Emerson - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2004

OR

For the transition period from                     to                    

Commission file number 1-278

EMERSON ELECTRIC CO.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (314) 553-2000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

Common stock outstanding at January 31, 2005: 419,323,600 shares.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

EMERSON ELECTRIC CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

THREE MONTHS ENDED DECEMBER 31, 2003 AND 2004

(Dollars in millions except per share amounts; unaudited)

See accompanying notes to consolidated financial statements.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in millions except per share amounts; unaudited)

See accompanying notes to consolidated financial statements.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED DECEMBER 31, 2003 AND 2004

(Dollars in millions; unaudited)

See accompanying notes to consolidated financial statements.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

(Dollars in millions; unaudited)

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Net postretirement plan expense for the three months ended December 31, 2003 and 2004, is summarized as follows (dollars in millions):

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

For the three months ended December 31, 2004, Other included a pretax gain of $13 million related to the sale of a manufacturing facility which was exited in 2004. Also in the first quarter of 2005, the Company recorded a $13 million gain for a payment received under the U.S. Continued Dumping and Subsidy Offset Act.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Rationalization of operations by business segment is summarized as follows (dollars in millions):

During the first three months of fiscal 2005, rationalization of operations primarily related to the exit of over 5 production, distribution or office facilities including the elimination of approximately 500 positions, as well as costs related to facilities exited in previous periods. Noteworthy rationalization actions during the first quarter of 2005 are as follows. Process Management segment includes severance and plant closure costs related to a valve plant due to consolidating operations within North America in response to weak market demand, as well as several other cost reduction actions. Network Power segment includes severance and lease termination costs related to certain power systems operations in Western Europe shifting to China and Eastern Europe in order to leverage product platforms and lower production and engineering costs to remain competitive on a global basis. This segment also includes severance and start-up and moving costs related to the consolidation of North American power systems operations into the Marconi operations acquired in 2004. Appliance and Tools segment includes severance, plant closure costs and start-up and moving costs related to consolidating various industrial and hermetic motor manufacturing facilities for operational efficiency. Severance costs in this segment also relate to shifting certain appliance control operations from the United States to Mexico and China in order to consolidate facilities and improve profitability.

Including the $29 million of rationalization costs incurred during the three months ended December 31, 2004, the Company expects rationalization expense for the entire fiscal year to total approximately $125 million to $130 million, including the costs to complete actions initiated before the end of the quarter and actions anticipated to be approved and initiated during the remainder of the year.

Rationalization actions implemented during the first quarter of 2004 include the following. Process Management segment includes severance and plant closure costs related to a valve plant due to consolidating operations within North America in response to weak market demand, severance costs related to the consolidation of European measurement operations in order to obtain operational synergies, and several other reduction and consolidation actions. Network Power segment includes severance and lease termination costs related to certain power systems operations in Western Europe shifting to China and Eastern Europe in order to leverage product platforms and lower production and

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

engineering costs to remain competitive on a global basis. Climate Technologies segment includes severance costs related to workforce reductions in the European temperature sensors and controls operations due to weakness in market demand. Appliance and Tools segment includes severance and start-up and moving costs related to shifting certain industrial motor manufacturing primarily from the United States to Mexico and China in order to consolidate facilities and improve profitability.

Summarized information about the Company’s operations by business segment for the three months ended December 31, 2003 and 2004, follows (dollars in millions):

Intersegment sales of the Appliance and Tools segment for the three months ended December 31, 2003 and 2004, respectively, were $82 million and $87 million.

The Company is also considering the implications of the Act on repatriation of foreign earnings, which reduces the Federal income tax rate on dividends from non-U.S. subsidiaries for a one-year period. As of December 31, 2004, management had not decided whether, and to what extent, the Company might repatriate foreign earnings under the Act, and, accordingly, the financial statements do not reflect any provision for tax on undistributed foreign earnings which may be repatriated subject to the provisions of the Act. Based on the disclosure in Emerson’s 2002 Annual Report, the Company may be able to repatriate up to approximately $1.5 billion of undistributed earnings of non-U.S. subsidiaries under the Act in either 2005 or 2006. The related income tax effect from such repatriation is dependent upon a number of factors that are also being analyzed, including the issuance of additional guidance from the U.S. Treasury Department. The Company expects to complete this analysis before the end of this fiscal year. Accordingly, the Company’s current estimate of the tax effect if these foreign earnings are repatriated would be a tax liability based on the 5.25 percent effective rate in the Act, plus withholding taxes and less foreign tax credits applicable to certain foreign tax jurisdictions.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Items 2 and 3. Management’s Discussion and Analysis of Results of Operations and Financial Condition.

OVERVIEW

The first quarter of fiscal 2005 was strong, with sales for all of the business segments increasing over the prior year. The Industrial Automation, Network Power and Appliance and Tools businesses drove U.S. gains as domestic manufacturing expanded in the first quarter. International sales growth was driven by the Process Management and Industrial Automation businesses. Strong growth in Asia and Latin America, a modest gain in the United States, favorable exchange rates and 2004 acquisitions contributed to the first quarter results. Profit margins remained strong primarily due to leverage on higher sales volume and benefits from previous rationalization actions, which were offset by higher material costs and lower margin on sales from the acquired Marconi operations. Emerson’s financial position remains strong and the Company continues to generate substantial cash flow.

THREE MONTHS ENDED DECEMBER 31, 2004, COMPARED WITH THREE MONTHS ENDED DECEMBER 31, 2003

RESULTS OF OPERATIONS

Net sales for the quarter ended December 31, 2004, were $3,970 million, an increase of $370 million, or 10 percent, over net sales of $3,600 million for the quarter ended December 31, 2003, with both U.S. and international sales contributing to this growth. The consolidated results reflect increases in all five business segments, with a 5 percent ($181 million) increase in underlying sales (which exclude acquisitions and the impact of translation of non-U.S. currencies to the U.S. dollar), a 3 percent ($97 million) favorable impact from the strengthening Euro and other currencies and a 2 percent ($92 million) positive impact from acquisitions. The underlying sales increase of 5 percent for the first quarter was driven by a 3 percent increase in the United States and a total international sales increase of 7 percent, which primarily reflects growth of 15 percent in Asia, 14 percent in Latin America and 1 percent in Europe. The Company estimates that the underlying growth primarily reflects an approximate 4 percent gain from volume and an approximate 1 percent impact from market penetration gains.

Cost of sales for the first quarter of fiscal 2005 and 2004 were $2,558 million and $2,318 million, respectively. Cost of sales as a percent of net sales was 64.4 percent in the first quarter of 2005 and 2004, resulting in a gross profit margin of 35.6 percent for both three-month periods. Selling, general and administrative expenses for the first quarter of 2005 were $872 million, or 22.0 percent of sales, compared with $790 million, or 21.9 percent of sales, for the first quarter of 2004. The increased volume and leverage on higher sales, as well as benefits realized from productivity improvements and cost reduction efforts were offset by negative impacts from higher costs for raw materials (particularly steel and copper) and for wages and benefits, as well as margin dilution from the Marconi acquisition.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Other deductions, net were $52 million for the first quarter of 2005, a $26 million decrease from the $78 million for the same period in the prior year. The first quarter of 2005 includes an approximate $13 million gain from the sale of a manufacturing facility. Also included in the first quarter is an approximate $13 million gain for a payment received under the U.S. Continued Dumping and Subsidy Offset Act (Byrd Amendment), compared with a $2 million payment received in the prior year first quarter. Payments under the Byrd Amendment are expected for at least another year. For the three months ended December 31, 2004, ongoing costs for the rationalization of operations were $29 million, compared to $33 million in the prior year. See notes 7 and 8 for further details regarding other deductions, net and rationalization costs.

Earnings before income taxes for the first quarter of 2005 increased $77 million, or 22 percent, to $434 million, compared to $357 million for the first quarter of 2004. These earnings results reflect increases in the Process Management, Industrial Automation and Climate Technologies business segments. The higher earnings also reflect increased volume and leverage from the higher sales as well as savings from cost reduction efforts, partially offset by higher raw material and wage costs during the quarter. The increase also reflects the gains discussed above.

Net earnings were $297 million and earnings per share were $0.70 for the three months ended December 31, 2004, increases of 22 percent and 21 percent compared to net earnings and earnings per share of $244 million and $0.58, respectively, for the three months ended December 31, 2003.

BUSINESS SEGMENTS

Process Management

In the first quarter of fiscal 2005, Process Management segment sales increased 13 percent to $962 million and earnings increased 45 percent as this segment continues to grow internationally. All of the businesses reported sales increases, with sales and earnings particularly strong for the valves and measurement businesses reflecting growth in oil and gas projects, and expansion in China. Underlying sales increased 8 percent, excluding a 1 percent contribution from the Metran acquisition and a 4 percent ($29 million) positive impact from currency translation. The underlying sales gain reflects 29 percent growth in Asia, a 3 percent gain in the United States, 16 percent growth in Canada as well as 17 percent growth in the Middle East compared with the prior year. First quarter earnings before interest and income taxes increased 45 percent to $130 million from $90 million in the prior year. Leverage from higher sales contributed approximately 2 points to the margin improvement. The earnings improvement also reflects savings from prior cost reduction efforts, partially offset by higher wages.

Industrial Automation

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Sales in the Industrial Automation segment increased 14 percent to $796 million for the three months ended December 31, 2004, with sales increases in all of the businesses and geographic regions. The 10 percent increase in underlying sales, excluding a 4 percent ($30 million) positive impact from currency translation, reflects a 12 percent increase in U.S. sales and 8 percent international sales growth, with 6 percent growth in Europe and 15 percent growth in Asia. The underlying sales growth also reflects an approximately 1 percent positive impact from higher sales prices. The underlying sales increase was due to growth in all of the businesses, with particular strength in the power generating alternator and the power transmission businesses, reflecting increased global industrial demand. Earnings increased 39 percent over the prior year quarter to $120 million, reflecting increased volume and leverage from higher sales, benefits from prior cost reduction efforts and higher sales prices, as well as the approximate $13 million payment received from dumping duties related to the Byrd Amendment by the power transmission business in the current quarter, compared with a $2 million payment received in the prior year first quarter. These benefits to earnings were partially offset by higher material costs and wages.

Network Power

Network Power segment sales increased 18 percent to $773 million for the first quarter of 2005 compared to the prior year reflecting acquisitions and continued demand for power systems and precision cooling products, global services and OEM embedded power modules. The Marconi acquisition added 12 percent ($80 million) to the increase, currency had a 2 percent favorable impact, and underlying sales grew 4 percent. The underlying sales increase includes higher volume and penetration gains, partially offset by an estimated 2 percent impact from lower sales prices. Geographically, underlying sales reflects an 11 percent increase in Asia (primarily China), and a 5 percent increase in the United States, partially offset by a 5 percent decrease in Europe. Earnings of $67 million declined $3 million (4 percent) from the prior year. Higher sales at lower margin from the Marconi acquisition and related integration costs negatively impacted the results. In addition, leverage on higher underlying sales and benefits from prior period cost reductions nearly offset negative product mix in embedded power and price/cost pressures across the business.

Climate Technologies

Sales of the Climate Technologies segment increased 1 percent to $604 million for the quarter ending December 31, 2004. Excluding a 1 percent positive impact from currency translation, underlying sales were flat against tough prior-year comparisons as market share gains were offset by volume decreases due to inventory reductions by customers in the U.S. residential air conditioning market. The underlying sales reflect a 3 percent decline in the United States, partially offset by a 3 percent increase in international sales, reflecting 5 percent growth in Asia and a 42 percent increase in Latin America, while Europe declined 7 percent compared with the prior year. Earnings from Climate Technologies operations increased 8 percent during the quarter to $86 million due to benefits from prior cost reduction efforts and $5 million in lower rationalization costs compared to the prior year, partially offset by higher material and wage costs.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

Appliance and Tools

Appliance and Tools segment sales increased 4 percent to $938 million in the first quarter of 2005. This increase reflects an almost 3 percent growth in underlying sales and a nearly 2 percent favorable impact from currency translation. The underlying sales increase reflects an estimated 1 percent growth from volume and an approximately 2 percent positive impact from higher sales prices. The first quarter results were mixed across the businesses, with most experiencing solid growth. Increases in the consumer storage and disposer businesses resulted from strength in new and existing home markets, as evidenced by the strong growth in U.S. residential investment and higher demand at major retailers. Underlying sales in the United States and total international sales each grew nearly 3 percent during the quarter. Earnings of the Appliance and Tools segment decreased 6 percent to $119 million from the prior year first quarter due to a $9 million negative impact from a quality issue with an appliance component, and higher raw material costs (particularly steel and copper in the motors business), more than offsetting higher sales volume and price, as well as benefits from prior cost reduction efforts which included shifting production to lower cost regions.

FINANCIAL CONDITION

A comparison of key elements of the Company’s financial condition at the end of the first quarter as compared to the end of the prior fiscal year follows:

The ratio of total debt to total capital has been reduced to 35.2 percent, or 4.2 percentage points below the 39.4 percent ratio for the prior year first quarter. The Company’s long-term debt is rated A2 by Moody’s Investors Service and A by Standard and Poor’s. The Company’s interest coverage ratio (earnings before income taxes and interest expense, divided by interest expense) was 7.9 times for the three months ended December 31, 2004, compared to 6.8 times for the same period in the prior year primarily due to higher earnings.

Cash and equivalents increased by $139 million during the three months ended December 31, 2004. Cash flow provided by operating activities of $261 million was down $23 million, or 8 percent, compared to $284 million in the prior year, reflecting additional working capital necessary to support the higher levels of sales. Operating cash flow of $261 million and the increase in net borrowings of $126 million were used primarily to pay dividends of $175 million, fund capital expenditures of $92 million (including unitary air conditioning scroll compressor capacity expansion in the United States and Asia) and fund purchases of businesses of $28 million. For the three months ended December 31, 2004, free cash flow of $169 million (operating cash flow of $261 million less capital expenditures of $92 million) was down 22 percent from free cash flow of $217 million (operating cash flow of $284 million less capital expenditures of $67 million) for the same period in the prior year, primarily due to increases in working capital and capital expenditures, partially offset by higher net earnings.

The Company is in a strong financial position, with total assets of $17 billion and stockholders’ equity of $8 billion, and has the resources available for reinvestment in existing businesses, strategic acquisitions and managing the capital structure on a short- and long-term basis.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

New Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment.” FAS 123(R) requires recognizing compensation costs related to share-based payment transactions, including previously issued unvested awards outstanding upon adoption of the statement, primarily based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards are remeasured based on their fair value each reporting period until settled. Effective October 1, 2002, Emerson previously adopted the fair value method provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” and began expensing options granted, modified or settled after September 30, 2002, based on their fair value at date of grant over the vesting period, generally three years. The Company is in the process of reviewing the provisions of FAS 123(R), which is effective July 1, 2005, to evaluate its impact on the financial statements.

The American Jobs Creation Act of 2004 (the Act), which was signed into law on October 22, 2004, allows a special one-time dividends received deduction on the repatriation of certain foreign earnings. The FASB issued Staff Position No. FAS 109-2 in December 2004 which requires recording related taxes if, and when, an entity decides to repatriate foreign earnings subject to the Act. The Company is evaluating the provisions of the Act and has not decided what, if any, distributions may be made; as such, no provision has been made for taxes on undistributed foreign earnings which may be repatriated under the Act. See Note 10 of the Notes to Consolidated Financial Statements for further discussion of the potential impact of the Act on the financial statements.

OUTLOOK

The pace of customer orders and overall business activity remain favorable. Based on the performance this quarter in conjunction with continued strong order rates, earnings per share for fiscal 2005 is expected to increase in the range of 10 percent to 15 percent over the $2.98 earned in fiscal 2004. Earnings for fiscal 2005 are expected to be driven by an 8 percent to 11 percent increase in reported sales and by an overall improvement in operating margins. Rationalization of operations expense is estimated to be approximately $125 million to $130 million for fiscal 2005. Operating cash flow is estimated to be $2.1 billion and capital expenditures are estimated to be approximately 3 percent of sales for 2005.

Statements in this report that are not strictly historical may be “forward-looking” statements, which involve risks and uncertainties. These include economic and currency conditions, market demand, pricing, and competitive and technological factors, among others which are set forth in the “Risk Factors” of Part I, Item 1, and the “Safe Harbor Statement” of Exhibit 13, to the Company’s Annual Report on Form 10-K for the year ended September 30, 2004, which are hereby incorporated by reference.

Item 4. Controls and Procedures

Emerson maintains a system of disclosure controls and procedures which are designed to ensure that information required to be disclosed by the Company in the reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified under the SEC’s rules and forms. Based on an evaluation performed, the Company’s certifying officers have concluded that the disclosure controls and procedures were effective as of December 31, 2004, to provide reasonable assurance of the achievement of these objectives.

Notwithstanding the foregoing, there can be no assurance that the Company’s disclosure controls and procedures will detect or uncover all failures of persons within the Company and its consolidated subsidiaries to disclose material information otherwise required to be set forth in the Company’s reports.

There was no change in the Company’s internal control over financial reporting during the quarter ended December 31, 2004, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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EMERSON ELECTRIC CO. AND SUBSIDIARIES

PART II. OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

(c) Issuer Purchases of Equity Securities.

The Company’s Board of Directors authorized the repurchase of up to 40 million shares under the November 2001 program. The maximum number of shares that may yet be purchased under this program is 37,287 thousand.

Item 6. Exhibits.

(a) Exhibits (Listed by numbers corresponding to the Exhibit Table of Item 601 in Regulation S-K).

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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