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Rockwell Automation, Inc. (NYSE:ROK)

Q1 2009 Earnings Call

February 2, 2009 8:30 am ET

Executives

Rondi Rohr-Dralle VP IR

Keith Nosbusch – CEO

Theodore Crandall – SVP & CFO

Analysts

Robert Cornell - Barclays Capital

John Baliotti - FTN Midwest Securities

Nigel Coe – Deutsche Bank

Mark Koznarek - Cleveland Research Company

Nicole Parent – Credit Suisse

Richard Eastman – Robert W. Baird

John Inch – Banc of America

Jeff Sprague – Citigroup

Steve Tusa – JP Morgan

Operator

Welcome to the Rockwell Automation's quarterly conference call. (Operator Instructions) At this time, I would like to turn the call over to Rondi Rohr-Dralle, Vice President of Investor Relations. Ms. Rohr-Dralle, please go ahead.

Rondi Rohr-Dralle

Good morning. Thank you all for joining us on Rockwell Automation's first quarter fiscal 2009 earnings release conference call. Our results were released this morning and the press release and charts have been posted to our website at www.rockwellautomation.com.

Please note that the press release and charts include reconciliations to non-GAAP measures. A webcast of the audio portion of this call and all the charts that we reference during the call are available at that website. The webcast will be available for replay and the materials from this call will be accessible for the next 30 days.

With me today are Keith Nosbusch, our Chairman and CEO and Theodore Crandall, our CFO. Our agenda includes opening remarks by Keith followed by Theodore’s review of the quarter and discussion of 2009 guidance.

We expect the call today to take about one hour. As is always the case on these calls, I need to remind you that our comments 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 will turn the call over to Keith.

Keith Nosbusch

Thanks Rondi and good morning to everyone who joined us on today’s call. Let me start by making a few comments on our results this quarter and then spend more time talking about the balance of the year.

At this same time a quarter ago we talked about how challenging 2009 would be for Rockwell Automation, one that anticipated a revenue decline of 1% to 5% from 2008 levels excluding the effects of currency.

As you know a lot has changed in the market environment since then and business conditions are markedly different. After a very solid October we experienced a severe decline in customer demand during the second half of the quarter.

This was due to deteriorating economic, financial, and credit market conditions in all regions and most industries aggravated by an unusual number of customer plant shutdowns resulting in performance for the quarter below our earlier expectations.

Organic sales declined 5% in the quarter plus a 6% decline due to currency. Segment operating margins were down considerably compared to last year primarily due to the rapid decline in sales volume.

Free cash flow was weaker then our normal seasonal performance and Theodore will talk more about this shortly. And even with these results our return on invested capital was 22.3%. Now let me shift gears and focus on the future.

We expect an extremely difficult market environment in the balance of 2009. The global recession has grown deeper and wider then we originally anticipated. Key economic indicators and projections continue to weaken and we see a significant deceleration in customer demand.

Negative GDP is now projected in all mature markets and all emerging market growth projections are substantially lower. Industrial production for all markets have worsened with significant declines expected in the mature markets and growth expectations substantially lower in emerging markets.

US manufacturing capacity utilization fell further in December to 70.2 compared to 79.2 in December, 2007. The purchasing manager indices are in the 30’s in mature markets and no emerging market is close to 50 except India.

December US PMI was at 32.4, the lowest level since the mid-80’s and capital expenditure budgets have been reset and a survey of our top accounts show a double-digit reduction in capital spending. There is no doubt that all the indicators and trends have continued to decline significantly.

This was further confirmed when we ran our quarterly business review and forecasting process where we received input from our sales organization, channel partners, and customers in every region. The clear consensus was that we are operating in a rapidly declining environment and that we will confront very challenging business conditions in 2009.

We evaluated backlog and front log order trends and plant shutdowns. Our backlog was up slightly over Q1 2008 and our front log and pipeline analysis we are seeing a noticeable increase in project delays and a slight uptick in cancellations. Product front log is down, project front log varies by region, but in general it is only positive in process, oil and gas, cement, power and energy, and legacy conversion.

The situation is further complicated given the abrupt fall off in sales volume and uncertainty around the depth and duration of this synchronized global recession making it very difficult to forecast sales and revenues.

What is clear is that we have not seen the bottom yet and that with this rapid volume decline we expect a very difficult Q2. Accordingly we are now planning for a fiscal 2009 organic revenue decline between 12% and 17% excluding the effects of currency.

We will also face currency headwinds impacting revenue negatively another 7%. Based on this sales forecast and the savings related to cost reduction actions, we are revising our fiscal 2009 earnings downward to a range of $1.55 to $2.25 per share.

We took cost actions in Q4 in anticipation of a slowing market and out ongoing mix shift. In November when we provided guidance we anticipated the need for additional actions based on an expected moderate decline of negative 1% to negative 5% in market conditions and built in about $25 million of implementation costs to permit pay as you go cost reduction actions.

It is now clear that we need to aggressively continue to reduce our costs and restructure our businesses to reflect a more significant change in customer demand levels. In addition to the restructuring actions we announced in September which we are already realizing the planned benefits from, we have frozen all headcount additions and replacements, clamped down further on all discretionary spending, eliminated temporary and contractor positions, suspended the January salary increase that is normally scheduled for January 1, eliminated overtime, moved to shortened work weeks in some of our production facilities, and implemented additional headcount actions in Q2 and planning for further reductions in the balance of the year consistent with the previously announced pay as you go cost reduction actions that were included in our original guidance.

All of these actions are targeted to take a total of $240 million out of our cost structure and is factored into today’s guidance. In addition we now have also initiated a process to analyze and identify further cost reductions in the range of $50 million to $100 million on an annual basis.

This analysis builds on previous actions and will consider the following, further reduction in, or consolidations of manufacturing and business locations, additional organizational consolidation and simplification actions, an evaluation of the future for underperforming product lines.

We intend to protect the investments we have made in emerging markets to support future growth. We also plan to continue our investment in technology leadership including the evolution of our [logics] architecture.

We are aggressively attacking working capital to improve cash flow conversion. Before I turn it over to Theodore to discuss Q1 and 2009 in more detail I would like to conclude by saying our balance sheet provides a source of strength in challenging times like these. We have ample cash and credit facilities at our disposal giving us flexibility to invest in growth, strengthen our portfolio, and fund our current dividend.

Although our outlook reflects the dramatic declines in most of our global end markets I want to stress that there is nothing fundamentally wrong with our business or our strategy. Our diversification strategies are working and represent an important source of strength in dealing with the current environment.

This was evident in the quarter with growth across multiple dimension, specifically our process business grew 11%. We also introduced plant PAF, the unifying brand for our entire process portfolio and process automation system. Our oil and gas strategy is gaining traction. We experienced growth in the first quarter anchored by a multimillion-dollar win with a leading oil company in Canada. Also our integrated control and safety system allowed us to win a significant technology differentiated order with another major oil company.

We are increasing wins in applications and markets that we previously could not compete in. Our solutions and services businesses grew and we experienced 10% organic growth in Latin America. Our employees are doing an outstanding job navigating through these global market challenges and are committed to improving our customers’ experience and increasing our share.

We will remain focused on dealing with near-term cost and business issues and we’ll keep a keen eye on executing our long-term growth and performance strategy. While we must deal with reality I am confident that we are well positioned to outperform the market in these challenging times and that we will emerge from this downturn more competitive and more successful then ever before.

Now let me turn it over to Theodore.

Theodore Crandall

Thanks Keith and good morning. We posted charts to our website, my comments will reference those charts. On chart one, Q1 results summary, starting at the top of the slide revenue in the quarter was $1,189 billion, down 11% from Q1 last year.

The effective currency translation accounted for six points of the decline. Segment operating earnings were $178 million, down from $258 million in Q1 last year. Purchase accounting expense was a bit below last year. General corporate net was up about $4 million from last year but last year’s number included a $6 million gain on the sale of [Baldor] stock received as part of the power systems sale.

Interest expense was $3 million lower then last year and the effective tax rate in the quarter was 17.1% below last year’s effective rate of 28.5% and below our guidance range. The lower rate included the benefit of a discrete tax item result in the quarter and the effect of the retroactive extension of the US Federal research tax credit.

EPS from continuing operations was $0.81 and we recognized $2.8 million or $0.02 of income related to discontinued operations. This resulted from a favorable ruling in litigation related to a legacy environmental reserve.

Average diluted shares outstanding in the quarter were 142.2 million, that’s down from 151 million in Q1 last year. During the quarter we repurchased approximately 1.7 million shares at a cost of $50 million. At the end of Q1 we had $621 million available under our $1 billion share repurchase authorization.

Moving to chart two Q1 results Rockwell Automation, as noted previously sales for Q1 declined 11% year-over-year. Sales declined by 20% sequentially, both comparisons including currency effects. Q1 sales are typically lower then Q4 but this was a larger then expected decline.

I’ll discuss regional performance in a few slides. Moving to the earnings side of the chart you can see the significant decline in segment earnings both year-on-year and sequentially. Year-over-year segment operating margin contracted to 4.4 points.

As we discussed last year and in our guidance revenue mix and the impact of acquisitions continue to create some headwind. Our higher margin product business is declining more rapidly in the early part of the cycle then the solutions business. But the more important part of the story in Q1 is the impact of volume leverage related to the 5% organic sales decline.

Its not displayed on the chart but our trailing four quarter return on invested capital was 22.3%, down from 24.7% last year and primarily due to the earnings decline.

Please turn to chart three which summarizes Q1 results of the architecture and software segment, sales in Q1 were down 12% year-over-year, down 6% excluding the effects of currency translation. In this segment acquisitions contributed a bit less then one point of growth year-over-year.

On a sequential basis sales were down 18%. Operating margin down 4.1 points year-over-year and 1.3 points sequentially, volume leverage is the primary driver. Chart four covers our control products and solutions segment. Sales in Q1 were down 9% compared to last year, down 3% excluding currency translation and down 21% sequentially.

Operating margin declined by 4.5 points year-over-year and 4.7 points sequentially. The drop is due to lower volume aggravated by mix and in the year-to-year comparison, inflation. The next chart, chart five provides a geographic break down of our sales in the quarter. In the center column you’ll see an overall growth rate by region.

The far right column shows growth rates excluding the effects of currency translation. In comparing the two columns, you can see the significant impact that currency had on all non-US regions. I’ll focus my following comments on the far right column.

In the US sales were down 4%. Transportation was particularly weak both automotive and tire and an unusual number of plant shutdowns and productions slowdowns across many industries impacted the quarter.

Canadian sales declined by 14% compared to prior year primarily driven by declines in the eastern part of the country which from a vertical perspective is largely automotive and general manufacturing.

In EMEA sales declined 9% compared to Q1 last year. We saw weakness pretty much across all industry categories. EMEA also saw an unusual number of plant shutdowns and slowdowns and particular weakness in the OEM business.

In Asia Pacific we experienced a 2% decline. Emerging Asia including China saw 6% growth year-over-year but this was more then offset by declines in mature markets.

Latin America was the one bright spot in the quarter with growth of 10% compared to last year. Auto held up well in this market and resource based industries continued to generate growth particularly mining, cement, and oil and gas.

Please turn to chart six, Q1 results free cash flow, free cash flow for the quarter was $22 million and that’s 19% conversion. Q1 is typically a low conversion quarter due in part to the timing of prior year incentive compensation payments. However this year cash flow in the quarter was also negatively effected by three other issues.

There was a higher then normal amount of US payroll payments in this quarter and a change this year in the timing of interest expense payments. These will naturally correct in the balance of the year. We paid out $15 million of the restructuring costs for our September 2008 actions that negatively impacted conversion by about 13 points in the quarter and this will continue for about the next two quarters.

And inventory increased in the quarter, not that unexpected given the speed and magnitude of the Q1 sales decline. As sales continue to decline in fiscal year 2009 we do expect this to reverse and inventory to be a source of cash for the year.

Before we move to the next slide I want to remind you as Keith mentioned that our balance sheet if very solid with net debt to total capital of only 25% at the end of the quarter and that brings us to the next slide which addresses our fiscal year 2009 current outlook.

As Keith mentioned we’re revising guidance to reflect the much more rapid and significant decline in market conditions then we expected in November. We now expect full year sales to decline in the range of 12% to 17% excluding currency effects.

We expect currency effects to cause a further decline of about 7%. That assumes that rates stay at approximately recent levels. Our previous guidance incorporated a 5% decline. Given this expected sales decline and taking into account the cost actions that Keith discussed, we expect operating margin in 2009 to be in the range of 10% to 13% and EPS in the range of $1.55 to $2.25.

The implied conversion margins for the remainder of the year require that we continue to take cost out of the business. We expect the full year effective tax rate of between 22% and 26% and we expect free cash flow conversion of about 100%. That includes the cash outflow associated with our September restructuring actions. Excluding that conversion would be closer to 120%.

And now I’ll turn it over for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Robert Cornell - Barclays Capital

Robert Cornell - Barclays Capital

You mentioned that you hadn’t seen the bottom yet, did that include a comment on January as well, is January continuing to drop away?

Keith Nosbusch

January is continuing along the lines of our guidance for the remainder of the year so I would say January is similar to what occurred in November and December.

Robert Cornell - Barclays Capital

You gave the organic growth guidance the 12 to 17, how would you expect that to array as you go forward. In other words, none of the balance of your quarter is going to be exactly 12 to 17, its going to be a pattern. Are you going to see a greater then, are you going to have to have a greater then that decline because your first quarter is only down 5 so how do you see the other three quarters of the year laying out in terms of this organic growth guidance.

Keith Nosbusch

We see the second quarter dropping substantially from a sequential standpoint. But we expect similar declines year-over-year in each of the remaining three quarters.

Robert Cornell - Barclays Capital

So the exit rate of organic growth in the fourth quarter will be about what do you think, in your model, in your guidance.

Keith Nosbusch

At about the high end of the range.

Robert Cornell - Barclays Capital

You talk about the adverse margin effect being attributable to volume but did you actually have an inventory build in the quarter that’s going to have to come off in subsequent quarters.

Keith Nosbusch

Yes we did and that’s what we’re planning for to have that come down which will positively impact cash flow and negatively impact the margin line.

Robert Cornell - Barclays Capital

You saw October was decent and November and December fell off, obviously the whole fall off was surprising but when you look at it was there anything in particular as to that in terms of end markets, controlled products was off more then I expected relative to architecture software and that’s a bit of a backlog business, I’m surprised that that business has much of a miss relative to my model in A&S.

Keith Nosbusch

If you remember the split in controlled products and solutions about 60% is solutions and that actually did not fall off and so the magnitude of the fall off was in the product side of that business. The product side of that business is very heavily associated with MRO and I believe what we saw here was companies trying to conserve cash. It wasn’t just the fact that they were slowing some of their projects but they stopped buying MRO as a way to conserve cash over the last couple of months of the year.

Theodore Crandall

You said was there anything surprising, I’d say what was surprising was how broad based the decline was across regions and industries.

Operator

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

John Baliotti - FTN Midwest Securities

Could you give us more color on your revenue expectations, if you look at the different geographies and maybe in each of those if there’s any end market that’s worth noting in terms of building up into that expectation.

Keith Nosbusch

I can talk about some of the assumptions that we have in the revenue projections by region, certainly we expect the largest declines in the developed markets, US, EMEA and Canada. We expect to be three to four points lower then our average. Asia Pacific we expect to be flat to mid single-digit decline and Latin America we’re expecting growth of low single-digits.

John Baliotti - FTN Midwest Securities

Is there any other, in terms of end markets within those regions, anything that is worth pointing out or are you just, similar to what Theodore was pointing out that the broad end market decline is, you’re assuming the same for the balance of the year.

Keith Nosbusch

I think where we see the best opportunities from end markets, we believe those are mainly in the I’ll call them the process related industries still. So we expect to continue to see strength in oil and gas. We expect to see strength in the cement markets and in the energy and power markets for us.

And those tend to be the longer cycle businesses which have a lower ability to immediately reduce the project activities. So we expect those to remain strong and then obviously at the other end of the spectrum the most difficult and challenging markets will be in global automotive and tire and that is a much broader scenario now then we had been talking about previously which was with the big three from Detroit. Its truly now a global automotive decline and that’s where we’ll see the toughest.

Metals will be a very difficult market, at least in the short and intermediate term and that’s a little more color around the end markets.

John Baliotti - FTN Midwest Securities

So oil and gas despite oil being at about $41 a barrel, that still supports investment.

Keith Nosbusch

It is. If you look at, and its not a black and white. If you just look at this past week, Shell increased their CapEx for next year. Most of the majors are holding it reasonably flat. However many of the minor category, any of the secondary players are starting to lower theirs. But these tend to be very long duration projects and those will keep, they have permits, they have other things that are required to continue on and so we do expect that to happen.

Where we hear the break is, if you get under $40 and to $35 that will start impacting some of the I’ll call it more global players in that market.

Operator

Your next question comes from the line of Nigel Coe – Deutsche Bank

Nigel Coe – Deutsche Bank

Could you be a bit more specific about what the 12 to 17% organic declines imply, so at the low end of that range would that just basically extrapolate the current trends or can you just, along those lines just give us some color on what each side of that range implies.

Keith Nosbusch

I think the 12 really looks at what’s been currently happening and so that’s I think the depending on which way you view it, the lower or upper side of our guidance. Going down from there we just believe that we have not seen the bottom, that there will be continued decline here and really that’s based upon a number of factors.

Obviously one is the review that we took just two weeks ago across the different regions that identified the continued slowing. We certainly see the rapid decline in the macroeconomic indicators that point to continued contraction and we have seen now starting in the mid summer, certainly in the fall and now at the start of the new year an accelerated decline in the outlook of each of those key indicators which is telling us that we still have a ways to go before we achieve the bottom.

And that’s across the board whether it be GDP, industrial production, capacity utilization or just CapEx expenditures. I think that’s some of the changes in what’s going on in the OEM markets, particularly the major OEM markets in Europe. But at the end of the day what I would say is its not an exact science. We’re trying to take our most realistic and look at each one of the pieces that fit into the puzzle but I have to tell you it is not an exact science and which is what we’re trying to do is give it our best call given what we know today and what we’re seeing.

This range we believe creates the most realistic look at the remainder of the year.

Nigel Coe – Deutsche Bank

You mentioned some of the long cycle markets remain pretty good, does the 17% build in any cracking in those markets at all.

Keith Nosbusch

No, we expect those to play out reasonably well the remainder of this year and I would say it’s the longer term outlook for those that would be the next area that we have to look at but that’s a longer term and too hard to predict at this point in time.

Nigel Coe – Deutsche Bank

On 2Q will you expect to make money 2Q?

Keith Nosbusch

Yes.

Operator

Your next question comes from the line of Mark Koznarek - Cleveland Research Company

Mark Koznarek - Cleveland Research Company

I am wondering if you could review the restructuring actions in a little more detail. It seems we talked about pretty significant actions in the fourth quarter. You took a charge in that quarter, it sounds like now you’re cutting deeper and there’s more pay as you go so could you refresh us on where you stand and how the benefits are expected to roll out over the course of the year and then into next year.

Theodore Crandall

We talked about our need to get about $240 million of cost out. That’s a combination of direct and indirect costs that has to come out of cost of goods sold as sales decline and then also SG&A. Of the $240 million think of $75 million of that as coming from the actions we took and announced at the end of September and we’re probably about roughly 80% complete with those actions as of the end of Q1.

There is another sizable chunk of money that’s going to have to come out of the direct and indirect cost of goods sold and I would say that is just starting and then the balance comes out of various other areas. In total I would guess that, of the total $240 a little more then half is going to come out of SG&A and the balance out of cost of goods sold.

Mark Koznarek - Cleveland Research Company

Given that we already spent some money in the fourth fiscal quarter to get that first tranche, the $75 million and now you’re going to need $165 million more of cost reduction, how much pay as you go expense is that going to hit the income statement by over the course of the year.

Theodore Crandall

You’ll remember that we talked about having built into the original guidance in November about $25 million of additional pay as you go, some of that cost reduction is in that $240. I would say it will come from areas that don’t require up front implementation costs. Examples would be sales commissions will be lower with lower sales, bonus will be lower with lower sales, we’re eliminating temps and contractors. We’re eliminating overtime, we’ve gone to shortened workweeks in the manufacturing facilities.

Those are all ways of driving cost out that don’t have implementation cost and then we believe that the $25 million of pay as you go that was in that original guidance will cover the balance of the actions that we need to implement this year. The additional $50 to $100 million of cost that Keith talked about, the process we have started to analyze and identify that, there is no implementation cost related to that reflected in the 2009 guidance.

Mark Koznarek - Cleveland Research Company

But there likely would be once you identify it and decide to take those actions.

Theodore Crandall

Yes, I would expect that there will be implementation costs related to that but we’re so early in that process both the amount and the timing is uncertain at this point.

Mark Koznarek - Cleveland Research Company

Could you review what the logics business did and the overall processors, how well legacy PLCs did in the quarter.

Keith Nosbusch

The logics business for the quarter grew, we grew that at 3%. The legacy sales were down 17% which is significantly higher then what we had planned for the year which is around 8 to 10% decline. We certainly believe that MRO cut back spending to conserve cash as well CapEx spending reductions were a big factor in that and total processor sales were down 5% for the quarter.

Mark Koznarek - Cleveland Research Company

Of the overall processor mix how much is legacy at this point. Is there that much more to fall away or are we getting pretty close to where it just can’t hurt you that much more.

Keith Nosbusch

There’s two dimensions to the legacy, the PLC family, that will not hurt us much more. The SLC has a significant revenue pace yet and that’s where we’re seeing the accelerated decline this quarter mainly because of some of the capital spending reductions but also it’s a good product with the OEM community and that dropped rather dramatically in the quarter and in total I believe legacy would be about a third of the total with SLC being the predominant piece of that total.

Operator

Your next question comes from the line of Nicole Parent – Credit Suisse

Nicole Parent – Credit Suisse

You’ve been doing this for a long time I guess, can we get your perspective on what’s going on today versus prior downturns that you’ve experienced and what’s maybe different and what’s similar.

Keith Nosbusch

We have been through a bunch of these and quite candidly I think that’s one of the advantages that we have with the leadership team here. We know what to do, how to do it and how to make the right trade off decisions. But I think what’s different, let’s go to the most recent one and what’s different is in 2000 and 2001 it was basically a manufacturing depression and the rest of the economy barely saw anything.

As a matter of fact GDP never declined. So what’s different this time is it started in the financial markets, it moved to the credit markets, it moved to the consumers, and it moved to manufacturers which is a little different then the previous one which mainly was never impacted consumers in a big way.

And I think that’s probably the greatest difference and in that regard this is probably closer to what was occurring in the early 80’s as opposed to either the 90’s or early 2000. I would also say one of the big differences this time, this is probably the first time since World War 2 that we have had a synchronized global recession. That’s also something different here where we’re seeing for sure all of the mature economies and the developed economies entering into a recession and in some cases very substantial recessions if you look at some of the recent numbers in Japan, recent number in the US and certainly countries in Europe.

I would say that from a broad characterization is what we see as different and that’s why we’re very focused now on making sure we take the appropriate actions in the business.

Operator

Your next question comes from the line of Richard Eastman – Robert W. Baird

Richard Eastman – Robert W. Baird

Just a question on inventories here, so with the core growth down 5% overall presumably it was down more, the sell through was down more at the distributor level, so basically the situation with inventories is that’s what we need to work down here in the next couple of quarters, is that the right way to think about this?

Keith Nosbusch

Yes it is. We have at least for the majority of our inventory in the US we basically have that on an order process based upon what they’re selling. So we’re a little behind if you will on what they’re seeing simply because of the timing of those algorithms and the flow but certainly there was some reduction in the quarter of their inventories and we would expect that to continue until we see a stabilization of the revenue.

Richard Eastman – Robert W. Baird

How does it effect your pricing outlook, would you expect to be able to hold price or do you, in your guidance do you have some price discounting in your guidance, factored in.

Keith Nosbusch

No we expect to be able to hold price in our guidance, certainly the environment is different from what we were talking about in the summer timeframe where we thought we would get more price but then we also had less inflation now so I think those two will offset and we’ll probably end up basically around what we’ve been doing historically which is minimal if any and that varies depending on the industry and the current situation at customers.

Richard Eastman – Robert W. Baird

What was the impact of currency on EPS and then what is the pension expense jump this year?

Theodore Crandall

Currency impact on EPS in the quarter was about $0.05 and pension expense year-over-year is going to be up somewhere between $5 and $10 million.

Operator

Your next question comes from the line of John Inch – Banc of America

John Inch – Banc of America

On the price, just to pick up from what you just said, what kind of pricing pressures though are you seeing say from competitors, I’m just curious why do you not have to cut price particularly if customers are deferring or holding back so aggressively.

Keith Nosbusch

Certainly with respect to competitors many of the competitors really don’t have a lot of options to compete in these markets particularly the second and third tier competitors. And they will use price and certainly price is one of the first tools that they will bring to the forefront as a way to attack customers and in general to attack Rockwell Automation.

I think from our perspective basically we have lots of options to work with our customers on and that is the entire lifecycle cost that they see, the ability to move them to different platforms, the ability to help them utilize perhaps newer technology in replacing some of the older products and so it still boils down to the value that we can provide and that’s more involved then just the initial purchase price so we talk to them about productivity, we talk to them about being able to improve their outputs and yields with less input.

Those are all factors that go into a final decision and our goal and certainly the way we approach customers is that it is all of those dimensions and all of those pieces which many customers will give us credit for, the ability to save costs in multiple areas of their operation and throughout their organization as opposed to just an initial purchase price.

John Inch – Banc of America

Are you seeing say Siemens or the big Asian players, are they cutting price. I hear you on the small guys but presumably the big players also have a decent value proposition as well. What’s going on competitively there?

Keith Nosbusch

I think at this point we have not seen significant pricing competition anything more then usual from any of the major Asian or European competitors.

John Inch – Banc of America

Could we get a bit more color on some of the verticals and how they performed, so life sciences, the mac businesses, that sort of thing.

Keith Nosbusch

Well certainly in the quarter those that performed above the Rockwell Automation average as I mentioned earlier was oil and gas and food and beverage, particularly food. Beverage was a little weaker but food was very strong. At the Rockwell Automation average would have been the home, health, and personal care area. Below our average would have been life sciences and metals and significantly below would have been the global automotive and tire markets.

John Inch – Banc of America

What are your thoughts vis-a-vie share repurchase, you have a very strong balance sheet as you called out, you are going to have to spend some money for restructuring and some other things, how are you thinking about share repurchase now and using the rest of the authorization.

Keith Nosbusch

The way we think about it now we would start out by saying we really have no different thoughts in our cash deployment priority which would be first funding organic growth and good opportunities there. Second would be strategic acquisitions. Third would be returning any excess to our shareholders in the form of dividend and then finally any excess from that would be share repurchase.

Given the current environment and with the I’ll say volatility and uncertainty I think its fair to estimate that we will be much less in the share buyback environment at this point in time and certainly we would not be on a path to conclude that over the next 12 months with the outstanding authorization that we have.

Operator

Your next question comes from the line of Jeff Sprague – Citigroup

Jeff Sprague – Citigroup

Just to clarify on the restructuring I think that dialogue you had with Mark earlier so there’s $165 million of costs to get out beyond the $75 million that is covered by the charge, could you clarify how much of that $165 is again the volume driven changes. It sounds like that includes lower raw mats and everything like that that just comes with lower volumes and lower commissions and things that come with lower volumes so how much of that $165 is true structural costs that need to come out.

Theodore Crandall

Let me try to answer that this way because when you get into these levels of sales declines I’m not, try exactly know how to distinguish between normal and structural. But on the cost of goods sold side something in the range of $60 to $90 million has to come out of direct and indirect cost and cost of goods sold.

Jeff Sprague – Citigroup

That is not included in your pay as you go $25 million target.

Theodore Crandall

I would say pieces of it are but I would say we would expect to be able to get most of that out without a lot of up front implementation costs.

Jeff Sprague – Citigroup

If there is additional restructuring should we expect it to be pay as you go from here or is there the chance of a larger charge again like we saw as you exited 2008.

Keith Nosbusch

Its really too early to make that call because we just started that process and really there its more of a trade off of what is the pay back and how quickly you can get that pay back as to whether we want to take it all at one point in time or spread it out over an extended period and so not knowing exactly what will fall into which bucket, I’ll defer on that one until we’re a little more knowledgeable about what the makeup of the cost out is going to be.

Jeff Sprague – Citigroup

Stepping back from all this and thinking about the bigger picture of your competitive position and what your priorities are, if we think about logics, its been in the marketplace for eight or nine years, obviously that’s not a static introduction, you’ve added a lot to it and its evolved over time. But are you thinking about or working on some significant changes in your offering platform and how do you think about that relative to the macro environment, even if you had something new, would you be inclined to sit on it here and let some of these fundamentals play out, just trying to think given what does look like a fairly good balance sheet what you might try to do here to actually take advantage of how tough it is.

Keith Nosbusch

We would not sit on anything in this environment. We believe this is a great opportunity to continue to extend our technology leadership. We believe its an opportunity to take advantage of the weaker market participants in this type of an environment and we certainly believe that if we make the investments now and if we continue to focus on working with customers in a downturn that that is a huge advantage for us as we come out the other side.

Our goal is to continue to focus on the technology differentiation. As you said while the product was introduced it’s a product that continues to evolve and we want to add more pieces to that platform. We want to move it up to better job in process, move it down to do a better job at global OEMs and certainly we think that we have an advantage here because of our strong balance sheet that we will be able to continue to take the steps and continue to take the actions that will allow us to emerge even stronger as we come out and I think everyone understands how the upside plays out for us during the leverage that we receive on the recovery side.

Jeff Sprague – Citigroup

Within controlled products and solutions, naturally you saw products drop off quickly, its through distribution, its quick turns, and so solutions didn’t take the hit but are you seeing evidence yet or is there an effort to basically as your customers are under severe duress here, Rockwell providing some avenue for them to take costs off by further engaging from a solutions standpoint, is there any evidence of that really going on in the last couple of quarters or any new effort there.

Keith Nosbusch

Certainly I wouldn’t say of anything of significance but always when we’re in these difficult economies, customers look at what are opportunities for them to reduce their cost structures and we believe that falls into two categories for us. We can work on more projects to your point, the solutions businesses are able to support more strongly the [inaudible] of the project work that some of our customers have and then secondly our services business which also continued to grow in the quarter it presents opportunities for that organization to also support customers in their operations and in their facilities and certainly we have people deployed in our solutions and in our services businesses globally specifically to be able to be that local touch and that local capability to support customers.

So we do expect that to be a positive as this plays out but I think with the significance of the decline and the speed of the decline those actions have not been implemented and executed yet that we’ve seen any difference in that position at this point in time.

Jeff Sprague – Citigroup

Back to this question of channel inventories, at this point you believe distributor inventories are still on the high side but its your inventories at the Rockwell parent level that are most, are the largest issue, is that a correct statement and then does title to all that inventory pass to the distributors when you ship it or do they have some recourse back to you or consignment type arrangements or anything where really the inventory is still on your dime until they ship out their end.

Theodore Crandall

The inventory of our distributors is owned by our distributors. Secondly we have very good visibility of the inventory that is at our distributors in North America and what we saw in Q1 was that inventory declined, but I would say it was declining at a rate that was in line with what we think is going on with end customer demand and that there was nothing unusual there.

We extend what we were seeing in North America and tried to estimate what we think might be happening across the globe in the distribution channel, we would estimate that maybe the inventory adjustment at our distributors was worth about one point of the five points of organic sales decline in the quarter.

Operator

Your next question comes from the line of Steve Tusa – JP Morgan

Steve Tusa – JP Morgan

On the process business what were the order rates in the quarter and you talked about the long lead nature of these projects, does that mean that the revenue growth holds up in the high single-digit, double-digit range throughout the course of the year and then we kind of come to a slowing period in 2010 or would you expect that to begin to slow in the second half.

Keith Nosbusch

We would expect the order rate to slow as we go through the year. This is an area where we have a longer, larger backlog then in other businesses and so that’s what gives us the short-term perspective but certainly given the other dynamics that are going on we are expecting a [decline] in orders as we go through the year and we expect that to get a little stronger as we go towards the end of the year.

That business will also soften but it will be a quarter or two out from where we were up.

Steve Tusa – JP Morgan

Do the worst declines of that business sees this year approach, in orders, the Rockwell sales average, a down double-digit a some point in the fourth quarter?

Keith Nosbusch

That’s not what we’re currently planning. We expect it to be down only in the mid single-digits as we go through the year and we do still see a good front log in some of the legacy [DCFs] migration to a newer platform so some of these activities still go on simply because of the aging of the installed base and the need to make that transition.

Steve Tusa – JP Morgan

And that’s mostly oil and gas, do you have a lot of chemicals exposure as well.

Keith Nosbusch

No we’re not, chemicals is not as strong of a market for us. We do participate but most of my comments were made around oil and gas and certainly the cement and power and energy from more of a global basis then specifically chemicals.

Steve Tusa – JP Morgan

On the balance sheet the short-term debt went up a bit and also I know you have a measurement date on the discount rate in June, but I think you’re plan gets measured the end of September, do you expect given the [data] may not reflect all the declines in asset values that we’ve seen this year, or maybe it is a December year, would you expect a lot of companies are taking hits to equity because of the decline in asset values, would that be something you planned for this fiscal year instead of the previous fiscal year given the tough markets out there.

Theodore Crandall

Short-term debt did go up a little bit in the quarter. You know we use commercial paper to fund normal operations and I would say nothing unusual there but it was up a bit in the quarter.

Steve Tusa – JP Morgan

I’m not a pension expert and we’ve been seeing a lot of big hits to equity at a lot of the companies, given the pension plan underperformed so dramatically into year end and given the difference in your year end relative to some of these other companies, September instead of December, is there more of a lag effect whereas this fiscal year will now reflect a little bit later the declines in asset values we’ve seen out there.

Theodore Crandall

There was an accounting rules change that impact that accounting for pensions that we reflected last year in equity. I’m not expecting any significant additional changes this year. Our valuation date this year will be at the end of our fiscal year.

Keith Nosbusch

Certainly we hope that this turns out better then what we’ve outlined here but quite frankly we think is a realistic assessment and we’re using this assessment to guide us in how we position the business to best perform in very, very difficult market conditions and we’re going to run the business consistent with this outline and if it gets better that’s great, but I think given where we’re at and what’s going on in the external markets we believe this is the most prudent and appropriate way to manage the business and certainly the leadership team here is committed to manage through this and quite frankly take advantage of the opportunities that may present themselves during these challenging times.

Rondi Rohr-Dralle

That concludes today’s call and thank you all for joining us today.

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Source: Rockwell Automation, Inc. F1Q09 (Qtr End 12/31/08) Earnings Call Transcript
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