Emerson - 10-Q quarterly report FY

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2005

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

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 (or for such shorter period that the registrant was required to file such reports), 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer     (X)            Accelerated Filer (  )             Non-Accelerated Filer (  )

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes (  ) No (X)

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common stock of $0.50 par value per share outstanding at January 31, 2006: 411,409,059 shares.

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FORM 10-Q

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

EMERSON ELECTRIC CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

THREE MONTHS ENDED DECEMBER 31, 2004 AND 2005

(Dollars in millions except per share amounts; unaudited)

See accompanying Notes to Consolidated Financial Statements.

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FORM 10-Q

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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FORM 10-Q

EMERSON ELECTRIC CO. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

THREE MONTHS ENDED DECEMBER 31, 2004 AND 2005

(Dollars in millions; unaudited)

See accompanying Notes to Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

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Changes in the goodwill balances since September 30, 2005, are primarily due to additions from acquisitions in the Industrial Automation segment ($19 million) and the Climate Technologies segment ($4 million), as well as from the translation of non-U.S. currencies to the U.S. dollar.

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Net postretirement plan expense is summarized as follows (dollars in millions):

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For the three months ended December 31, 2005, Other included approximately $12 million of lower losses on foreign exchange transactions and hedging contracts compared to the prior period. For the three months ended December 31, 2005 and 2004, the Company recorded gains of approximately $18 million and $13 million, respectively, for payments received under the U.S. Continued Dumping and Subsidy Offset Act (Byrd Amendment). Also, for the three months ended December 31, 2004, the Company recorded an approximate $13 million gain from the sale of a manufacturing facility which was exited in 2004.

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

Rationalization of operations decreased in all business segments during the three months ended December 31, 2005, compared to the prior year period as the costs were related primarily to completing actions initiated in the prior year. Industrial Automation segment includes start-up and moving costs related to shifting certain motor production in Western Europe to Eastern Europe, China and Mexico to leverage costs and remain competitive on a global basis. Network Power segment includes mainly severance and vacant facility costs related to the consolidation of certain power systems operations in North America and the consolidation of administrative facilities in Europe to obtain operational synergies. Appliance and Tools segment includes start-up and moving costs related to the shifting of certain tool and motor manufacturing operations from the United States and Western Europe to China and Mexico in order to consolidate facilities and improve profitability.

Including the $12 million of rationalization costs incurred during the three months ended December 31, 2005, the Company expects rationalization expense for the entire 2006 fiscal year to total approximately $80 million to $95 million, including the costs to complete actions initiated before the end of the first quarter and actions anticipated to be approved and initiated during the remainder of the year.

Rationalization actions during the first quarter of 2005 included the following. Process Management segment included severance and plant closure costs related to a valve plant due to consolidating operations within North America, as well as several other cost reduction actions. Network Power segment included 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 included 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 included 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 related to shifting certain appliance control operations from the United States to Mexico and China in order to consolidate facilities and improve profitability.

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Intersegment sales of the Appliance and Tools segment for the three months ended December 31, 2005 and 2004, respectively, were $117 million and $87 million.

In addition, on January 31, 2006, the Company acquired Knürr AG of Germany for approximately $96 million (including assumed debt). Knürr is a manufacturer of indoor and outdoor enclosure systems and cooling technologies for telecommunications, electronics and computing equipment. Knürr has annual revenue of approximately $150 million and will be included in the Network Power segment.

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

OVERVIEW

The Company’s results for the first quarter of fiscal 2006 were strong, with sales and earnings for all of the business segments increasing over the prior year. The Network Power, Process Management and Climate Technologies businesses had strong performances and drove gains in a favorable economic environment as gross fixed investment expanded during the first quarter. Strong growth in the United States and Asia, a modest gain in Europe and 2005 acquisitions contributed to the first quarter results. Foreign currency translation had a slightly unfavorable impact in the first quarter. Profit margins remained strong primarily due to leverage on higher sales volume and benefits from previous rationalization actions. Emerson’s financial position remains strong and the Company continues to generate substantial cash flow.

THREE MONTHS ENDED DECEMBER 31, 2005, COMPARED WITH THREE MONTHS ENDED DECEMBER 31, 2004

RESULTS OF OPERATIONS

Net sales for the quarter ended December 31, 2005, were $4,548 million, an increase of $578 million, or 15 percent, over net sales of $3,970 million for the quarter ended December 31, 2004, with both U.S. and international sales contributing to this growth. The consolidated results reflect increases in all five business segments, with a 14 percent ($532 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 ($116 million) positive impact from acquisitions and a 2 percent ($70 million) unfavorable impact from foreign currency translation. The underlying sales increase of 14 percent for the first quarter was driven by an 18 percent increase in the United States and a 9 percent increase in total international sales. The strong U.S. demand was driven by the favorable economic environment, market share gains, anticipatory purchases in the Climate Technologies segment, and to some extent, the Gulf Coast hurricanes. The international sales growth primarily reflects increases of 16 percent in Asia and 4 percent in Europe. The Company estimates that the underlying growth primarily reflects a more than 10 percent gain from volume, a more than 2 percent impact from market penetration gains and an approximate 1 percent impact from higher sales prices.

Cost of sales for the first quarter of fiscal 2006 and 2005 were $2,955 million and $2,558 million, respectively. Cost of sales as a percent of net sales was 65.0 percent in the first quarter of 2006, compared with 64.4 percent in the first quarter of 2005. Gross profit was $1,593 million and $1,412 million for the first quarters ended December 31, 2005 and 2004, respectively, resulting in gross profit margins of 35.0 percent and 35.6 percent. The lower margin reflects unfavorable product mix and higher pension costs, which were partially offset by the increase in volume and leverage on higher sales, as well as benefits realized from productivity improvements. Increases in sales prices more than offset higher raw material costs.

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Selling, general and administrative (SG&A) expenses for the first quarter of 2006 were $950 million, or 20.9 percent of sales, compared with $872 million, or 22.0 percent of sales, for the first quarter of 2005. The increase of $78 million was largely due to the increase in variable costs on higher sales. The reduction in SG&A as a percent of sales was primarily the result of leveraging fixed costs on higher sales.

Other deductions, net were $23 million for the first quarter of 2006, a $29 million decrease from the $52 million for the same period in the prior year. The three months ended December 31, 2005, included approximately $12 million of lower losses on foreign exchange transactions and hedging contracts compared to the prior year. For the three months ended December 31, 2005, ongoing costs for the rationalization of operations were $12 million, compared to $29 million in the prior year, which reflects a lower level of activity due to the favorable economic environment. See notes 7 and 8 for further details regarding other deductions, net and rationalization costs.

Earnings before income taxes for the first quarter of 2006 increased $136 million, or 31 percent, to $570 million, compared to $434 million for the first quarter of 2005. The earnings results predominantly reflect increases of $46 million in the Process Management, $41 million in the Network Power and $23 million in the Industrial Automation business segments.

Income taxes were $171 million and $137 million for the three months ended December 31, 2005 and 2004, respectively, resulting in effective tax rates of 30 percent and 32 percent, respectively. The decrease in the effective tax rate primarily reflects the resolution of tax items during the quarter. The effective tax rate for the entire fiscal year 2006 is expected to be between 30 percent and 31 percent.

Net earnings were $399 million and earnings per share were $0.96 for the three months ended December 31, 2005, increases of 35 percent and 37 percent, respectively, compared to $297 million and $0.70 for the three months ended December 31, 2004. The 37 percent increase in earnings per share also reflects the purchase of treasury shares.

BUSINESS SEGMENTS

Process Management

In the first quarter of fiscal 2006, Process Management segment sales increased 14 percent, on higher volume and acquisitions, to $1,097 million, and earnings increased 36 percent. Nearly all of the businesses reported sales increases, with sales and earnings particularly strong for the measurement, valves and regulators businesses due to worldwide growth in oil and gas projects and expansion in China. Underlying sales increased 13 percent, excluding a 3 percent ($32 million) contribution from the Tescom and Mobrey acquisitions and an over 2 percent ($23 million) negative impact from foreign currency translation. The underlying sales increase reflects growth in all major geographic regions, including 21 percent growth in the United States, 13 percent growth in Asia and nearly 5 percent growth in Europe compared with the prior year. First quarter earnings (defined as earnings before interest and income taxes) increased 36 percent to $176 million from $130 million in the prior year. The increase reflects higher sales volume and leverage, which together are estimated to have contributed approximately 3 percentage points to the margin improvement. The earnings improvement also reflects savings from prior cost reduction efforts, which were offset by higher wages and benefits (pension).

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Industrial Automation

Sales in the Industrial Automation segment increased 8 percent to $860 million for the three months ended December 31, 2005, with sales increases in nearly all of the businesses and major geographic areas, reflecting the favorable economic environment for capital goods. The first quarter results show growth in nearly all of the businesses, with particular strength in the power generating alternator, electrical distribution and fluid power and control businesses, reflecting increased global industrial demand and an estimated 2 percent positive impact from higher sales prices. Underlying sales grew 7 percent, excluding a 4 percent ($33 million) favorable impact from the Numatics and Saftronics acquisitions and a 3 percent ($25 million) negative impact from foreign currency translation. The increase in underlying sales reflects a 10 percent increase in U.S. sales and a 5 percent international sales growth, with 15 percent growth in Asia and 2 percent growth in Europe. Earnings increased 20 percent over the prior year quarter to $143 million, reflecting higher sales prices, leverage from higher sales and benefits from prior cost reduction efforts. The earnings increase was aided by an $18 million payment received by the power transmission business from dumping duties related to the Byrd Amendment in the current quarter, compared with a $13 million payment received in the prior year first quarter. Payments under the Byrd Amendment are expected for at least another year. These benefits to earnings were partially offset by higher material, wage and benefit (pension) costs.

Network Power

Network Power segment sales increased 21 percent to $939 million for the first quarter of 2006 compared to the prior year, reflecting continued demand in the power systems, embedded power and precision cooling businesses. Underlying sales grew 21 percent, excluding a 1 percent ($11 million) increase from acquisitions and a 1 percent ($9 million) unfavorable impact from foreign currency translation. The underlying sales growth of 21 percent reflects an approximate 14 percent gain from higher volume and an estimated 9 percent impact from market penetration gains, which were partially offset by an estimated 2 percent impact from lower sales prices. Geographically, underlying sales reflects a 26 percent increase in the United States, a 35 percent growth in Asia (primarily China) and a 6 percent increase in Europe. The U.S. growth reflects the substantial investment in communications and non-residential computer equipment. The Company continues to build upon its Emerson Network Power China division resulting in market penetration in China and other Asian markets. Earnings of $108 million increased $41 million, or 61 percent, from the prior year reflecting higher sales volume and leverage of approximately 4 percentage points, as well as benefits from prior cost reduction efforts and a $9 million reduction in rationalization costs versus the prior year. The earnings increase was impacted by negative sales prices, partially offset by material cost containment, and negative product mix in the embedded power business.

Climate Technologies

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Sales in the Climate Technologies segment increased 24 percent to $748 million for the quarter ended December 31, 2005. Excluding a nearly 1 percent ($4 million) negative impact from foreign currency translation, underlying sales increased 25 percent largely due to strong demand in the air-conditioning business, increased demand in the refrigeration business and an estimated 3 percent positive impact from higher sales prices. Higher material costs more than offset higher prices. The air-conditioning compressor business was very strong in the first quarter primarily due to demand relating to the transition in the United States to higher efficiency standards that became effective January 23, 2006. The Company estimates its OEM customers purchased approximately $100 million of legacy products in anticipation of the efficiency standard change, which could negatively impact results in subsequent periods. The underlying sales reflect a 40 percent increase in the United States and a 4 percent increase in international sales, with 10 percent growth in Europe and 15 percent growth in Latin America, while Asia declined 7 percent compared with the prior year. Earnings from Climate Technologies operations increased 18 percent during the quarter to $102 million primarily due to higher volume and leverage on higher sales. The profit margin was negatively impacted by higher material costs and material shortages resulting from higher than expected demand, higher wage costs resulting from the surge in sales of air-conditioning compressors, as well as unfavorable product mix. The Company approved plans for capacity expansion in Mexico that will produce next generation scroll design and hermetic motors for the North American market.

Appliance and Tools

The Appliance and Tools segment sales increased 11 percent to $1,040 million in the first quarter of 2006. This increase reflects an approximate 7 percent growth in underlying sales, a nearly 5 percent ($40 million) favorable impact from the Do+Able acquisition and a 1 percent ($9 million) negative impact from foreign currency translation. The first quarter results were mixed across the businesses with most experiencing moderate to strong growth. The hermetic motors business was very strong due to the air conditioning demand discussed above. In addition, the appliance and commercial motors and the tools and storage businesses showed strong growth driven by the U.S. market. Growth in the storage businesses resulted from the continued strength in U.S. residential investment, higher demand at major retailers and market share gains. The underlying sales increase of 7 percent reflects an estimated 4 percent growth from volume, an approximate 2 percent positive impact from higher sales prices and an estimated 1 percent impact from market penetration gains. Underlying sales in the United States grew approximately 8 percent and total international sales grew approximately 6 percent during the quarter. Earnings of the Appliance and Tools segment were basically flat despite the higher volume. The increase in profit for the motors and appliance components businesses was offset by declines in the tools and storage businesses, reflecting customer penetration costs, new product costs and restructuring inefficiencies, including costs related to plant shutdown and ramp up of Mexican capacity in the motors and tools businesses. Overall, increases in sales prices were more than offset by higher material (particularly copper, steel and plastics), wage and benefit (pension) costs, diluting the profit margin.

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:

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The ratio of total debt to total capital has been reduced to 32.0 percent, or 3.2 percentage points below the 35.2 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 11.3 times for the three months ended December 31, 2005, compared to 7.9 times for the same period in the prior year primarily due to higher earnings.

Cash and equivalents decreased by $609 million during the three months ended December 31, 2005, primarily reflecting the reduction in short-term borrowings of $262 million and payments made on long-term debt of $254 million. Cash flow provided by operating activities of $319 million was up $58 million, or 22.3 percent, compared to $261 million in the prior year, reflecting higher net earnings. Operating cash flow of $319 million was used primarily to pay dividends of $183 million, fund capital expenditures of $101 million and fund purchases of businesses of $57 million. For the three months ended December 31, 2005, free cash flow of $218 million (operating cash flow of $319 million less capital expenditures of $101 million) was up 29.0 percent from free cash flow of $169 million (operating cash flow of $261 million less capital expenditures of $92 million) for the same period in the prior year, primarily due to 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.

OUTLOOK

The pace of customer orders and overall business activity remains favorable. Based on the performance this quarter in conjunction with continued strong order rates, earnings per share for fiscal 2006 is expected to be in the range of $4.10 to $4.30 compared to the $3.40 earned in fiscal 2005. Earnings for fiscal 2006 are expected to be driven by an overall improvement in operating margins and an 8 percent to 11 percent increase in reported sales, before the impact of pending acquisitions. Rationalization of operations expense is estimated to be approximately $80 million to $95 million for fiscal 2006. Operating cash flow is estimated to be $2.3 billion to $2.5 billion and capital expenditures are estimated to be $0.6 billion for 2006.

This outlook considers the strong first quarter 2006 sales, earnings and earnings per share performance. Sequential quarterly percentage increases over the first quarter for the remainder of 2006 are not anticipated to be as sizable as historical seasonal trends due to these strong results. The first quarter results included benefits from anticipatory buying by OEM customers in the Climate Technologies segment, which could negatively impact future periods’ results, one-time gains, lower than average rationalization costs, and a favorable income tax rate.

Statements in this report that are not strictly historical may be “forward-looking” statements, which involve risks and uncertainties, and Emerson undertakes no obligation to update any such statement to reflect later developments. 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, 2005, 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 or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to management, including the Company’s certifying officers, as appropriate to allow timely decisions regarding required disclosure. Based on an evaluation performed, the Company’s certifying officers have concluded that the disclosure controls and procedures were effective as of December 31, 2005, 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 report material information otherwise required to be set forth in the Company’s reports.

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There was no change in the Company’s internal control over financial reporting during the quarter ended December 31, 2005, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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 27.2 million as of December 31, 2005. The Company anticipates repurchasing approximately 6 million to 9 million shares under this program throughout the entire fiscal year 2006, depending on market conditions, the Company’s level of acquisition activity and other factors.

Item 6. Exhibits.

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

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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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