洛克威爾自動化 (ROK) 2007 Q2 法說會逐字稿

Welcome to Rockwell Automation' s quarterly conference call. I need to remind everyone that today's conference call is being recorded. (OPERATOR INSTRUCTIONS)

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

Thank you. Good morning and thank you all for joining us for Rockwell Automation's second quarter 2007 earnings release conference call. Our results were released earlier this morning, have been posted to our website at www.Rockwellautomation.com. A webcast of the audio portion of this call and all the charts that we reference during the call are available at that website. These will remain there for the next 30 days.

With me today are Keith Nosbusch, our Chairman and CEO; and Ted Crandall our CFO. Our agenda for today includes some opening remarks by Keith and then Ted will review both the quarter and our outlook. We will as always leave plenty of time at the end of the call to take your questions and again ask that you self- limit to two questions to allow broader participation.

We expect the call today to take about 50 minutes. As is always the case on these calls I need to remind you that our comments today will include statements related to the expected future results of our Company and are therefore forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from our forecasted projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all of our SEC filings. With that I'll turn the call over to Keith.

Thanks, Tim, and good morning to everyone who joined us on this mornings call. Let me start by making a few comments about this quarter. Top line growth accelerated slightly in the quarter. Revenue was up 8% driven by very strong growth in Europe and Latin America. During the quarter, we also saw some of our growth investments, in particular our process and compact logic initiatives, our efforts in Western Europe and Latin America and in the life sciences industry vertical, all deliver incremental revenue. However, central to understanding this quarter is that we had zero growth in North America. It is clear that we lived through a tough quarter in the U.S. economy as demand did slow, but I believe this is only a pause and that the second half of this year will be better. I will talk more about the second half in a moment.

What I was not satisfied with in the quarter, however, was the fact that we did not execute on our productivity initiatives. While we had better than usual productivity in quarter one, we were unable to sustain it in this quarter. This in combination with zero growth in North America and a disadvantageous revenue mix caused our profitability to be below our targeted range. And I've said many times that extrapolating any one quarter's result is is not a good way to predict future results. The success of our business model requires that we achieve growth and productivity simultaneously. I remain confident in our ability to realize both and deliver consistently strong results over time.

Now let me shift gears and turn to the second half of the year. As we described in the press release, we have changed the basis of our guidance to now exclude all things related to the former Power Systems business. That means we are excluding both the financial impact of the transaction and the financial results that were attributable to Power Systems during the four months that we did own them. In other words, we have moved to EPS from continuing operations.

I want to call your attention to two things related to our new guidance. First, the new EPS range is equivalent to the higher end of our previous range. The simple math is to subtract the $0.25 that we expected Power Systems to earn from the previous 3.70 to $3.90 range, which everything else being equal would result in a new range of 3.45 to $3.65. We now expect EPS from continuing operations to be $3.55 to $3.65.

Second, the financial results that we expect to generate in the second half of the year are considerably more robust. In every line item than those that we delivered in the first half. While some of this increase is due to the redeployment of the divestiture proceeds and some can be attributed to the typical calendarization of our results, the predominant drivers of this improvement will be higher demand from the very important U.S. market and better returns from our aggressive productivity efforts. Our management team and our entire sales organization feel good about the second half. We have had an in depth review of our sales prospects in all regions and we believe we are well positioned to drive growth in all regions.

Our second half outlook anticipates continued strength in Europe and Latin America, some modest revenue reacceleration in the U.S., improved performance in Asia, better revenue mix in both business segments, and better, more consistent execution of our productivity initiatives. The combination of all these factors gives me confidence that our revenue growth from continuing operations will be in the 9 to 10% range and that our conversion margins will return to the targeted 30 to 40% range for the second half of the year. The entire organization remains intensely focused on the execution of our growth and productivity initiatives and I believe this organization will produce the impressive results planned for the second half of the year.

As you know, James Gelly recently left to pursue new challenges and opportunities, and Ted Crandall is our new CFO. I will now turn the call over to Ted to provide more details on the quarter. Ted?

Thanks, Keith, and good morning to all those on the call. We've posted charts to our website and my comments will reference those charts. Turning to slide 1, entitled second quarter results summary. This slide summarizes key items from the income statement. I should note at this point that similar to the first quarter, this information has been restated to reflect Power Systems as a discontinued operation. So Power Systems has been collapsed in the single line entitled discontinued operations.

Starting at the top of the slide revenue in the quarter was $1.207 billion, an increase of 8% over 2006. Segment earnings were $220 million up 1% year-over-year resulting in 1.1 percentage point decline in margin. Walking down the page, you'll note that general corporate net was $14 million, down about $10 million from last year. The primary driver of the year-over-year decrease is interest income of about $8 million on the proceeds from the Power Systems sale. Also included in general corporate net this quarter was $12 million of dividend income received from the corporate parent of our former First Point contact business, and $13 million of charges related to environmental remediation at Legacy sites. Going forward, you should think of general corporate net expense in two pieces--20 to $25 million of expense as a normal quarterly run rate and interest income on the remaining proceeds from the Power Systems sale that show up on the balance sheet in the form of cash.

Moving down the page, you'll note that we took a $43.5 million special charges in the quarter. These charges were for various restructuring activities that will drive future cost productivity and advance our globalization strategy. The payback on these actions vary from several months to several years but they all have very attractive internal rates of return.

Moving down the page, interest expense was up due to higher debt balances and higher interest rates. Upon receipt of the proceeds from the Power Systems sale, we repaid all of our outstanding commercial paper so interest expense should decline going forward. Looking at income taxes. When you do the math, you'll calculate a second quarter effective tax rate of about 25%, down about 4 points from last year. The rate was reduced by about 2 points as a result of the tax effect of the special charges we took in this quarter and was further reduced as a result of the resolution of various prior year federal and State tax matters. We estimate the rate will be 28 to 29% for the remainder of 2007, but to repeat the message of the past couple of quarters, there can be minor tax events that could make the actual rate vary somewhat from quarter to quarter. Average shares outstanding in the quarter were 163.8 million, down 9% from one year ago. During the quarter, we repurchased 8.3 million shares. At the end of March, we had $667 million available under our $1 billion repurchase authorization.

Let me now turn to Chart Two, second quarter EPS walk. I certainly understand that this is a complicated quarter for us so let me walk you through diluted EPS. Starting in the middle of the chart and working left, reported EPS from continuing operations was $0.65. This includes $0.17 of charges in the quarter. Excluding these charges, diluted EPS from continuing operations was $0.82. This result compares to $0.69 in the year ago quarter up about 19% year-over-year.

Moving to the right on our chart, the results of Power Systems for the one month we owned them during the quarter was income of $0.05 per share. When you combine the diluted EPS from continuing operations excluding special charges with the results of Power Systems for the one month, you get diluted EPS of $0.87. In addition, other discontinued operations resulted in income of $0.07 per share. Finally, the gain on sale of Power Systems was $3.68 per share and with all of these components, reported diluted EPS was $4.45 per share.

Let me now move to the next chart, Q2 results, Rockwell Automation from continuing operations. As we always do we're showing total Rockwell results over the past five quarters, again excluding Power Systems. As I said before, growth was 8% year-over-year or 6% excluding the effects of currency translation. Sales were up 5% sequentially. From a regional perspective, growth was led by strong performances in Europe and Latin America. Operating margin in the quarter was 18.3% down 1.1 points from the second quarter of last year. You can't see it on this chart but our trailing four quarter return on invested capital was 22%, up 2 percentage points versus the year ago period.

I'd like to move now to the next chart which summarizes our architecture and software segment results. Sales were up 6% year-over-year. On a sequential basis, sales were up 2%. Logix sales grew 18% in the quarter, a very good result compared to the 11% growth last quarter. Legacy PLC sales were down about 14% in the quarter. Operating margin was 24.1%, down 1.2 points from the second quarter of last year. The decline in operating margin was primarily due to weak revenue mix and higher spending to support growth and globalization.

Let me turn to slide 5 which covers our control product and solutions business. Sales were up 9% year-over-year and 8% sequentially. Margins declined by about 1 point year-over-year to 13.5%. The decline in operating margin was due to revenue mix, spending to support growth, and the gain on a building sale in the second quarter of 2006 that did not recur this quarter.

Let me now turn to the next chart, slide 6, the geographic break down of our sales in the quarter. This chart provides regional growth rates and the far right column shows growth rates excluding the impact of currency translation. As you can see in the chart, we had a strong global mix of sales in the quarter. Our Europe sales were up about 26% in the quarter, a very good result continuing the progress we've seen the last few quarters. We're optimistic that we'll see continued momentum in Europe with help from short-term economic factors as well as the benefits of growth investments we've made in the region. Latin America sales were up 19%, continuing strong performance. Asia Pacific sales were up 3%. Once again, our Asia results are the average of emerging Asia and the slower growth developed Asia. Canada sales were down 6%. This performance is a reflection of weakness in the automotive and forest product end markets as well as the effect of the strong Canadian dollar on machine builder OEM exporters.

Looking at the U.S, sales were flat year-over-year. The U.S. accounts for 54% of our sales which consequently has a big impact on our average growth rate. We think we're getting through some of the particularly tough year-over-year comparison and even more importantly, we continue to receive positive signals including improving distributor and customer activity levels which bode well for the second half.

Let me now turn to the next chart which is our cash flow walk. The next chart gives you our second quarter cash flow detail. We had $89 million of free cash flow from continuing operations. This is a bit lower than our normal Q2 cash flow primarily due to higher income tax payments. We effectively made a half year's worth of estimated payments in the second quarter. Capital spending was less than depreciation and amortization. We don't have a balance sheet chart, but I'll point out a couple of items. Short-term debt at March 31, is $349 million. This primarily the current portion of our long term debt. One of our bond issues matures in January of 2008. Equity has increased $267 million year-to-date. The net increase is a function of net income including the power systems gain offset by dividends and repurchases.

I'll close with Chart 8 which summarizes our first half results and our second half guidance. After delivering 7% growth in the first half of the year, we are now expecting 9 to 10% for the second half of the year with control products and solutions delivering a higher rate of growth than architecture and software. We expect conversion margins, that is, incremental operating earnings divided by incremental sales to be in our targeted 30 to 40% range in the second half of the year. We expect better revenue mix and productivity to contribute significantly to improve conversion margins in the second half. Diluted EPS from continuing operations for the second half is expected to be between $1.96 and $2.06. This combined with the performance of the first half excluding the special charges approximates the high end of our prior guidance range. And finally, we expect free cash flow of about $330 million for the second half. Hopefully that was helpful. I know this was a complicated quarter so thank you for your patience. We would be happy now to answer questions.

Operator? We're ready to take questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Bob Cornell with Lehman Brothers.

Very positive surprise I have to say. Quick question initially. It seems like March was probably a strong month relative to Jan and Feb. Could you comment on that before we get into something more substantive?

Sure, Bob, I'd be happy to. Our second quarter is probably one of the quarters that has just a pattern that you talked about which is a slow start generally, rationale being that it's the start of the new fiscal year for many of our customers and obviously, the return from the holidays produces a tough start, and so historically, March is one of our stronger months and certainly, this was a very good March. So we had good momentum as we exited the quarter and certainly April is off to a good start with being in line with our expectations for the second half of the year.

Yes, of course, that segues right into my other question. I'm sure everybody here listening is interested in having you flesh out why you're so confident on the second half. You articulated a whole bunch of things that give you some optimism for the second half and bumping the guidance. Maybe just take a minute and flesh out that thought a little bit more?

Sure, I'd be happy to. From the first half, what we see basically in our control, in our control products and solutions segment, we have in the project part of that business, we have a very healthy backlog, and that backlog grew in the first half of the year. So the expectation is that we will be able to convert that during the second half and see continued growth in that sector of our business.

When you look at the rest of control products and solutions in all of architecture and software, we, as I guess we've said before, we rely on the order activity, the quoting activity, number of engineering studies, et cetera, That are going on, and that when we poll our selling, organization, and our channel partners and these are the people quite frankly that are talking to customers every day, we are getting a feedback that they believe the second half is going to be stronger than the first half. And so based on our experience , we can't always predict the timing but they have proven to be directionally correct in this regard, so it's a less than perfect indicator, but it has predicted eventual upswings in the past and certainly we have not heard anything recently that has detracted from that expectation and so I believe those are two of the major reasons.

I guess I'd just add to that, Bob, that we expect Europe, although quite candidly, we don't expect 20% plus every quarter out of Europe but we do expect continued strength midteens. We expect continued strength in Latin America and right now, we're optimistic that in the second half, we will see some improvement in Asia and the reason for the belief of improvement in Asia is because the order rate has picked up in the first half of the year and we have a better backlog position today than we had going into the first half, the first quarter of fiscal year '07. So those are the majority of the pieces, Bob, behind why we do have confidence and have expectations for a better second half and that's as we see it

Okay, thanks, Keith. I got to pass the baton.

Thanks, Bob.

Your next question comes from the line of John Baliotti with FTN Midwest Securities.

Good morning. Keith, could you, a couple prior quarters you've given us a little color on flushing through some of the end markets. I guess along those lines I was positively surprised that Logix picked up because I was expecting at least one more quarter of tough comps in the auto, in the U.S. auto guys, so could you maybe give us a little color on some of that?

Sure, I'd be happy to. Let me take the Logix one first and then give you a little flavor on the verticals. We were heartened by the return to nearly 20% in Logix. As you stated, we had two straight quarters where it was below our expectations and last quarter I would say significantly below our expectations, and this quarter, Logix growth was very strong in all regions except Canada and Asia, and two-thirds of that Logix growth in the quarter came from our growth initiatives, and I mentioned that in some of my remarks, both process and compact Logix performed very well in the quarter, and while we continue to target the growth rate of 20%, to get there, it requires strong performance in all regions and certainly with the lack of contribution from Canada in particular and Asia to some degree, we got to get all the regions up closer to the 20% mark to hit it and we have action plans in place to drive that level going forward.

If I could just follow-up, you mentioned that some of the charges that you took in the quarter will affect -- some of them are short-term, some are long term. Is it possible to give us maybe a little bit of color on the differences, what you think would affect the second half of the year, given that you're expecting incremental margins to come back up and maybe some of the longer term things that you've done?

John, this is Ted.

Hi, Ted.

The charges do reflect a variety of restructuring actions that are designed to drive productivity both short-term and long term. The actions included workforce reductions, realignment of administrative functions, and rationalization and consolidation of global operations kind of particularly in our manufacturing operations. The items that are going to have relatively nearer term pay back will be those related to workforce reductions and realignment of administrative functions and some of that is a follow-on to some of the activity we talked to you about in Q1. The items that are going to have longer term pay back will be those related to supply chain reconfiguration.

Great, thanks.

Let me go back and answer the second half of your question which was verticals, and just give you a feel for how those played out over the quarter, and automotive, to the point you made, was down globally, down 4% but more than that in our traditional Detroit based market. The good news is the situation in Detroit appears to have stabilized and the hard comparisons are now behind us. Consumer facing verticals were in line with our expectations. Food and beverage were up midsingle digits. Life sciences were up more than 20%.

Our home health and beauty sector was down 3%, and that was really due to some tough comparisons last year in the second quarter, particularly we had seen some positive, I'll say one-time opportunity following the Katrina situation and a lot of that hit in our second quarter last year. The resource based end markets, oil and gas, mining, aggregate, and cement, all of those grew again above the Company average but at a slower year-over-year rate, simply due to difficult comparisons but still growth and still growth above the average, so I guess I would say back to Bob's earlier comment, another reason for why we think the second half will be better is because really housing and automotive are the only markets that we see struggling at the moment. Obviously both of those have extended supply chains but outside of those two, we still see activity at a modest rate.

Okay, thanks, Keith.

You bet, John.

Your next question comes from the line of Mark Koznarek with Cleveland Research.

Hi, good morning.

Good morning, Mark.

Keith, can I explore the issue of the margin decline year-over-year and the productivity issue? Because it strikes me especially in the A& S segment if we had an acceleration in Logix that's thought to be one of the better profit mix components within A&S and it was surprising to see the margin decline relative to that, and I'm wondering about the issue of structural cost increases internal to the Company because one thing I had been hearing a little bit in the channel was some concerns about SAP installation this year and some of the manufacturing facilities and what it is doing to lead times and therefore it makes me wonder whether there are cost related issues internal that you're having to grapple with, so kind of an extended question, but I'd appreciate the color.

Sure, sure, let me talk to the first one which was the architecture and software margins, and why they weren't more positive with respect to the fact that Logix grew at 18%, and your hypothesis is exactly right. One would expect that with Logix growth very close to our target, that we would have had a better conversion and I think there were a couple of reasons there. The one, going back to a comment Ted made in his opening remarks and that was that while Logix was up 18%, the legacy portfolio was down 14%. That is almost twice what we would expect the decline to be, so the net benefit of our processor business was much smaller this quarter than it normally is and that was a huge contributor to the lack of performance in architecture and software.

In addition to that, also software had a weak quarter, so the margins were driven by the revenue mix and the impact of lower, the revenue mix within the processor business itself and the fact that that software had a weaker quarter and obviously everyone understands the margins associated with the software portfolio. So those were the primary reasons.

Your second question was around SAP. We are implementing SAP throughout our company and we had one additional set of sites that went up this quarter. We had one in the first quarter. One in the second quarter. We'll have another one in the third quarter and while those start ups don't always go perfectly smooth, we've been managing that process well throughout the Company with a lot of hard work by a tremendous amount of resources, and I would say quite candidly that part of the reason for our productivity shortfall this quarter was because some of the productivity actions, there's trade-offs you have as you're implementing systems versus driving plant productivity and in the margin line, we probably felt a little bit, we fell a little short in productivity and part of that can be attributed to the fact that we needed to have our resources focused on execution and implementation of SAP.

So I don't want to sound like I'm whining there from the margin standpoint but that's just the fact that prioritizations move a little as you're going through the different initiatives that we have and as they flow through some of our manufacturing facilities, quite candidly, that's where the tougher productivity tasks are to begin with and if you're going through a business system transformation and conversion at the same time, it puts a lot of pressure on those resources to be able to juggle multiple balls.

Okay. That's very helpful. Could I just ask for a clarification of Ted's comments with regard to the $0.17 charge. Is it possible to be more specific and get a sense of whether we might receive the benefit of say half of that in the second quarter and then the remainder during '08 or is that too aggressive of a return set of assumptions?

Mark, that's too aggressive of concerns. We will receive some benefit in the second half of the year but the majority of this is longer term and it's around the refootprinting and the globalization of our operations and in fact, quite candidly, this charge is one of the longer ones that we've taken and as Ted said, these are all excellent returns, but quite candidly, this is teeing up productivity to some degree out in '09 and '010 for us from a facilities and manufacturing viewpoint.

Mark, more important to the second half will be the first quarter charges and the follow-on full run rate of the benefits from those. Far more important than the early returns in the second quarter charges.

Okay, great. Thanks very much.

Your next question comes from the line of Steve Tusa with JPMorgan.

Hi, good morning.

Good morning, Steve.

Sorry to get detailed here but it's kind of a little bit of a messy quarter, but some of the below the line items like corporate interest, can you just give us a little bit of guidance on where they are going to come out towards the end of the year in the back half? You've given us a tax rate. Maybe the share count as well.

Steve, this is Tim. On general corporate net, use 20 to 25 million as the ongoing expense in that line, and then of course the other two are related to each other because they will either have interest expense or will buy back shares.

Right.

To be honest when you do the math, the accretion one versus the other isn't that dramatic, but I think it's fair to suggest that you know how much money we now have left, about $670 million at the end of last quarter on the buyback, you can bet we were probably aggressive in the month of April. Just straight line the rest through September and you're going to get, keep the remainder in cash invested at whatever you want to invest it at, that will get you the right answer.

Okay, and then -- and we don't expect anymore of these charges coming along? I mean, this is just part of offsetting some of the gains from Power?

Well, we don't, you take charges--.

Obviously you take them but these are kind of unexpected.

To be clear, you take charges when it's appropriate to take charges.

Yes.

We absolutely needed to see the productivity for '08 and '09. This is now a productivity culture, with that being said, I know if we anticipated further charges we would have already taken them.

Right obviously. And then lastly, just Keith, if you might just touch on Asia. Could you get a little more specific as to what you guys are doing there, maybe a couple of examples of changes you've made and other than just the end market remaining strong there, why we have the confidence that you guys can attack that region like you've attacked Europe and it looks like you're being pretty successful there?

Absolutely. Obviously, Asia is a very important region for us and it's one that has a lot of focus on all the organization quite frankly. What we have been doing in Asia is to go through and do a very granular country by country assessment and that assessment starts with the leadership of the region, of the country, and more importantly, because of the rapid growth that we've had, particularly in the emerging parts of the region, the emerging economies in the region, a look at the second level of leadership in that organization as well to really determine, do we have the capacity and when I mean the capacity I just don't mean the numbers but the capacity of the leadership to be able to grow our business at accelerated rates for an extended period of time, and we have been through that process now in some of the key countries and we have made some changes.

We have made changes in some of the leaders of those areas and we have also done a job in China in particular of taking over a number of our better branch managers in the country here that have gone over and worked with their counterparts in Asia, to help them understand how you run with some of the tools for the disciplined selling process and model that we talk about, which is a very granular build up of the business, account by account, sales person by sales person, with the appropriate dashboard to manage that on an ongoing basis. So I guess I would just call that leadership training, on the ground, where it makes a difference, which is in each office throughout the country, and that's been very well received. We did that during the second quarter. I want to make sure we keep this in the right time frame which is why we said last time we don't expect to have a quick turnaround here and as you can see in the second quarter, we didn't, but we're putting in place, I'll call it more of the fundamentals, more of the simple blocking and tackling disciplines that are required to aggressively grow and more importantly, be able to understand where you are throughout that process so that you know how good your front log and pipeline is and how you expect to convert that business, and then we also have, we also have the continued effectiveness and the maturity of the additions that we made, so we expect that we're going to get to a run rate from the headcounts that we have added, particularly in the direct customer facing part of that segment, and we keep tracking and monitoring that as we go forward and as I said, the good news here is that we've seen an uptick in orders and that's one of the reasons we believe we will see improvement in Asia and in particular, in China during the second half of the year.

So it's back to building up the capabilities, the competencies , and creating the proper tools, metrics, disciplines to manage just in evolving new area where we don't have that infrastructure that you can rely on based upon the years of experience like we have in North America. These are a lot of new adds in the last 12 months, a majority of them in the last six to nine months and it's not in a mature region with mature leaders that have grown up in the automation space. So a lot of this is new, new technology, new people, new processes, and I can tell you though that the entire organization is supporting and focused on getting Asia

So one last quick one. What specifically, which product type have you seen your customers there go after? Is it across-the-board? Is there a specific product that's selling better there than another, Logix versus a Legacy PLC? Can you just comment very quickly on that?

Sure. Well, obviously Logix is a core product throughout the world and Asia quite candidly is no different. What we probably see is a little more unique in Asia is the greater usage of our deployment and solution delivery capability simply because of the lack of maturity of that capability in the region. So we have a stronger solutions business in Asia, in particular in the emerging economies and also given the makeup of the business, the fact that it is more infrastructure driven currently, that we have a more power control and power centric makeup of our business there as well and certainly in the future, we see greater consumer spending and greater disposable income which goes to our customer consumer facing verticals as where we see the future growth, but right now it's more of a power centric infrastructure natural resource spend.

Got you. Thank you very much.

Thanks, Steve.

Your next question comes from the line of Jeffrey Sprague with Citigroup.

Thank you, good morning, everyone.

Good morning, Jeff.

I'm sure we're not going to talk about James Gelly on this call but I am wondering, Keith, as you think about a new CFO and what changes may come around that, what would you like to see out of a new CFO? What might be new initiatives, and I also just wonder on if there is any change in capital allocation, Tim went through kind of burning through the rest of the authorization but once we're kind of on the other side of this Power redeployment, is there any change in your thought process around capital allocation?

Well, let me start with the first part of it. James provided a lot of positive contributions to the Company and we're very appreciative of the efforts that he made in driving a lot of our productivity and ongoing financial controls and the performance of the Company and the performance of our financial reporting all got better with James' contributions and that's been very helpful for us. So with James leaving, however, we are not changing any aspect of our strategy or the execution, and the implementation of our growth and performance initiative, so that's business as usual for us and we're very much focused on the growth initiatives and we're very pleased to see a number of those starting to perform at a more acceptable rate and obviously while productivity is lumpy at times, we have great expectations to continue to implement and execute that.

And we have currently, we have initiated the search for the new CFO. We will look at internal and external candidates, and we're hoping to be able to fill that as quickly as possible, but we do need to do a thorough job for a very important role, and what we're looking for in the new CFO is basically someone that can continue to be a great business partner, be able to work with our businesses to continue to drive growth and to push our productivity programs and certainly help us become a more global company and a better company at execution, which is always, always on the top of our minds of how we can do better and to continue to drive this continuous improvement culture throughout everything we do as a company and to build and grow and lead a very strong finance organization to continue to allow us to excel in overall performance. So those are the types of things we would be looking for in a new CFO and we believe we'll be able to be able to find that person and continue the tradition that James and the people before him have started and continued in this company.

And just the second part of that kind of capital allocation on the other side of Power, does like an interest in more maybe international competency lead to maybe more M&A activity on the international front as you try to build out there?

Jeff, we've been very clear that the proceeds from the divestiture have done little to change our appetite for acquisitions or our processor in acquisitions. We still -- we had plenty of capacity prior to this transaction. It is clear that once we've executed the redeployment of the Power proceeds we will still be an under levered company that needs to think about what the appropriate capital structure is. We're not inclined to keep cash sitting around in the balance sheet idle. We don't need to do that for any of our growth expectations, but it is fair to say we probably owe you a more articulate answer once we get through redeploying the proceeds we currently have.

And then just a second question and I guess some of this is addressed in all this commentary about mix and growth, investments and the like, but I guess I look at '07 and it would be the second year in a row that the products business outgrows architectural and software. That's an interesting observation. I don't know if you have got some thoughts around what that really means about what's going on in your marketplace, and really the margins in architecture look like they've just kind of been stuck here on a two year plateau. So you're obviously talking about the conversion margins kicking back into gear. I mean, how do we get comfort with that, Keith? Is it simply the investment versus the payoff on the growth investments finally flip to the positive side or is it more around a resumption of better growth and a couple of those key vertical markets that kind of stalled out on you?

Well, I think it's a combination of both of the elements that you've identified. One is, we do expect, the preponderance of our growth investments, we're in the architecture and software part of our business, and certainly the reason you're seeing control products and solutions growing more rapidly now is because it's a dramatic growth in the end markets. They are very much in the natural resource energy sectors of the market and we have continually identified the fact that the consumer facing industries have more, have steady but not dramatic growth on a continuing basis, and we're seeing a very rapid build up in the Control Power and Control Products and Solutions business because of what's going on in the natural resource markets and the global aspect of all of those areas.

So it is about the verticals and it is about where our investments are, and we expect that we can continue to grow the architecture and software business and do it by broadening our tier zero and tier one accounts in the more control and information centric verticals being the consumer facing. So that's the strategy and your thought about conversion in the second half really, that's driven by -- predominantly driven by two factors. One is an increase in business in the U.S. And second, a tick up in our productivity, and both of those are needed for us to be able to perform at the levels that we've outlined for the second half of the year.

Mark, what should be clear to you from the margin rate at architecture software is that we are still somewhat out of phase on the returns from our spending. We told you that we had ramped up, sorry, Jeff, called you Mark.

That's all right I won't hold it against you.

It's clear that there we're still out of phase. We spent money early. We added cost to drive the growth, and to your point, the growth is coming. It's just coming a little more slowly than we would have thought and we have not taken out the cost as quickly from productivity perspective as we would have thought so a slight lag in each of those initiatives versus relatively robust spending commitments that started in the middle of 2005, I think explain the mild degradation in margin over the last six quarters or so and you're right, we do anticipate that getting back in phase and having that reversed.

Thank you very much.

Operator, we have time for one more question.

Okay. Your last question comes from the line of Scott Davis with Morgan Stanley.

Hi, good morning, guys.

Good morning, Scott.

I'm a little taken back by your weak free cash flow for the first half of the year looks like it converted about 68% of net income. Can you talk to us about maybe how some of that was just timing issues because it looks like you're forecasting a fairly robust recovery in the second half and I mean that's pretty much the question.

Well, Scott, we did use a little bit more working capital in the first quarter than we expected. The second quarter cash flow shortfall in terms of conversion of earnings I think can be explained by we effectively made six months worth of payments in that one the quarter for taxes, but we did use more working capital in the first quarter than we expected. We were hoping to see some recovery of that in the second quarter and we were able to hold it flat but didn't get a recovery. I will say we have a little bit of a challenge with the growth that we are driving outside North America and particularly in receivables where receivable terms outside North America, and particularly in parts of Europe, are higher than the typical terms we would see in our home market and so that's putting a little bit of pressure on our cash flow in the first half.

And Scott, if you do the math on our new guidance you'll see that we're somewhere between 90 and 100% conversion and 100% has been our mantra and it's entirely attributable to the structural change and where our receivables are ending up and admittedly our inventory plan for the year now is somewhat back end loaded but not too atypical for us. A good second quarter, I think the problem was in the first and we'll, as you know, working capital or free cash flow is a zero sum game. We'll make up some ground in the second half.

I understand. I'm getting actually 85% conversion on your cash net income on your full year guidance, but maybe I'm calculating something wrong. Which would be certainly lower than what you guys have done in the last several years which has been 100 and 100 plus.

Yes. I'll check the math. We anticipate being above 90 for the full year.

Okay, got it. Just a couple clean up items because I think most of the questions have really been answered. First of all, the special charges of $0.17, any way you can break that down by segment for us so we can think in terms of what were normalized margins? Or maybe you did that and I just can't find it.

It was in a line item unto itself.

So you can't break it out by segment?

No.

No.

No and in part because a large part of this related to supply chain reconfiguration and because supply chain services both segments, we kind of held this at the corporate level.

Okay, got it.

And Scott, it's a separate line, so it didn't--.

I understand. I'm just trying to think in terms of what might be normalized incremental margins.

I see.

X the charges.

I see.

And then the other discontinued ops of $0.07, just not familiar what's in that line. If you could help us understand that?

That was basically settlement of several matters related to previously divested companies.

Can can you be more specific?

No, I really can't.

Okay.

There were some legal matters and some tax matters related to previous divestitures.

Okay, got it.

Scott, let me just come back to your previous question around normalized.

Okay.

That $0.17 charge is not sitting in the segment numbers we reported this quarter.

Okay.

So you don't have to normalize this quarter's segment numbers.

So that 11% incremental was a real number?

Yes.

Okay. All right, I think I get it. The only thing that I'm still trying to figure out when I'm working through the model I'm kind of struggling to get to your guidance levels and I guess, and this is a first time I think I could say that in a few years, normally, it's pretty easy to, you folks have been pretty conservative on guidance. When you think in terms of how confident you are and kind of the 3.55 to 3.65, I mean, it feels like you're stretching a little bit particularly with your recovery in North America, the rest of the year and I know the comps get easier in auto, but what is your level of confidence? I mean, I understand you can see kind of April but we still have a long ways to go here for the rest of the year and the guidance seems just a little heavy. I guess I don't understand a couple things. Why, one, tighten the range up to the higher end after a disappointing quarter, but I guess the second thing is just you've had a couple, you've seen decline in growth for a couple quarters in a row here. And all the other companies we cover are all saying North America is soft without much of visibility on it improving. What really drives your confidence there, I guess, Keith?

Well, I mean, to be honest, Scott, that was the whole concept behind the conversation we had earlier with respect to the analysis we do with our selling and channel organization and their look at what's happening with respect to order activity, quoting activity, the engineering studies that are going on, and they continue to be positive in that outlook, and that, in addition to some improvement in Asia and the continued strength that we have in Europe and Latin America is the background as to why we have confidence in the outlook that we provided, and the guidance that we shared today. So I don't think in that regard or in regard to your comment about how we normally approach giving guidance, nothing has changed in that regard.

We continue to tell you what we know, when we know it, and yes, we are on the leading edge of the economy and certainly right now, we have confidence in how we're viewing the second half of our year and we have full expectations of achieving these objectives and certainly, I outlined what's going into it and let me just recap by saying a continuation of strength in Europe, in Latin America, an uptick in U.S. and Canada, modest growth in Asia, and continued improvement in our productivity actions for the second half of the year and we think that combination is what we need and why, and our confidence in achieving each one of those is why we gave the guidance that we did for the second half of the year.

Okay. Well, good luck, fellows, thank you.

Thanks, Scott. Operator that concludes the call. Thank you all very much for joining us and we'll speak to you later.

That concludes today's conference call. At this time you may disconnect. Thank you.