艾默生電氣 (EMR) 2005 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Emerson fourth-quarter and fiscal year 2005 results conference call. [OPERATOR INSTRUCTIONS] And as a reminder this conference is being recorded today, Tuesday, November 1, 2005.

Emerson's commentary and responses to your questions may contain forward-looking statements.

Included in the Company's outlook for the remainder of the year.

Information on factors that could cause actual results to vary materially from those discussed today is available in Emerson's most recent Annual Report on Form 10-K as filed with the SEC.

In this call, Emerson management will discuss some non-GAAP measures in talking about the Company's performance and their reconciliation of those measures to the most comparable GAAP measures is contained within a presentation as posted in the Investor Relations area of Emerson's website at www.gotoemerson.com.

I would now like to turn the conference over to Chris Tucker, Director of Investor Relations.

Please go ahead, sir.

Thank you.

I am joined today by David Farr, Chairman and Chief Executive Officer of Emerson;

Walter Galvin, Senior Executive Vice President and Chief Financial Officer; and Jim Burgess, President.

Jim has joined us today for one of his last official acts as President of the Company, retiring effective at the end of today.

So we thank Jim for being here with us.

Today's call will summarize Emerson's fourth-quarter and fiscal year 2005 results.

A conference call slide presentation will accompany my comments and is available on the Investor Relations section of Emerson's Corporate website.

A replay of of this conference call and slide presentation will be available on the website after the call for the next three months.

I will start with the highlights of the quarter as shown on Page 2 of the conference call slide presentation.

Fourth-quarter sales were up 13% to 4.6 billion with increases in all segments.

We had strong underlying sales in the quarter, up 9% and operating profit margins improved 80 basis points to 16.1% of sales, earnings per share was $1.01, up 20% which includes an additional repatriation tax expense of $0.01.

Operating cash flow was $879 million and free cash flow was $711 million.

Our operational efficiency initiatives continue as average days in the cash cycle improved by two days and operating cash flow to total debt came in strong at 53.4%.

Next chart, sales as we said, 4.643 billion, up 13%.

Increases in all five segments, underlying sales up 9%, led by three segments with double-digit underlying sales growth.

Process management at 10%.

Network power at 15%, and climate technologies up 11%.

Operating profit dollars were 746 million, up 19% as we saw benefits from restructuring and sales volume leverage.

Net earnings for the quarter were 419 million, up 18%.

Diluted average shares outstanding were 414.9 million, which led to EPS on a reported basis of $1.01, again up 20%.

And the earnings per share excluding the additional repatriation impact was $1.02, up 21%.

Next chart we'll take a quick run through the underlying sales analysis.

Again strong underlying sales of 9% led by the U.S. strong growth in the U.S. of 10%.

Internationally, we were led with 14% growth in Asia, 23% growth in Latin America, 12% growth in Canada, and in Europe, growing slower at 2%, but it did turn positive in the quarter for a total International growth of 7% and then again, total underlying growth of 9%.

No impact from currency in the quarter, acquisitions added 4 points to growth for consolidated growth of 13%.

Next chart, a little income statement detail.

Gross profit dollars of 1.669 billion, up 12%.

Operating profit of 746 million, 16.1% of sales and 80 basis points improvement again driven by the volume leverage and restructuring benefits.

Other deductions were 76 million in the quarter, an increase of 27 million on increased litigation and FX.

Interest expense up slightly at 51 million, which leaves pretax earnings of 619 million or 13.3% of sales, the tax rate in the quarter was 32.2%, but on an underlying basis, excluding the repatriation impact the rate was 31.4%.

Next chart, cash flow and balance sheet.

Operating cash flow in the quarter was 879 million, up 21% in the quarter driven by the strong earnings performance and also strong working capital performance.

Free cash flow in the quarter of 711 million up 28%.

If you look to the bottom of the chart, you see the components of trade working capital.

Very strong performance here as the percent of sales for the quarter was 17.4% a 90-basis point improvement from the prior year.

Chart 7, take a look at the segment earnings.

The business segment EBIT at $706 million, up 15%.

The difference in accounting methods of 38 million up 4 million.

Corporate and other of 74 million, up 7 million, and then again the interest expense up slightly to get you to the pretax number of 619 million up 17%.

Now we will take a quick run through each of the segments.

First on chart number 8 is process management.

Sales in the quarter of 1.168 billion, which is up 14%.

Underlying growth here was 10% with acquisitions adding an additional 4 points of growth.

Geographically, sales were up 24% in Asia, up 2% in the U.S., and up 4% in Europe.

EBIT dollars were 203 million which is up 22%.

The margin increased in the quarter 110 basis points as we saw good leverage on the high sales volume and savings from prior cost reduction programs.

The key highlight here for Emerson Process Management really an exceptional year for the group with sales for the whole year up 13% and EBIT dollars for the whole year up 41%.

Next chart number 9, industrial automation.

Sales in the quarter of 821 million, up 6% on a reported basis and up 6% underlying with no currency impact.

By geography the sales were up 16% in the U.S., up 1% in Europe, and down 11% in Asia.

EBIT dollars of 120 million which is up 7%.

Margins improved by a tenth as we had leverage on the sales volume and price increases to offset the material inflation.

Key highlight in the quarter we closed the Pneumatics acquisition during the fourth quarter, which is a nice fit with the Company and expands our fluid power and control offering.

Chart 10, network power.

Sales of 941 million in the quarter up 28% versus the prior year.

Underlying sales were up 15%.

Currency added 1 point of growth and acquisition added 12 points.

By geography, the sales in the U.S. were up 16%, Asia up 25%, and Europe up 2%.

EBIT dollars in the quarter were 131 million, up 44%.

Nice margin improvement here again on the cost reductions and leverage on the sales growth and also the successful integration of the Marconi Power business.

Key highlight here is strong results in our core UPS and precision cooling business has driven strong sales in margin performance for the segment.

Next chart, climate technologies.

Sales in the quarter of 825 million which is up 11%.

Also up 11% on an underlying basis with no currency impact.

Geographically it was driven by very strong results in the U.S. up 19%.

Europe was down 3%, and Asia was down 9%.

The residential AC markets in the U.S. really drove the growth in the quarter as we had strong heat in the late summer months and low inventories to drive the growth.

EBIT dollars for the quarters were 115 million, up 2%.

The margins were down 90 basis points, excluding restructuring as price increases were not able to offset material inflation.

We had a strong finish to the year in this segment but 2005 was a volatile year given the dynamics and we would expect that to continue as we move into '06 with the pending SEER changes in January.

Next chart, appliance and tools.

Sales in the quarter of 1.020 billion up 8%.

We had underlying growth of 4% and acquisition added an additional 4 points of growth.

Asia was up 37% on a small base.

U.S. was up 3% and Europe was flat.

EBIT dollars were 137 million, up 5%.

Margins decreased 50 basis points on a negative price cost impact and margin dilution of acquisitions.

We continue to work on price increases here to offset the persistent commodity cost increases and we are taking the necessary restructuring activities to recover the margin losses.

Next chart, chart 13, just wanted to do one quick chart on the fiscal year.

Really a great year for Emerson after a very strong year in fiscal '04 as well.

Sales for the year at 17.305 billion, up 11%.

Underlying sales growth was 6% for the year which is in line with the long-term goals of the the Corporation.

Operating profit was 2.588 billion, 15% of sales which is a 40-basis point improvement.

Great OP performance on significant headwinds on the material side.

As we said earlier, EPS then on a reported basis $3.40 which is up 14%.

Earnings per share excluding the repatriation was 355 up 19%.

And operating cash flow was 2.187 billion.

Strong performance here as well as the '04 results included a $140 million tax refund that did not repeat this year.

Return on total capital 16.1% excluding the repatriation impact.

So very nice improvement on this very important measure for the Company.

Last chart, summary and outlook.

Basically, strong momentum for the Company as we move into 2006.

Order trends have remained strong, with approximately 15% growth in the fourth quarter.

The end markets for our key businesses remain favorable and our eight key growth initiatives continue to deliver.

We expect -- based on this we would expect first-quarter sales growth in the range of 8 to 10%.

First-quarter earnings per share growth in the range of 12 to 15%.

We will have pension expenses next year.

The increase by 60 million for the full year.

And we will provide further full-year year guidance at our investor update in February.

So with that, I would like to turn it over to David Farr.

Thank you, Chris.

Good afternoon, everybody.

I guess my opening comments would have to be that, 2005 was an outstanding year on top of what I call a very strong 2004.

We look at the measurements of sales up 10.8% underlying 6% this year.

OP up 40 basis points to 15.0%.

OP dollars up 13.3.

EPS, 19.1% to 355.

Operating cash flow 2.2 billion and our ROTC, return on total capital at 16.1%, up from 14.2 last year.

A record year on all fronts when you look at it.

I have to commend the various business leaders and the businesses they run in delivering a great job with strong sales growth, underlying sales and penetration, margin leverage, restructuring benefits are flowing through, and tremendous strong cash flow in ROTC.

As Chris mentioned we leave 2005 with a record backlog, our fourth-quarter orders were 15%.

Up 15%.

Strong momentum going to our new fiscal year.

As I look at the underlying market dynamics for process, industrial automation, and network power, tools and storage and climate technologies I look at very good dynamics right now.

Tougher dynamics for our consumer related business in the motors and appliance components.

Our U.S. markets are very good right now.

Our European markets are improving.

Latin America is strong, and I think will stay that way for the next couple of quarters.

Asia-Pacific is still strong.

Also going to contribute nicely in 2006.

I anticipate 2006 to be another very good year for Emerson.

As Chris mentioned, we look at first-quarter sales growth in the 8 to 10%.

EPS in the 12 to 15%.

And many of you might have forgotten if you'd looked at the first quarter last year we had a $0.02 gain from property sale in Ireland so we are actually growing underlying closer to 15 to 18% growth in the first quarter of earnings offsetting that $0.02 gain we had in the first quarter last year.

So net-net as we look at 2006, a lot of momentum going into it.

We feel very good about it.

And as I say to people read my lips, I am very positive.

I'm upbeat about it.

We had a great Board meeting and I feel very good about what we see right now.

Before we open up the lines, I also like to -- I really want to thank Jim for his 30 years with the Company.

I won't go into the dissertation.

I did at our planning conference last week, it would be kind of embarrassing.

But I want to thank Jim for his network power contributions the last several years.

He has been been a tremendous help as long -- as well as Walter and Ed and the whole CEO transition the last five years.

Jim and I have done a lot of acquisitions and planning together over the years, and I really appreciate what he's done to help the Corporation and to help me.

He has agreed to stay on and consult with us for a couple of years in between sailing, vacationing, drinking wine, and no telling what else he is going to be doing.

But Jim is -- Jim has made a tremendous contribution to this company and we should all thank him.

I know all of you out there know Jim, and he's going to be going to Europe with me next week and giving presentations even though he is retired he's going to go to Europe and present for me.

So I appreciate that.

With that I want to open the phone lines and let the questions flow.

And we are looking forward to responding.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from Jeff Sprague with Citigroup.

Please go ahead.

Thanks, good afternoon, everyone.

Jim, congratulations.

Good luck.

Have fun.

I guess maybe if we could start first with Asia.

Is there anything to glean from the fact that your businesses seem all over the map in the quarter on Asia?

Process strong, IA week, network strong, climate weak.

It just strikes me as very odd.

A lot of our businesses in that marketplace will have lumpy orders, lumpy sales because of major projects.

I would say that the only one that had a trend all year long was climate, and they after a very strong three-year period in China had a softer market as the government cracked down.

We talked about this in non rev construction and also res construction but they have seen that marketplace actually improve in the last couple months.

So there's nothing unusual about it.

You would always see us have lumpy up and downs in our businesses in Asia.

I'd expect -- and we will talk more about it in February but I would expect our Asia business again to be in that 12 to 13% sales growth for next year.

And also, Dave, no mention of prebuy or anything in your HVAC commentary, it sounds like you don't think it was significant part of your equation in the quarter.

But could you give us kind of your after action here on what happened in the season vis-a-vis kind of the transition and any prebuying you saw intense here.

As we talked over the last couple conference calls, we've talked about a volatile year in climate technology.

We saw a very strong surge.

We did mention a prebuy in our press release if you read it.

There is a mention in there.

There's a lot -- there is a lot of different views of this right now.

The key issue is we had a hot end of the season.

The inventories got really worked down in the marketplace.

Customers are building again into the season right now.

As we look at it, we see across the industry some tense here production build going on.

We anticipate that to continue.

We then see that shifting into the first calendar quarter as they start building more 13 SEER product.

Net-net as I look at 2006, I would look at a volatile year where we could have some very strong quarters followed by a weak quarter but I -- and overall I anticipate a very good 2006 as we make this transition to 13 SEER.

Just one last one, more kind of long-term Emerson picture.

Certainly '05 was a great year, but kind of thinking about 6% organic growth, even though you were building off 8% last year.

You had kind of negatives in the three years preceding that.

I'm just wondering if we think about how good the industrial economy looks and feels.

Do you actually need to make more changes to the portfolio to be able to maintain 6, 7% looking out into the future?

Based on what we see in the underlying gross and fixed investment environment around the world and way our mix is right now, the current mix of the portfolio looks pretty good.

Maintaining our growth through a cycle in that 5 to 7% range.

The cycle looks pretty good for us right now.

All right.

Thanks a lot.

Thank you.

Our next question comes from John Baliotti with Fulcrum Global Partners.

Please go ahead.

Hey, Dave, could you touch on maybe some of the trends that you saw in process and industrial as the year went on?

Did you see any kind of change in the types of orders or the types of projects that you were working on as the economy kind of matured a little bit even though there still seems to be pretty good growth there.

No change.

The pace in the oil and gas and the PAR market space, the chemical space.

We saw orders pretty good.

Pretty consistent all year long.

I don't think it got any stronger or any weaker.

Obviously we are in a pretty good cycle there right now, based on our orders you can see that and it's across the board, it is not just -- as some people would say it is a product.

Actually our whole solutions and solutions business is equally as strong as our device business, so I look at that, and I have not seen anything changing from quarter to quarter.

So those capacity utilizations held in here around 80%.

You have seen pretty steady types of business activity?

Correct.

Okay, thanks.

Our next question comes from Michael Schneider with Robert W. Baird.

Please go ahead.

Hi, Dave.

Hi, Mike.

I wonder if you can just first address kind of your outlook for organic growth going forward, and I reference, I guess, just where we stood a year ago versus where we stand today.

Last year we were running about 9% growth with orders actually decelerating.

This year we are running a 15% order growth adjusted for currency and we are accelerating.

What does that say to you about having achieved 6% organic growth in the past 12 months and what you see coming forward?

Is it a case where we should actually see an acceleration in organic growth in fiscal '06?

I would say that what you see right now going -- based on our order rate the last, say, three or four months and our backlog.

What we see right now is a fairly strong first half, and based on the gross fixed investment, the year might, on a comparison basis might be weaker in the second half but a very strong start.

Total, right now, the underlying gross fix investment numbers that we track are still very strong and have been increasing over the last couple of months.

So I wouldn't say accelerating, but I would say that we are reaching some pretty good high levels right now and you will see a strong first half.

Okay.

And then just on the eight initiatives you referenced in the slides and Chris went through.

I guess maybe lay out for us what has been most successful and maybe what has been most disappointing in those initiatives.

Because I think you were targeting about 1.5 billion in incremental revenue from those initiatives during the year.

We will go through them in great detail in February like we had the last couple of years .

But in total, the initiatives that were really strong this year were what I refer to as our distributed power, it was very strong.

Our network power business is very strong, and our process business is very strong and that's -- and scroll was kind of flat with a strong close to the year.

In total, I think they grew around the 15% level for the year.

Is that what we told them? 15%.

But clearly -- you think about the industrial automation.

You think about network probably.

You think about the process initiatives on that page.

Those are the ones that were extremely strong.

What did not meet your expectations?

I would say scroll.

Scroll as we said at the beginning of the year was very volatile.

We started out weak and it gained in the second half of the year.

That was -- and then I would also say the big box.

Yes, the big box.

Thanks, Jim.

Jim just gave a pitch on this.

He should be answering this question.

The big box -- the big box was not as strong as we anticipated earlier this year.

Okay.

Just one nuance in the process numbers.

Asia up 24%.

It had been running basically at 4% for the year.

Was there some year-end shipments or what happened in Asia?

In a process business, you will have big projects come and go in -- and we've obviously -- we obviously got some big projects finished in the fourth quarter.

The process business, as is the network power business will be lumpy.

You will see quarter-by-quarter numbers that could go anywhere from 5 to 25%.

It moves.

I didn't think that the process business was that weak in the first -- Walter, you agree with his numbers?

What were the numbers there?

No, they were in the 20s all year.

In sales?

Be careful.

I don't think they were.

In sales.

Walter -- oh, no, I want to say it looks like 7.

He is right in what he said.

In 5 to 10% range.

5 to 10 -- I would say it goes lumpy like that, Mike.

Okay, thanks again.

You are welcome.

Our next question comes from John Inch with Merrill Lynch.

Please go ahead.

Thanks, good afternoon.

Hey, maybe Walter.

The $0.10 pension headwind, where did we end up in the plan in terms of rate of return discount rate and what you are thinking in terms of perspective funding of the plan this year?

We are looking at a discount rate because our plan actually ends on June 30.

So we are looking at -- we are looking at a discount rate for fiscal year '06 for that P&L of about 5.25%.

We are looking at return assumption of approximately 8% in fiscal year 2006 versus the 8.5% in 2005.

We're looking at a funding similar levels of cash going out the door in the range of 75 to $150 million which is in line with the funding we had this year, which wound up being approximately $125 million.

Okay.

The other question I had was just of a cash that is being repatriated you took another charge for some more this quarter.

Dave, I am not sure if you have outlined this or you are going to outline this in greater detail in February.

But big picture, how would you like us to think about the uses of this cash that's been brought back to the states?

Big picture, it is being used to fund engineering sales -- salary expenditures in the United States right now.

That is the bigger picture.

That's what we are using the money for.

New product development and selling.

Okay, there is no underlying message here that you are looking to do some sort of deal in the states?

Nothing different than what we have been looking at for a long time.

We just have -- we had a window here to bring back significant amount of cash at a very low tax rate, and reinvest that money in the U.S., and we did it.

There is no hidden agenda.

Okay.

Then maybe a question for Jim Berges.

Jim, as you depart, how are you thinking about network power, specifically -- network power shares, its market share position perhaps versus APCC and just the outlook, perhaps a little bit more of a perspective on the outlook for that market?

Well, we obviously had a very strong year, and as Chris pointed out, our fourth-quarter strength, both in the sales and profitability and in the orders that we reported, a lot of that came from our UPS and air conditioning business at Liebert so relative to others in that segment we think we are outperforming right now.

I think the business is terrifically well-positioned.

I feel really good about leaving at this time.

I mean, we've done everything we set out to do, restructured the business, got the margins back to respectable levels.

We brought the Marconi acquisition in and very, very quickly made it a contributor to the business.

The margins frankly, for the Marconi piece in the fourth quarter were a little bit below my expectations but that was because their order rates are so high that we are in an expedite mode trying to keep up with customer demand.

We are incurring a lot of air freight and overtime cost to keep up with the demand.

That is kind of a good kind of problem to have and I feel good of our ability to get that margin up in '06 to where we expect it to be.

The only thing I would add, we did not have down profitability in the quarter or for the year in our Liebert business.

And considering Marconi and the strength of this business the past couple of years, where would you guys peg this business in terms of its end markets and the cycle?

Are we kind of midway, still a little bit early, or are we past the midway point, do you think?

I think it is early.

All the trends I talked to you guys about in February of the continued wireless buildout, both of 3G and the developing -- and the developed world and just plain wireless for the first time in places like India and Nigeria.

That has continued to be a very strong demand for us.

The broadband deployment that's going on in this country with the RBOCS trying to take on the cable TV guys have been a very, very strong driver for demand, and we are seeing this Voice over Internet Protocol of -- really start to kick in for us too.

So I think it is early frankly, and it is by -- it's real companies.

These are people like SBC and BellSouth and Verizon and Telefonica and folks like that spending money not these start-up companies that we saw back in '99.

So I think there's a lot of sustainability here.

So Jim, you are not top ticking this?

Pardon.

You are not top picking this, the departure.

Oh, no.

Not like Chuck did. [ LAUGHTER ]

I wouldn't say that.

We had two good quarters.

We had two good quarters.

Congrats, Jim.

Thank you.

That is a new phrase, top picking.

Our next question comes from Chris Chotowicz with AG Edwards.

Please go ahead.

Good quarter.

Thank you very much, Chris.

Question for you on raw materials.

I think some of us are probably a little surprised that -- that may have snuck up on a couple of your business platforms in the quarter.

Is there anything you can say there to give a little more color?

Is there a tail end to the next quarter?

Is that implicit in the guidance? .

The -- I don't think there -- there is nothing new in the material area from our standpoint.

We feel the worst is behind us from our standpoint of price cost.

We feel that -- we know we turned the fourth quarter, it went positive, and with the sudden surge in some orders say at our climate area, and we had to buy in some materials faster than we normally would have and therefore probably had to pay some premiums.

Net-net, right now our materials are in pretty good shape and our price costs going into 2006 is on the right side.

That chart I show, you would see us -- right now the swing is positive.

We are above the line both in the price, cost.

You are going to basically recapture your margin pretty quickly in the first half of '06 then is the thinking?

I would say so.

The one thing in the climate area we are continuing to invest in capacity.

And we will be doing that.

We are in the process of building a new facility in Mexico, so -- that will be adding some costs, but net-net right now, we feel pretty good about the price cost in the margin recovery in that business.

I mean, you have a business that goes -- as volatile as that business has been this year, profit margin, move up and down quite rapidly.

Okay.

On the conversion to 13 SEER, how far along are you in that effort?

I guess--.

We don't control that.

We make the product.

So we make 10 SEER product, we make 13 SEER product and we have no problem making either one.

So depending on what the OEMs do they make that call and each OEM is doing its own plan and I know they talk about that, I've read that in the transcripts of these people.

So the -- it is proceeding. 10 SEER production will end effective January 23, in 2006 and then we are at 13 SEER and beyond.

I guess the reason for the question is, is that part of the reason for some of the pressure on margins specifically in this quarter?

Is that something we would expect to see also in the first quarter?

The margin pressure -- climate technologies had a good quarter last year.

They had -- European business was weaker this year than last year which is very profitable.

Their Asian business was weaker last year.

So from that standpoint they had a strong recovery in what we call the residential piece.

So I don't see -- there is nothing extraordinary going on there in one quarter and one quarter does not make a trend in anyone's margins.

You know that Chris.

Sure.

Thanks a lot, guys.

Good luck, Jim.

Thanks, Chris.

Thank you our next question comes from Nicole Parent with Credit Suisse First Boston.

Please go ahead.

Good afternoon, guys.

Hey, Jim, I appreciate all the time you've spent educating me about Emerson, probably more specifically network power so I want to wish you all the best in your retirement.

Thanks, Nicole.

Dave, I guess just a little bit in terms of the restructuring, any change to the level of restructuring that you alluded to on the last call for '06?

And then I guess the next question would be, based on the restructuring activity you did in 2005, where do you think we should look for the most margin expansion in '06.

Chris was pointing out the last phone call, being older I have to remember these things.

It is harder -- we said 75 to $100 million.

Over the long term.

So I would anticipate that we'll be next year somewhere in that 90 million to $100 million range for restructuring because our trend is to go back towards that 75 million to 90 million level.

As I look at next year's business model, I would say that margin expansion will continue within the process business.

They're obviously having a very good run right now with orders and sales and we're leveraging our plans.

I would say based on what Jim has done in network power and the restructuring and the strength we are seeing on orders, I would expect his business to have good margin expansion going back to some of the higher levels of margins that Jim saw before the downturn.

I would expect that our industrial automation business will continue to improve margins at that market place.

A lot of restructuring will come through.

I think we will have a -- as I said a better price/cost situation there next year.

I think the toughest place will still be our motors and appliance component because I think that market sector is still very stressed.

The price cost is tougher there, and the underlying market dynamics are not as good.

I would say that restructuring underway in the tools and storage business will pay off and we'll see some of that margin improvement coming back.

We did a lot of restructuring in some plants.

North American plants moving into best cost areas.

And the climate margins, in my opinion will improve next year as we see the -- a more consistent growth given the fact that it might be volatile from quarter to quarter.

So I would say -- margin increase next year I wouldn't be surprised if it is not in the same range or delta that we saw this year.

We saw 40 basis points.

So that is probably a pretty good number for right now.

That's our best estimate right now.

I guess just one follow-up specifically on Marconi.

How should we think about this business?

I mean you've characterized the integration as being successful.

When we think about just the margins because you still had some nice margin performance in network power despite overcoming that.

So I guess, as we look ahead, how should we think about the margins ramping up along with the volumes?

Nicole, we think -- first of all, we took -- these guys did a terrific job.

They took $45 million of cost out of this business on a run-rate basis in ten months.

Effectively.

And we will see the carryover effects of that into next year, plus additional projects that we've identified that will be implemented next year.

So my hope would be to see this business as I've always said.

I would expect it to be at the average for network power.

Okay.

Terrific.

Thank you.

Our next question comes from Don MacDougall with Banc of America Securities.

Please go ahead.

Good morning, everyone.

That's Don McDougall.

Hi, Don.

Good-looking quarter and my congratulations to Jim as well.

I would like to drill in a little bit more on this prebuy question.

A fairly simple question.

Were the prebuys in your estimation 10 SEER or 13 SEER products?

In other words filling the channel for next year's production or building old inventory to sell next year.

10 SEER.

10 SEER.

Okay.

And the volatility that you referred to several times and noted that you expect that there could be some impacts next year, is that related to the -- just manufacturing transitions or channel fill issues?

If we could get some more color there.

I think you are looking at two things.

One, we had -- if you look at the fourth quarter this year was an extremely strong quarter.

People one -- they had -- inventories come down and they start ramping up and producing more 10 SEER product.

That will be a very difficult comparison next year as you look at the fourth quarter.

I think you will see the first quarter will be very strong.

As they continue, one, some are really ramping up to 13.

Some are still pushing hard on 10 SEER.

I think you will see a very strong first quarter.

Then you will see it slow down a little bit as they shift into the 13 SEER and then maybe see them building it and then you could see it work off in the third quarter.

So when I talk volatility, I'm -- rather than a steady growth where you expect maybe 5, 6, 7, 8% type of growth in an underlying business, you could see 12, 2, negative 2, flat or something like that if you move around the quarters.

And that's the last type of business.

Tom Thatcher has got his hands full this year to manage that.

With the plants and everything.

Okay.

The thing is there's so many OEMs out there and they all have their own strategy.

And so we have to be -- we have to be flexible to deal with all those strategies, and we are flexible.

That will cause some movement around.

Substitution has been a big driver for climate.

Where do you see kind of the maturation of that substitution effect in the numbers within the next few quarters?

Is that -- does that happen in the first half?

Does that happen in the second half?

I think that you started seeing it and you will see it quite strongly throughout most in the first half and you would see it primarily in the first half.

By the time you get halfway through the calendar 2006, you will see it -- most of it done.

Okay.

Just one final one on climate.

Where do you think your share of the 13 SEER market domestically will shake out based on the customer commitments you have for next year?

Kind in last year.

We don't give that number out.

Well, you have given it in presentations before.

I think -- I think the number was projected to be around 70%.

I don't think -- we never gave that number.

Some people could try to impute that.

Oh, I see.

Okay.

We never gave that share number out.

Okay.

One final one, Dave.

What's your expectations for the acquisition pipeline over the next few quarters?

I would -- the pipeline looks pretty good right now.

We did around $500 million last year.

We could easily do 1 billion next year, but I guess if I was planning a number I would plan somewhere in the 5 to -- 500 to $700 million for us next year.

Thank you.

You are welcome, Don.

Our next question comes from Steve Tusa with JP Morgan.

Please go ahead.

Sorry.

My question has been answered, thanks.

Okay.

Thank you, our next question comes from Bob Cornell, Lehman Brothers.

Please go ahead.

First of all, I would like to say thanks to Jim too.

A lot of thanks.

But it's well deserved over the years I must say.

The question actually for Dave or Walt first.

The process margins were good in the fourth quarter but I was wondering, you mentioned that a lot of projects got finished in the quarter.

Were there any unusual end of project costs in the quarter that took the margins down a little bit relative to the normal fourth-quarter spike the process gets?

No.

I thought the margins were pretty good.

You are going to see -- we are adding capacity so in the third quarter we had a very strong leverage in the process margins but these margins are at record levels for the process business right now.

You got asked about the cycle in network power, Dave.

Where would you characterize the Company in the cycle for in the process business.

Are we early in the cycle?

Late in the cycle?

Early.

Right.

The -- network power, a lot of questions on network power, but the -- I think, Jim, you alluded to the fact you get back to Corporate average margin I think is what you meant to say--.

No, I said Marconi would get to network power margins which I have always said would be lower than the Corporate average margins because Aztech -- well, Aztech will always dilute from a margin viewpoint although it has very good ROTC because there's a low capital employed in that business on a relative bases.

We will never see the Aztech piece of network power at the Corporate average.

So I think network power will always be a little bit below the Corporate average and Marconi ought to be at the average, I think, of network power.

You know--.

Jim, you've talked about the network power business in true cycles running from, say, 8% to 14%-type numbers over the years.

And -- I mean, you kind of have to throw out a lull which was a crazy leverage here and we grew 35%.

I just kind of take that one and set it aside.

We grew 35% and didn't add any people.

We can't do that again.

But, I think that the EBIT margin on network power could be 14 to 15%.

At the peak and down to?

And down to maybe 11 or 12 and really if you have another big down draft.

Just in terms -- you mentioned, I think, that Liebert really was -- had a great year but the embedded power business has been coming back and I think that you alluded that -- in the press release you alluded to that there was a product issue earlier in the year and you got some new products out that's been helping to drive the business lately.

Could you give a little more visibility what was going on there?

Well, specifically Aztech's order.

The embedded power business has been very strong for the last three or four months.

Some of that is seasonal, Bob.

We sell -- we do sell charges to the cell phone industry, the cell phone industry is white hot right now.

I think they are going to build over 800 million units this year, and a lot of that is for -- is done for the Christmas season when they launch their new models and things.

So we are very busy in that space right now.

I would not expect to continue at that kind of pace, but certainly things have been picking up for us all year.

We had that very weak first quarter last year if you will remember in the embedded.

And I think our comparisons in the embedded space in the first quarter this year will be very strong, because we have built a pretty significant backlog there.

How about early in the year Marconi was winning significantly some of the big buildout orders and their RBOC I think.

What is the -- an update there and a flesh-out for the year perspective?

We are still doing terrific there.

It's -- the buildout of the -- of the high data rate wireless networks.

We are getting -- we are getting a lot of lift on that.

And the buildout now of these broadband optical networks.

We are getting a lot of -- we are getting a lot of wins in that space.

Are there there a lot of big contracts that are out there to win in the next year or so?

There are still plenty more.

I can't go into details on them because none of them have been awarded, but there is a lot are activity.

A lot of quotation activity right now, and a lot of interest on the part of the RBOCs in particular to get this IPTV they call it out in the marketplace so they can start competing with the cable guys.

It sounds to me like network power is going to have a great '06.

Is there something I am missing that would suggest that is not the case?

It ought to be really good.

The growth rates ought to be good and as Dave said the margin ought to expand again significantly because we have got a lot of carryover, particularly on the Marconi thing.

The first half of last year we barely got started.

We really were hitting on all cylinders in the fourth quarter and I think that's going to -- I know that's going to carry over into next year.

So I would expect that we have a really nice '06 in that business.

Okay.

Thanks, Jim.

As long as Dave doesn't [Expletive] it up, he is kind of running it now.

Yes.

I got Berges as a consultant here, so I will be calling his [Expletive] don't worry

Okay.

Thank you guys.

See you, Bob.

Our next question comes from Robert McCarthy with CIBC World Markets.

Please go ahead.

Good afternoon, gentlemen.

Great quarter.

I wanted to touch base on pricing trends across the segments.

In particular, network power.

What you are seeing.

I will answer the other ones and I'll let Jim answer network power.

The pricing trends right now from our standpoint, we continue to push some modest price increases out there across the Company relative to the commodity inflation it is out there.

It has obviously moderated a little bit but we are still pushing through price for commodities.

We also still have the oil and gas and natural energy -- natural gas costs.

So we are continuing to push price, and that's why we feel good about the price cost situation for the next two or three quarters.

We will see how the second half of the year, second half of the economy comes through, but we feel very good about the overall price cost situation of Emerson.

Network power works in a different dynamic and I will let Jim explain that because he -- the redesign.

It's a whole different dynamic.

It is really hard for us to tell a lot of times what is price and what is mix in new product in the network power space because the rate at which we introduce new models is so high that we literally are turning over our entire product families about every three years.

So the competition is doing similarly.

Probably not as fast but something similar.

So many times we have to redesign to a smaller form factor and a lower cost solution just to keep up.

And I am not sure it is a price cut because we have taken a lot of cost out as well and our margin actually is going up while we are taking price down.

So--.

In effect it could have been a potential tailwind for you in the quarter then, just given the fact that underlying trends are so strong?

We certainly are not seeing as much -- the quarter-to-quarter, month-to-month, day-to-day pushing on price on existing products from the procurement folks and our customers has not been quite as bad as it was say this time last year, and it is because we are busy and I think a lot of other people are busy right now.

They want the products.

Understood.

Dave, could you amplify any further commentary you might have on Europe?

It looks like the trends picked up in the quarter.

Do you have a constructive outlook for '06?

What are you seeing there?

We are heading over to Europe this weekend, we will be over there all next week having a European planning session.

But my feel right now, I can give you more sense later -- in a week or so, but my feel right now is the underlying economic trends for our business have -- they bottomed about three or four months ago as I talked about and they are improving and I would expect our underlying Europe orders and sales next year to be better and help us on a delta basis.

So this year, we are probably slightly flat or -- I don't know -- what was our total all growth in Europe this year, Walter.

It was flat? 1%?

Say it was flat.

I think you are looking -- I think you're going to look for 2 to 3% growth for Europe for us next year

The final question is just on the hurricane.

The hurricanes in the quarter.

Was there any kind of timing issue or anything that kind of affected the margin or mix and process management or any of the other businesses that we should think about just in terms of going out and think about the quarter and modeling?

No, it is not big enough.

We built some inventory, got it down there, we worked it out, but it's not big enough to move any model.

Understood, thank you.

Thank you very much.

Our next question comes from Deane Dray with Goldman Sachs.

Please go ahead.

Hi, this is Seung Han for Deane.

Specifically at process, where do you see continued growth or further upside in '06 coming from?

Would it be continued strength in oil and gas, demand, contribution for new products, backlog or market share gains?

I would -- the key market segments, all of the above you just said will happen.

But the key market segments would be oil and gas and power.

We see pretty good and we are seeing chemical business still doing pretty well there.

Those are the key market segments for us next year.

We are seeing tremendous momentum relative to our whole plant web strategy, driving the systems and solutions and some -- our next generation technology products are now out taking -- really making plant web even stronger.

So we feel pretty good about participation gains again in 2006 and globally, you're seeing pretty good investments maintain in Latin America, China, Canada, and Eastern Europe, and Russia.

Thank you.

You are welcome.

Our next question comes from Dan Jenkins with State of Wisconsin Investments.

Please go ahead.

Good afternoon.

I was wondering on the first page of your press release where you talk about the operating cash flow, you mentioned that there is a 1% decrease from the fiscal 2004, $140 million capital gain tax.

Yes.

I was wondering as far as 2005, if there was any impact from the repatriation taxes that would not reoccur.

Is that all in payables right now and hasn't affected cash yet?

The repatriation tax is accrued and charged to the P&L expense in fiscal year 2005.

And it will be paid in 2006.

Okay.

So you'll -- the negative effect on a cash basis will show up in next year's number.

$3 million.

Yes.

Okay.

Then also I was wondering, you talk a little bit about the margins in both process management and industrial automation being -- benefited from the restructuring activities.

I was wondering how much farther do you expect to get in those two units from restructuring or does that pretty much run the course or?

The restructuring in process is fundamentally behind us.

We always have some minor restructuring but fundamentally behind us and I think you're -- as long as the business is growing, you will see some leverage impact.

You could see a little bit more margin expansion but those margins are running at fairly high levels.

You are seeing industrial a automation -- we had a litigation settlement this year.

We had a lawsuit that we settled at EGS.

So industrial automation, there is not a whole lot of restructuring next year.

A little bit but not a whole lot so I would anticipate the OI of the restructuring line to drop off next year.

The big restructuring continued is a repositioning, again, of our motor, supply, and components business and some tools and storage business is restructuring and I would anticipate Jim's network power business, or now my network power business restructuring to drop off.

Thank God Jim got it all done.

Nothing left to move.

Okay.

And then when you talk about the climate technologies.

You mentioned that part of the problem with the cost of decrease in margin there was product mix.

I was wondering if you could give a little more color on that?

That's more a function of our residential business growing much faster than our commercial business in the quarter.

That causes a swing in your mix, and also our European business was weaker, which is more profitable than our U.S. business.

So those are the two mixes that we were referring to in the press release or the comments.

Okay.

That's all I had.

Thanks.

Good, thanks.

Our next question comes from Tyson McCall with [INAUDIBLE].

Please go ahead.

Thanks, good afternoon.

Great results.

Got a question -- a couple of questions on network power.

Obviously very nice trends in that business.

How much -- do you have any sense on how much is underlying market growth and how much is share gains?

Well, I wish I could tell you that.

The numbers you see are -- out there are that the UPS market is growing 7 to 8% or something.

I am not sure I believe that.

We are going quite a bit more than that right now.

So there is no really good indicator of -- to go to for this data center space in particular.

It is really hard to figure it out.

So I do think as I told you earlier based on comparisons to other people in our space, I think we are outperforming right now.

So I do believe we are gaining some share, but I can't tell you how -- I couldn't tell you with any precision what the penetration was versus the market growth rate.

I do think the market's quite a bit more robust than it was at this time last year though.

Okay.

And obviously we had a couple of big token mergers this week with AT&T and MCI being built by the RBOCs.

Bearing in mind that AT&T and MCI cut back in investment in the last three years.

Do you see any upside in the near term as the RBOCs integrate those networks?

Yes, I think so.

By the way, we didn't do a lot wither either AT&T -- AT&T wasn't spending any money for quite a while, and so we have not done a lot with AT&T or MCI, either one.

So frankly we see nothing but an uptick with them now being -- having new parents with a new strategy and a home.

So I think you are -- your read that we'll -- that we could see some updraft there is probably accurate.

Great.

Thanks a lot.

Our next question comes from Bob Cornell with Lehman Brothers.

Please go ahead.

Yes, we can't let Walt get off the hook here.

I forget to ask the OIOD question.

The what was really going on with the 76 versus 49?

You might want to explain what he means by 76 versus 49.

Are you referring to the other income, other deductions?

Yes.

For the help of the other people in the fourth quarter?

The issue would be the two major components increasing the expense would be in the fourth quarter of '04 we had currency gains, and in the fourth quarter of '05 we had some currency losses.

So you get a gain to a loss a swing that drove it.

Also, as Dave commented, litigation settlements was a higher expense in the fourth quarter of '05 than the fourth quarter of '04.

And those two more than offset by the 27 which you identify.

The reduced restructuring in the quarter which was about $10 million.

So the other two had a delta of that difference.

Yes, they should be behind us now, Bob.

Those are not repeatable.

Just any -- a size in the litigation number at all, or a range?

The absolute number would be between 15 and $20 million.

And the swing over the year-ago, Walt?

The amount last year was also -- I am just looking it up to confirm it.

It was also an expense last year.

I was giving you the absolute level this year that we had.

13 million swing year-over-year.

But the absolute level of the litigation was 15 to 20 this--.

Yes, I think I heard 13 as a swing.

Yes.

Exactly, 13 is the swing.

Okay.

Thanks.

Our next question comes from Chris Chotowicz with A.G. Edwards.

Please go ahead.

Thanks.

A follow-up question on the orders. 15% orders for the three months ended September.

I guess your guidance -- that is a two-to-four-month typically lag, right, between realization of those sales and the booking of the orders?

The function of -- yes, it is a function of which business, but you'd look at the capital guide just a little longer, process guides probably six, nine months, but typically when I look at that quarter going in, you would say that would be a good indication of where our sales are going.

Yes.

I guess yet I have is could you guys provide some kind of general feeling for how much of the order activity was long cycle, more that 6 to 9 versus short cycle?

Well, I think that when I gave the range of 8% to 10%, that sort of gives you an idea.

Orders are 15 and we are saying sales are going to be up 8 to 10.

And we have an -- currency impact is negative.

How much are we going to lose in currency this year -- on the quarter, Walter? 2 points?

Yes.

2 points.

So we're going to lose 2 points of currency quarter to quarter in the first quarter, Chris.

Okay.

And therefore we are going to grow 8 -- we think we will grow reported sales 8 to 10% with the orders up 15.

That tells you basically -- that gives you a mix of what was the long versus the short right there.

So pretty good momentum going into your second quarter probably in, what, process management?

Process and Jim's business network business, yes.

And network power.

Okay.

That's all I had.

Good, thanks.

I guess -- wrapping up, there's two things I want to remind for the people still on the phone.

We will be having a session in New York.

We've moved to February to get away from everyone's reporting.

It will be Friday, February 10.

We will be sending a note out to you.

We're going to want three and a half hours.

We are going to bring several people in and share different parts of the business.

Unfortunately Jim won't be there, so we can't pick on him but maybe we will invite him.

I guess -- what I want to say is that we have a lot of positive momentum going into this new year 2006.

As I said, we feel very good about it.

Backlog looks good.

The order rate looks good.

We feel very strong conversion rate relative to our price cost, restructurings are coming through and I know a lot of people say that we have a lot of conservatism out there but fundamentally we try to call it like we see it right now and we intend to deliver what we say.

So we feel good about it and we feel good about 2006.

And with that, I will look forward to seeing everybody the following February.

Ladies and gentlemen, that does conclude the Emerson fourth-quarter and fiscal year 2005 results conference.

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