.
I’d say probably the low end is likely to be global automotive growth. Those two would kind of be the two wings if you would that you’d get to the average of the zero to maybe down 1% overall.
William Hartman
Our next question comes from Christopher Glenn - Oppenheimer & Co.
Christopher Glenn - Oppenheimer & Co.
The underlying electrical margins really look pretty good. Can you talk about what’s left for restructuring in that next year and talk about how the benefits have flown through?
You haven’t taken much of the bulk of restructuring but the margins are really turning pretty good there.
Alexander M. Cutler
You’re exactly correct. The big benefit if you will that starts to come through from the synergies really are largely untapped at this point so what you’re really seeing in the business is great end market balance both from a geography point of view and then from a segment point of view within it.
But you’re seeing the strength of the MGE business that we bought a year ago in November, the Phoenixtec business that came in in February, the Moeller business that came in in April plus improvement of the base. So what you’re really beginning to see we believe here is the real strength that comes through from a better mix and balance of the business.
Our hope as was mentioned to several of the earlier questions is that even in a period when we see some economic weakness that we’re forecasting out ahead of us across our businesses, we believe as we start to bring the synergies in we can help to mitigate any economic weakness impact upon margins. But your assumption is right.
You’re not seeing significant or a material benefit from the synergies yet.
Christopher Glenn - Oppenheimer & Co.
The other corporate expense net, can you just talk about what’s the normalized range and then the variability around that looking forward?
Alexander M. Cutler
It’s normally +/- 0.5% of sales. That’s the kind of experience that we’ve had over a long period of time so what you’re seeing is a number for the third quarter that’s very much in that typical range.
As I did point out, in order to compare it to the third quarter of a year ago you have to remember that there was $16 million of charitable contribution expense in the third quarter. If you adjust for that, last year was $15 million of income and this year was $17 million of income.
Christopher Glenn - Oppenheimer & Co.
I meant the other corporate expense net in the segment income statement line.
Alexander M. Cutler
Oh, those are simply our corporate expense charges which typically have been in the neighborhood of $35 million to $40 million. That’s been a typical running rate.
For the full year our view is that fourth quarter’s likely to be around $40 million so you’re likely to be for the full year around $185 million.
William Hartman
Our next question comes from [Dan Doud].
[Dan Doud]
I just wanted to follow up. On the truck segment your revenues are up significantly compared to Q3 of last year.
Your margins are down a great deal. Can you give us a little more color on what’s driving that?
Is it mix? Is it pricing deterioration?
Can you mention that for us?
Alexander M. Cutler
You’ve got a very big impact of 5% of Forex and that’s a large issue obviously in here. Secondly, if you actually go through the heavy duty market place, what we’ve been growing a fair amount of our revenues outside of the US.
That’s what’s contributing to the Forex. I’d say that’s the biggest issue that’s in there.
We had a very different mix of heavy duty versus light/medium US versus international in the fourth quarter of last year. I think the other thing that you tend to see happen in the truck industry after a period of prolonged downturn or flatness in the market is that the various different owners start to depopulate options and more expensive alternatives on their truck.
That’s part of what we’re experiencing at this point as well too is that the percentage of the kind of fleet trucks is a bigger percentage of what’s actually being sold out there than people who may want to take on a higher option vehicle. That’s nothing different than you normally see as you go through these kinds of cycles and that’s what we’re seeing happen right now.
[Dan Doud]
Does that imply that next year you’re likely to see some continued margin deterioration there as outside of the US grows more strongly than NAFTA or is that not the right inference?
Alexander M. Cutler
I think the real message about our truck business is that at these relatively low levels of activity, we’ve been able to maintain 15% margins four quarters in a row. You’ve never seen that done before.
Actually I get quite a bit of solace out of the fact that our business is performing we think really, really well while markets are low. Many people’s concern historically has been there would be a blow-off year in 2009 and then a big sag in 2010.
The clear implication for valuation of the company of this forecast of relatively flat demand through 2009, a minor flip in the fourth quarter, means that we don’t expect to see a big falloff in 2010. That reduces cyclicality across the business cycle for Eaton.
[Dan Doud]
On hydraulics you mentioned that in the construction vehicle segment you’ve seen a lot of weakness. Are you seeing that across all of the regions of the world or is that mostly concentrated in North America and Western Europe right now?
Alexander M. Cutler
I think part of the surprise that has occurred and how quickly it has occurred in lighter credit markets is that there are certain markets in Asia that have slowed down fairly strongly. I think that’s one of the pieces that convinces us that the credit crisis is impacting multiple markets, not just the develop markets.
We would characterize that the worldwide construction market growth is one that is being not very robust currently.
William Hartman
Our next question comes from Brian Rayle - FTN Midwest Securities Corp.
Brian Rayle - FTN Midwest Securities Corp.
Most of my questions have been answered but I was going to kind of go through the electrical margin expansion of 100 basis points. Was any of that from raw material benefits or anything like that or was it pure volume mix leverage?
Alexander M. Cutler
I think it’s volume and it’s also more importantly really the mix of our businesses. We’ve got a better mix now than we’ve ever had before.
Brian Rayle - FTN Midwest Securities Corp.
You didn’t see any benefit from raw materials in that number at all?
Alexander M. Cutler
No.
William Hartman
Our next question comes from Jeffrey Hammond - Keybanc Capital Markets.
Jeffrey Hammond - Keybanc Capital Markets
To the earlier question about acquisitions, can you just speak to the alternative? I was surprised to see you guys need in-buying stock.
What do you see as your capacity to buy back stock at this point and I guess your preference to do that versus acquisitions?
Alexander M. Cutler
I think we put it in the same category as acquisitions at this point. We don’t feel during this time period when there’s substantial risk out there in credit markets and there’s also risk obviously around economic forecasts that it makes a lot of sense for Eaton to stretch its balance sheet.
We will be staying fairly conservative through this time period whether you look at that from an acquisition point of view or you look at that in terms of rebuying shares.
Jeffrey Hammond - Keybanc Capital Markets
Do you feel like you need to delever the balance sheet some or you can just ultimately use free cash for acquisitions?
Alexander M. Cutler
I think what we’ve said on a couple of occasions is that we didn’t expect to close any acquisitions until we got into the end of this year or early next year. That’s still our view is that we really think it makes some sense to have cash on hand as you’re going through a time period like we’ve been seeing in terms of the unpredictable nature of the credit markets.
As Rick mentioned, we’ve not had a specific challenge at Eaton but we think prudence through this time period says that you ought to be managing your balance sheet conservatively, and that’s what we’re doing.
Jeffrey Hammond - Keybanc Capital Markets
On automotive can you just maybe clarify what you think the big drivers are of the underperformance versus market growth in that segment?
Alexander M. Cutler
Really the reasons behind both Nittan and the Kirloskar acquisitions, we for about two years have been signaling that as consumers move in North America away from the big vehicles there’s not as much content on a small vehicle as there is on a big vehicle. The second piece is that there’s been significant market share gain by Japanese and Korean manufacturers, and they have outstripped their domestic capacity here in the US so they’re bringing more vehicles in than they used to.
That’s why we formed the more detailed relationship with Nittan so that we can get a higher presence in content on vehicles that are exported from Japan to the US and Kirloskar so we have that similar capability in India as well. Nittan helps us with the Korean market as well.
Both those are actions that we’ve taken this summer are really aimed right at that issue.
William Hartman
Our next question comes from Eli Lustgarten - Longbow Research.
Eli Lustgarten - Longbow Research
Last time we had the downturn you were very proud that you thought you could hold truck margins at 15%. I assume that you’re hoping to be able to do it as you go through this period.
In automotive with the margins cutting in half, are we looking at this level of profitability in automotive well into 2009 or are those steps you’re taking be able to get it back to a double-digit number?
Alexander M. Cutler
That’s clearly our objective. I think we’ll have a more insightful conclusion to share with you in January because we’re working right through that plan at this point in terms of both trying to understand specifically where will the OEMs come out in terms of their production rates as we exit the fourth quarter and there’s a fair amount of change going on in that arena from a day-to-day basis right now, and then what our ability obviously is to respond to that.
Certainly that’s the kind of target that we’ve got but we can’t tell you at this point that that would be good guidance for 2009 till we really finish our operating plan.
Eli Lustgarten - Longbow Research
And holding truck our profitability is near current levels as sort of still the objective?
Alexander M. Cutler
Yes, we actually feel very good about the profitability right through this time period where we’ve had frankly disappointing market volumes, but we think the business has done very well.
Eli Lustgarten - Longbow Research
From [inaudible] the profitability looks like it could begin to deteriorate because the volume looks like for the next couple of quarters to be under pressure. Is that a fair statement or can you hold levels of profitability about where it is today?
Alexander M. Cutler
I think if we think about it, it kind of depends which way you look. There’s normally a little seasonal weakness in the third quarter versus the second quarter.
It’s usually about 1% to 1.5% and what we saw happen here in the third quarter is that some of this high profit flow short-term goods ramped down significantly right at the end of September. So we’re working to get our business sized correctly in case that’s indeed what we see going forward.
We think that business has been improving each year in terms of its profitability. Clearly as the market weakens up we’ve got to be very attentive on the cost side and that’s specifically what we’re working on right now.
Eli Lustgarten - Longbow Research
So the fourth quarter [inaudible] will probably be very similar to the third as opposed to pick up and trying to improve overall next year. Is that what I’m hearing?
Alexander M. Cutler
We didn’t look to see big changes in that segment, that’s correct.
William Hartman
Our next question comes from [Ted Wheeler].
[Ted Wheeler]
On the 2,000 census reduction I wondered if you could indicate the costs that have been flowing through the income statement for that and maybe the timing of getting the costs down so that you realize some benefit from those actions? Secondly, are there additional census reductions that will be steady as we go through this downturn or are you a little bit out ahead of the downturn with the 2,000?
Alexander M. Cutler
No, we don’t have a breakout of the numbers because they’re baked right in. Our reason for sharing it is that we weren’t announcing a one-time hit.
We’ve really been taking these costs as they go so they’ve been in our results and they are in our forecast as well at this point. I think the question about what’s the right resource level, probably Eaton is not alone at this point in terms of trying to gauge that question relative to the changes in the economic forecast.
One of the reasons we’ve dialed down our economic forecast is we think it’s prudent to have a more conservative economic view through this time period and we will manage our costs and resources to that lower level. If it does prove that we’re too conservative, and some may feel that way, we’ll manage on the upside just fine but we do not want to be in a situation where we’re chasing our market down.
[Ted Wheeler]
Does that imply then that the 2,000 represents an adjustment to the new reality that you’re seeing or there are still significant census reductions that need to be done to get to the level?
Alexander M. Cutler
Remember that 2,000 is in addition to the plant closing that we announced today as well as all of the synergy activities in Moeller and Phoenixtec to an earlier question I mentioned will probably go faster on those than we would have originally, and then that’s on top of all the work we did in Excel 07. So I wouldn’t take the 2,000 as that’s the whole in the parcel.
It is beyond those top three things we mentioned to you there.
[Ted Wheeler]
The plant closing, that’s done this quarter?
Alexander M. Cutler
Yes.
William Hartman
With that I appreciate everybody’s attention and always I’ll be on the phone all afternoon working on your questions. Thank you much.
Operator
Ladies and Gentlemen, that does conclude our conference for today.