洛克威爾自動化 (ROK) 2005 Q1 法說會逐字稿

Thank you for holding and welcome to Rockwell Automation's quarterly conference call. I would like to remind everyone today's conference is being recorded. Later in the call, we will have a question-and-answer session. (OPERATOR INSTRUCTIONS)

At this time, I would like to turn the call over to Mr. Tim Oliver, Rockwell Automation Vice President and Treasurer. Mr. Oliver, please go ahead.

Good morning. Thank you all for joining us for Rockwell Automation's first quarter earnings release conference call. Our results released this morning have been posted to our website at www.RockwellAutomation.com.

The webcast of the audio portion of this call and the charts that will be referenced during the call are also available at that website. These postings will remain available for the next 30 days.

With me today are Keith Nosbusch, our Chairman-elect and CEO, and James Gelly, our CFO. Our agenda today includes summary comments by Keith, followed by our view of both the quarter and our outlook by James.

We will leave plenty of time to take your questions at the end of the call. But at the request of many of you I am going to make a slight change to our procedure. I would ask that you limit your questions to 2 per participant to allow broader participation.

I know this will take some adjustment by some of you and we won't be too militant in our enforcement of this policy this quarter.

The call is scheduled to last about an hour. Please note that our comments today will include statements relating to the expected future results of the Company and are therefore forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from our forecast and projections, due to a wide range of risks and uncertainties that are described in our earnings release and are detailed in our SEC filings.

With that, I will turn the call to Keith.

Good morning, everyone. I'm pleased to be with you all today on this call. This was an exceptional quarter and we indicated that a few weeks ago. Sales were up 20 percent on a year-over-year bases and we had strong growth across nearly all businesses, regions, and industries. We saw steadily improving industrial economy, particularly in the U.S. where Rockwell automation is the care market leader. Business investment climate is less cautious than in earlier period of the recovery; but it is still very disciplined.

We are seeing a strong pull-through from the Rockwell Automation installed base. Project spending is now increasing; but it is spending within the existing 4 walls. There is very little if any Greenfield expansion.

This quarter also saw continued solid performance in Asia and Latin America. While sales were strong, the story of the quarter was the exceptionally strong profitability generated from those sales. We successfully leveraged our fixed-cost structure, our broad-based productivity. Relentless focus on cost discipline and an improving price cost dynamic were responsible for the earnings growth. Overall results support the key attributes of our business model transformation, including the ability to grow without traditional investment base or cost structure increases. Fastest growth in high ROIC segments. Our Logix sales were up over 30 percent and strength in other advanced technology products and our innovative services and solution portfolio. The proliferation of the Logix Integrated architecture continues; and growth in our leading power control offering is improving our market positions.

The new guidance that James will elaborate on includes incremental spending on additional growth initiatives. This is key to sustaining high rates of organic growth and extending our technology advantage into 2006, 2007 and beyond.

We are committed to investing through good times and that. We have a rigorous process to prioritize these initiatives to assign incremental performance expectations and to track the results. Not only are they strategically important, but they also have exceptionally high rates of return. Focus is on the best return growth ideas within our highest return businesses. We have additional good opportunities that we have not funded at this point in time.

You should think about our reinvestment initiatives as driving our serve market expansion opportunities. They fit into three categories.

First, product and technology investments. Here, I am referring to accelerating the proliferation with features and functionality of our Logix Integrated control and information architecture. Things like simplification, expansion of Integrated safety and greater depth to our batch and hybrid offerings, among others.

Second, sales and marketing investments. And these are customer-facing investments. Here I am referring to the expansion of domain expertise and key verticals, where we are forming vertical teams and adding key resources in areas such as food, life sciences and water and wastewater. Our past experience has proved growth acceleration results from investment in understanding our customers business drivers.

And third, customer intimacy and market access, which are also customer-facing investments. Here, we are upgrading our business systems to improve our ability to seat and interpret customer needs worldwide. This, combined with our investment in adding resources to further penetrate emerging markets -- China, Central and Eastern Europe, and Latin America -- are intended to sustain a higher rate of organic growth, as I mentioned earlier.

I am pleased that our exceptional performance over the past several quarters gives us the resources necessary to commit incremental funding to our already powerful internal growth engine.

And now all turn the call over to James for details on the quarter and our outlook. James.

I am going to go to the first chart on the web presentation entitled "Q1 Results Summary" which gives some of the key facts for this quarter.

As you recall, this first quarter is an easy comparison versus a relatively weak year-ago period. As Keith said, revenue organic growth was 20 percent, reaching 1 billion, 185 million. That 17 percent growth excluding the effects of currency translation and we will get into the source of this growth in a few slides.

Net income from continuing operations was 122 million, up 114 percent year-over-year. As Keith said, volume leverage, productivity and relentless cost discipline were a big part of the story in the quarter.

Diluted EPS from continuing operations were 65 cents, up 124 percent year-over-year; and if you note that the -- you may have noticed that the tax rate this quarter comes to 32 percent, which is higher than the 31 percent guidance that we provided only a short time ago. The reason for the increase in the tax rate is the fact that much of the income upside has been in higher tax jurisdictions. That will drive the 32 percent rate for the year.

We had discontinued operations, as you can see. 6 cents this year versus 3 cents last year which gets this year first quarter to a reported EPS of 71 cents. Discontinued ops this year relate to state tax refunds related to divested business.

Go to the next slide. Q1 Results. Looking at Rockwell as a whole. On the left you can see organic growth is 20 percent year-over-year 17 percent excluding currency but down 2 percent sequentially; and that is primarily due to a seasonally shorter number of work days in our first quarter versus the fourth.

On the right hand side of the chart, you can see that operating earnings were up 95 percent year-over-year and margins expanded about 7 points to 18 percent. Clearly, that is related to the easy comparison versus year ago and the operating leverage that Keith talked about. Limited amounts of cost added to support incremental organic growth.

Going to go to the next chart. Next two charts and provide some detail on each of our two reporting segments. First, starting with control systems. On the left, 19 percent year-over-year organic growth, 16 percent excluding currency. Down 1 percent sequentially, again, due to holidays and seasonality. As Keith said, the fastest growth was in our high return on invested capital segments. An example of that is the Logix increase of more than 30 percent.

You will see in a couple of slides that we had good momentum around the world in terms of growth.

Looking at the right hand side of the chart at margins year-over-year we had about 7 points of expansion. And that was the result of an easy comparison, good volume leverage productivity, good product mix, and cost control.

If you go to the next slide, we will talk about power systems. Again I think we have said for some time now that the management teams at Power Systems is doing a great job running a lean operation and quite a bit of discipline in terms of the cost structure; and now organic growth of 23 percent shows you what the effect of both growth and productivity can be in this business.

Sequentially, again, sales down this time 4 percent, again related to seasonality. Power Systems has some strong market positions in the aggregates mining and industry segments which were the strongest end markets this quarter. So the strong price of coal and other resource prices is, as you know, leading to some reinvestment in an area where we are strong.

On the right hand side of the chart, operating earnings were up 159 percent year-over-year again. A weak year ago quarter, but also some strong effects of volume productivity and price increases which, we think this quarter, basically offset higher raw material costs that we see emerging.

Go to the next slide entitled "Regional Sales". Give you some details about our results around the world. Go to the far right column, which excludes the impact of currency and shows effectively local currency growth rates. Starting with the United States, you can see we are up 19 percent. Latin America had very strong results. This result reflects a lot of time and effort by the local management team, expending effort on training, skills upgrade, as well as most contemporary product on the market. A good mix of new projects and of course some favorable resource based end markets that we play into.

Mexico was particularly strong in the quarter. Europe overall better year-over-year growth, again versus a weak 2004. In general, the slow recovery of capital spending in the manufacturing sector in Europe.

Looking at Asia-Pacific, we continue to benefit from strong local demand. Obviously, our local management is building a competitively differentiated market access. We have got the most contemporary offering, but we, for example in China -- which had more than 30 percent growth -- really saw no clear signs of slowdown in the quarter just ended. India, although only about a $75 million annual run rate, led the pack with sales growth of more than 60 percent year-over-year.

Let me turn now to cash flow which is the next slide. As you can see at the bottom of this chart, we generated about $90 million of free cash flow. That is about 75 cents on the dollar of net income. So it kind of breaks a long streak of graded and 100 percent conversion so let me spend a minute on that.

First you can see a voluntary pension contribution of 50 million to our U.S. qualified plan. That compares with an expense of about $22 million. We had seasonal use of working capital; and working capital, in general, still represents an opportunity for us. We had normal seasonal outflow related to incentive compensation and payroll benefits. We are still targeting for the year that our free cash flow be no less than net income.

In terms of use of cash during the quarter for the record, we repurchased 2.6 million shares during the quarter. That should be compared with 2.9 million of option exercises in the quarter; and as you know, we have an authorized 9 million share repurchase for exercise during the course of 2005 fiscal year.

My last slide is entitled "2005 Guidance". As Keith referred, we are taking up our guidance in the wake of the strong results you saw in the first quarter, we have spent some quality time here in the last few weeks looking at the outlook for the balance of the year. At the moment, we are raising guidance, both on revenue margin and net income. Starting with revenue, we now expect topline growth, organic growth of 10 percent approximately, excluding the effects of currency versus the 6 to 8 percent range that you would have had from us in our conference in New York.

Our operating margin is now targeted at 17 percent for the fiscal year versus the approximately 50 percent that we talked about in December. These translate to full year EPS of 255 to 265, about 40 cents higher than our previous guidance. As Keith described, the 255 to 265 is after, that is, net of the 15 to 20 cents of incremental investment that he spoke of.

Finally, as I mentioned earlier, we are still targeting cash flow, free cash flow at no less than net income. That concludes my charts and my comments; and we would be happy to take any questions that you might have.

Jake, we're ready to take questions.

(Operator Instructions) Bob Cornell. Lehman Brothers.

Keith, you started off with this answer a little bit, but let me ask it, flesh it out a bit. Over the last six months, what has really happened to result in the accelerating growth in the topline? You go back to March, April -- maybe you could just expand on what is happening and then give a little more of the visibility you have over the balance of the year at even '06?

Well if we go back from where we were six months ago, at that point, the real growth was being generated by what was happening in Asia and Latin America; and then the steady increase of what I will call the flow goods MRO part of our business. We were constantly looking at better project work in quoting (ph) and everything but not a lot of closure of orders at that point in time yet.

If you fast forward now to today, what we're seeing is a continued strength in Asia and Latin America and the acceleration of what I will call our small and midsize projects in the U.S. In particular, projects that improve productivity and cost-effectiveness as opposed to let's just go and put in totally new capacity. We are seeing that -- the other differences -- we are seeing that across a very broad spectrum of industries.

So what we are now really able to not just see but enjoy is a broad-based recovery of manufacturing in the United States. That is probably the most significant difference on a six- to nine-month window; and what we're starting to see is the opportunities to see potentially some capacity expansion in the raw material energy-related businesses, because of the strong pricing that is now in those segments as well as total, total lack of investment over probably a decade.

So James mentioned earlier what is happening in mining. Historically that was outside the U.S. while in the last nine months it has picked up in the U.S. Same thing can be said in transmission of energy; and so that need continues to drive and so the breadth of the recovery is what is important to us. The fact that it continues to be mainly within the existing footprint of the manufacturers.

There's a lot of questions but I will ask one more and then I will let other people ask questions. You guys have previously said that as the project work came on, that margins would come under pressure, but here we have project work doing better and the margins are doing even better than we thought. Maybe that's a recalibration of that for the year?

Yes, that's a great question, actually, because that was probably one of the -- not probably -- that was one of the unexpected I will say pleasant surprises to us this past quarter. Really, it boils down to a little bit of what I said on the last call on the last question which was really what we are seeing is smaller plant-generated projects around the installed base. Which means, it is quite candidly into Rockwell Automations' sweet spot.

The other dimension -- and this is the one that was a little different -- is that like our sales organization, we did not take out all the costs in our project solution-related businesses during the downturn either. We were able to absorb the increase without any additional cost in the people-related areas. So this last two quarters, really, we have been able to generate above what I will call ongoing margin conversion opportunities, even in our projects business; and that was because of underabsorbed capacity, which we now see coming to an end.

So going forward, we do believe we will see some -- we will need to put in some additional people investments into our project solutions-related business and we expect to revert to more traditional margin conversion in those businesses going forward.

Is that part of your 15 to 20 cent investment you're talking about? Or is that outside of that 15 to 20 cents?

The reality is that probably outside of it. The 15 to 20 cent investment is really in investments in what I will call extensions of our business model. The expansion into more verticals. It is really not around simply being able to deliver and deploy the projects business that we have received.

Mark Koznarek, with FTN Midwest.

Keith, a couple of months ago, we were in New York and you gave us a real detailed look at what underpins the business; and then you followed it up with a five-year forecast I think a lot of us thought was pretty conservative with expectation of topline growth of only 6 percent. And here we are and there is one great quarter behind us. But, given some of these new investments you are making and how the market is unfolding, are you ready to move away from that longer term forecast? Because the implication is, I guess, you started it last year and if you look at the growth last year and now your 10 percent growth this year there is only 13 percent growth left for the next three years. So could you comment on that, please?

Sure. We are not in a position at this point to raise that, the long-term outlook. These are investments that will take a while to be able to validate our ability to deliver and execute. So it is about execution. We feel very confident that we are going to be able to do that, but to predict it at this point in time would be premature.

What about the fact that, in this environment, we seem to be perhaps two-thirds of the way there?

I think, Mark, the correct way to look it that is to not view it as 6 percent for five years as opposed to -- we believe the correct view is to look at it as 6 percent from here going forward as well. And if that changes, that is what we will be able to calibrate down the road based upon how well we are doing with those investments.

But right now, I would not say the correct way is to subtract the growth that we have currently seen and divide the remainder a month by 4 and say, "Oops, all of a sudden now we are going to see 2 to 3 percent growth."

That is not what I mean either and so I want to -- that is a good follow-on question. I want to make sure I am characterizing it the correct way. We do expect to see 6 percent per year going forward and as we demonstrate the execution of our initiatives, we will inform you as to how that is going.

So it is not really a pull forward? You don't really see -- ?

No, that is correct.

Then if I could ask a follow-up in terms of the revised revenue outlook. Is there a different expectation for pricing? Are you getting better price realization or more than that? They're relatively modest I think it was what? 50 or 100 basis points is what you were looking for?

I think today the pricing environment is better than it has been over the last couple of years. So we are probably a little bit higher than that, but the wild card here is the cost input. While we have been able to generate price increases to almost offset all of the input rises, particularly the steel and copper type of commodities and energy to some degree, it is just not sure how that will remain. So I don't want to become too optimistic with the price realization, given the uncertainty of the ability to predict those commodity prices going forward with any certainty. But we watch that all the time. The offset to all of this is we continue to work very aggressively on productivity. Now productivity doesn't get you 50 percent steel increases but be able to offset that but the part of the reason we demonstrated that -- part of the reasons we achieved the year-over-year operating margin improvements has been because of the hard work of the businesses to drive the efficiencies of our productivity programs.

That is something we are not slowing down on. Independent of price, that other vehicle is something that we have to be driving as hard as ever, if not harder going forward, and that is really I think a core part of our philosophy, of our business strategy, and of just the makeup of who we are as a company. So that remains very front and center. If we get the benefit of price great, if not, we've just got to keep our heads down and working on productivity.

Nicole Parent. CS First Boston.

I guess you broke out the 15 and 20 cents and characterized it as incremental spending on growth initiatives. But it does seem consistent with the numbers and the strategy that you discussed at the December analyst meeting. So I guess I'm wondering, first, what was the initial amount of money that you had thought you would allocate to the growth initiatives over and above, I guess prior to the December analyst meeting? And then, could that number move higher than the 15 to 20 cents if we continue to see better-than-expected results?

The answer to that is, yes, it is consistent with what we thought about in New York. What you're seeing here is an acceleration, based upon the performance; and that is exactly why I said we still have additional projects that are viable. And if we continue to perform, my goal -- as we have said now for over a year -- is to continue to invest in really good businesses with good return potentials and try to find out how we can drive higher organic growth.

That is our goal and we certainly understand the ROIC levers that we can pull; and organic growth probably generates the best in that area. So what you're seeing with the 10 to 15 is acceleration and acceleration based upon business performance. These are plans that we had in place. Not in place, but plans that we started putting in place a year ago and not being able to predict the shape of the recovery, I would say what you saw in the fourth and the first quarter was probably greater acceleration and performance than our ability to generate the incremental investments that we are committed to doing at this point, given the strong performance of our business.

So that is how we've looked at it. But Nicole, I would go back to your first comment and say, it is absolutely consistent with what we talked about in New York.

Just one follow-up on that, Keith. As we looked at what you are spending in '05, how many years -- I mean, you mentioned in the press release that that could continue into '06, since we are accelerating it in '05 -- would that number come down in '06 or is it just more steady run rate until we get to a certain level in the businesses?

I think that is the way to think of it. It is a core run rate that we would love to be able to add to as the business continues to -- that we continue to perform. I would not view it as a slug over a short period of time that we will see coming back. Our expectation is that we are able to generate better topline growth because of these investments; and it is just too early to declare victory there. But that is where we're going and it is really all focused around the customer, and driving our focus and delivering on the expectations that they have for us going forward.

Brad Dewey (ph) with Deutsche Bank.

Putting my arms around the 15 to 20 cents. What was the total discretionary spend or however you categorize this into 2004?

Brad, it's James Gelly here. The way the plan was constructed in 2004, I wouldn't say that we had visualized it as a discretionary spend. In other words, I think what you've seen here is the Company at that time was heavily focused on holding the line on cost, uncertain about the pace of revenue recovery. If you remember, maybe you weren't on the job a year ago, looking at the stock. I guess you were. We didn't have a lot of topline growth and it was still sounding a lot like pay as you go restructuring. And we really were working productivity and the plan for '05 once we saw that -- in fact, it was a good-looking sustainable recovery -- was to create a growth, if you will, a growth fund paid for through productivity and of course the volume leverage we are getting. And what Keith is describing is the acceleration of that reinvestment in the highest return segments as the topline and income the Company has accelerated.

So if I can dodge your question about '04 by saying there probably wasn't. We didn't visualize it in that fashion.

Okay and is cap spending going up for '05 vs. what you gave guidance for in the December meeting?

Probably it will. I have to work out how much. I don't want to sound vague, but yes there probably will be an increase in capital spending that we will come back to you guys with. First I've got to go and talk through it with my board and get authorization and then come back to you. But we are working that and probably the answer is yes.

John Baliotti from Fulcrum Global Partners.

Keith, relative, you sort of answered some of this with Bob's question on project vs. higher project demand in the quarter, but -- related to your original outlook when Logix was launched, are you finding that the margins are better than you originally looked at when you were guiding us toward being a little bit cautious if the demand shifts to project vs. more traditional product?

No, I wouldn't, we always had very strong expectations for the margins on Logix. If you remember what we were talking about is don't worry about the conversion, that we were going to a lower margin product. We've said, "Hey, we are driving the cost out of this and we expect to have the same margins as the products that replaced."

So the answer to that part is no, but the other half of that question is, what we have seen is a slowdown in the cannibalization factor in Logix. Therefore, the installed base portfolio plus the new has generated a faster growth rate than it did a year ago where there was a lot of -- I'll just call it left pocket, right pocket exchanging, and no total growth or minimal total growth for Rockwall Automation.

Today most of the conversion at the high end of Logix, most of that is done. We still have some at the intermediate level. The medium size controllers with compact Logix. But what we're seeing is greater total growth of, let's just call it the PLC portfolio of which is made up of multiple platforms. That is generating -- which I think is what you are getting that -- that is what is causing the greater margin expansion or one of the reasons that we are seeing the greater margin expansion and now the ability to spend more to continue the proliferation of that architecture.

Somewhat related to that, the returns you are getting on the businesses was translating well into returning capital which was up, it looks like 900, 1,000 basis points year-over-year. How do you expect that to transition through the rest of the year?

James Gelly here. I think your numbers are directionally in order of magnitude correct. We are not planning a large expansion in the investment base of the Company. So Keith's introductory remarks, what is in the press release, that is the business model that is emerging here. High margin revenue in the differentiated technology we have been talking about, not accompanied by a ballooning of the investment base. So I don't know if that answers your question but it shouldn't be any dilution to the return of invested capital through some action on our part in the investment base.

If we continue to leverage in the way that we described, probably everything has diminishing marginal returns.

The leverage factor declines a little going forward. (MULTIPLE SPEAKERS) still not going to back to the pre-existing levels as James mentioned because the model is changing and it is a combination going forward. It is not the traditional business that we have enjoyed previously.

So what we saw in the first quarter could be representative to what we see at the end of the year?

Yes.

Jeff Sprague with Smith Barney.

Can I pick up on, actually, your response I think it was to John's question about this cannibalization factor and everything? And I guess it also just goes to this project within the four walls. Just trying to understand the dynamics of this. It seems like projects within the four walls are in essence a kind of a quasi-MRO activity, with projects sprinkled in. And therefore you have got this very good MRO pull-through which, I guess, supports the non-cannibalization if you will.

Can you give us some sense of the margin differential between a virgin project, if I can use that word, vs. this inside the four walls maybe MRO-oriented type project? And how that might play out over the next year or two?

Yes I can, Jeff, and we had -- I think it was actually maybe even your question. We characterized a while back the makeup of the business from the standpoint of part of it was MRO; and then we had project-related and there was two dimensions of the project-related. One was what we call generally plant-generated which were local expansions, local sign-offs. And then the corporate or headquarter sign-off of larger capacity expansion and, we would use the term, maybe more greenfield type of investments.

If we talk about that project category, what we're seeing particularly in the United States is the majority of the investments are in the small local expansion projects which favors the installed base. And certainly in the United States, we have a very large installed base as you well know. A lot of that installed base is the legacy platform of businesses that we have. If they're going to add a line or they are taking another line out of mothballs that wasn't running, they're generally going to first think about just doing more of what they had been doing. And that is what is benefiting the older portfolio of our products.

Our project work as it grows -- whether we are doing the projects or a system integrator is doing the projects -- we tend to, we would have a higher probability of getting the components that go into that project. Because we were underabsorbed in our internal I will call it system integration resources, we were able to leverage that with higher operating leverage and higher margins, based upon the absorption of that I will call it fixed cost if you will of project people.

That is what is going on and the outlook would be that we would see, if there was brand-new capital investment then we -- in greenfield -- that gives us the opportunity to quote Logix, to be able to differentiate ourselves, but it still tends to be a more cost-competitive, broader competitive situation that does have impact on product margin -- on margins, whether it be the products that go in and/or the resources that deploy.

When we were talking about the generation of mix, we were mainly talking about the need to be in much more competitive environments and, therefore, greater margin pressures and, therefore, the MRO margins would come down. And in greenfield situations, we still feel that would be representative of the environment that we would see going forward.

Would it also -- so if I think about the growth you have enjoyed in the U.S. in Logix, relative to the total 30 percent Logix growth, I guess it is very fair to say then that your growth in Logix is actually stronger outside the U.S.? China, in particular, and some other markets?

If you look at just from the base, the answer would be yes. But Logix -- the growth in the U.S. is really into new application as opposed to just doing, I will call it bad choice maybe that the same old, same old because they can do that with their current platform that they are buying from us. Whether it be a PLC 5 or an SLC. So where people are making the change to Logix in the U.S., it is for the advantages that it brings to them that exceed the need for new or additional training for their organization. Whereas, external from the U.S., people want the latest technology. A lot of that is greenfield. They want to buy something that is forward-looking for the next 15 to 20 years, as opposed to they want to maintain what they have invested in in the last 15 to 20 years.

So it is just a little different of the dynamics of the customer base and of the competitive situation that really drives that more, Jeff, than anything in particular with the new vs. the old technology.

One last quick one, could you comment on cash deployment and, clearly, you have got the ability -- I understand you have an authorization, but you have got the ability to buy more than just your share creep (ph). What are your thoughts on that looking forward?

Yes the answer is the plan for this year was to basically default mode repurchased shares with the free cash flow. We have been doing that in the first quarter. If you look back a couple of quarters, we have gotten ahead of the creep. I don't think we did so in the first quarter because of the number of option exercises. And my guess is, as you go through an appreciation like the one we have had and go through a management change as well, you probably will see some option exercises. We don't have an oversized overhang, we will work through this, and we probably will as a default buy back stock. And we probably will reduce the number of shares outstanding. So, I hope that answers your question in the affirmative.

John Inch with Merrill Lynch.

Keith, going back to your point on Logix growth with respect to new applications. Whether it is controlling air conditioner systems or whatever, is there any way you guys have been able to access how much of that is coming from these areas vs. penetrating the installed base?

Not precisely but we do have some surrogates that we look at. For example, we look at the number of integrated motion cards that we sell as a percentage of all of the processors. By that measure, we would say that probably 30 percent of the Logix purchases are in new applications that we had not been doing before.

Likewise in process. It is not quite as easy, but we do have redundancy modules that generally would only be used in batch hybrid or continuous process types of applications. There we know it is about 8 to 10 percent. We look at the applications and I would say, right now, our best estimate is probably 50 plus percent of Logix is going into new applications that -- today, anyway -- feature motion, batch hybrid process, information, centric needs. And as we go forward over this next year, we will include safety into that equation.

That's really the focus of our investments; and part of our incremental investing is going to be to expand and proliferate Logix even more. And you do that by expanding the features. That generates the ability to approach and address more applications and it is just an acceleration of I will just call it the game plan that we had for that portfolio. It is all about, to your point, growing the applications which allows us to expand the served market and drive higher organic growth.

I have got to believe that whether the driver is the proliferation of technology and manufacturing, or whatever, that this 30 to 50 percent of Logix growth probably has a pretty long tail of demand ahead of it, apart from simply the industrial capital expenditure cycle or the demand cycle for traditional automation. Is that how we should interpret this, do you think?

That is certainly our expectation. That is one of these again that has to be proven as time goes on, but the goal here is that Logix gets us out of the traditional thinking and the traditional applications that have been more PLC capital spending centric. And the whole idea of what it can do for information, the whole idea of what it can do to drive down the asset utilization for our customers now allows us to address a much larger spectrum.

So when you look at this it is applications, it is also the geography and globalization of our business and our customers as well as the services that we can now deployed around it. That is how the tail, to your comment, that is how we view the ability to drive this in a different way and to think about it in a different way than, perhaps, we did when it was more viewed as a box that was placed on a machine and only controlled that machine for an individual application. It is a much different business model associated with that. It becomes more software-oriented. It becomes more service-oriented. Certainly, the globalization of our business and our customer base is the other piece that allows us to generate higher growth because, certainly, we did not enjoy the market shares outside of the North American continent that we do here. That whole piece of it is the other dimension of where we see the opportunity to grow and have a long secular growth associated with the product.

Just as my follow up question here, you guys -- for a few years, at least -- have been incurring this pay as you go restructuring which sometimes you've called out, sometimes you haven't but, by and large, as part of an initiative to get your cost footprint where you'd like to see it. Now you are incurring spending for growth. I'm wondering has one hand replaced the other or are you still incurring these cost initiatives? Spending the same time that you are targeting the growth spending or are we really, in some respects, spending a run rate, it is just that the definitional argument has changed? Just wondering, too, if you could comment on how the 15 to 20 cents keeps delineating the U.S. vs. other parts of the world?

Yes, let me start and then maybe James will want to finish here to make sure we get all of the dimensions of that question. Because it is a core part of our going forward.

The answer is no. We have not stopped the pay-as-you-go productivity types of investments. And the need to continue to invest that and the need to continue whether it is rationalize, whether it is consolidate, whether it is better utilize our footprint on a global basis, that is kind of never-ending. So it is maybe not the highlight of the discussion this quarter, but it is something that we are doing. We expect our businesses to come up with opportunities to drive productivity because that is what gives us the fuel to go and make these additional investments.

Just jump in and say, one of the reasons that we had such strong operating leverage in the quarter was all the work that was done in '03, '04 to drive productivity which, excluding volume, is a good 3, 4 plus percentage points in a quarter like this. And it will be the thing that we will have to build in '06, '07 by the stuff we do now. Your point is exactly right, John. We are going to keep doing that. We didn't call it out and it is programmatic and we do it opportunistically as we said. But it is not that we stopped doing one of them, we are starting doing another.

Or take another eraser and change the name.

Correct. That is a good point. We have an umbrella program, it is lean enterprise and under that we have just a great tool box that we keep expanding, quite frankly, with additional tools, additional capabilities. So that our businesses and our functional staff areas can continue to drive productivity. So lean enterprise has not gone away. If anything we have given more emphasis to it in the nonmanufacturing environment and that is part of, if you remember James's chart at the December meeting, we showed a continuing 4 percent type of line that we have to keep working. There's lots of different elements that will make that up. But we are not, we don't believe we are done nor can we ever be done in that aspect. It is just that it is more fun to talk about growth, quite frankly. And we think the investment in these initiatives are what is most important for us in the long run, at this point.

Scott Davis, Morgan Stanley.

I think most of my questions have been answered. I wanted to come back a little bit to this option issue and, obviously, it is a high-class problem since your stock has been so great. But I'm calculating that you are going to be diluted by 12 or 13 million shares this year on options, which is going to eat up the lion's share of your cash flow. Does this at all change your view on how you use stock options for compensation?

Let me say first of all, Scott, I don't have -- you and I obviously don't have the same numbers in front of us, but I come up with half the number of option exercises that you do. So we should probably talk on another occasion for how you come up with your number. But I would say our baseline assumption is that the 9 million share repurchase is executed during the course of '05, would lead to a net reduction in the number of shares outstanding of 2, 3, 4 -- you never are sure -- but it is ideally something that we stay ahead of and you can't predict any one quarter's worth of option exercises. I am not sure. I can go check, Scott, but I'm not sure I have that many vested exercisable options. But I will come back to you and let you know that answer.

The second part was an interesting question which is, what do we think about option as a tool? And I say for the historical period it has been a very effective tool issue as a money option. I say the Company does not have an exorbitant overhang of option exercises. In fact, I can say -- and I will pass the baton here to Keith -- that quite a lot of discipline goes into making sure that we see it as an overhang and manage it and control dilution and, therefore, the use of cash. I'm going to hand it off to Keith.

Yes, I would concur. I think options have worked well for us. We continue to evaluate our compensation philosophy and certainly the one point that I do want to make is, the way we approach it is not the number of options, it is the values. We are trying to make sure that we are competitive and obviously as value changes and prices change, the numbers make go up or down depending on upon which way it is going. But we are focused on delivering value and total compensation to a large population of our organization.

It is an important part of our total compensation and we think options have worked well for us and we view it as part of the compensation strategy going forward.

Fair enough. We can share notes later, James, as far as getting our models in step here because I am getting a 12 plus million share dilution number. So clearly -- .

Good. I look forward to it.

Clearly we are off. Anyway, second question, just to clarify a little bit and I think, Keith, you did answer this question but I didn't get it. Is one of the reasons why margins are going up on Logix so substantially a result of the product has been around long enough that your software development costs are rolling off sharply here in 2005?

No, I guess I wasn't real clear. What I wanted to say was the margins in Logix are not going up as a percentage. Because that has been a product that has been designed at a cost-effective approach where the margins are equivalent to the product that we place. So we are not going to see a margin degradation whether we were selling PLCs or control Logix.

What I meant to indicate was because the older portfolio has not declined as rapidly as it has earlier, the margin dollars to the Company increased more as opposed to the margin percentage changing. So the total sales were greater and, therefore, margin dollars were greater as opposed to the margin percentage of Logix vs. the older.

So there is nothing to the fact that the product is -- I think the product really was first launched in what was it? '98?

Yes.

And some of the software -- I am assuming that when you develop a project like this you have high upfront costs and -- ?

Yes. That is a very good assumption and, but in this case we continue to invest in that portfolio. That is not a portfolio that has seen the tail-off of ongoing investment. That is part of the strategy and the breadth of that portfolio and the breadth of the applications. We need to maintain a very robust investment model in that area. We are not seeing a reduction and in fact, if anything, we have accelerated it with this last round of growth investment to be able to do more faster as opposed to the way the plans were out for a couple of years to get some of this capability embedded.

Makes sense. One thing, I know when Logix was rolled out there was a lot of chatter or obviously a lot of talk that it was being priced at roughly 30 percent discount to PLC 5. As you come up with new generations of product or add-ons to the base software are you able to realize a little bit better pricing on that, and close the gap?

Well I don't, the answer is no. I say that because the reality is, this is electronics and it is technology. And the cost structure of it continues to go down and we need to drive it down and that is what our customers expect. One of the reasons they buy from us is because we are able to deliver lower total cost of ownership on an ongoing basis. Now how we do that may be a little different and it may not be in the hardware cost if you will, but it is everything that goes with it. It is the software, the communications, the information. So we have more of an opportunity to generate revenue than we ever had before, but our goal is to continue to drive to take advantage of I'll call it commercial technology to drive the cost down and the price performance up.

In our opinion that is how you create value for our customers; and if we can demonstrate value and continuing innovating the platform and the portfolio, we view that we have more opportunities to generate more revenue, as opposed to driving the margins and price realization of any one piece of the system higher. It is part of a broader system and what we are trying to do is to proliferate it, as opposed to continue to increase the price or not deal with the realities of electronics which is continuously reducing cost, improving performance and, therefore, better value for our customers. That is the path we are on, is driving value for them; and it just so happens part of that value equation is the cost of new technology.

No, that's clear and obviously you are doing something right with these strong results. So, congratulations.

Jake, I typically leave time for one more question but I'm afraid we have run over our hour. So I'm going to end it there. There are other calls starting after us. Thanks to all for joining.

That does conclude today's program. We thank you for your participation. Everyone may now disconnect. Have a wonderful day.