艾默生電氣 (EMR) 2007 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen.

Thank you for standing by.

Welcome to the Emerson third quarter 2007 results conference call.

During todays presentation, all parties will be in a listen only mode.

Following the presentation the conference will be open for questions.

(OPERATOR INSTRUCTIONS)

Emerson's commentary and responses to your questions may contain forward-looking statements including the Company's outlook for the remainder of the year.

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

In this call Emerson management will discuss some non-GAAP measures in talking about the companies performance and the reconciliation of those measures to the most comparable GAAP measures is contained within the presentation and is posted in the Investor Relations area of Emerson's website at www.emerson.Com.

This conference is being recorded Tuesday, August 7, 2007.

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 we'll summarize Emerson's third quarter 2007 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'll start with the highlights of the quarter as shown on page two of the conference call slide presentation.

Third quarter sales were up 13% to 5.9 billion with increases in all five segments.

Underlying sales grew 9% led by strong international growth.

Operating profit margins improved 40 basis points to 16.1%.

Earnings per share was $0.72, up 22%.

Operating cash flow was $899 million and free cash flow was $755 million, up 45% and 57% respectively.

Order growth in the quarter was in the range of positive 5 to positive 10%, and the balance sheet remains strong with average days in the cash cycle and the trade working capital as a percent to sales ratios showing improvement and a strong operating cash flow to total debt ratio of 61%.

We go to the next page, we have the P&L, the summary P&L for the quarter.

Sales 5.874 billion, again up 13%.

Underlying sales up 9%.

Currency translation added 3 points of growth and acquisitions net of divestitures added 1 point.

Operating profit dollars in the quarter were $945 million or 16.1% of sales with the 40 basis point improvement driven primarily by restructuring benefits and sales volume leverage.

Net earnings in the quarter were $574 million up 18% and diluted average shares outstanding during the quarter were 802.1 million which drives down into the EPS of $0.72, again up 22%.

If we go to the next page we'll look at the underlying sales by the major regions of the world.

First, we had the United States up 4%, Europe up 8%, Asia up 21%, Latin America plus 12%, Canada up 1%, and Middle East and other up 41%, so you had total international growth in the quarter of 14% which again drives the underlying number of plus 9% with currency and acquisitions divestitures adding 4 points of growth to get to the consolidated sales growth of 13%.

Next chart we have some additional income statement detail.

Gross profit dollars 2.105 billion, which is 35.8% of sales.

SG&A as a percent of sales was 19.7 as we showed nice leverage on the higher sales volumes and again that gets you down to the 945 of OP, at 16.1%.

Other deductions in the quarter were 59 million higher by 5 million and we had lower gains this quarter compared to the prior year quarter, and interest expense was 62 million as we had higher average debt balances during the quarter.

That gets you down to the pre-tax line of 824 million or 14% of sales.

Taxes in the quarter were $250 million for a tax rate of 30.4% and we now expect the full year tax rate to be in the range of 31 to 32%.

Next page, cash flow and balance sheet.

Operating cash flow in the quarter $899 million.

Very good performance up 45% in the quarter and up 19% year-to-date.

Capital expenditures in the quarter were 144 million which is an increase of 3% in the quarter and also up 19% year-to-date, and that gets you down to the free cash flow line of 755 million.

You see the cash flow to total debt ratio there again strong at 61.1% of sales and the trade working capital balances at the bottom of the page with good improvement in this ratio in the quarter going to 17.6% and we expect the full year ratio to be approximately 18%.

Go to the next page, Chart 7, the business segment P&L.

Business segment EBIT in the quarter 928 million or 15.4% of sales so we had improved margins in four of the five segments.

Difference in accounting methods was 56 million up 10 million.

Corporate and other of 98 million, an increase of 19 million as we had higher incentive share expenses in the quarter and interest expense net of 62 million again up 11 million, gets you down to that pre-tax number of 824 million.

Now we'll go to the individual businesses, first process management on page eight.

Sales in the quarter 1.471 billion, an increase of 19%.

Underlying sales were up 14%.

Currency added 3 points of growth and acquisitions added 2 points.

By geography you had the U.S.

up 11%, Asia up 20%, Europe up 8%, and Middle East and other up 53%.

EBIT margins in the quarter were 269 million or 18.3% of sales, so we had good leverage on the higher sales volumes, was partially offset by an 11 million expense that was booked for an adverse commercial litigation judgment.

The wireless plant web launch here as been successful, we're now shipping products and we again achieved double digit order growth in the quarter so the business remains well positioned for future growth.

Next page, industrial automation.

Sales of 1.095 billion, up 13%.

Underlying sales up 9%, currency translation added 4 points of growth.

By geography you had the U.S.

up 6%, Asia up 17%, and Europe up 11%.

EBIT dollars in the quarter of 161 million or 14.7% of sales, margins improved by 10 basis points as we had sales volume leverage and cost reduction benefits somewhat offset by unfavorable product mix and higher material and wage costs.

Order growth in the quarter was 10% and we continue to see strong global growth from the power generating alternator business.

Next page, network power.

Sales here of 1.322 billion, up 14%.

Underlying sales were up 11%.

Currency added 2 points of growth, and acquisitions net of divestitures added 1 point.

By geography you had the U.S.

up 8%, Asia up 25% and Europe down 1%.

EBIT dollars in the quarter of 178 million or 13.4% of sales so we had good leverage on the sales volume increases and also favorable impacts now that the integrations of the Artisan and Kaneur acquisitions are complete.

Very strong quarter for the power systems business in Asia and also the core UPS and precision cooling business serving the data center markets.

Next page, climate technologies.

Sales here in the quarter 1.043 billion, up 13%.

Underlying sales were up 8%, acquisitions added 3 points of growth, currency translation added 2 points, by geography you had the U.S.

up 3%, Europe up 21% and Asia up 14%.

We see Europe and Asia remaining strong with a softer U.S.

due to the milder weather so far this summer and a slow housing market.

EBIT dollars in the quarter of 174 million or 16.6% of sales.

Margins were down 20 basis points here as we continue to see margin pressure from commodity inflation and we also had a 30 basis point dilution from the India Compressor acquisition.

Order growth in the quarter was 5% up against a tough comp, in the prior year orders were up over 20%.

Next page 12, the appliance and tools segment, sales here of 1.107 billion, up 1%, we had underlying sales down 1%, acquisitions added 1 point of growth and currency added 1 point of growth.

By geography we had the U.S.

down 3%, Europe down 2%, and Asia up 25%.

EBIT dollars of 146 million or 13.2% of sales, so we had a margin increase here of 30 basis points driven primarily by benefits from prior cost reduction activities.

We continue to see the consumer and housing led businesses remain soft, but strong performance from the professional tools business driven by non-res construction and good performance in Europe.

If you go to the next chart, page 13 for the summary and outlook, good quarter for Emerson, again strong metrics really across-the-board, underlying sales up 9%, operating profit improved 40 basis points, very strong operating cash flow performance, and the order trends continue to match expectations.

So through the first nine months we've set a solid foundation for another very good year at the Company.

Looking for full year underlying sales growth in the range of 6 to 7%, reported sales growth in the range of 10 to 12% and full year earnings per share in the range of 2.58 to 2.63 which equates to growth of 15 to 17%.

Strong cash and return to expectations for the year, full year operating cash flow at 2.8 billion, capital spending at 700 million, free cash flow at 2.1 billion and return on total capital over 19%.

So, that's the highlights for the quarter and with that I'll turn it over to David Farr.

Thank you very much, Chris.

Welcome, everybody, who is joining the conference call today.

I appreciate you taking the time to spend it with Walter, Chris, and I.

I know you probably have better things to do than listen to us talk, but I'm glad you're here.

As you have seen in the numbers, we had another excellent quarter on all financial measurements, in particular, I really want to recognize the global operating corporate executives for the strong performance in delivering what I consider several key areas that have separated us from our global competitors.

Number one is the 9% underlying growth rate we have for this quarter.

As you all know we've had some very good underlying growth rate for the last several years and 9% in the type of marketplace that we're facing right now is I would call exceptional extraordinary performance.

I still believe the same range of underlying growth rate for the full year that I said back in February, it's 6.5 to 6.8%, basically the same number I said back in February and we're still grooving right toward that number.

The other issue I really want to commend the operating people on is the 16.1% operating margin performance.

We've been on a trend to get back to or exceed our 16.5% number that we exceeded in the last cycle and I still believe we'll do that in the next 12 plus months, and the operating executives are delivering on the restructuring and delivering on the leverage and all of the ratios are important relative to delivering higher operating profit.

The other area I really want to commend them is the operating cash flow.

It was up 45% for the quarter, nearly $1 billion for this quarter, and we're on track to reach a $2.8 billion operating cash flow or better, and even though we have very slow start as we build inventories in anticipation of a stronger U.S.

marketplace which I've discussed in the past, I blew it and in anticipating a much stronger and particular residential AC marketplace, we build excess inventory and now as you can see from our balance sheet we have taken that out plus some and they did a superb job.

Then finally the fourth area I think that the operating people need special recognition on is return on total capital.

As we talk about is [ROXE].

We're going to have another very good year.

We're going to add probably 100 basis points, maybe 80, 90, 100 basis points, somewhere around there to reach the 19.4% number up from last years 18.4.

Our long term goal is to reach 20% plus.

I think we will reach that relatively soon.

Clearly, it will move around based on acquisitions, based on the size of that acquisitions but I think we as a corporation can keep this in the 18 to 20% range assuming we don't have a major significant acquisition at some point in time.

But it was an excellent quarter, tremendous execution by the business leaders and the Presidents and we're really well positioned to have a strong finish to our fiscal year 2007, our fourth strong performance with underlying sales growth, margins, cash flow and ROXE.

On top of that I think we've been very prudent relative to strong operating cash flow and where we've invested it.

We have given back in the last several years over 60% of this operating cash flow to our shareholders in dividends and share buyback and I think we're well positioned for solid, long term growth.

As you know, we're not talking about quarter-over-quarter numbers here.

We talk about trying to develop a business that through the cycles will outperform the underlying market measures and actually a lot of our competitors.

So I feel very good about the first three months or the last three months and the first nine months.

We reviewed this with the Board today.

They Board was very pleased, they like the momentum we have at this point in time and despite the tough comparisons we're showing some very good numbers throughout this year.

The top 40 global Emerson executives are getting together here in the latter part of this week for three or four days, and we're going to be talking about 2008 and we're going to be talking about what we have to do next to keep this momentum going, where do we have to invest as we continue to generate significant levels of operating cash flow and what do we need to do to make sure that we deliver the value for our shareholders around the key areas of underlying growth, margin, return on total capital, and operating cash flow, all of the key measures that we look at within this Company to derive value for our shareholders but again it was an exceptionally good quarter.

I'm very pleased with it, the Board is pleased with it and again I want to thank everyone out there on the call that actually delivered these results.

Walt and I sit here and we can manage it but in the end we depend on a lot of people to deliver and they delivered and they delivered a very strong quarter and I want to thank them.

With that we'll open up the phone line for questions and I promise to be very good.

I'm not going to tell you any movie jokes.

I have some great ones but I'm not telling any movie jokes and so with that we're just going to open the lines to have questions.

Thank you very much.

Thank you, sir.

(OPERATOR INSTRUCTIONS) Our fist question is from John Inch with Merrill Lynch.

Good afternoon, Dave.

Good afternoon, John, what do you think?

Well, you said it all.

Hey, industrial automation, you guys called out some unfavorable product mix given the flattish margins but the revenues were pretty strong.

Could you elaborate on that and tell us what's going on with the Gen Set business?

Our Gen Set business, we have a long term relationships with many global Gen Set manufacturers so the alternators that go into that from the profitability standpoint, it's not the same profitability as the total business segment.

It's still a very good business.

It's very profitable and it has great returns but it's a typical relationship we have and we have long term contracts and that business definitely when it grows as strong as it's growing right now, mix is down in margin but I'll take it every day of the week and so that's the driver right there to be honest.

So when you look at the business and you think of Gen Set today should we be extrapolating that for the coming quarters just in terms of the profitability of the segment?

I think as long as you see the Gen Set marketplace, the back up power marketplace as strong as it is right now, you can see it here and you can also see it in the uninterruptable power supply business, the UPSs that you would expect that type of mix.

They've done a pretty good job of offsetting that in other parts, but it's very difficult to do that.

So I think you should look at that as long as you're seeing and feeling that Gen Set market being strong.

Are you going to have to build capacity for that business down the road?

We're already building two capacities.

We're building a Mexican facility which is already up and running and we're actually building, expanding in China, I guess I lied, there's three, and we're expanding in the Czech Republic which I think you went to the Czech Republic plant didn't you?

I did, yes.

So we're expanding in three locations around the world.

It's been very strong demand and as you know this business runs in long cycles and are very aggressive and then it tails off so we're very very careful of what type of capacity we put on place but it's going to best cost locations.

Just my other question, Dave.

You've got this growing cash balance not only year-over-year but it's been sort of progressively growing here.

I presume a lot of that cash is overseas.

Could you talk about sort of the comfort level with how high it's going to build given the strength of the cash flow and obviously the, begs the question of proceeds and how you're going to deploy it?

Yes, the cash balance overseas and we review this, we have a map, we review this with the finance committee it's about $1.3 billion right now overseas.

It's well disbursed around the world and we move it into good places like Ireland and Switzerland and other places like that.

Right now, if you look at the global business and we have crossed over the 50% level this year, our operating cash flow is good around the world.

It's just as good, it's basically in line with our profitability and our sales so 50% sales offshore, we're generating 50% of our operating cash flow offshore.

The key issue for us is to use that cash as we invest globally which we try to do, but unless there's another window opening up with that job security thing which basically was (inaudible) we got a free pass from bringing the cash flow back from all of that passed two years ago?

Homeland Investment.

They called it job creation.

Homeland Investment.

Unless that happens again we're going to have to make sure we invest that cash overseas and we do it very carefully and we watch where it is.

We have enough cash in the U.S.

right now to do what we need to do but it does restrict us a little bit.

I guess the question is does the cash just keep building because of, I can't imagine all of a sudden you're going to rush to make a bunch of investments.

No, we won't rush to make investments and it will continue to go up and at some point in time if we have a window open up we'll bring it back.

We need to move on, John.

Understood.

Our next question comes from Deane Dray with Goldman Sachs.

Please go ahead.

Thank you, good afternoon.

Good afternoon, Deane.

Dave I'd like to hear your comments on M&A opportunities.

I know John just started to touch on that, but what is the current conditions?

Last quarter you talked a bit about market volatility and you're a better seller but we've had more volatility here.

Any change in your outlook?

No.

From our standpoint right now, we are still in the process of trying to sell some assets.

We are in the process of looking at some assets.

There are are more assets we're looking at today than we were the last time we talked, Deane.

I think the window is going to open up more as I said before, I think the last time we talked about this more mid to late 2008 and so from what we talked about today in the finance committee meeting is that we want to keep our cash balance and liquidity real strong because we think the window will open up here and some of those sellers, I mean some of these private equity firms may have to start paying some debt off and that will allow us to get in and get some of the assets we want.

So I think the window is going to expand gradually and really expand as you get into the middle second half of 2008 so right now we're being patient, we're buying stock back, we're paying the dividend, and we'll make sure we stay very liquid and ready to go at the right time.

Very good, and then on network power, it's interesting that you call out some additional orders coming out of telecom.

A quarter ago, it was barely showing a heart beat and now you're talking about order trends improving.

Where does that stand and can you link that with the data center buildout?

For all the network power people out there you were more than a heart beat a quarter ago.

You guys are still pretty good even though Mr.

Deane here thinks you're dead, but the business as I said, I think I said this in February, we expected the North American Telecom guys to start ordering equipment in the second half of 2007, and that's happening.

All the mergers have happened and shakeouts going on and you're seeing that pace of business in North America, you're seeing that pace of business in Asia doing pretty well and you see a little bit of a pace of business in Europe but it's not that strong.

We would expect this cycle to be good for the next 12 months but not I would say not to be super accelerating but a nice steady pace for awhile here, and it's really sorting out relative to all of the post-merger issues from people AT&T and Verizon and guys like that, so this is what we expected and we've been restructuring the first half of the year and I think we're ready to take the increased business and I would expect it to be pretty good here for the next two or three quarters.

That includes the data center buildouts?

Yes, the data center buildout is I don't look at the Telecom side as data center.

The data center is more reflected in our lever business and that business has continued to be very strong and if you notice in the press release, we talk about 20% plus orders, we've had orders well above 20% now for many many many quarters so we have a strong business base around the world, both in data centers and basically people looking at backup centers and we go not see any slowdown in this business market at this point in time.

Thank you.

You're welcome.

Our next question comes from Bob Cornell with Lehman Brothers.

Yes, hi, everybody.

Hey, Bob.

Just following up from that question, I mean, the margins in network power was stronger than I expected.

Is that a reflection of the completion of the integration of acquisitions or the mix, and I guess the second part of that question would be as these North American Telecom Orders come in do they add or subtract to the margin comps?

The margin, two things going on is we launched some very aggressive restructuring in this business space late last year when we did the (inaudible) acquisition and then we worked it very very hard the last 12 months, and knowing that this recovery was going to come.

So at this point in time as we've looked at that Bob, we've got a lot of our costs better in line, we're starting to leverage that structure much better on the new pace of orders and we have a lot better what I call best cost, low cost, locations at this point in time so I feel very good about the position.

We will do more restructuring again next year, but we're going to wait until things probably slowdown a little bit and when we see this window open up.

Relative to the margins, the North America Telecom, we should be okay at the good, at the current pace.

I would expect our margins in this quarter to begin to be very good sequentially.

We'll have good margins year-over-year.

We had a good margin.

The coms are easier because last year we had a bust as you know in Mexico and we really talked about that, so it's easy compare against last year and the Fourth Quarter, but I would expect us to see pretty good margin as this business continues to have pretty good underlying growth rate even with the telecom business we'll have good margins and I expect our margins to continue to improve through the first half of 2008.

I'm not going beyond the first half of 2008 right now.

My window is not that clear a path at this point in time, Bob.

It does sound like you said your cost structure was improved over what it's been so you're going to leverage lever some of the volume?

Is that what I heard?

Exactly what's going on.

I guess the other question I would ask is some more insight into the climate business, particularly the North American business, it's actually up which I think most of us would have been characterized as a big surprise.

Is that the margin gains you're getting there, market share gains?

What's really going on at Climate Tech and in the U.S?

In the U.S., right now, first of all, I did blow it early on this year.

I made a call that I thought would be better than it is, it's okay, but the U.S.

residential market continues to struggle for all of us in this market space.

It's not the getting any better clearly.

In fact in my opinion, it's getting a little bit worse.

From our standpoint, the share gain that we had relative to the transition to 13 SEER is obviously helping us this year but it should be helping us a lot more.

It's clear to me also that our large OEMs are being very very tough with inventories, and with the cooler start of the season and now it's very very hot, they're managing inventories to be very very tight and I think they are managing them on a dollar level and as you know, the units and the dollar cost of these units is much higher at 13 SEER, so they are managing for dollars, that means they are keeping less units, so if you look at our production right now I would expect it to be much stronger this year than we are seeing.

It's still okay but I'm not very happy with the fact there's obviously this residential marketplace is as weak as it is and probably will be for the rest of this calendar year.

And I think we're going to struggle with the North America, around the world commercial, around the world both Europe, Asia, and commercial we're doing extremely well.

We are doing well.

We're gaining I feel good about that, but I'm not hitting on all cylinders which I like to hit on all cylinders.

Sounds pretty good anyway.

Thanks.

Shoot, you got to have something to complain about, Bob.

Yes, I'll find something.

Good, other than my back.

Our next question comes from Nicole Parent with Credit Suisse.

Good afternoon.

Good afternoon, Nicole.

I guess the first one on process, could you elaborate on the litigation that you had there and I guess as we think about the orders you had tough comps, how should we think about 2008, the margins were phenomenal if you add back the litigation charge.

How do you view process as we move ahead into '08, '09?

Relative to litigation, unfortunately, the former business leader that left this, turd, behind, me, for John Barr is relative to our Daniel acquisition, and it's a situation going back into 1999 with a situation in West Virginia and it's a bad place for us to be.

We lost, and we booked it and we moved on.

It's around 11 million $12 million range and it's unfortunate but there's not much we can do about it and life moves on.

We lose once in awhile.

We don't lose very often but we do lose once in a while and this goes back, Nicole, to a situation from Daniel and what I did when I did the acquisition and I blew it.

Relative to the order pace, I think the order pace and the process industry continues to be very good as you can see.

Our orders are strong.

They're getting tougher and tougher.

Obviously the comps globally are getting tougher.

I believe the marketplace will continue to be pretty good here for the next 12, 18, 24 months.

We will find pockets where we have very large project orders that will open up and we might have a month or two where things drop off because of the comps versus a very large project, so I think as we look into 2008 and especially the second half of 2008, you could see some pockets opening up where we could, things could weaken for a little bit relative to orders and then come back up a month or two later so right now I look at 2008 and 2009 very good for the process, industry, and very good at the steady slow pace of this industry right now.

We are not having problems executing.

We're not having problems finding people and we're not having problems with finding materials, as you can tell from our numbers.

Great and one last one, just on commercial construction in the U.S.

You mentioned global commercial looks healthy.

Could you talk a little bit about where you think we are in the cycle in the U.S?

I think that, boy, to be honest I think we're probably going to start slowing down in the U.S.

If you just look at the underlying capital spend in the U.S.

has continued to slow.

It's still good.

I wouldn't say very, but it's still good.

As I talked about, I thought the economy would be being okay in the second half, it wouldn't be that strong compared to what people thought was going to happen given the weak first quarter.

It's still going to be better but it's not going to be that much stronger and I think the commercial construction is in that same mode right now.

We're okay here for the next probably into the middle of 2008, based on my visibility and I think we're going to be looking at underlying growth rates in the certain markets we see around the world about the same level in 2008 we saw in 2007.

The mix is going to be different, and we'll sort of get a vision on that in the next six months as we unfold that group as we move into the fourth calendar quarter.

Great.

Thank you.

You're welcome Nicole.

Next question comes from Jeff Sprague with Citigroup.

Please go ahead.

Thanks, good afternoon.

Hi, Jeff.

Hi, how you doing?

Not too bad.

Just on margins obviously making some good headway there but if you think about going through that goal and reaching a new peak, other than operating leverage, what is it that the one or two things that you really have to get at to achieve that goal?

I think the key issue there for us is the continued mix of our type of business and the new product business.

We are weeding out as you think about how we create value, I don't know if you have seen the matrix that I look at different levels of our business, we're looking at how we're trying to downplay certain parts of our business which are very low margin, low return.

Either milk them, either disinvest and bring them down or actually sell them so that's going to be a part of how we do this and the second thing is a continuing movement of our, what I call operating and other cost structure into best cost levels so we have a combination of things going on so you're going to see a hybrid of both as we sell some of these businesses off as we start winding down some of these businesses that will help our margins.

At the same time we'll continue to do our best cost leveraging and the third thing would be the new product mix we bring into play we typically add value and technology.

For instance like the wireless products which are are coming out and we're getting orders for right now in process.

That's going to be a higher margin mix for us going forward.

Just on that, where is the, it's early days but where is the initial take-up on the wireless in process?

It's doing very well.

We booked several multi-million dollars orders this quarter.

I think this is going to take off.

The product is being out there being beta and tested and worked, it's more than beta, it's going into sites where people are are running a wireless product in their plant to see what it's like.

I think you're going to see pretty good momentum here in the next two or three years as this takes off and as companies look at the benefits of beyond monitor looking for emissions and looking for other ways they can manage their plant better.

I think we're in early days but I like where we are right now and we have our new product portfolio which I will show again in February.

We're on track to what we committed to.

I know Steve Sonnenberg is out there and he's probably listening to me, Steve committed to me that we're still on schedule and we're on schedule, we have a very large amount of new products coming out in this area here in the next six months.

Then just last one from me.

Europe overall looked pretty strong but kind of an interesting array of performance across your segments, appliance down 2 and the other extreme climate up 21.

Yes.

What's your overall take on just the tone and the forward outlook in that market?

I think you're going to continue to see mix of businesses like that.

Obviously take appliance.

I consider trying to figure out how to make sure we make acceptable returns so I'm not taking any businesses walk down the street.

I'm being very selective in that market space and I think you're going to see businesses like the Climate business like process to continue to do pretty well there.

As they import or export into Eastern Europe as they go into Middle East and as I think people invest in Europe.

My feel for Europe next year it will outgrow the U.S.

again which is probably the third year in a it row for us.

Thanks a lot.

You're welcome.

It's good talking to you, Jeff.

Our next question comes from Robert McCarthy with Banc of America Securities.

Good afternoon, David.

Good afternoon, Bob.

How you doing?

Good.

First question is maybe you could talk about the margin opportunity you see at the network power business.

Obviously you've kind of hit a high watermark here versus I think 13.6 in 2000.

Could you talk structurally how that business, where that businesses margins could go in a pronounced up-cycle?

I think my gut tells me we could get this business as currently structured, currently structured at the peak around 15%.

We never lost money in this space, even in a very very difficult time period, but I think as we look at how we restructure the business and what we want to be in and what we don't want to be in as we continue to basically get out of certain businesses and that's why some of the underlying growth rates were very weak in the first half of this year, I think you could see this business being that 14, 15% range, peeking around that 15% range at that point in time as I currently see it, and maybe we can change that down the road but right now as I snap at it and I know that business reasonably well I think 15 is the number.

Understood and then on process management it looks like the incremental draw through margins are running excluding the commercial litigation around 25% going forward, do you think that's still sustainable for the business?

I think that will slip down.

I'm a big believer if you ever hear me talk about this you go into cycles and you start out your profitability level because you're restructured going into that cycle, your profitability level is higher and then as the cycle slows down, it will drift down to under 20% into the 15, 20% range.

Right now, process probably started out leveraging well above 30%, 35% and now it drifted down towards 25.

I would expect them to drift down into the 20% range and eventually drift down towards 18, 20% and so I think that eventually, you will see that.

The other key thing you have to keep in mind is we continue to aggressively invest in technology and aggressively invest in our global SG&A to support a $6 billion process business, and so even though I talk about our margins doing well, we are are continuing to aggressively invest and as the business slows a little bit you'll see some of that leverage slow down a little bit but still it's running at very high levels as you know.

Thanks for your time.

Thank you.

Our next question comes from Michael Schneider with Robert W.

Baird & Company.

Good afternoon, guys.

Good afternoon, Michael.

HVAC for a minute, Dave.

Could you just talk about your outlook is for soft markets to continue, where are you in the production levels, I guess heading into Q4 in early '08 and then also can you kind of walk us through '08 and '09 if we assume U.S.

residential remains soft, when does Europe begin to slowdown as the heat pump regulation is digested and when does Asia start to pick up with their new labeling and SEER requirements.

Man, you want to join our management meeting or something , Mike, you know?

We are right now, my opinion, in North America, this is our production, okay, in a cutback mode versus trying to get the inventory back under control.

I think you're going to see for the whole year, our unit production will be down as we fine tune things, and we would normally be looking at probably a stronger production level at this point in time but the residential market has had no recovery.

In fact in my opinion it has continued to slip.

The replacement markets continue to slip.

Our customers that I mentioned earlier are keeping their inventories extremely tight and in fact are managing the dollars not units therefore it's a higher price point, there's less units.

We are in the mode right now we have continued to expand and bring our Mexico plant up online and we're optimizing our plant structure.

It's clearly hurting us in the margin standpoint but this is going to allow us as we move into the normal season which is January, February, March, to be able to serve our industry, our OEMs without building inventory which from a company standpoint is much better utilization of assets.

So I think what we're going to see in my opinion, the next six, maybe nine months are going to be very tough in North America residential.

And I think I've said that from my standpoint I've said this before, North America residential, investment North America residential will be down again in 2008.

It will be a tough market.

That's how we're structuring our business.

That's what we're doing relative to restructuring right now and all of the things we're doing within the Company.

Relative to when does Europe get hit, I think Europe will eventually slow down a little bit from the U.S., however a lot of the growth coming from Europe is going to Eastern Europe, Middle East, Africa and a rebuilding of their own infrastructure.

Clearly it will be negatively impacted by the strong euro and the weaker U.S.

marketplace, but they had the same thing this year, Michael, so I think you're going to see a little bit of weakness in Europe from that but it's still going to have good underlying economic growth next year versus

And Asia, when do you expect that acceleration to occur?

Is that an '08 event or is that '09?

Acceleration or deceleration?

Acceleration.

And well I think our business is doing pretty well in Asia so I don't know from an acceleration standpoint, I don't think you're going to see anything accelerating more in Asia next year.

We've had a pretty good year so far in Asia from our climate technology business.

Well, I guess I asked because of the new labeling in SEER requirements with some of the refrigeration.

That's going to be more 2009 from that standpoint.

You know more than the average duck here.

That's going to happen more in 2009, 2010.

Then just a quick question on network power, I believe that's a business where you are probably most aggressively managing the product mix and trying to prune some products.

What do you believe it carved out from '07 revenue and then what's the incremental hit in '08?

I haven't tried quantifying it but I can tell you it's probably taking a point or two out underneath the underlying growth rate this year.

We probably were normally, we're going to be close to underlying growth this year around 10%.

We would normally be probably closer to 12, 12% in a cycle right now, and we're going to be closer to probably 9, 10, so I think that's what's going to happen.

Next year it's pretty much carved out and we should be pretty good.

I think we're still looking at underlying growth of a high single digit next year, probably 7, 8, 9%.

But you do continue to prune products?

Continue to prune, correct.

I prune in several locations.

I prune in appliance components, I continue to prune in network power, and I continue to prune a little bit in our storage business.

Okay, thank you.

You're welcome, Michael.

Our next question comes from Stephen Tusa with JPMorgan.

Please go ahead.

Hi, good afternoon.

Hi, Steve.

Question for you on Climate.

I'm not sure how much visibility you have down the chain.

Obviously, a lot of the OEMs talk about how housing doesn't matter over the long term.

Are you seeing more fix type of business in compressors going into broken units as opposed to follow-on system replacement, and the other question would be you talked about the OEMs managing their inventory.

Is there a sense that distribution is really managing their inventories tight and if we do get a little bit of a heat wave here, there could be some product shortages?

Well, first of all the heat wave is pretty hot in St.

Louis right now so we've got a heat wave around the country.

The distribution is managing their inventory very tight right now.

They do not want to bring on anymore inventory.

The issue really is not only residential, it's also residential spending.

A lot of the repair, reported repair or replacements not going on right now because people aren't selling homes and when you buy a home you typically remodel.

Right now people aren't doing that because they aren't selling or buying homes.

The underlying equity capabilities within their homes right now have been reduced, and so therefore, you're not only seeing the residential, the new construction kill the business which I think still matters by the way you got to build homes, despite what people think.

Then you're also seeing very negative investment in residential and replacement and repair, and I think this is going to continue here as I said throughout most of 2008 if not all of 2008.

The inventories are being managed.

We're managing our inventory very tightly right now.

I think that we can turn on the dime as our OEMs can turn on a dime and in certain respects it means that maybe when things do get better relative to demand you'll see a nice steady pick up or a strong pick up and we have the capacity now to serve that, so it's been a challenging time but given the strength that we have globally and the strength we have in other businesses it's been a good time to have this issue come at us and we're now ready for any type of recovery with our new facilities both in Mexico and our new facilities in Czech Republic.

So weather is not quite enough to save the day in the face of this consumer pinch?

I don't think so.

Okay.

And then lastly--?

It can't get any hotter in St.

Louis than it is today.

I guess it could but it's not.

Just lastly, I'm not sure if you commented specifically, but obviously with the recent market volatility and a little bit of a pullback in risk taking, how do you see kind of the global economic environment in the macro scene out there for the next 12 to 18 months?

Steve, it's a little bit too early.

I did say I think that the global economy is going to shift again and overall, the mix of our underlying growth profile is probably going to be very similar to what this year in the market serving us, that's our current, excuse me, that's our current look.

I'll get a better view relative to what happens as you move out of this calendar year.

One month, two months type of transactions like you're seeing now doesn't drive your economic numbers.

It takes awhile for them to come through but as I look at 2008 right now, I still think we're going to be facing pretty good fixed investment opportunities around the world driving pretty good growth rates for us.

I still think tat we'll be within the 5 to 7% zone next year, we will be at the low end of that zone this year.

Not the high end as we were this year.

Thanks a lot.

You're welcome.

Our next question comes from Chris Kotowicz with A.G.

Edwards.

Please go ahead.

Hi, guys, good quarter.

Hi, Chris, thank you very much.

Appreciate it.

I guess my question--.

Chris, is it hot here in St.

Louis?

It is pretty hot here.

It's about time.

The only guy who cares about that apparently is Al Gore.

Everybody else wants the heat.

I love heat.

Let me ask you a question maybe big picture here.

Your sales growth has been very strong on a core basis.

How much of that do you think is your product mix versus your sales channel and your capability to deliver globally versus having the capacity?

There's a couple different things there, but do you have a sense of where your edge has been coming from ?

I think our edge has been coming from our huge investment in the technology area in the downturn that we really invested much more aggressively than our competitors did and we by repositioning our assets both in plants and technology and the capabilities and people around the world during the downturn in 2003, 2002 time period we were better positioned in this upturn than a lot of our competitors.

I don't think it has anything to do with our capacity issue at this point in time.

I think we've historically been very good at measuring and adding capacity at the right time and dealing with that.

I think it's all about technology.

I think it's about how we repositioned this company so aggressively in the downturn and took the money that we invested in that area and cut back in other areas but you all allowed us to take a big hit which we've never done before and then get on with things and I think we repositioned the Company and that has been the big benefit of us as we come out of this.

Okay, and then I guess along those lines, from a capacity standpoint, it hasn't been a hang up for you guys, you're spending a lot of money this year, you're saying $700 million.

It seems like relative to some of your counterparts, you actually are investing in capacity, everyone else seems to think that they can get by on 2 to 2.5% of sales as CapEx.

You guys are going to be over 3 if you hit your 700 million target and it seems like every year despite having a pretty rich mix of technology in your industrial businesses still spending more so does that continue to be the case in 2008 or are you kind of at a level where you don't need to do that?

I think you're going to see and the range I talk about is us spending somewhere between 2.8 and 3.2 and this is down from 4.5 or 5% of many many several years ago.

I think we will spend again at that 3, 3.1, 3.2 range next year.

We have some investments that we need to make in some key areas around the world.

We try to, as you know try to balance our manufacturing capacity capabilities around the world so we can serve our customers globally out of two markets at any point in time.

That is a unique advantage.

Can I say we gain market share from that?

It's hard for me to tell but I can tell you right now our cost position and our speed to our customer gives us that advantage and therefore we do extremely well so we will continue to invest.

It's not big numbers.

You're probably talking next year somewhere around 775 million, $800 million.

So we're going to be up again.

It's still growth.

I think you're still going to see good investments next year and I think people are making a mistake if they aren't investing for technology and global capabilities.

Okay and then one question on a specific business.

You highlighted the drives orders in your 8-K today.

Is there something going on there as far as a share gain or new technology?

Can you talk a little bit about why that piece of industrial automation is doing so well?

Yes, we have major new product introductions under way the last 12 months and 12 months coming forward on a global basis, and they've been doing extremely well and industrial automation area, that business segment has been doing well as you know, Chris, and we believe we've done better than our competitors in particular in Asia.

With the acquisition of Avantis, we picked up a Chinese based drive company and now with them, we have been able to invest both in local manufacturing and also new technology allow us to go after the Asian marketplace like never before, so we've been doing extremely well in Asia because of Avantis which is another capability we picked up back in 2001 with that acquisition and that's why we highlighted it.

It's having very strong growth, it's a very good business and I think that we are, we like that space and we're going to continue to invest in that space.

Sounds good.

Thanks, guys.

Take care, Chris.

All the best to you.

Our next question comes from Christopher Glynn with CIBC World Markets.

Couple of easy questions for you.

Industrial automation the orders have been so strong and so consistent there, you are really emphasizing the alternator business there but I suspect there's more breadth there, maybe the harsh and hazardous electrical products.

Could you just talk about what the breadth is and what kind of visibility that gives you or doesn't into kind of the sustainability of these types of order rates?

We have, you're exactly right.

We have a very broad industrial motors and drives business and we just highlighted the alternator business because that's growing at very high levels and it has been for the last several years now, but we have a very broad industrial channel that goes through distribution and also direct, and we have pretty good visibility there, so if you look at what's going on in the capital spending marketplace around the world, that's what's driving this business and so that's why you hear me talk about gross fixed investments because if that's growing up 4, 5, 6% you're going to see our business growing 6, 7, 8% and pretty good visibility and we still see people spending capital including people like Emerson and we're all spending money on productivity which is the new energy efficient motors, the new drive and things like that, so that's why that segment has done pretty well here for the last couple of years and I think we'll have another good year next year, probably a little bit lower growth but we'll have a pretty good year next year.

And on process management, talked about no problem getting people.

Seemed like a change versus the previous line with the global engineering talent bottleneck.

Maybe I missed something along the way.

No, I just think people are out there hyped and you can't get people.

We were able to get people and maybe is it any easier than last time?

No.

But it's not holding us back.

I hear people talk about holding back in their business right now and I don't think we are holding back, being held back by getting people.

I think the projects are slowing.

The projects are held back.

Some of our customers are being held back because they can't get people, but the engineers, the EPCs out there are struggling getting people but from our standpoint we're not having that same problem because we made a lot of global investments in this area over the last several years and we're pretty strong.

However on the flip side as you're pointing out our customers are in some cases are having problems and that's slowing some of the projects down which does impact us a little bit.

Great.

Thanks very much.

Take care.

At this time I'm showing no further questions in the queue.

I'd like to turn the call back over to management for any concluding remarks they may have.

I want to thank you very much again and I want to thank everyone for being here today, as you heard me say up front it was a very good quarter.

The operating executives did a great job and I think it set us up strongly for a nice solid finish to 2007 and a good start to 2008.

So again, thanks, everyone for joining us and we look forward to seeing many of you in the coming weeks and months and all the best.

Take care now.

Bye.

Ladies and gentlemen this concludes the Emerson third quarter 2007 results conference call.

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