艾默生電氣 (EMR) 2006 Q1 法說會逐字稿

As a reminder, this conference is being recorded Tuesday, February 7th commentary and responses to your questions may contain forward-looking statements including their outlook for the remainder of the year.

Information on factors that could cause actual results to vary materially from those discussed today is available on Emerson's most recent annual report on Form 10-K as filed with the Securities and Exchange Commission.

During today's call, Emerson's management will discuss some non-GAAP measures in talking about the company's performance.

Reconciliation of those measures to the most comparable GAAP measures is included in the back of the slide presentation or within the slide presentation that was accessible by a hyperlink posted on the Investor Relations main page at Emerson's corporate 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 Eric.

I am joined today by David Farr, Chairman, Chief Executive Officer, and President of Emerson and Walter Galvin, Senior Executive Vice President and Chief Financial Officer.

Today's call will summarize Emerson's first quarter 2006 results.

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

A replay 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.

First quarter sales were up 15% to 4.5 billion with increases in all segments.

We had strong underlying sales growth in the quarter of 14%, with three segments posting double-digit underlying sales growth.

Operating profit margin improved 50 basis points to 14.1%, earnings-per-share came in at $0.96 up 37% from the prior year quarter.

Operating cash flow was 319 million and free cash flow was 218 million up 22% and 29% respectively.

Next page, income statement - - sales of 4.548 billion, up 15%, and with increases in all segments, underlying sales were up 14%, acquisitions added three points to growth and currency subtracted two points of growth.

As we mentioned double-digit growth from three segments, Process Management up 13%, Network Power up 21%, and Climate Technologies up 25%.

Operating profit in the quarter was 643 million or 14.1% of sales, a 50 basis-point improvement driven by the leverage in restructuring benefits.

Net earnings in the quarter were 399 million up 35% and earnings-per-share again at $0.96, up 37%.

Next chart, take a quick look at the underlying sales growth by the major geographies.

First of all, United States very strong growth up 18%, international growth was 9% in the quarter, led by Asia and Canada, both up 16%.

Latin America up 10%, and a nice start to the year for Europe up 4%.

That gives you the underlying growth of 14%, and again currency was negative by two percentage points, acquisitions added three points for the consolidated number of 15% growth.

Next chart, income statement detail.

Gross profit 1.593 billion, up 13%, down as a percent of sales as we had unfavorable product mix, including acquisitions and pension cost increases.

SG&A as a percent of sales was down as we leveraged the sales growth leaving operating profit 643 million, up 19%.

Other deductions for the quarter was 23 million, lower this year on the lower restructuring of 17 million and FX of 12 million.

Interest expense for the quarter was 50 million, leaving pre-tax earnings of 570 million up 31%.

Taxes in the quarter were 171 million, generating a tax rate of 30%.

We had a lower rate versus the prior year quarter due to resolution of items during the quarter, but we do expect the full-year rate to be between 30 and 31%.

Next chart, cash flow and balance sheet.

Operating cash flow in the quarter was 319 million, up 22% over the prior year quarter driven by the higher earnings and also improved working capital management.

Capital expenditures in the quarter were 101 million, leaving free cash flow of 218 million, up 29%.

Cash flow to debt ratio increased to 62.7% as we have a strong and flexible balance sheet at this point.

And you can see at the bottom of the chart the trade working capital balances, great execution on the initiatives here drove the ratio in the quarter to 18.8 percent of sales, a nice improvement from the prior year.

Next chart is the Business Segment P&L.

You can see the Business Segment EBIT of $649 million, up 24%, we had the benefit of prior restructuring, leverage on the sales volume, and lower restructuring spend in the quarter.

Difference in accounting methods was 40 million, up 7 million on the increased volume.

Corporate and other up slightly at 69 million, and interest expense 50 million, down 4 million on the lower, short-term debt balances.

Again, that drives the pre-tax number of 570 million up 31%.

Now we'll run through each of the segments, starting on page 8, first with Process Management.

Sales in the quarter were $1.097 billion, up 14%.

Underlying growth here was 13%, acquisitions added three points to growth and currency subtracted two points.

By geography, the underlying sales in the U.S. were up 21%, Asia was up 13%, Europe up 5% and Canada up 25%.

EBIT dollars were 176 million, up 36%, with margin increases driven primarily by leverage on the higher sales.

Process Management continues to perform at very high levels and the outlook for the serve markets here remains strong.

Next chart is Industrial Automation.

Sales in the quarter of 860 million, up 8%, underlying growth of 7%.

Acquisitions added four points to growth and currency subtracted three points.

By geography, we had the U.S. up 10%, Asia up 15%, and Europe up 2%.

EBIT dollars were 143 million, up 20%.

Margins expanded 160 basis points, the sales volume leverage and price increases more than offset material inflation.

We also received 5 million of incremental duties from the anti-dumping duties versus the prior year.

And we continue to see strength from the Power Generating Alternator Business and the Electrical Distribution Businesses.

Next chart is Network Power.

Sales in the quarter of 939 million, up 21%, underlying sales were up 21%.

Acquisitions added a point and currency subtracted a point.

By major region, the U.S. was up 26%, Asia up 35% and Europe up 6%.

EBIT dollars were 108 million, up 61% as we had leverage on the sales growth and the benefit of prior restructuring activities.

There was also lower spending and restructuring during the quarter.

And we continue to see strength in our core North American UPS and Cooling Business, which grew more than 30% in the quarter.

Next chart, Climate Technologies.

Sales in the quarter of 748 million, up 24%, underlying growth of 25%, with currency reducing growth by a percentage point.

By geography the U.S. was up 40%, Europe up 10%, and Asia down 7%.

Demand in the quarter was driven by 10-SEER product in the U.S. residential air-conditioning markets, as customers ordered the product ahead of the transition to 13- SEER.

EBIT dollars were 102 million, up 18%, margins, excluding the restructuring, were down 80 basis points as we had higher material inflation due to commodity shortages during the quarter and we also had negative product mix.

We estimate that approximately 100 million of sales was pulled into the first quarter ahead of the 13-SEER conversion, with an approximately $0.03 per share impact, which we would expect to impact the second half of 2006.

Next is Appliance and Tools.

Sales in the quarter of 1.040 billion up 11%, underlying sales were up7%, acquisitions added nearly five points to growth and currency subtracted one point.

Asia was up 32% off a small base, the U.S. was up 8%, and Europe was down 1%.

EBIT dollars were 120 million, up 1%, margins dropped 120 basis points as price increases were not able to offset inflation from commodities, wages, and pension benefits.

We also had incremental costs for share gains and new product launches and continue to work the price initiatives and address the cost structure here to recover the margins.

So if we go to the last page, the summary and outlook, clearly based on the sales and earnings performance in the first quarter, we've had a very strong start to the year.

Order trends remain strong during the quarter with 10 to 15% growth.

As we look at the first quarter in earnings-per-share comparison issues, it's important to note that we'll have our easiest comps of the year in the first quarter.

We also do not expect to see the normal seasonality given the strong Q1 dynamics at Climate Technologies.

As I said previously approximately $0.03 per share impact there.

We also have probably about a $0.03 impact due to lower restructuring spend and the timing of that spend during the year in '06.

So including those items, we expect our future year earnings-per-share in the range of $4.10 to $4.30.

And I would remind you that Friday we'll be in New York City for our annual investor community update.

We'll look at our 2006 assumptions as well as update the investors on long-term initiatives.

With that I'd like to turn it over to David Farr.

Thank you very much, Chris.

As you can tell, we had what I call an excellent quarter.

A CEO doesn't get many quarters like this in their life and the board members pointed out to me last night and again this morning, and Chuck pointed out to me, and my dad pointed out to me, enjoy it, but don't gloat or - - because there will be times it won't be quite is a good.

We had a great quarter and people are doing a great job.

Tremendous orders and sales momentum across the majority of the businesses.

We're clearly executing on our key growth initiatives.

We will talk about those in great detail in New York on Friday.

I also want to commend the business leaders and division presidents for really executing on operational - - on the operations and on most all parameters.

Solid profit margins are flowing through despite the headwinds of higher pension costs, despite seal prices, despite copper, oil, they're doing a great job and the restructuring benefits are flowing through as you look at these numbers and now, most companies would have struggled generating cash flow like we generated in this quarter with sales, - - underlying sales growing 12, 14%, we actually increased our operating cash flow by twenty-some-odd percent and our trade working capital as a percent of sales dropped down to 18.8% versus 21 last year.

That is not an easy task and the operating guys did a great job there and I commend them across the company.

We are also spending capital.

We're investing for growth, we're investing for capacity, we're investing for new products.

So you'll see capital this year up somewhere around 15, 16, 17%, just like we did last year.

We are investing for that growth, but we're keeping it in a line as a parameter of a percent of sales in that 3 to 3.2% range.

So we're not getting ahead of ourselves in that area.

But, again, I have to commend the operational team.

They're doing a great job.

We'll be in New York on Friday.

We'll be talking for four plus hours, we'll be getting into a lot of details.

We'll have Berra there talking about the process business.

We'll have Tom [Boettcher] talking about Climate Technology, we'll have Jean-Paul Montupet talk about Industrial Automation and then you'll have me talking about Network Power.

And we'll also Walter there and Ed Monser talking about our operational issues, and we'll get into a lot of details and talk about what's going on in this company and how we're investing this company and why we see the market dynamics being pretty positive for us here, not only in 2006 but probably for the next couple years.

We clearly see pretty good growth in the U.S., we see our Europe rebounding as we talked about the last two conference calls.

I expect Europe to strengthen throughout this year.

Latin America had a very strong quarter and I think we'll have a strong year in Canada and Asia Pacific.

We're hitting in all regions and that's good to see.

And based on the first quarter and based on what I see in the market right now, I would expect us to be above the zone in our growth rate that we talk about in that 5 to 7% range, and we'll talk more about that on Friday.

But I look at pretty good underlying growth.

I look at pretty good leverage and right now, obviously with the guidance we gave you for the year we're looking at a very good 2006 given the current things that we face, assuming nothing bad happens out there, and hopefully nothing will.

But right now things are going well and again it was one of those great quarters that you'd wish you had a lot, but we're going to take it and move on.

And we'll now take your questions and we have a couple people that got on a couple hours ago.

It looks like, they got in the queue and so the first person up, Chris, we'll turn it over for questions now.

Ladies and gentlemen, we'll begin the question-and-answer session. [OPERATOR INSTRUCTIONS] Robert McCarthy with CIBC World Markets, please go ahead with your question.

Congratulations on an excellent quarter, gentlemen.

Thank you, Robert.

Could you give us an update - - there's been a flurry of recent acquisition activity, and I know you're going to cover a lot of that on Friday, but could you just give an update as to kind of the rationale, a little bit of background about the acquisitions and prospects for those segments?

I guess I'd rather do that live on Friday to be honest.

We're going to have a section in the Network Power on and Artesyn.

It's better to show the charts and look at that information.

Needless to say, in just roughly, as you can imagine Knurr really comes into our whole cooling, center of strategy, our Telecom strategy.

It fits very nicely with us and relative to the whole data center and now we have the complete package, which we'll talk about and, from the standpoint of Artesyn, clearly goes into the Embedded Power and it has tremendous customer relationships.

And I guess I'd rather talk about that live when we can discuss it with some charts, and it's going to be - - those are both very good acquisitions and fit in very nicely with our core business and we'd expect them to grow nicely

Fair enough, and then just one more on Europe.

Were you surprised, - - I mean, I know you gave some commentary on the quarter which says, - - which seemed to indicate that you would expect some uptick there, but were you surprised by the strength you saw so far and what really surprised you in the quarter?

Relative to Europe, I saw no surprise.

I think from the standpoint we could see it coming in August.

We're out-performing the marketplace.

We could see our growth initiatives and some of the restructuring we had undertaken the last two years there really kick in, so you could see, - - you could feel it and I talk about that in August and I talked about that in November so it was not a surprise to me.

I guess the biggest surprise would be what happened in the U.S. relative to the Climate business, relative to, what I would say, our compressor business, how strong that was and that would be the biggest surprise.

The long-term long lead time orders from Process and Network Power, those orders had been building for the last couple months in quarters so you can see that coming but Climate was extremely strong.

We clearly think there's going to be some give-back.

It's a best estimate that we can give you right now.

There's not a precise science out there.

If we have a hot spring, there will be very little impact, if you have a cold spring. it will be pretty ugly with the inventory that we have built already out there in the channel, if you want my opinion, but we'll have to wait and see.

There's a lot of elements that could play here.

No one knows at this point in time.

Thank you for your time.

Thank you, Robert.

Our next question comes from Nicole Parent with Credit Suisse.

Please go ahead.

Good afternoon.

I guess, just - - when we think of Industrial Automation margins, this is probably the second business, - - Process being the first, where we're kind of transitioning into a new shift where we think margins could go, and I'm sure you'll talk about it on Friday, but how should we think about Industrial Automation as we roll forward for the year, now that you're starting to get better price?

Industrial automation is business that really still has not gotten back to the peak level in all areas and from the downturn back in 2000, 2001 so there's been enormous restructuring there.

I think you're going to see the margins continue to expand as this industrial sector continues to grow with the investments going on in gross fixed investments.

So I would suspect and you'll see that we will be talking about this, I would expect that business to see continued margin expansion throughout the year and going into the 2007 time period because of the underlying growth and growth fixed investments.

Now we got help this quarter because of the Byrd amendment, but we had that last year too and we anticipate that - - to have that again 200 - - in December 2006, so, Nicole, from the standpoint of industrial margins, they should continue to improve as we continue to invest and grow that business.

Great.

And just on restructuring, I think Chris mentioned something tied to timing.

For the full year what are you expecting for restructuring, is there any change there?

We're expecting 75 to 95 for the full year.

Okay.

That, - - we're going to share those numbers with you on Friday too, but the first quarter, with the strength of the quarter, we could not get after some of the restructuring.

The key thing was to serve the customers, we backed down, and we're looking at a number for the whole year of 80, - - I'm sorry, 80 to 95 that we'll be showing on the chart on Friday.

Walter just showed it me, 80 to 95.

Okay, terrific.

Thanks, good quarter.

Thank you very much, Nicole.

Our next question comes from Bob Cornell with Lehman Brothers.

Please go ahead.

Yes, thanks.

Cornell, don't ever accuse me of showing good results, huh?

Well that was two years ago.

You promised you would.

You did, wow.

But, now that you're on that subject, you're the guy that said revenue would be up 8% to 10% back in the fourth quarter, but seriously, what really happened over the course of this quarter.

When you gave first quarter guidance initially it was eight to ten, and then obviously things got better.

You mentioned climate, obviously, but maybe you could expand on how the business rolled in during the quarter and what kind of momentum you have going out of the quarter.

I forgot to mention that in the 8-K I raised it on you, Cornell.

I did raise it from 10 to 12.

I know.

That was the starting point.

Okay.

You know things get better, get better with age.

I'm older, I'm a little older.

Me too.

I'm not commenting on that one, but clearly when you look at the momentum we had in the process business that did extremely well, I would say that business came in stronger than we anticipated.

A lot of projects that we've been working on executed and came forward.

Clearly I would say the appliance business, - - Walter and I both thought we'd be down in the first quarter.

They were not down in the first quarter.

They executed a little bit better, that's good news and that would be nice for us for the whole year if that continues.

And then finally with the climate.

I would say the aggressive build across the channel, across our customer basis, they made that conversion from 10-SEER to 13-SEER, some people went 13-SEER, some people stayed at 10-SEER, and we benefited from that.

As we gained that share that we talked about, we benefited from it and, so it was one of those quarters that we scrambled from day one making product and it's a good problem to have, but we produce a lot of product as you can see.

Yes, actually you mentioned that I think you had some capacity issues in that regard.

Maybe you could flush that point out a little bit.

When all a sudden you have a quarter that you have 100 plus million above what you would normally produce, we were not geared up for that level of capacity.

I mean, you normally would, - - this would be our weak quarter in Climate.

You'd be actually declining off the fourth quarter and we didn't decline.

We actually probably pretty flat relative to production.

And from quarter-to-quarter which is unusual and we had the problem of getting steel.

I mean, production was way above what we thought and we had to scramble, we had pay premium prices for steel and copper and that was a problem for us.

Things have stabilized nicely in the month, - - in the first month out of the box.

So that's good to see.

But, you don't get upset about - - when that happens, but at the same time it was one of those unique situations that won't happen for quite some time again, if ever again.

Okay.

Say one final question [inaudible] Can you give us a little bit of an idea about the pipeline in the Process, maybe the pipeline that prior you said you had visibility in those businesses.

I mean, how do they look over the next so many quarters in the year?

They look pretty good.

I would say our growth, and we'll talk about those businesses extensively in New York. the growth in those businesses are good, - - are very good with strong order pace and we've had strong 10-plus orders on average, 10, 15, 20% orders average there for several quarters now and that's good news.

That backlog looks good right now.

It definitely does.

Thanks.

Good quarter, Dave

Thanks very much Bob, and thanks for pointing out that low ball forecast.

You needed a little humility.

Our next question comes from Deane Dray with Goldman, Sachs.

Please go ahead.

Thank you.

Get some additional color on Network Power.

The commentary said you saw both uninterruptible power supply and cooling both up 30.

Is that - - were they both together up 30, the same drivers behind that business level?

They're both up 30%.

Is this what your business head is telling you?

What?

Is this what the business head is telling you?

Yes, that's what the business head - - I'm telling you, they're both up 30%.

We had a very good quarter in that space.

The business is turning and we've had good order pace there for quite some time.

Our new products, both in Asia and the U.S., are taking off and if you look at the underlying growth right now, marketplace right now is clearly above, - - the marketplace is above, and we'll talk about this on Friday, above the long-term range and growth rate, and we're performing way above that at this point in time.

A lot of our new technology products, the Knurr system fits in nicely with this, so we're very excited about what's going on in that space right now.

How much of that is new product driven?

You mean, from the standpoint - - their ratio of new products is quite high.

It's quite - - kicking in - - I mean if this replacing some old products, it's hard to say at this point in time, but I would say a couple of points of extra growth come from new products.

We don't look at how much growth comes from new products.

We measure it on an annual basis, but just knowing that business, I would say a couple of extra points of extra growth there.

And the underlying demand is coming from consolidation of data centers, build-out of data centers, or is it new technology?

It is build-out of new centers, expanding of old centers, upgrade of centers.

You're seeing investment, these are stable - - this is not the IBECS, RBECS- - or not the RBECS, what do you call these, CLECs that came out, CLECs that came out many years ago that built and then died.

The RBECS are building right now, the date center's is building right now.

They're expanding, it's new, they're upgrading, you think about the trends, the trend are very good right now.

There's a lot of heat being generated in these centers with the new products going in there and they need to fix that.

Good, and just one housekeeping question for Walter.

Of the 14% organic growth, how much of that was price in the quarter?

Thank you.

Yes, it's not that much at all.

Price cost was positive, but I would say we have it in the "Q" which is filed this afternoon.

What is it, 1%, less than 1%.

I'd say about 1%.

About 1%.

We crossed over, if you remember correctly, we crossed over in the fourth quarter which we talked about last year from that red-green analysis, we crossed over, and we're slightly positive right now and we anticipate to be positive for the full year.

Thank you.

You're welcome.

Thanks, see you Friday.

Our next question comes from Scott Davis with Morgan Stanley.

Please go ahead.

Sure, good afternoon and congrats, guys, good quarter.

Thank you very much, Scott

Has there ever been a 37% quarter in Emerson's history?

Not that we can easily recall looking at the numbers, no.

To quote, Chuck, he says, "Oh, my God, I've never seen one like that."

I guess he would know.

He would know.

My really only question today and the rest can wait till Friday is just with margins and HVAC, what changes, - - when you go to from SEER -10 to SEER-13, are you able to keep your margin, keep your percent margin, or is it one of those issues where you raise your dollar margin, your actual percent margin goes down?

We should be able to keep and improve our margin in this conversion.

Right now there's a lot going on in the Climate business.

We're investing, and we'll talk about that on the next generation.

We're investing in capacity, we're investing in our, - - what I call the solutions business.

You have the situation when the plants are running very inefficiently, some days you have to shut down the plants because you didn't have steel.

A lot of inefficiencies going on there.

You will see the transition to the higher volume, or the higher SEER product which does allow us the higher price and we should be able to make more money as it stabilizes.

I would expect us to see margin improvement as the year progresses.

But the key issue there is there was a lot of going on in the quarter that really hurt their margin.

A quick housekeeping for you Walter, just on tax rate.

Can you give a little bit of guidance, maybe a little bit of color beyond how the tax rate went down when the business was so strong?

Oh, it's because - - it went down very slightly.

We're looking at range of 30 to 31% for the year and the actual rate for the first quarter as we check,- - with Sarbanes-Oxley now, you have to go through a hard close effectively, almost on your tax rate analysis.

And it was at 30.0%, so it was no big item.

You're also looking at international operations who have much lower tax rate.

The growth internationally - - obviously the international tax rate, as you can see in our segment reporting from the annual report, is lower, and clearly as you also look, you can see that half of our net earnings are outside the United States lower tax rate so that mix is slightly favorable as well.

There was some minor settlements of some accounts.

Okay.

Fair enough, thanks, guys, see you Friday.

See you Friday, Scott, thanks.

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

Please go ahead.

Hey guys, great quarter.

Thanks, Mike.

Dave, just attacking this organic growth forecast from a different angle.

If you had, - - we weren't privy to what your assumptions were last quarter but when I asked last quarter, you were basically counting, on or striving to just maintain, the 6% organic growth of fiscal '05 in fiscal '06.

You know what the numbers were back then versus what's built in the forecast today.

What were the biggest changes or what segment assumptions changed the most so we can gauge exactly what's well above your expectations?

The number one would be Network Power is stronger.

And will - - as I said earlier, I think you'll see that, therefore, will be above last year and will be above the zone, our own line growth rate.

Process I would say is pretty well triangulated into what I thought it would do, maybe a tad stronger.

The Appliance Components business, Walter and I factored in basically negative growth for the year and they had positive growth I believe for the first quarter and that one.

And Tools is pretty much in line.

Industrial Automation was a little bit stronger and that base driven off because the Caterpillar, the Alternator business is much stronger so we're seeing good strength there.

I guess overall, a little bit here, a little bit there and the positive surprises which - -

Motors?

No, I said Appliance Components, Motors are max - - the Motors Business, which we thought would be down,- - so right now as I look at that forecast, you know, our long-term zone - - to be in the zone from time - - from five to seven, we'll be above that seven this year, and we'll talk more about that in the quarter on Friday.

But clearly you had a great start, there it's going to drive us above the zone which is good.

Great.

And drilling down just in the climate for a second, Asia now has been down,- - we've talked about excess inventory there.

Where are we in that inventory de-stocking and I guess is there anything about the market that maybe you've begun to realize has depressed the [inaudible] there and isn't just an inventory overhang?

I think I said last couple times, inventory, plus the government has made a very strong effort to slow down the excess building in residential and non-res building.

They've made it tougher and I think your - - the government has had an impact here and clearly that's where that air-conditioning goes.

So we've seen both those things happen inside China.

Outside China our business is doing pretty well in the Climate business.

And my gut would tell me that this will stay there for maybe another quarter or two and then work its way out.

Europe has flipped and Europe went through it and Europe's coming back up and China is taking a little longer.

Okay, and on the U.S.

Climate Business, give us your thoughts now on pricing, going forward for the balance of the year on the new platforms.

And then on expenses, it just seems to me you guys had a great quarter obviously and business has been extraordinarily strong, so I suspect the expenses are front-end loaded and with that assumption, is it a case where we have yet to really see the true leverage potential of this business in the second half and that's where a lot of upside lies is in the U.S.

Climate margins?

Okay, first of all, you can't front load any expense any more today in the world of Sarbanes-Oxley.

You expend money and you report money and you can't inflate the quarter with cost to help your quarter in the second half.

That's a no-no in today's world.

It's the first thing any auditor will look at.

We are expending heavily this year, we will - - I think you'll see us spending heavily in this segment all year long as we position for long-term growth.

We are investing in that business and so yes, I think the margin will recover .

The margins on the 13-SEER product is higher, just like you're seeing the margin of profitability higher at our customer level and the higher 13-SEER product so you'll see that and that will help us as we shift into that.

You'll also see margin improve because of orderly transition relative to production.

When you settle into 10, 12, 15% growth versus 50% growth, it's a lot easier to produce.

So from the standpoint - - we didn't front load any expense.

There's not anything hidden in that quarter to help us for the second half of the year, but we're investing in that business, and we'll be investing at this rate all year round.

Great, thanks again.

Our next question comes from John Inch with Merrill Lynch.

Please go ahead.

Thanks.

Hey, Dave, Walt.

Hi.

Hey, John.

How did HVAC, and what happened this quarter, affect cash flows?

I would say that, you know, from a cash flow standpoint, I mean, I didn't look specifically at their business but I would have to say given the growth, I would say they did okay because I mean, they liquidated inventory.

I'm sure, I know they got paid so they probably contributed to our cash flow increases.

So you think there was an incremental working capital benefit in the December quarter because of HVAC?

I would say they helped us a little bit, but they didn't hurt us.

Most people would expect - -

- - that their working capital would have hurt us this quarter because of that growth.

Right, that's what I thought.

And I don't think they did.

I think they did a tremendous job managing this growth rate relative to their payables, receivables, and inventory.

Were any of the business segments sort of net users of working capital versus sort of the trendline of other the business segments in the quarter?

No.

Okay.

No one gets a free lunch.

Bankers get free lunches, but we don't give free of Bankers get free lunches, but we don't give free of lunches in our operations. in our operations.

I understand.

Hey, Dave.

U.S.

Process, it looked like, I don't have the Deltas in terms of the sequential progression, but it looked like the U.S. strengthened a little bit.

If that was true, what sub-segments of that actually improved?

Was it, - - did you see some energy improvement or - - and then how you would you characterize backlogs in that business specifically?

U.S. business strength - - we had a couple things happen to us in the quarter.

We did finally see some benefit from Katrina and the rehab work in the U.S.

We actually saw increase in moneys being spent in the power industry which is very good.

So we actually - - and obviously some of the oil and gas investments going in into the North America asset is happening.

So Katrina, power, and oil and gas, the backlog right now in the Process business and Walter - - is at an all-time high, I would say, big number.

We don't give that backlog number out, do we?

No.

No.

It's bigger than a dollar and it's growing.

We had a very good, - - we had good orders again in January in the Process business.

Yes, I'm just thinking like the December order growth rate I think slowed, but I think you called out tough comps, big picture is there - - I mean, are we sort of sustaining momentum in Process, perhaps in U.S., gaining momentum?

How should we be thinking about this business?

The Process business, the Network Power Business, you've got to be careful, and Industrial Automation.

We have three businesses that can have big lumps.

You win a big project, you book a big project, your timing.

For instance, take Process, yes, they slowed down. they had tough comps, but they had growth rates that will more than drive the Process orders up for the next three month rolling average we'll see coming out .

They're well in the double-digit again, strong double-digits in the month of January.

So they had very strong orders in January.

It's very lumpy and you got to be careful.

The momentum in the Process business, in my opinion, is still upward.

I think the momentum in Network Power is still upward.

And so I think those two businesses will see a very good year as we progress.

Process in the recent 8-K issued for the quarter was hurt by the currency move on repricing.

Every month we re-priced the backlog to the current exchange rates.

So in the 8-K, I think we disclosed that the currency impact was 7 to 8 points of growth, so the underlying impact of Process orders on a fixed rate basis would still be in the 10 to 15% growth fixed rate, lower than that at GAAP.

But that's not impacting the overall business I'll say from looking - -

No.

- - from a look-forward perspective and I think the current tempo of the business is equally very strong.

Very strong.

Momentum is good.

Okay, and then just maybe one more.

Dave, I know you're going to probably talk about M&A and perspectives on M&A on Friday.

Correct.

But you look at the Artesyn deal, it seems like a very good deal on a price basis - - there's consternation in the market that Emerson may go out and build a new platform.

My question is with business and backlog so good, it strikes me that you guys have the luxury of perhaps waiting a little while until pricing in the market for whatever properties you may or may not be looking at improves.

Why not just sit back and let the good rolls here and then come to the market on a contrarian basis when the cycle for pricing changes down the road.

Is that - -

We are not in a big rush.

There's no big deal waiting to happen.

You have to understand, the deals that we do, we obviously initiate them.

We're out there looking for - - asking.

So the companies we're buying right now are companies that we've been courting, we've been talking to for a long time.

I met with Joe back when I was head of Aztec, back in the mid '90s, so we've been talking to Artesyn for a long, long time and the time was just right for us to work out, and a couple of other people looked at, but fundamentally it was a deal that we spent a long time talking about.

The same thing with Knurr, the same thing with other deals that we announced this year.

There's a not this urge that we have to do deals, but we're always working a matrix of deals of companies that we think would be fantastic inside our company.

And so when we're courting them, we're courting them and eventually say okay, we're willing to sell.

It's not something like we have to do tomorrow, but we are doing that.

And we are not out there - - money's not burning a hole in our pocket.

We're going to be buying stock back as we - - and we've increased the dividend and when the time comes right we'll keep our flexibility, and we'll do a big deal when it happens, but we're not trying to drive it right now, we're not trying to push it.

Right.

So certain individuals should not misconstrue strong fundamental results with a propensity to step up M&A activity?

Correct.

Thank you.

Chris Kotovicz with A.G.

Edwards and Sons, please go ahead with your question.

Good afternoon, guys.

Hey.

Great quarter.

Thanks, Chris.

I wanted to ask David about Climate.

And do you guys have a sense of the pre-buy activity versus maybe share gains versus some of your competitors?

That's pretty sensitive information, wouldn't you say?

I'd still love to have it.

That makes two of us.

I'm not going to give you that, Chris.

Fair enough.

Good try.

Okay.

I got a question about the - - I guess the commentary about the demand in the quarter being obviously a lot higher than it normally would, be but being flat quarter-to-quarter.

I guess what I'm wondering is was there an issue more with the preparation, whether it was ordering materials?

You mentioned that you had an availability issue there.

It seems like that was the bigger piece of it than having the capacity, right?

Well, let's just put it this way.

All the sudden, someone says I want to increase my orders by 100% or 75%, you have not factored that into your processes of ordering material, getting labor onboard and so when you talk about capacity, you talk about staffing, you talk about equipment up in line and things like that.

If you try to say, okay, I'm going to make $100 million this week versus normally you'd make $100 million over two or three weeks, you then clearly have a capacity issue.

And that's really what happened to us.

We went from running at one level, then all of a sudden they said , "Okay, we want to increase that 75%, 100%."

You just don't have infinite amount of capacity sitting around.

You wouldn't want me to do that.

Now we're increasing capacity in our scroll right now in Mexico, but that's for long term projects and that will come online over the next 18 months.

So we have capacity around the world.

We ship product from Asia.

We do what we have to do to serve our customers.

And we do not keep hundreds and millions of dollars sitting by the side there wasting from a capital structure standpoint.

That's a no-no.

It sounds like this was just really a flow or timing of orders maybe coming in.

It was a timing of orders.

Yes, okay.

I mean, the orders came in over a two-month period extremely high.

I mean - -

You didn't get a lot of signal from your customer.

I'll switch gears to a question and then I'll get back in the queue.

You talked a little bit about the - - I guess remarking of your backlog to exchange rates.

Was that specific more so to one geography than another?

I mean, was that mostly Europe, was it mostly Asia?

Mainly Europe if you just look at currency.

Obviously if you look at Asia in relation to China and a lot of the other quasi linked currencies to the U.S. dollar, you don't have the issue.

When you look at the Europe with the Euro, the Euro moves and you can calculate the rate we use every quarter.

And it impacted us in repricing the backlog, not a big deal, but when you have a larger backlog, it distorts the one month order slightly.

And that's the impact, and that's why we gave you as well as a GAAP numbers, which is a very important number obviously, but we gave you the GAAP number was 5%.

We also told you the currency impact was 7 to 8 points so the underlying fixed rate, order rate really didn't move much.

It was still in the 10 to 15% range, and as we said to the prior caller, we still think the orders there are very strong and have excellent momentum, and we'll see what the next 8-K issue is when it comes out.

We try to - we remark our backlog every month.

We do that for a reason to make sure we don't have some big surprise down the road.

Sure.

Good problem to have.

Great quarter, guys.

Thanks.

Thank you very much, Chris.

See you.

Are you going to be there on Friday?

Looking forward to it.

Good.

Our next question comes from [inaudible] with [Legg Mason], please go ahead.

I just want to, echo others.

Congratulations on a great quarter, first.

Can you hear me?

Yes.

Yes.

I just want to ask you about the pensions.

I was just wondering if you could just remind us what kind of headwinds you factored in on for '06 on the pensions and healthcare side.

Well, 60 million, - - Walter, go ahead.

60 million of higher pension costs.

Okay.

And one other thing that I was wondering if you could just help us basically understand the balance sheet seasonality.

When we look at the fourth quarter [lots] the big cash flow conversion is about 50 to 65% in the quarter.

Yes.

Can you help us understand why this seasonality is created and how it happens every year in the same quarter?

The fourth quarter of the fiscal year.

We also generally, the inventory in the first quarter, normal seasonal pattern principally because of the climate and air-conditioning market, sales in October, November, December, are generally lower than in July, June, because the normal seasonality.

Going into the quarter, generally our inventory is reduced because you don't need as much as inventory in September as you do in December looking ahead to the amount of shipments you're going to make over the next 60 to 90 days.

So the major reason for the seasonality of the working capital issues deals with approximately a quarterly offset to the sales trend and the sales trend is heavily impacted by the weather, meaning we don't sell as many generally air-conditioners in December when it's cold.

It's also impacted to a lesser degree in Asia, in January, when the Chinese New Year is impacted.

And it's also impacted slightly in Europe because Europeans tend to shut down in the month of August.

Those are the driving seasonality factors that impact sales trend, and then our balance sheet trends follow that because inventory is bought in advance of anticipated shipments.

Okay.

Is there any other seasonality that we should be aware of on other businesses such as Industrial Automation or Network Power?

I mean, it's more like a project based, more like as you mentioned it during calls.

Other than seasonality in shipments as you look at Industrial Automation, is in the United States you generally have more holidays in October, November, December, than you do in January, February, March.

They all have about 91 days.

But in the November-December period, we generally have four holidays.

Across a normal year you generally have 10 holidays.

Right.

So December, the first quarter is also impacted by the holidays which are obviously generally two days for Thanksgiving and two days for Christmas.

Uh-huh, uh-huh.

That's very helpful.

Thank you very much.

Our next question comes from Dan Jenkins with The State of Wisconsin Investment Board.

Please go ahead.

Hi.

Hi, Dan.

I was wondering just to clarify, you mentioned on your summary that in markets in four out of the five segments remain strong.

Is it the Climate that you expect to not be strong because of the inventory situation we talked about?

Appliance,.

Walter and I, we like to see two quarters before we change our stripes.

So we appliance to maybe down.

Yes, Walter and I still believe the Appliance - - the Appliance and Components business will be down in the quarter and so if they go two quarters in a row, Walter and I will probably change our registration.

Okay.

On Appliances, I was wondering, you mentioned that you're working to get the margins back up.

What kind of levels can we expect going forward?

Closer to the 12-7 or somewhere between where we're at now and the 12-7 of last year?

For which segments?

Appliance and Tools.

Oh, the Appliance and Tools, a couple things are going on.

We are - - right now, in particular, there's two things.

For the Appliance side you have a huge material cost squeeze going on at this point in time.

We're working with that with our customer base.

But that - - it's still there because of the normal enormous increase in steel and copper and we made an agreement long term and we have to work those agreements off.

So we have that pressure a little bit.

Relative to Tools, we've made some investments primarily in capacity and we've moved some capacity down to Mexico and right now we have two facilities that are actually operating and eventually one of them will be closed.

So right now we have dual production going on as we make an orderly transition.

We're a company that likes to do things very carefully and so actually we'll keep both plants going until we know that the new plant is operating right from a quality standpoint and delivery and then we'll shut the other one down.

And with that you have a double overhead, basically.

That's an investment for both growth and also cost structure and that will come online,- - off line, as the year progresses and so we should see a profitability improvement in the Tools as we get better in the second half of the year.

And the other thing is we had in this business, we actually have some incremental growth, share gains, and a couple of our large big box stores, and with that what we have to do is we actually buy the old inventory off the shelf and replace it and that's a cost to us and that we'll earn back over the next 12 months.

That's an investment for us both in business in both share and long-term profitability improvement.

And I expect that business to come back in profitability by the second half of this year and clearly as you move into 2007.

Okay.

And then the last thing I was wondering about, you mentioned that you stopped some benefits from Katrina spending.

I was wondering if you expect to see more of that and what segments--

I think you'd expect the Katrina benefit to occur in our industrial business probably through the next couple of quarters.

I do not have a tracking mechanism out there, so if anyone asked me how many dollars, I cannot tell you how many dollars.

I just know based on the pace of business in those businesses in our U.S. market places and I look at our underlying trends, I would say we're getting the benefit .

So I would expect to see a pretty good benefit in the first half of the calendar year of 2006 as they continue to build.

Okay, and that's Industrial Automation mainly you said?

Industrial Automation and Process.

Okay.

And [inaudible]

Yes.

Okay, thank you.

Our next question comes from Steve Tusa with J.P. Morgan.

Please go ahead.

Hey, Steve, where have you been hiding?

Good afternoon.

Hey Steve.

Looking at the Climate business and, you know, this whole transition of 13-SEERs is kind of complicated by what happened last season with the weather.

How should we think about the comparisons over the next few quarters?

Is it, - - if we just assume that there's kind of a normal weather year, how are you guys thinking about how the growth is going to look, obviously it's not going to be 15 to 20%, something,maybe below, above for March and how can we think about that for the rest of the year?

We'll talk a little bit more about that on Friday, but my feeling right now, let's say normal weather, we'll have a good second quarter, which is the first calendar quarter.

The 13-SEER product will be built and so that build will be going on, so we'll see a pretty good quarter here, that [inaudible] which is the first calendar quarter.

I still think we'll see a reasonable growth period in the third quarter.

If we have normal weather, I would fully anticipate our fourth quarter, which is the third calendar quarter, to be down significantly.

And I think that's where you're going to see some of the give-back.

We had a strong fourth quarter in the U.S. as the initial build started, but it really took off in the fourth calendar quarter, which is our first fiscal quarter.

So Steve, I think you're going to see normal weather, we're going to have a good growth year, but you're going to see strong first quarter which we just had, really good second quarter, weaker third, but still positive, and then a down fourth.

Walt, what do you think?

But that's my call, who knows, but that's my call.

When you lay out the normal seasonal pattern, I think Dave's totally right.

I don't know what the weather's going to be in May and June, - -

[laughter]

- - I don't know.

It'll make a difference, other way, he's right.

Normal quarter, it'll come out of the fourth.

Got you.

How are order rates right up until,- - I know some of the players were going right up until the 23rd selling 10-SEER.

How was - - how did January look and then have you seen any kind of change in the last week and a half I guess here?

You know, the build is happening in 13-SEER.

I won't comment on who was doing what up to January 23rd.

That's - - the OEMs can comments on that, but we did produce 10-SEER product on January 23rd.

Let's put it that way and I think the order pace is pretty good.

It's stabilized and it's setting up for a pretty good growth quarter.

People have to put the 13-SEER product in, they have to get ready for spring, they to get ready, and that means the product has to go out there and we'll talk about the inventories from our perspective on Friday too.

Okay.

I just want to congratulate you, not on the quarter, Dave, but calling this pre-buy-back in fall of 2004 and there were a lot of people saying it wouldn't happen.

There are a lot of naysayers including my own management team and they owe me a lot of money, but I haven't seen one [expletive] penny from them yet.

I think you actually said you were going to pre-buy yourself, so I am wondering, did you contribute to this?

Yes I did and I'm selling them, I'm going to hold on to them.

It's like a wine.

I'm going to hold on to them for a little while because when that guy down the street needs that air-conditioning in that Pacific state and he dosen't, - - the 13-SEER product doesn't fit in, I've got just the unit for him.

I think maybe stick with the Emerson stock for now -- Good quarter.

[laughter] [expletive] Steve.

Thank you, Steve.

Our last question comes [Nigel Filler] from Deutsche Bank.

Oh, hi guys.

You haven't had your first drink yet, Nigel?

Sorry?

You had your first drink?

Yes, I think so, I think so.

You're not in Europe, I thought you were - - you're in New York?

I'm in New York, yes.

Okay, I thought you had your first drink in London.

Well It's only - - it is 3:00 so maybe I should.

You mentioned the negative mix in the - - in Climates as parts of the reason, - - one of the reasons, why the margin was down in that segment.

Can you just add a bit more color on that and perhaps quantify that?

I'll talk.

There are a couple things going on.

You have the 10-SEER product, you know, the different grate grades.

If you think about the compressor have I and the climate or the air-conditioning industry out there.

As you move up the price point and profitability improves.

And so therefore, as people were quickly trying to build up and build older product, 10-SEER and also are trying to convert to 13-SEER product, we had a pretty strong surge of orders, from out low end, non-scroll - - non-scroll re-SEER product and that caused us some margin pressure, in addition to the fact that we had to pay very premium prices on steel.

I'm not going to quantify the numbers because. at this point in time, that would be revealing competitive, - - what I call competitive information, but we had a pretty strong order pace and production pace at the very low product, re-sip product, from that standpoint.

Okay.

So as we move into 13-SEER and, there's going to be a high mix of scroll, we should see that the margins actually improve.

Correct, that's it.

See we're investing in the segment right now, and we will be investing throughout the whole this year and early 2007, but we should see profitability improve as they go to 13 and as they stabilize the production.

I was with the head of Hermetic motors last night, we were working out, and he was telling me that it was pretty nice to have normal production and do normal overtime.

It was kind of crazy for about two months.

Okay, great.

And on [inaudible] obviously we saw some great margin expansion from a - - quite a low base.

Where do you see the longer term margins in this business and how soon do you think we can get there?

I think this business cycles.

I think you'll see this business cycle up to a 15% margin.

I think you'll see it cycle down - - I mean we had a lope point probably around the 8% level.

That was extraordinarily low. think - - my feeling right now is this business will cycle between 10 and 15%.

We were on the up curve right now.

We'll be above the long-term trend growth-rate this year and we should be above the long-term trend, - - growth-rate next year.

So you should see the margin expansion as we utilize our low cost facilities as we grow and leverage the structure.

You should see the margin expand this year and expand next year on the current core businesses.

And as we do the acquisition, we'll have to reshuffle the deck for you, and we'll do that after the acquisition close in May.

Okay, great.

Final question.

We saw some pretty aggressive inventory reductions at Home Depot and Lowe's in December and January.

Did that impact the order growth for appliances in December?

Not in appliances, in fact our Tool Storage business, we saw a minor impact and that was all, but that's corrected.

Their fiscal year is over with now.

They're back into ordering February so - -

Okay, great.

Thanks a lot, guys.

That does include our question-and-answer session.

Gentlemen, do you have any further comments.

I think I'll just close it out and say thank you again for everyone joining us today.

It was a very nice quarter and look forward to seeing everybody on Friday, and we'll enjoy it right now, but we'll also keep it very humble as we go forward here.

Take care.

Bye.

Ladies and gentlemen, this concludes the Emerson first quarter, fiscal 2006 results conference call.

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