艾默生電氣 (EMR) 2006 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Emerson Electric second quarter fiscal year 2006 conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded today, Tuesday, May 2, 2006.

Emerson management's commentary in 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 at Emerson's most recent annual report on Form 10-K as filed with the Securities & Exchange Commission.

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

The reconciliation of those measures to the most comparable GAAP measures is included in the back of the slide presentation or within the slide presentation as accessible by a hyperlink posted on the Investor Relations main page of Emerson's corporate website at www.gotoEmerson.com.

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

Please go ahead, sir.

Thank you.

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 second 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.

Second quarter sales were up 15% to 4.9 billion with increases in all segments.

We had strong underlying sales growth of 14% and four of the five segments had double digit underlying growth.

Operating profit margin improved 60 basis points to 15% and earnings per share was $1.05 up 27% compared to the prior year quarter.

Operating cash flow was 549 million and free cash flow was 436 million up 24% and 45% respectively.

We continue to see improvement across our operational efficiency metrics.

Go to the next page, a quick look at the P&L.

Sales in the quarter 4.852 million, again up 15% with increases in all five segments.

The underlying growth was 14%.

Acquisitions added 3 points of growth and currency subtracted 2 points of growth.

Operating profit was 729 million or 15% of sales, a 60-basis point improvement driven by restructuring benefits and leverage offset by pension cost increases and dilution from acquisitions.

Net earnings in the quarter was 434 million up 25% and earnings per share again $1.05 up 27%.

Go to the next page, a quick look at the underlying sales by the major geographies, really strong dynamics across the globe.

The United States grew at 15%, Europe a nice number up 5%, Asia up 19%, very strong growth in Latin America, up 33%, Canada up 10%, which gets you to the underlying number of 14% growth again currency slightly negative more than offset by acquisitions to get you to the 15% consolidated sales growth.

Next page some additional income statement detail.

Gross profit dollars of 1.734 billion which was 35.7% of sales.

SG&A was 20.7% of sales, so good numbers, good leverage here on these two metrics also helped by cost reduction benefits.

Operating profit at 729 million, up 20%, and then we had other deductions of 54 million, interest expense of 50 million, which gets you to pre-tax earnings of 625 million, an increase of 26%, and the tax rate in the quarter was 30.6% in line with the guidance we had given previously.

Next page the cash flow and balance sheet, strong operating cash flow performance in the quarter, $549 million which was up 24% driven primarily by the higher earnings, capital expenditures were down in the quarter at 113 million which left free cash flow of 436 million a 45% increase.

We saw very strong improvement in the cash flow to total debt ratio the 66.4%.

On the bottom of the chart you can see the working capital balances, the dollars were up slightly as we had strong sales growth, but if you look at the ratio of trade working capital as a percent to sales it came down nicely as we continued to execute on our working capital initiatives.

Next page is the business segment P&L.

You can see the business segment EBIT was $716 million or 14.3% of sales.

Again we had restructuring benefits flowing through, leverage on the sales volume, and in the quarter price increases offset material inflation.

Difference in accounting methods was 42 million up 7 million.

Corporate and other at 83 million, up 6 million, and interest expense of 50 million down 2 million which brings you back to the pre-tax number of 625 million.

On page 8 we'll start with the individual segments, first off, Process Management, sales in the quarter of 1.143 billion, up 13%.

Underlying growth for this segment was 12%.

Acquisitions added 3 points and currency subtracted 2 points.

In the U.S. sales were up 14%.

Asia was up 13%.

Europe was up 1%, and very nice growth in Latin America, up 50%.

EBIT dollars in the quarter was 190 million or 16.6% of sales.

The margin increase was driven by leverage and benefits from prior cost reduction activities.

During the quarter process announced the acquisition of Bristol Babcock a nice addition to our already market leading portfolio of measurement devices.

We also had some nice project announcements during the quarter as we continue to win large projects in the oil and gas markets.

Next page, Industrial Automation.

Sales here of 931 million, up 17%.

Nice underlying growth of 14%, acquisitions added 7 points of growth, and currency subtracted 4 points.

Looking at the major geographies, the U.S. was strong, up 22%, Asia up 8%, and Europe up 9%.

EBIT dollars of 131 million or 14.1% of sales and 80-basis point margin expansion as we had leverage on the volume more than offsetting dilution from acquisitions.

We look at the growth drivers here.

We continue to see robust demand for back-up electrical power driving growth in our alternator business.

We also saw strength in the oil, gas, and metals, and mining markets driving growth in the quarter as well.

Next chart is Network Power.

Sales in the quarter 1.004 billion up 31%, very strong underlying growth, up 28%.

Acquisitions added 4 points of growth and currency subtracted 1 point.

Looking at the geographies, the U.S. was up 35%, Asia was up 43%, and Europe was down 1%.

EBIT dollars in the quarter were 119 million, up 56% from the prior year, again leverage on the sales growth and benefits from prior restructuring.

We also had a reduction in the restructuring spend which helped the margins in the quarter.

We look at the growth drivers here, we continue to see strength in our core UPS and precision cooling business and also very strong results from our Network Power China business.

We also had solid results in the Embedded Power business, which kind of leads into the next chart, I wanted to go take a minute to it talk about the Artisan Technologies acquisition.

As you know, we announced we were going to acquire Artisan back in February.

The transaction closed last Friday, April 28.

For the year we expect to realize approximately 200 million in revenue, and we expect earnings per share dilution of $0.02 to $0.03 due to the amortization of intangibles, the one-time inventory write up and integration restructuring.

When we combine Artisan with our existing Embedded Power business we will have an entity with approximately 1.3 billion in revenue and we expect to integrate these two entities over the next 18 to 24 months and expect spending of 30 to 35 million on the integration and restructuring and we look to generate 45 to 50 million of savings from these actions.

Additionally we expect this acquisition to be accretive to earnings per share in 2007.

Next chart back to the segment detail, Climate Technologies, sales in the quarter of 852 million, up 10%.

Underlying sales was 11%, and currency reduced it by 1 point.

Going across the geographies, the U.S. was up 12%, Europe was up 24%, and Asia was down 2%.

During the quarter the U.S. residential AC markets made the final conversion into the 13 SEER product lines.

We also saw good growth in Europe driven by refrigeration and the retail services businesses.

EBIT dollars in the quarter was 125 million, margins excluding restructuring were down 50 basis points.

As we continue to see commodity inflation persist which we're not able to offset with price increases.

We are having success with Scroll in the new higher efficiency applications and we are achieving market share gains, and as we look to the key summer selling season, weather will obviously be very important as channel inventories appear reasonable at this time.

Next chart Appliance and Tools.

Sales in the quarter of 1.072 billion up 6%.

The underlying growth was also 6% with acquisitions and currency offsetting each other.

The U.S. growth was 6%.

Asia was up 39%, and Europe was down 1%.

We've seen a pick-up in the non-residential construction driving growth for this business.

EBIT dollars were 151 million in the quarter for a margin of 14.1%.

Margins expanded 80 basis points.

Again with benefits from prior cost reductions and leverage on the sales growth.

Looking at the growth drivers here, we saw nice growth from the tools and storage businesses, and also in the motors business we had solid growth from the industrial and HVAC motors.

Going to the last chart, summary and outlook, as we summarize the first six months, we've obviously gotten off to a great start.

Sales for the first six months up 15% and earnings per share up 31% through the first six months.

We've also seen order trends remain strong with 10 to 15% order growth in the quarter.

So we now expect full year earnings per share in the range of 4.25 to 4.35.

That's driven by consolidated sales growth which we expect in the range of 12 to 15% and underlying sales growth which we expect in the range of 10 to 12%.

We expect restructuring expense in the range of 85 to 95 million, and I want to remind you that the outlook does include the impact of the Artisan acquisition.

Additionally this year we expect full year operating cash flow of around 2.5 billion, and capital expenditures of approximately 600 million, and we're looking for a return on total capital of over 17.5%.

As we see things now, 2006 shaping up to be a very nice year after great results posted in 2004 and 2005 as well.

With that I would like to turn it over to David Farr.

Thank you very much, Chris.

I also want to thank Walter for joining me today.

We had a nice two-day Board meeting here.

It is enjoyable to talk to the Board about these results.

First, I really want to thank the operating team and the corporate team as you can tell by these results they're executing right now, doing a great job and I think some very strong markets and they're delivering.

Clearly we always have issues out there, and we're addressing those issues, and we're investing and restructuring and dealing with any operating issues that come up, so we'll make sure we have the Company in a stronger position as we move into 2007.

If you look at the first half of fiscal 2006, we have strong momentum and sales, market participations, and new products that we've been investing in and key acquisitions, margin improvement, trade working capital, operating cash flow and [Inaudible].

Clearly the operating people are doing a superb job right now and I want to thank them all.

As you know, we've been going through a major repositioning of the core business over the last several years trying to globalize the business, increase the engineering of new products and making those investments in emerging markets that are really paying off when you look at what's going on in Asia Pacific, China, and India.

Latin America up 30% for the quarter, the Middle East, eastern Europe, and Russia and on top of that we have strong underlying performance in mature markets U.S., Europe, and Japan.

It is great to see.

I know Walter and I have talked about this.

We haven't seen too many six-month periods like this where we have so many of our key markets going the right way.

A lot of that comes from the restructuring we initiated back in 2001, the second half, and then drove through hard through 2003 and that is really starting to pay off.

As you saw with the slide on Artisan, we have a very aggressive integration plan to create a very strong Embedded Power business, in my opinion we have some excellent people there with some excellent technology, and I like what we see so far, and integrating this company I think we're going to have a strong team, and we'll continue to deliver as we go through this process.

Net/net a great start to 2006.

The underlying fundamentals are strong right now.

As Chris mentioned, the issues really are some -- on the operating area are driven around materials and commodities.

We're having to fight in some cases to get adequate materials.

The pricing issue from some of these materials in the commodities is an issue for us, and we're having to continue to increase prices to help offset this material inflation.

We are getting the job done, and we are still ahead of the power curve in this area, and we intend to stay that way.

It is not unfolding as we initially thought back in February.

As I wrap up here and open the floor for questions, I really want to thank the business leaders out there, the Presidents, and Walter, and all the Corporate people in delivering the great quarter.

It is great to be able to sit in front of a Board and talk about a quarter like this, and I know that some day it will be the other way around and I have to keep that in mind when things go the other way so the Board will remind me that we weren't doing such a bad job.

With that I turn it over to Chris, and some questions and look forward to the questions from the field.

[OPERATOR INSTRUCTIONS] Our first question is from John Baliotti with Cathay Financial.

Please go ahead.

Good morning or I guess afternoon.

Looking at your trade working capitals as you're pointing out and also your return on capital, both each of the first year quarters and for the six months have shown pretty significant improvements, and I think historically the working capital as a percent of sales, I think you're saying somewhere around target was around 16, 17%?

Is that sort of a long-term?

The target that we talked about was getting down to 15% that we talked about in February.

Right.

It seems like you're well on your way to getting close to that this year or at least a significant improvement over last year?

Yes. we got to make it year by year as you know, John.

Sure.

Do you think -- is there any reason why 15% is anything more than sort of just a stop-off point here?

When we get to 15% I will let you know if it is a stop-off point.

As we look at the current mix of businesses and how we have a global structure relative to our balance manufacturing around the world, I think a 15% is a very aggressive target.

Can we beat it, maybe.

The current mix right now tells me that is a very aggressive target and one, it is going to take us several years to get there as you can see we are making some progress this year.

Right.

How about on return on capital?

Seems like you have had nice improvements 3 to 400 basis points the way I calculate it so far this year.

When we were -- in February we talked about trying to get in the 17% range this year.

I think now with a strong performance we'll be over 17.5 approaching 18 this year.

Our target was to get to 18 by I think 2008, and clearly we probably get there a little sooner than that, and the next goal will be to get to 20%.

Okay.

Thanks.

You're welcome.

Our next question is from Mike Schneider with Robert W. Baird.

Please go ahead.

Good afternoon.

Good afternoon, Mike.

Dave, could you just address climate margins for a minute?

I am curious if you were surprised at all by the margin in climate this quarter being down 50 basis points before restructuring?

Not surprised at all.

We are investing in this business right now.

We're going through a transition in this business relative to the 10 SEER, 13 SEER, and we had one month basically of 10 SEER product in here.

We also have a situation where the business is running pretty hot right now and material disruption is costing us money, and we are investing in additional generation product and also new capacity.

This is not surprising.

As we laid our plan out this year, we anticipated climate technology margins to be down in the first half of the year and we'll gradually improve throughout the rest of this year.

We do invest in our business in many ways over the years, and we are investing in our solutions business there, and so you're not going to see every business within Emerson always go up, and you have to bank on the fact that we are -- there is a master plan of what we're trying to do here, and there is a master plan.

If I recall, the analyst day you had said that the operating margin for the segment would be up 20 to 50 basis points for the year.

It implies a fairly meaningful ramp in third quarter, fourth quarter margins.

Is that still to be expected given what copper has done and even some of the other materials have done in the last few weeks?

I would say based on what we're seeing, the material and the mix right now, Mike, to be honest I would say we're going to be at the low end.

I do anticipate to still have margin improvement in the -- for the whole year, but it would probably be at the low end, the 20 basis point range right now.

And can you just give us some more detail?

Because I think I have been surprised that with the substantial increases in production you've seen in what is presumably been market share gains and even more pricing leverage, we haven't seen or we've still seen the declines in margins in the first half.

Can you just give us more color of actually where the money is being invested?

I know you've got new bricks and mortar going up.

But what else is occurring?

Well, there is a couple things going on.

One, you have the material issue within this business has been pretty dramatic given the fact because the volume has been good, and we've been having to chase the components, the steel, the copper, and we're having to pay pretty good premiums in this area here for this material, and it is causing inefficiencies in our plants as we manage this.

The other area we are investing would be in people.

We are hiring people in our solutions business, and we're hiring people in eastern Europe and we're investing in some new products for the next generation type of product, but the biggest issue we've had here fundamentally is that it's a material issue, and conversion of that material when we get it into the product, and so that's been the big issue and we're not out there from the standpoint of pricing.

You might say we have all the flexibility we want.

That is not true at all.

We have commitments to our customers, and we honor our commitment to our customers, and we price accordingly.

You've never been shy about price, Dave, in a market where you're HVAC OEMs are reporting 20% pricing benefits, why aren't you participating in that wave?

We are participating in that.

From our standpoint with the continuing inflation on the materials, we do not price instantaneously.

We make commitments and there would be a three-months, six months or twelve-month commitment to our customers.

That's the way we operate, and it cuts both ways, so we are not shy about pricing, and we will deal with this issue, but at any point in time you will see a disruption from the profitability standpoint.

I am not concerned about this at all.

Congratulations on a great first half.

Thank you very much, Mike.

Our next question is from Nicole Parent with Credit Suisse.

Please go ahead.

Good afternoon.

Good afternoon, Nicole.

I guess first would just be within Network Power, could you talk -- you mention the strength of the core UPS business, the competitor was out last week talking about high double digit systems margins.

Could you give us a sense what you're seeing and also geographically give us a perspective?

Yes.

Nicole?

Yes.

Caught me by surprise.

I am grabbing something here, okay?

I got to have facts because if I don't give you the right facts, you will publish the wrong information.

The facts are if you look at our business we were up over 30% in the space here what I call the uninterruptable power supply position there and the service space that you're referring to here.

I see the market right now growing pretty nicely in the 15, 16% range with the market strong, and we're two X-ing that at this point in time, maybe a little bit better than that.

We have seen very good strength in this market space for the last two quarters, and we feel good about it, and I think the competitor you're referring to had a 17% growth for the quarter which is pretty good but basically as I look at the market right now, that is just a little bit above the marketplace.

On a global basis, we've had a very strong and I am looking for facts here, but if I look at what we've been totally, we're looking at strong growth in Asia.

And I don't want to refer to the number, but it is well north of 30%.

I am looking at Europe.

Pretty good European growth in the 15 to 20% range, and I am looking at North America.

America is above 30% growth, so we saw very good growth around the world in this space, and a lot of this comes off in major new products, there are people out there insinuating that we're a sleeping giant and I can tell you right now this giant doesn't sleep a whole lot, and we've been vesting a lot of money in new products and we're really pushing hard out there and we feel good about what's going on.

So we enjoy the competition and we're having a lot of competition right now.

Great.

And I guess just sticking with Network Power, you noted you're going to be picking up the integration efforts there.

Could you just talk when you think about Artisan, and what it brings to the table and what needs to happen over the balance of the year, and what you think that sets you up for for margins in that business next year?

Well, it is a little bit early to give you a sense of the margins for next year given the fact that -- I will give you a sense of what I call Embedded Power margins.

These Embedded Power margins will run through cycles anywhere from the 8% range into I would say 13, 14, and maybe the peak would be 15% Embedded Power margins.

And Artisan Embedded Power is not anywhere close to that.

They're barely making money if they're making money at all in this space.

What we'll be going through is a major restructuring from the standpoint of leveraging each other's facilities wherever we are around the world for manufacturing and selling office and then also leveraging the technologies we have and we have to take a look at the various technologies, and if there are some technologies that are redundant then we are going to have to deal with that from a standpoint of restructuring as Walter knows as part of the acquisition.

It is called the in-process R&D.

I think what you're going to be looking at here is we are going to be going through the process here the next three or four months and then seeing where we can improve on both sides.

It is not just one.

It is both sides and create a very strong organization and our goal would be to over time drive the profitability of this business back into that range, in that 8 to 15% range which we are right now in the middle of that range for the Aztec Embedded Power business.

I think it is a little bit early.

We only closed it three or four days ago.

Give us a quarter or two, Nicole, before we have a sense of what I think is going to happen next year.

It will be accretive as we said.

It will be based on the aggressive restructuring we're going through.

Great.

Just one last one on process.

The core growth there looks very strong.

One competitor had cited project delays.

Doesn't look like you guys are seeing that.

Could you just give us a sense of kind of underlying demand trajectory there?

From our standpoint we've seen no slow down in execution of projects.

I think what you -- you might see a little from the standpoint of material or standpoint of labor, but as you know, we've been having 15, 20% underlying growth rates in process now for a couple years, and we have been delivering 10 to 12% sales growth rate.

We're moving forward around the world, and I feel very good about the underlying market growth.

I don't see a back off in the oil and gas industry investment and based on what I am hearing talked about right now that's going to continue for several more years.

We have not seen a delay at all.

Great.

Thank you.

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

Please go ahead.

Good afternoon.

Good afternoon.

First of all, I was curious on your chart on page 4 where you show the growth rates for the various geographies.

Could you give me what the actual percentage of overall sales was for those same geographies?

I don't have it off the top of my head.

We can get it to you.

Okay.

We do not put that in the queue.

Do we put that in the Q?

We could give you a rough idea.

We give it out annually and let's get you a rough idea numbers here.

Hold on one second.

You want the percentage growth rates?

No.

That's what's already on there, I think.

He wants approximate dollars.

Yes, like what percent was from the U.S., what percent from Europe, what percent from Asia, of total sales?

The sales in the second quarter, what was in the U.S.

I can get that back to you off line.

I know we were like 53% sales in the U.S. for all of last year.

So we can get that break down to you.

It is just because you have such varying growth rates that obviously those proportions are changing.

No, they are not changed that much.

If you take a look at -- I bet you if I looked at what was reported last year for 2005 you probably won't see those percents changing much at all for the first half of the year, and I will give you a rough number right now.

Let me have it.

It is 2-point -- for the U.S., you're looking at 2.5 billion in sales.

You're looking at $1 billion in Europe.

You're looking at a little bit under 100 million in Japan.

You're looking at Asia over 600 million.

You're looking at Latin America over 200 million.

You're looking at Canada, approximately 200 million, and you're looking it the Middle East about 150 million, and then you're looking at acquisitions which we break out of that about 150 million.

Then the other thing, you talked about how strong your cash flow is going to be and it is obviously going to be well in excess of your -- almost 2 billion in excess of your CapEx, so if you could just talk a little about what you're going to do with that cash, if you're going to look at share buybacks or dividends?

If you go to the chart in February I actually laid that out in detail.

I'll look here again for it.

Let's say we deliver around $2.5 billion.

We'll spend -- our target is to spend around $600 million for capital spending this year.

It could be plus or minus $10 million.

I can't call it that tightly.

Maybe Walter can but I can't call it that tightly.

I wouldn't even be that tight.

Share repurchase is going to be around $500 million.

We have not got as much done in the first half of this year as we thought.

We did around 600 million last year.

We've had a lot more black-out periods relative to the market space and we have not been able to get as much done in the first half as we wanted to.

Our target is for the year around $500 million.

We're looking at acquisitions around $1 billion.

I think it is going to be real close if not slightly over $1 billion and the rest of the money will go into the dividend, it's going to be around 600 and -- what? 650.

700 million.

$700 million in dividends.

We target paying back to our shareholders between 50 to 60% of our operating cash flow, so the 2.5 billion we're looking to pay back 50 to 60% of that back to the shareholders.

The rest we invest for long-term growth.

You don't see share buybacks as part of that, then.

It is.

I said, we're going to do about $0.5 billion this year in share buyback.

We did 600 million last year.

Okay.

That's all I had.

Thanks.

Thank you.

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

Please go ahead.

Good afternoon, everybody.

Good afternoon.

Could you amplify your comments, Dave, on just the pick up in nonresidential construction, what you're seeing there, how sustainable that you think prospectively this could be?

Just any additional commentary there?

The non-res construction -- around the world it has been pretty good here for back up in the last six, eight months, and I think that in the U.S. right now as I look out for the next two, three quarters, it looks pretty good.

We still think it looks pretty good in Asia, and in Europe and eastern Europe has been gaining momentum.

Our near term forecast between six and nine months look pretty good in non-res construction.

And I think you were somewhat prophetic in saying Europe was kind of poised for a nice modest rebound here.

Looking out now in terms of what you're seeing in global fixed investment, is there anywhere across the global economy that gives you pause or gives you concern looking just at the fundamental macro economic trends?

It looks pretty good right now.

As you know I track this very closely.

It looks pretty good.

I am a little bit concerned about a euro going to 1.26 because if it continues to strengthen and the dollar weakens.

That will clearly hurt the European economy.

Because it will hurt their export capabilities.

If the euro goes to 1.30 I think this will be a very short recovery.

Thank you for your time.

You're welcome.

Our next question comes from Deane Dray with Goldman Sachs.

Please go ahead.

Thank you.

Good afternoon.

Good afternoon, Deane.

Before the 14% core revenue growth, did you say how many percentage points came from price this quarter?

I would say it is less than 1 percentage point.

Terrific.

And then on Artisan, if I heard it correctly, the game lan on the restructuring might take 18 or the integration 18 to 24 months.

Is there a reason that is being extended?

Could that be done earlier?

And what might we be up against there?

I just think you're looking at two very global organizations, and you don't want to do anything crazy, so our goal would be to get it within eighteen months, but if business -- if you saw our Embedded Power business was quite strong and you know my philosophy, Deane, I am very careful about restructuring into a very strong operating plan, and so right now we're operating very high growth rates.

Artisan is not growing as rapidly.

But they have a very strong second half planned.

So we'll be very careful about messing around when a business is growing as fast as it is growing.

That will slow us down a little bit.

It will be more opportunistic.

Well, we have a road map.

You just have to be very, very careful of trying to accelerate things into a very strong order book.

I understand.

Regarding the inventory step-up, that's a non-cash charge.

Can you give us a sense of how big that charge will be?

Well, it is all embedded in our estimate of dilution will be $0.02 to $0.03.

It is not a very big number, but it does exist.

Is it the -- primary the dilution is from that step-up?

No.

I would say the restructuring would be the biggest part of the dilution.

Correct.

Then last question is we seem to be hearing more about tech companies needing to invest in data centers, and so we heard on Friday Microsoft making noises that they will need to build out data centers.

Is this -- are these estimates already included in your projections for the data center given your market share in power conditioning, back-up power, and precision air?

Did I give a forecast for that market space?

I forgot.

Yes, it is.

We're fully aware of what you just mentioned.

That would be within the sweet spot of network power?

As I talked about February, Deane, right now if you look at this cycle, the Network Power cycle, in this type of business you're looking at, when it is running hot like it is, you're running somewhere in that 15 to 16% market growth rate.

It will drift down typically next year in the 10 to 12% range and then it will drift down into just a little bit under that.

That's the way this market space works.

It runs hot for a couple years and then drifts down.

Right now we started about I would say about twelve months ago picking up, and I think you are going to see this run for at least another good through 2007.

Are you maintaining share or building share in this market?

Well, I don't comment on share.

But I feel pretty good given the fact I think the market is growing 15 to 16%.

I am not a rocket scientist.

You can calculate.

Great.

Thank you very much.

Our next question is from Ned Armstrong with FBR.

Please go ahead.

Good afternoon.

Hey, Ned.

With respect to the margins in the tool and appliance business, are they in your opinion sustainable at this level or could they go up even more?

First of all, I want to make a very special comment to the tools and appliance guys.

That -- this is a tough market space right now given all that's going on, the materials and the customer base and the disruptions that you can see in this market.

As you can imagine in this market space they're going through some very aggressive restructuring and some major new product launches and the fact they have up margins in the second quarter, those guys need to be commended on that, and so I think that we will see a pretty good second half in this space.

I feel good that we can sustain them at this level and I am looking for some additional improvement as we move throughout this year and go into 2007.

What type of magnitude would that improvement be?

Are you talking double digit basis points or 100 basis points plus?

Give me one second to confer with my CFO here.

We conferred.

As long as we see what's unfolding the mix right now, I think you're looking somewhere probably 75 to 100 basis points improvement.

Great.

Thank you.

Our next question is from Chris Kotowicz with A.G. Edwards.

Good afternoon, good quarter.

I guess I wanted to ask another question about climate.

Did I hear you imply in your comments and I mean imply, you didn't clearly say it.

That maybe you have less pricing power in your climate business than you do in--?

I did not say that.

What I said is we make commitments in our pricing sometimes with our customers we make contracts that last a year or two years or six months.

We do not price on a daily basis and so we will honor our commitments and we're always in discussions with our customers, and in steel prices and copper prices have taken a very strong kickback up, and we will deal with that issue the second half of this year.

The biggest issue we have in this space is right now is getting the material and making sure we convert with that material and the pricing of the cost of that material.

We have pricing flexibility, but we're also very careful because we have very valuable relationships with our customers, and so I take a very long perspective here.

I am planning to be around here for awhile.

I am not planning on [Expletive] off customers to make a quarter look good.

How is that different in terms of the long-term perspective and climate that you have on your pricing and your relationships with your customers than -- Appliance and Tools for instance because it seems like you have some similar dynamics there.

Well, yes, and from the standpoint of our compressor guys as we've entered contracts late last year, early this year and we're dealing with those contracts and we will go back in and discuss with our relative to the higher material input and we will deal with that.

It is an orderly process and our customers deal with it like we deal with our suppliers, so I don't think there is anything unique here.

When we make agreements, we make agreements.

We will honor those agreements.

We are going to go back in as we have the right to do and talk to them.

It doesn't make sense to go in every month and say okay this is the price for this month.

We deal with these customers for the long-term.

Okay.

So should I -- maybe I should look at it this way.

The margin leverage in this particular quarter, is that more a function of you just had so much work that inefficiencies in different areas, whether it is getting material or being stretched to capacity in a transitional period, are the real drivers for the margins this quarter?

I would say climate, that's exactly right, and the mix, yes.

We will deal with this issue.

Fair enough.

Thanks, guys.

Thank you, Chris.

[OPERATOR INSTRUCTIONS] At this time there are no further questions in queue.

I would like the turn the call back over to management for any closing comments.

I wanted to thank everybody.

Again, it was a nice quarter.

I want to thank the operating guys for execution and last couple years our growth rate has been -- we've been able to average approximately 12% growth and underlying growth rate around 8% and good margin improvement in cash flow, so we're having a good roll here right now and hopefully we're going to continue that through the rest of this year and well into 2007.

With that we will sign off and we'll see many of you in the coming weeks.

Take care now.

Bye.

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

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