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Rockwell Automation, Inc. (NYSE:ROK)

F1Q10 Earnings Call

January 27, 2010 8:30 am ET

Executives

Rondi Rohr-Dralle - Vice President of Investor Relations

Keith Nosbusch - Chairman and CEO

Ted Crandall - Chief Financial Officer

Analysts

Bob Cornell – Barclays Capital

John Inch – Merrill Lynch

John Baliotti – FTN Equity Capital Markets

Mark Koznarek – Cleveland Research

Steve Tusa – JP Morgan

Mark Zeff – Goldman Sachs

Mark Douglass – Longbow Research

Richard Eastman – Robert W. Baird

Operator

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

Rondi Rohr-Dralle

Thanks for joining us for Rockwell Automation’s First Quarter Fiscal 2010 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 of 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 Ted Crandall, our Chief Financial Officer. Our agenda includes opening remarks by Keith that will include highlights of the first quarter and thoughts about our outlook for 2010. Then Ted will provide more details around the first quarter financial performance our revised 2010 guidance. There will of course be time at the end of the call to take your questions and we’ll try to get to as many of you as possible, so please limit yourself to one or two questions and we’ll try and get to as many folks.

We expect the call today to take about 45 minutes to an 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.

So, with that, I’ll turn the call over to Keith.

Keith Nosbusch

As we exited last fiscal year we were cautious in our outlook for fiscal ’10. We had just experienced the largest and most rapid yearly revenue decline in my history with Rockwell Automation and we were just beginning to see stabilization in the macro environment and in our order rates. Fast forward three months and we now believe we are seeing the signs of recovery, reflected by continued improvement in key global economic indicators like industrial production and PMI and by our performance in the first quarter. I’ll talk more about our outlook later.

First, let me give you some highlights for the first quarter. Revenue in the first quarter was better then our expectation, particularly in our Product businesses in December. Even though we think Product revenue in the quarter benefited from some unusual year end budget consumption by our customers, it still exceeded our expectations.

In our Solutions businesses, revenue declined sequentially in Q1 as expected. We did see improvement in order rates for the first time since the first quarter of fiscal 2009. Favorable revenue mix along with the benefit of previous cost reduction actions contributed to sequential margin improvement in the quarter even after adjusting for the restructuring actions in the fourth quarter of last year.

The results in the quarter and an improved outlook for the year caused us to reverse our temporary pay and benefit cuts in January a quarter earlier then we originally expected. We believe this was the appropriate timing but it will create some additional sequential headwinds to margins for the remainder of the year. The first quarter was another very strong quarter for cash generation, over $100 million. I want to thank our customers, employees and partners for a great start to the fiscal year.

Let me set the stage for our outlook for the remainder of the year. While key indicators such as industrial production and PMI are improving, we remain concerned about other factors such as continued high unemployment, historically low levels of capacity utilization and a very cautious capital spending outlook. It now seems that the recovery has started but the shape of the recovery remains uncertain. Absent some unexpected shock to the global economy we believe demand will trend flat to up from here.

With this backdrop and using our Q1 results as a new baseline we are providing a revised outlook for fiscal 2010 full year revenue of $4.4 to $4.6 billion compared to our previous range of $4.1 to $4.4 billion. As in our previous guidance, to achieve the high end of the range we need to have meaningful second half over first half growth. At these new revenue levels we do expect to incur some additional expense from restoration of temporary action and higher incentive compensation in 2010. We expect to begin to make some incremental investments to support growth.

With these factors in mind we are raising our earnings per share guidance. Our new range is $2.00 to $2.40. This revised guidance reflects the strong earnings leverage that we would expect on incremental volumes, especially with respect to our product businesses.

Before I turn this over to Ted, let me highlight a few key developments in the quarter and then I’ll wrap up my comments. We talked at the November investor conference about our growth accelerators in the next cycle; process control, OEMs, safety, information, emerging markets, and sustainability. We continued to see progress in the first quarter.

We had another strong showing in the 2010 Control Magazine Readers Choice Awards, a survey of process control engineers. We placed first in 26 industry categories, almost three times the number of firsts of any other global automation company and a net gain of three positions from last year. In all categories we increased our first place finishes from 11 in 2007 to 36 in 2010. This further validates that Rockwell Automation is a DCS provider in the eyes of our process control customers.

Regarding our OEM business, we received a $10 million order from a European packaging machine builder for machines to be exported to China. We received the first order for our new scalable process safety product advance from a national oil company in Latin America. This product enables us to serve a broader range of process industry applications. Emerging Asia grew over 9% in the quarter. In our information software business we received a $1 million order for a production management system at a Chinese automotive company.

In closing, we believe that we are at the early stage of a recovery. We will continue to effectively manage our cost structure while appropriately investing in key technologies and growth opportunities. We are well positioned to take advantage of the recovery and we are ready to serve our customers needs when their automation spend increases.

Now I’ll turn it over to Ted.

Ted Crandall

We posted charts to our website and my comments will reference those charts. Starting with chart one, Q1 Results: Summary. Revenue in the quarter was $1.067 billion down 10% from Q1 last year. An organic sales decline of 15.5% offset in part by favorable currency impact of 4.4 points and contribution from acquisition of about one point. Sequentially, sales declined by 1%. In all a very good first quarter and a stronger then expected start to the year in our product businesses.

Segment operating earnings were $137 million down from $178 million in Q1 last year. General corporate net was $19.5 million compared to $18.1 million a year ago. The effective tax rate in the quarter was 20% a point below the low end of our projected range for the full year. EPS from continuing operations was $0.54 down from $0.81 in the first quarter of last year. We recognized a small environmental charge in discontinued operations. Average diluted shares outstanding in the quarter were 143.8 million and we did not repurchase any shares during the quarter.

Moving to chart two, Q1 Results: Rockwell Automation. As noted previously, sales for Q1 declined 10% year over year and 1% sequentially. Q1 sales are typically lower then quarter four but 1% was a smaller then expected sequential decline. We hadn’t expected a significant sequential drop in solutions and we expected product sales about flat to Q4 run rates. Solution sales actually declined more then expected but we saw significant sequential growth in products.

We believe a portion of that sequential products growth may have been due to some unusual year end consumption of customers operating expense budgets. However, even adjusting for that, product sales were stronger then expected. Moving to the earnings side of the chart, operating earnings climbed 23% year over year primarily due to the volume drop offset in part by cost reductions. Operating margin for the quarter was 12.8% down about 2.1 points compared to last year but up considerably from the trough margins experienced in fiscal ’09.

Looking at the earnings chart there’s an obviously large sequential earnings improvement on the 1% lower sequential sales, sequentially operating margin increased by 5.4 points. You may recall we incurred some significant restructuring charges in Q4 but excluding those charges operating margin increased sequentially by 2.3 points. That improvement reflects significantly richer product versus solutions mix in the quarter.

We’re very pleased with the margin results in Q1 but this might be a somewhat overstated base for sequential quarterly comparisons as we proceed into the balance of the year. As I mentioned, Q1 saw a very favorable mix of products versus solutions, probably in part due to some unusual year end customer spending.

Additionally, Q1 will be the only quarter this year where we see a year over year benefit of some of our temporary actions. We restored pay cuts and 401K match beginning in January. With an improving outlook we are planning to allow some increased spending and that didn’t get started in time to impact Q1. On the other hand, we believe we’re well positioned for good leverage as volume increases and you’ll see that reflected in guidance.

Although not displayed on the chart, our trailing 12 quarter return on invested capital was 9.5%, that’s down from 22.3% last year primarily due to the earnings decline.

Now please turn to chart three which summarizes the first quarter results of the Architecture & Software segment. Looking at the left side of this chart, a strong sales result for Architecture & Software in Q1 with a third consecutive quarter of increasing sales. Sales were down 7% compared to the same quarter last year with about a five point benefit from currency. Sequentially sales were up 11%.

Operating margins for the quarter was 21.1% one half point below the first quarter of last year despite lower sales. That reflects the impact of our cost reductions of last year. Excluding restructuring charges from Q4 operating margin improved sequentially by 7.3 points. That sequential margin performance is primarily due to the significant volume leverage we generate in this higher margin segment.

Chart four covers our Control Products & Solutions segment. Sales in Q1 were down 12% compared to last year with a 4 point benefit from currency and 2 points of growth from acquisitions. Sales were down 8% sequentially. We experienced sequential growth in the Products business of Control Products & Solutions but that was more then offset by the larger then expected decline in the Solutions business.

Segment operating earnings were down 44% year over year and operating margin contracted by 3.7 points consistent with the lower volume. Excluding restructuring charges in quarter four, operating margin was lower sequentially by two points also due primarily to lower volume.

The next chart five provides a geographic breakdown of our sales in the quarter. In the center column you’ll see the overall growth rates by region; the far right column shows growth rates excluding the effects of currency translation. This is the first quarter since the fourth quarter of fiscal year ’08 in which currency made a positive contribution. I’ll focus my comments on the far right column, excluding currency effects.

In the US sales were down 18% year over year but up 3% sequentially. The US was the only region with sequential growth and really all of that due to strength in the Product businesses, particularly Architecture & Software. Canadian sales declined by 8% compared to prior year but that comparison benefits from an acquisition made last year. Excluding that, the year over year decline was about the same as in the US.

In EMEA, sales declined 16% compared to Q1 last year. Asia/Pacific was the only region that demonstrated year over year growth at 5%. Emerging Asia including China saw over 9% growth year over year. Latin America was down 19% year over year with the largest declines in the solutions businesses.

Turn to chart six, free cash flow. For the quarter, free cash flow was $108 million, a very good start for the year and that’s just a little less then 140% conversion.

That brings us to the next side which addresses our current outlook for fiscal ’10. As Keith mentioned, we’re revising guidance. We have increased the range of full year sales to $4.4 to $4.6 billion to reflect a higher baseline based on Q1 performance. Excluding currency effects for the full year that revenue range represents a decline of 2% at the low end to growth of 3% at the high end. We expect currency to contribute about four points to year over year growth, one point more then in our November guidance.

We’ve adjusted our estimate of segment operating margin to 12% to 13%. We’ve increased our fiscal 2010 EPS guidance to a range of $2.00 to $2.40. We now expect the full year tax rate of 19% to 23%. We continue to expect free cash flow conversion above 100%.

With that I’ll turn it over to Rondi to begin the Q&A session.

Rondi Rohr-Dralle

We are ready to open the lines now for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Bob Cornell – Barclays Capital

Bob Cornell – Barclays Capital

The strength in the Product business that you saw the end of the quarter did that continue into January despite the year end adjustments you’re talking about?

Keith Nosbusch

We obviously exited Q1 at a faster rate then we thought and certain in January what does happen is we do see a fall off. Certainly that did occur and the rate slowed as expected. January to date daily order rate is below the average for Q1 and this is true in both Products and Solutions but I would say that’s our normal typical start. Its one of the reasons sometimes Q2 can actually be lower then Q1.

We really don’t know the continued strength until we get into the mid-February end of the quarter time period because obviously most of the companies are resetting their budgets for a new year and it takes a while for that to work through the system. I would say right now we are seeing exactly what we would have expected. Obviously that’s part of the factoring into our guidance that we provided.

Bob Cornell – Barclays Capital

What soft of magnitude of the temporary cost recovery feedback are you going to have in terms of dollars or margin, basis points? Could you quantify that for us at all?

Ted Crandall

Let me try that in two different respects. The restoration of the pay cuts and the 401K match is about a $15 million sequential expense increase from Q1 through the balance of the year.

Bob Cornell – Barclays Capital

That’s for year or for quarter?

Ted Crandall

That’s per quarter. The other large item we will have this year will be increase in incentive compensation compared to last year’s levels. At the new guidance midpoint we would expect that to be up in the ballpark of $70 million.

Bob Cornell – Barclays Capital

For the year?

Ted Crandall

For the year.

Bob Cornell – Barclays Capital

You talked about Solution orders improving; do you have a book to bill in Solutions?

Ted Crandall

The book to bill in Solutions in the first quarter was roughly 1.15.

Operator

Your next question comes from John Inch – Merrill Lynch

John Inch – Merrill Lynch

I want to focus a little bit on your commentary around; I think you used the term “unusual” to describe some of the year end customer budgetary spending. Why do you say that? Was there a concentration amongst a group of customers that you talked to that you sort of felt that was the case, was it broad based, or are you just basically trying to be cautious as the year unfolds?

Keith Nosbusch

No, I don’t think it’s because we’re trying to be cautious. I believe, this is more of a broad brush statement then we talked to a handful of customers. What we normally see as December unfolds is a normal start and then about midway through it starts tailing off and then certainly as you get between the holidays it’s pretty slow normally.

Obviously that’s certainly what we were expecting this year because if you remember last year basically everybody shut down and there was really zero going on which is obviously worse then normal. It was a very reduced level last year. We thought we’d get back to a normal seasonality at the end. What we saw was a continued acceleration in the Product businesses through the month.

As we went through our normal series of reviews in January getting ready for this call and obviously the remainder of the year outlook we got significant feedback from the various regions and verticals that certainly there was an increased spending thrust as they approached the end of the year. Certainly a portion of that, we believe there are a couple of factors behind that.

One, there had been such a reduction in what I would call just normal operating spending in our second and third quarters and into the fourth that because industrial production picked up there was a natural rebound there as well as supply chains were pretty well done and down and people had reduced their maintenance storerooms and other spending to a point where there was probably a little higher then average replacement.

Then also because that spending was decreased for such a long period of time we do believe there was some end of the year spending bubble that was why we called it unusual. That kind of gives you a lot of color around that question.

John Inch – Merrill Lynch

I know you guys have very good visibility into your own dealer channel and certainly talked about the end of a de-stocking. If I can infer from your comments, are you suggesting that there has been a degree of restocking and do you think that actually continues based on; you’re hearing chatter about this outside of Rockwell about a degree of restocking. Are you seeing that and do you think that actually has a degree of legs based on where channel inventories are set and where you sort of see demand picking up associated with macro variables and so forth.

Ted Crandall

We think we saw about one point of improvement in sales in Q1 due to restocking. As demand continues to increase, if demand continues to increase through the year we would expect that to continue.

John Inch – Merrill Lynch

If you look at the Architecture & Software business I think sequentially you’re talking a $45 million delta in revenues yet if you adjust for restructuring in the fourth quarter you almost had $40 or $41 million of sequential profit margin pick up. It almost looks like a 90% variable contribution margin. I know you referenced strong product sales but actually how did the A&S business put up such a very robust contribution margin in the first quarter?

Ted Crandall

I would say the most important factor in there is very strong incremental contribution margins in Architecture & Software. Obviously that doesn’t explain a 90% conversion. There are, in any two quarters, puts and takes and some unusual adjustments in the quarter and we probably had a couple negative items in Q4 and some positive items in Q1 that also influenced that conversion for Architecture & Software.

John Inch – Merrill Lynch

I’m assuming logics had a very good quarter is that true?

Ted Crandall

Logics sales for the quarter year over year were down about 7% but obviously that’s better performance then Architecture & Software as a whole and that’s on an organic basis.

Keith Nosbusch

Sequentially they were up 11% so yes they had a strong quarter.

John Inch – Merrill Lynch

You think Logics does what for the year?

Ted Crandall

As far as percentage growth for the year?

John Inch – Merrill Lynch

Yes, roughly.

Ted Crandall

We think we’ll get back close to 10% year over year.

Operator

Your next question comes from John Baliotti – FTN Equity Capital Markets

John Baliotti – FTN Equity Capital Markets

Obviously taking out the entire prior range in guidance and you guys are historically very conservative even throughout the last cycle, are you feeling better because you mentioned in your opening remarks that orders had picked up. Are you seeing what’s in the orders much more stable, higher profitability then you guys were seeing or not seeing anything before when the guidance was first laid out?

Keith Nosbusch

Yes, I believe we’re seeing two things at this point in time that we didn’t see when we gave our initial guidance. That is a sustained pick up of our product revenues. Obviously we thought that we would have a closer to flat to Q4 during our Q1 and it grew. As I said earlier it grew throughout the quarter which was unusual.

The other aspect is our Solutions business where we definitely expected it to continue to decline in sales but quite frankly we were a little surprised that we saw sequential order improvement. The last time we had talked we were still going down in our Solutions business. We believe that we now probably have seen the bottom of the Solutions business and we have more certainty that we have seen the bottom in our Products businesses, although obviously the shape as we’ve mentioned of the recovery is still very difficult.

We think with respect to the magnitude of the change that we’re trying to go right down the middle of the fairway with what we see today. I think traditionally that’s the approach we’ve taken to tell you what we know; when we know it, and try to make sure we’re as credible as possible on both of the sides of the range. I think we have a little more confidence in the stability then we did previously and certainly we believe that unlike last year where Products were going down at a much faster rate then Solutions and therefore we saw all the decremental margin impact.

We now fully expect Products to lead Solutions and therefore you’re seeing some of these higher incremental margins going the opposite way. I think it’s that plus obviously the macro economic indicators, we’ve got another quarter of looking at those. While there not have been significant change they’ve all stayed, certainly the PMIs have stayed above 50 now for a significant number of months. Industrial Production on a global basis continues to show, while not large, certainly some improvement.

I think it’s that total combination including talking to customers and while they may not be increasing their spending dramatically they’re talking about and they’re looking for more quotations. They believe they will be releasing projects later in the year. That’s why we talked about a meaningful second half over first half growth. It’s a number of those aspects that caused us to have probably a little different perspective then we did three months ago.

Ted Crandall

I think there’s one other thing. Similar to our November guidance, we’re assuming in this guidance that we don’t see any significant retreat on average in the balance of the year from the run rates we’re seeing in Q1. No “W” shaped recovery. This assumes that at worst things are flat and at the high end we see some reasonable improvement over the balance of the year.

John Baliotti – FTN Equity Capital Markets

I think you guys are pretty conservative, you guys are clearly concerned when you laid out the first numbers and try to caution us in terms of the amount of volatility of given a certain percentage of your more profitable business not showing up.

Keith Nosbusch

I think that’s a fair statement. Certainly the confidence at that point was certainly shaken given what we saw in the previous three quarters.

John Baliotti – FTN Equity Capital Markets

If you look back at this last cycle, I know we’re a lot lower in capacity utilization then before so it may be hard to interpret but if you take out even some of the unusual as you consider them unusual items in the quarter, the behavior of the patterns and you talk to a lot of customers obviously and just the behavior and the patterns that you’re hearing from them or seeing in your numbers. How does that compare to when we were in the 73.5 when we bottomed the last time of capacity utilization, have you seen any similarities or differences?

Keith Nosbusch

I think it’s a little too early to talk about the differences. The similarities that we see is I think people are cautious. This has been a very, very difficult period for many companies and I think we’ll see them trying to drive productivity as long and as hard as they can to try to offset incremental investments. Actually we’re hoping that that will drive some project activity that is more focused on cost reduction and productivity as opposed to true incremental CapEx spending. I just think people are still very sensitive.

I think the uncertainty looking forward is probably higher this time then ever, quite frankly. The uncertainty of what new regulations are coming, what new tax environment will they be involved with and certainly I think those are all things that are going to play out. Right now I believe people are probably a little more unsure of what does it look like over the next three to six months. I think we’ll see a little more cautiousness on their part.

Operator

Your next question comes from Mark Koznarek – Cleveland Research

Mark Koznarek – Cleveland Research

A couple details on the guidance, is there any change to the tax rate and is there any acquired revenue anticipated in the revenue outlook?

Ted Crandall

Our previous guidance for tax rate was 21% to 25%. The revised guidance is 19% to 23%. There is no assumption of acquired sales in the sales guidance outlook.

Mark Koznarek – Cleveland Research

The question that I’ve got more substantial is having to do with the surge here in the December quarter. There’s a couple things that seemed like they could potentially drive some of that that are lapsing, hopefully now or soon. One is that your price increase was announced for the end of January and typically those are in August. We have a non-comparability of when the price increase comes through and whether there’s pre-buying ahead of that.

Secondly, we’re hearing about the supply chain being somewhat taught for some of the product categories and some of the dealers are telling us that they’re actually building stock and you guys actually confirmed that with that 1% comment. As you get your SAP issues further resolved as the year unfolds and that we now have even year over year price comparisons, do you expect this sort of surge to subside and even reverse. Basically if we pulled forward a lot into the first quarter and then we have to pay it back later in the year.

Ted Crandall

We already talked about what we thought the restocking impact was which was about one point. I think as we move forward, assuming that we see some increase in demand as the year progresses and end demand at distributor level would expect to see some continued benefit from restocking in the balance of the year.

As it relates to price we don’t believe there was any significant pull forward as a consequence of the price announcement. Keith mentioned we do think there may have been some unusual buying in December particularly in our Architecture & Software segment that related to customers consuming year end budgets. It’s a little bit difficult to quantify that because we’re trying to discern between that and just a normal increase in demand now. That’s really the only thing we would peg as unusual in Q1.

Mark Koznarek – Cleveland Research

To clarify the comment you made earlier about the mix of business between products and solutions. How far off in the quarter was that revenue mix versus what would either be a normal year or what you would be forecasting for the full year?

Keith Nosbusch

Off hand I don’t know exactly what the percentage was compared to the expectation for the quarter. Basically we saw a strong sequential increase in product sales when we expected it to be flat. We saw a larger then expected decline in solution sales in Q1.

Mark Koznarek – Cleveland Research

Larger then expected decline in Solutions. Even though orders picked up your actual revenues.

Ted Crandall

Even though orders picked up. That was basically, we talked about having a hole in the backlog coming into the quarter. It was a very favorable mix in the quarter and not one I would expect to maintain as the year progresses. Even part of that mix may have been influenced by this kind of year end budget consumption by customers which obviously disproportionately practically all fell in the Products and primarily in Architecture & Software which is our highest margin area.

Operator

Your next question comes from Steve Tusa – JP Morgan

Steve Tusa – JP Morgan

I wanted to talk about the mix a little bit in A&S. What was legacy in the quarter, logics was down 7% was legacy?

Keith Nosbusch

Legacy was down 20% which makes it sound like a lot but it’s a lot better then fiscal year ’09 when it was down 35%. It was down 20% but up sequentially 9%. It goes into the same category as logics and Ted’s comment earlier that we saw an improvement in our highest margin portfolio which would be the combination of logics and legacy.

Steve Tusa – JP Morgan

You mentioned that China, the software deal, any kind of moving parts in software in the quarter that were notable either way?

Keith Nosbusch

First of all, software isn’t big enough to be notable at the end of the day. We are very encouraged with the continued building of what I’ll call the front log and the pilots that we’ve talked about earlier. We did have some good customer wins as far as the early stages of proof points and that part gave us an encouraging quarter in software. Like I said, it’s still a relatively small number but one that we do see very good signs for, for the duration of the cycle.

Steve Tusa – JP Morgan

You called out the $1 million is that an unusual deal? I’m curious, it sounds like a relatively meaningful deal in the scope of your software business.

Keith Nosbusch

It is. We called is out for two reasons. One that is a large software order. Secondly, it’s in China in the automotive. The other message is these emerging markets are looking at investing in technology and tools to help them be world class and productive. The fact that you’re seeing a plant floor software solution being implemented in China we feel that’s a demonstration of the importance of this type of technology and also the fact that it’s not just in mature markets and from mature companies that are willing to invest in the information space. It was really those two messages that we wanted to communicate.

Steve Tusa – JP Morgan

How many of those types of large deals are out there? Are they few and far between, are you working on more and more of them? Give us some context you talked about the front log in software, maybe just use the $1 million order from China as a baseline and describe.

Keith Nosbusch

Certainly that’s why we’re creating the pipeline is to be able to have more of those size orders as we go forward. This was one that was large in a single instance. What tends to be more typical is that we would have a smaller initial order in a plant or on a line and then we would want to see a sustained roll out of that across the enterprise globally. While this is a single instance, we believe the other dimension of this that is equally important if not more important to us is the ability to put this software in many of our customer facilities and to generate the performance for them across their enterprise as opposed to one offs.

Steve Tusa – JP Morgan

On the numbers, is there any kind of change in the moving parts when it comes to the restructuring charges, savings, temporary stuff come back in? Did you increase those numbers by a little bit so they’re now more of a headwind then you would have expected when you gave the previous guidance? You said some of these costs were going to come back in if volume returned. Is it in line or is this more of a headwind, maybe you could just walk through those moving pieces under the bridge?

Ted Crandall

First what I would say is that...

Steve Tusa – JP Morgan

Have you called off the dog at all in the restructuring perspective?

Ted Crandall

I was going to start by saying all of the savings we were expecting to see this year we still expect to see. As we talked about restoration of temporary actions in our previous guidance at midpoint as being about $30 million of headwind, we now think at the new midpoint that that is more like $70 million of headwind and that difference is comprised of two pieces. One is somewhat earlier, restoration of pay cuts and the 401K match but the larger chunk of it is really just higher incentive compensation at these new guidance levels. You may recall we have a very broad based, pretty much across all employees who are not quota carrying incentive plans.

Operator

Your next question comes from Mark Zeff – Goldman Sachs

Mark Zeff – Goldman Sachs

At the high end of the guidance range what’s the implied second half versus first half revenue increase?

Keith Nosbusch

In that, the high end if you look at it, we would expect that we have a mid-teens growth from first half to second half. It’s probably weighted more towards solutions.

Mark Zeff – Goldman Sachs

To follow up on the Solutions comment, could you provide any detail in terms of verticals, where you saw the order increase in the quarter and where you’re more optimistic for the back half of the year?

Keith Nosbusch

I think with our Solutions businesses where we have seen the pick up is in Automotive. We’ve seen it in Waste Water and a little bit in Oil & Gas although that’s been a very strong year for us, we do expect it to be slightly better this year. I would say that’s where the significant deltas were at this point in time.

Mark Zeff – Goldman Sachs

On capital allocation, still expecting to convert the higher earnings range and the strong free cash flow, any change in your thinking, priorities, M&A, buyback?

Keith Nosbusch

No, our cash deployment priorities remain the same. Investing in organic growth, small bolt on acquisitions and then any excess operating cash we would return to shareholders and there we have three vehicles; dividends, stock repurchase, dividend increase or special dividend if you will. I would say the one area that we constantly take a look at would be infusion into our pension plan, while we have no required contributions in the short term that could be an opportunity for us to utilize excess free cash.

Mark Zeff – Goldman Sachs

Is there any share repurchase embedded in the guidance?

Ted Crandall

There is no share repurchase embedded in the guidance. As you know, we curtailed share repurchase last year because we thought it was important to manage the balance sheet liquidity in that down economy. I would say given the current guidance and our expectations for excess free cash flow this year we will consider beginning share repurchase in the latter half of this year, at least partially to offset dilution from stock compensation.

Operator

Your next question comes from Mark Douglass – Longbow Research

Mark Douglass – Longbow Research

The $70 million headwind from compensation, that’s inclusive of incentive compensation, of bonuses and 401K and salaries being made whole?

Ted Crandall

I missed the very first part of your question. Could you repeat that please?

Mark Douglass – Longbow Research

The $70 million headwind that you talk about from temporary costs, actions coming back, is that inclusive of everything its not just bonus incentive compensation?

Ted Crandall

That’s correct, that’s inclusive of everything. I want to make sure I’m being clear. We previously talked about a headwind of $30 million. It’s an increase of $70 million so the new headwind would be $100 million. And a new midpoint.

Mark Douglass – Longbow Research

If you can talk about the Europe piece, what was the performance sequentially and also what are you seeing there, same with the OEMs, obviously the packaging order is that indicative of what’s happening?

Keith Nosbusch

Yes, I think in Europe we are continuing to see some softness in a number of areas. Certainly from a macro economic perspective we believe that Europe is somewhat lagging the US with respect to recovery and it’s probably the region that we have the least confidence in with respect to growth. However, having said that, what we have seen in Europe and its one of our growth accelerators is working more closely with the OEM industry. We have seen improvement on a quarter basis in the OEM sector and in particular in packaging OEMs which is the one that I highlighted during my comments. Europe is tougher but we are starting to see some improvement in the OEM sector.

Mark Douglass – Longbow Research

Does that imply that you’re gaining some market share in Europe? Could you also discuss if you’re gaining market share in process industries?

Keith Nosbusch

Europe is a hard one to call in this environment because we don’t have real good numbers. I would say published numbers if you will. It takes us a little while to get a feel for what is really going on in Europe. I would say I don’t think we’re losing share but I cannot say that we are gaining it in Europe. With respect to process, there we do have more confidence and we do know that we are gaining share in process and we’re gaining it through a number of vehicles.

Obviously the most important reason for process improvement is the fact that our plant wide control strategy and differentiation that we have as a company with our technology continues to resonate with our customers. That story is getting stronger, louder, and gaining a lot of traction.

The second reason is because of the activities that we have started probably a little over a year now, two years probably since our acquisition of ICST which is a process safety supplier. That, in combination with logics we now have an integrated safety and control system that is a very solid platform in particular for Oil & Gas and other heavy process industries.

We started to focus on the batch hybrid space but now in process we’re moving more and more into the heavy industry and continuous process and so that would be the other area that we are able to achieve share growth and one of the vehicles that we’re using there is the ability to replace legacy DCS systems that are no longer being supported. We get our credibility by replacing existing in a lot of the mature markets and then in emerging markets we’re able to compete effectively in Greenfield applications.

Operator

Your last question comes from Richard Eastman – Robert W. Baird

Richard Eastman – Robert W. Baird

Could you talk for a second or two, we talked about the Solutions business and where order strength but on the MRO side of the short term business it sounds like we had decent growth sequentially in the legacy and logics but what markets there did we see the up tick, some, especially auto one could make the argument that there was some budget flush and just an acceleration in spend at year end. I’m curious what markets maybe you could flag for us on the MRO or short term side of the business?

Keith Nosbusch

I think some of the MRO was just in general because of the depletion of activity over probably our second, third and into the early fourth quarters. So that was kind of broad. You answered half the question and that is where did we see a unique situation, it was auto. There is no question that auto bought more in the first quarter then they had previously. In addition to auto we saw a pick up in the tire industry. Generally speaking transportation had very good improvement in our first quarter and it’s an area that we would expect to see growth on a year over year basis going forward.

Richard Eastman – Robert W. Baird

Did it grow year over year in the first quarter?

Keith Nosbusch

Yes.

Richard Eastman – Robert W. Baird

Your commentary about as we rolled into January the daily order rate maybe down a little bit from where it was in the first quarter. Would it be your expectations this early in the quarter that we would see a normal seasonal downtick in revenue in the second quarter or is that still uncertain?

Keith Nosbusch

That’s uncertain. Certainly Q2 is the one that I would say in normal environments can be softer then the previous quarter. The difficulty is it always starts out slow in January. Then it’s a question of what happens later in the quarter and that’s why it’s a tough one to call because we don’t get to the edge of the building because of the first couple of weeks in January. If that continues into late February and March it’s a different story. It’s a hard one to distinguish at this early in the quarter. We have seen nothing that is different then what a normal start to the quarter would be at this point.

Rondi Rohr-Dralle

With that we’re going to wrap up today’s call. We want to thank all of you for joining us. I’ll turn it back over to the operator.

Operator

We thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Rockwell Automation, Inc. Name F1Q10 (Qtr End 12/31/09) Earnings Call Transcript
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