Rockwell Automation - 10-Q quarterly report FY

In the opinion of management of Rockwell Automation, Inc. (the Company or Rockwell Automation), the unaudited Condensed Consolidated Financial Statements contain all adjustments, consisting solely of adjustments of a normal recurring nature, necessary to present fairly the financial position, results of operations, and cash flows for the periods presented. These statements should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2006. The results of operations for the three-month period ended December 31, 2006 are not necessarily indicative of the results for the full year. All date references to years and quarters herein refer to our fiscal year and fiscal quarter unless otherwise stated.

In June 2006, we announced our intention to divest our Dodge mechanical and Reliance Electric motors and motor repair services businesses. These are the principal businesses of our former Power Systems operating segment. On November 7, 2006, we announced that we have entered into a definitive agreement to sell these businesses to Baldor Electric Company (Baldor) for $1.8 billion, comprised of $1.75 billion in cash and $50 million in Baldor common stock. The transaction is subject to customary closing conditions and is expected to close on or about January 31, 2007. These businesses are reported as a discontinued operation in the Condensed Consolidated Financial Statements for all periods presented.

In March 2006, we sold the assets of our ElectroCraft Engineered Solutions (ElectroCraft) business. ElectroCraft is reported as a discontinued operation in the Condensed Consolidated Financial Statements for all periods presented.

Effective October 1, 2006, we realigned our internal management reporting structure. As a result of this realignment, we now report our historical Control Systems operating segment as two new operating segments: Architecture & Software and Control Products & Solutions. The reporting structure changes include realignment of our services and solutions offerings from our former Control Systems operating segment to report through the Control Products & Solutions segment. Additionally, the drives and drives related parts and services business from our former Power Systems operating segment was also realigned to report through Control Products & Solutions. We no longer report our former Power Systems operating segment as a continuing operation as a result of our November announcement that we have agreed to sell this segment’s principal businesses.

Cash and cash equivalents include time deposits and certificates of deposit with original maturities of three months or less at the time of purchase.

Receivables are stated net of allowances for doubtful accounts of $12.1 million at December 31, 2006 and $11.2 million at September 30, 2006. In addition, receivables are stated net of an allowance for certain customer returns, rebates and incentives of $10.4 million at December 31, 2006 and $8.5 million at September 30, 2006.

At the end of each interim reporting period, we estimate a base effective tax rate, which is the effective tax rate that we expect for the full fiscal year based on our most recent forecast of pretax income, permanent book and tax differences and global tax planning strategies. We use this base rate to provide for income taxes on a year-to-date basis, excluding the effect of significant unusual or extraordinary items or items that are reported net of their related tax effects. We recognize the tax effect of significant unusual or extraordinary items in the period in which they are realizable.

We present basic and diluted earnings per share (EPS) amounts. Basic EPS is calculated by dividing net income by the weighted average number of common shares outstanding during the applicable period. Diluted EPS amounts are based upon the weighted average number of common and common equivalent shares outstanding during the applicable period. The difference between basic and diluted EPS is attributable to share-based compensation awards. We use the treasury stock method to calculate the effect of outstanding share-based compensation awards, which requires us to compute total employee proceeds as the sum of (a) the amount the employee must pay upon exercise of the award, (b) the amount of unearned share-based compensation costs attributed to future services and (c) the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the award. Share-based compensation awards for which the total employee proceeds exceed the average market price over the applicable period have an antidilutive effect on EPS, and accordingly, we exclude them from the calculation of diluted EPS. For the three months ended December 31, 2006, share-based compensation awards for 2.1 million shares were excluded from the diluted EPS calculation because they were antidilutive. For the three months ended December 31, 2005, share-based compensation awards for 1.6 million shares were excluded from the diluted EPS calculation because they were antidilutive.

The following table reconciles basic weighted average outstanding shares to diluted weighted average outstanding shares (in millions):

During the quarter ended December 31, 2006, we repurchased 340,000 shares of our common stock for $21.0 million that did not settle until January 2007. In September 2006, we repurchased 359,200 shares of our common stock for $20.6 million that did not settle until October 2006. These outstanding purchases were recorded in accounts payable at December 31, 2006 and September 30, 2006.

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — An Amendment of FASB Statements No. 87, 88, 106, and 132R (SFAS 158). SFAS 158 requires companies to recognize the funded status of pension and other postretirement benefit plans on sponsoring employers’ balance sheets and to recognize changes in the funded status in the year the changes occur. It also requires the measurement date of plan assets and obligations to occur at the end of the employers’ fiscal year. SFAS 158 is effective for us at the end of fiscal 2007, except for the change in measurement date, which is effective for us in fiscal 2009. Based on the funded status of our pension and postretirement benefit plans as reported in our Annual Report on Form 10-K dated September 30, 2006, we would have recorded approximately a 15 percent decrease in shareowners’ equity had SFAS 158 been effective at that date. It is unlikely that FAS 158 will affect our results of operations, our loan covenant compliance or our other financial arrangements. The ultimate effect on our financial statements depends upon the discount rate at our fiscal 2007 measurement date (June 30, 2007) and actual returns on our pension plan assets during the year.

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 will be effective for us beginning in fiscal 2008. We are evaluating the interpretation to determine the effect on our financial statements and related disclosures.

Effective October 1, 2005, we adopted SFAS 123(R), Share-Based Payment (SFAS 123(R)), using the modified prospective application transition method. Before we adopted SFAS 123(R), we accounted for share-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. We recognized $7.0 million and $5.8 million in share-based compensation expense in income from continuing operations during the three-months ended December 31, 2006 and 2005, respectively.

Our annual grant of share-based compensation generally takes place during the first quarter of each fiscal year. The number of shares granted to all employees and the weighted average fair value per share during the periods presented was (in thousands except per share amounts):

In December 2005, our Architecture & Software segment acquired Datasweep, Inc., a provider of production management software. The results of operations of this business have been included in our Condensed Consolidated Statement of Operations since the date of acquisition. Pro forma financial information and allocation of the purchase price is not presented as the effects of this acquisition are not material to our results of operations and financial position.

Inventories consist of (in millions):

We report inventories net of the allowance for excess and obsolete inventory of $34.6 million at December 31, 2006 and $31.4 million at September 30, 2006.

Property consists of (in millions):

Changes in the carrying amount of goodwill for the three months ended December 31, 2006 are (in millions):

Other intangible assets consist of (in millions):

The Allen-Bradley^® and Caribbean Integration Engineers^TM trademarks have been determined to have an indefinite life, and therefore are not subject to amortization.

Estimated amortization expense is $24.0 million in 2007, $22.0 million in 2008, $15.8 million in 2009, $7.4 million in 2010 and $6.2 million in 2011.

We performed the annual evaluation of our goodwill and indefinite life intangible assets for impairment as required by SFAS No. 142, Goodwill and Other Intangible Assets, during the first quarter of 2007 and concluded that no impairments exist. This evaluation, which we have historically performed in our second fiscal quarter, took place in the first quarter this year due to our change in operating segments. It is our intention to perform this test again in the second fiscal quarter of 2007 and continue to perform this test in the second fiscal quarter of future years.

Other current liabilities consist of (in millions):

We record a liability for product warranty obligations at the time of sale to a customer based upon historical warranty experience. Most of our products are covered under a warranty period that runs for twelve months from either the date of sale or from installation to an end-user or OEM customer. We also record a liability for specific warranty matters when they become probable and reasonably estimable. Our product warranty obligations are included in other current liabilities in the Condensed Consolidated Balance Sheet.

Changes in the product warranty obligations for the three months ended December 31, 2006 and 2005 are (in millions):

Long-term debt consists of (in millions):

We issued an aggregate of $800 million principal amount of our 6.15% notes, 6.70% debentures and 5.20% debentures in January 1998. The debt offering yielded approximately $750.0 million of proceeds. We issued the 5.20% debentures at a discount, and the 6.15% notes and 6.70% debentures at par.

In September 2002, we entered into an interest rate swap contract (the Swap) that effectively converted our $350.0 million aggregate principal amount of 6.15% notes, payable in 2008, to floating rate debt based on six-month LIBOR. The floating rate was 8.02 percent at December 31, 2006 and September 30, 2006. As permitted by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133), as amended, we have designated the Swap as a fair value hedge. Accordingly, the fair value of the Swap was recorded in other liabilities in the Condensed Consolidated Balance Sheet with a corresponding adjustment to the carrying value of the underlying debt at December 31, 2006 and September 30, 2006. The fair value of the Swap, based upon quoted market prices for contracts with similar maturities, was a liability of $5.7 million at December 31, 2006 and a liability of $6.8 million at September 30, 2006.

On October 26, 2004, we entered into a five-year $600.0 million unsecured revolving credit facility. On September 29, 2006, we entered into a 364-day $250.0 million unsecured revolving credit facility. Both credit facilities remain in effect and we have not drawn down under either of them at December 31, 2006 or September 30, 2006. Borrowings under these credit facilities bear interest based on short-term money market rates in effect during the period the borrowings are outstanding. The terms of these credit facilities contain covenants under which we would be in default if our debt-to-total-capital ratio was to exceed 60 percent. We were in compliance with all covenants under these credit facilities at December 31, 2006 and September 30, 2006. In addition to our $600.0 and $250.0 million credit facilities, short-term unsecured credit facilities of approximately $118.8 million at December 31, 2006 were available to foreign subsidiaries. There were no significant commitment fees or compensating balance requirements under any of our credit facilities. Borrowings under our credit facilities during the three months ended December 31, 2006 and 2005 were not significant.

Our short-term debt obligations primarily relate to commercial paper borrowings. Commercial paper borrowings outstanding were $530.0 million at December 31, 2006 and $219.0 million at September 30, 2006. At December 31, 2006 the weighted average interest rate and maturity period of the commercial paper outstanding were 5.4 percent and 19 days, respectively. At September 30, 2006 the weighted average interest rate and maturity period of the commercial paper outstanding were 5.4 percent and three days, respectively.

The components of net periodic benefit cost in income from continuing operations are (in millions):

Included in income from discontinued operations in the Condensed Consolidated Statement of Operations is pre-tax pension benefit cost of $1.4 million and $3.0 million and pre-tax other postretirement benefit cost of $2.0 million and $4.2 million for the three months ended December 31, 2006 and December 31, 2005, respectively. We will retain the pension liability related to the eligible Power Systems participants in our U.S. Plan and Canada Salary Plan and the other postretirement benefit liability for eligible U.S. non-union and Canada Salary retirees after the date of sale of our Dodge mechanical and Reliance Electric motors and motor repair services businesses, which will result in ongoing net periodic benefit cost for us. Pension liabilities for our Canada Hourly Plan and Mexico Dodge Plan, as well as other postretirement liabilities, including for U.S. union active and retiree participants, will be transferred with these businesses.

In the first three months of 2007 and 2006, we made a voluntary contribution of $8.0 million and $450.0 million, respectively, to our U.S. qualified pension plan trust, which increased our prepaid pension asset in the Condensed Consolidated Balance Sheet.

Comprehensive income consists of (in millions):

Various lawsuits, claims and proceedings have been or may be instituted or asserted against us relating to the conduct of our business, including those pertaining to product liability, safety and health, intellectual property, employment and contract matters. Although the outcome of litigation cannot be predicted with certainty and some lawsuits, claims or proceedings may be disposed of unfavorably to us, we believe the disposition of matters that are pending or have been asserted will not have a material adverse effect on our business or financial condition.

We (including our subsidiaries) have been named as a defendant in lawsuits alleging personal injury as a result of exposure to asbestos that was used in certain components of our products many years ago. Currently there are thousands of claimants in lawsuits that name us as defendants, together with hundreds of other companies. The great bulk of the complaints, however, do not identify any of our products or specify which of these claimants, if any, were exposed to asbestos attributable to our products; and past experience has shown that the vast majority of the claimants will never identify any of our products. In addition, when our products appear to be identified, in some cases they are from divested businesses, and we are indemnified for most of the costs. However, we have agreed to defend and indemnify against asbestos claims associated with products manufactured or sold by our Dodge mechanical and Reliance Electric motors and motor repair services businesses prior to their divestiture by us, which is expected to occur on or about January 31, 2007. But in all cases, for those claimants who do show that they worked with our products, we nevertheless believe we have meritorious defenses, in substantial part due to the integrity of our products, the encapsulated nature of any asbestos-containing components, and the lack of any impairing medical condition on the part of many claimants. We defend those cases vigorously. Historically, we have been dismissed from the vast majority of these claims with no payment to claimants.

We have maintained insurance coverage that we believe covers indemnity and defense costs, over and above self-insured retentions, for most of these claims. We initiated litigation in the Milwaukee County Circuit Court on February 12, 2004 to enforce the insurance policies against Nationwide Indemnity Company and Kemper Insurance, the insurance carriers that provided liability insurance coverage to our former Allen-Bradley subsidiary. As a result, the insurance carriers have paid some past defense and indemnity costs and have agreed to pay the substantial majority of future defense and indemnity costs for Allen-Bradley asbestos claims, subject to policy limits. If either carrier becomes insolvent or the policy limits of either carrier are exhausted, our share of future defense and indemnity costs may increase. However, coverage under excess policies may be available to pay some or all of these costs.

The uncertainties of asbestos claim litigation and the long term solvency of our insurance carriers make it difficult to predict accurately the ultimate outcome of asbestos claims. That uncertainty is increased by the possibility of adverse rulings or new legislation affecting asbestos claim litigation or the settlement process. Subject to these uncertainties and based on our experience defending asbestos claims, we do not believe these lawsuits will have a material adverse effect on our financial condition.

In connection with the divestiture of our former aerospace and defense businesses (the A&D Business) to The Boeing Company (Boeing), we agreed to indemnify Boeing for certain matters related to operations of the A&D Business for periods prior to the divestiture. In connection with the spinoffs of our former automotive component systems business, semiconductor systems business and Rockwell Collins avionics and communications business, the spun-off companies have agreed to indemnify us for substantially all contingent liabilities related to the respective businesses, including environmental and intellectual property matters.

We have, from time to time, divested certain of our businesses. In connection with such divestitures, lawsuits, claims and proceedings may be instituted or asserted against us related to the period that we owned the businesses.

In many countries we provide a limited intellectual property indemnity as part of our terms and conditions of sale. We also at times provide limited intellectual property indemnities in other contracts with third parties, such as contracts concerning: the development and manufacture of our products; the divestiture of businesses; and the licensing of intellectual property. Due to the number of agreements containing such provisions, we are unable to estimate the maximum potential future payments. However, we believe that future payments, if any, would not be material to our business or financial condition.

Our minimum future rental commitments under operating leases having noncancelable lease terms in excess of one year aggregated $276.0 million as of December 31, 2006 and are payable as follows (in millions):

Most of our operating leases contain renewal options for varying periods, and certain leases include options to purchase the leased property. Commitments from third parties under sublease agreements having noncancelable lease terms in excess of one year aggregated $9.9 million as of December 31, 2006 and are receivable through 2009 at approximately $3.4 million per year.

The following is a summary of the composition of income from discontinued operations included in the Condensed Consolidated Statement of Operations (in millions):

Our Dodge mechanical and Reliance Electric motors and motor repair services businesses are reported as a discontinued operation in the Condensed Consolidated Financial Statements for all periods presented. Related assets and liabilities that we have agreed to sell are classified as assets available for sale and liabilities associated with assets available for sale in the Condensed Consolidated Balance Sheet. Refer to Note 1 for additional information on this pending divestiture.

During the second quarter of 2006, our Architecture & Software segment sold the assets of our ElectroCraft Engineered Solutions business. Accordingly, we reflected the results of this business as a discontinued operation for all periods presented.

During the quarter ended December 31, 2006, we incurred $1.0 million ($0.6 million after-tax) of legal fees associated with the former Rockwell International Corporation’s former operation of the Rocky Flats facility for the U.S. Department of Energy.

Summarized results of discontinued operations are (in millions):

The assets classified as available for sale and the liabilities classified as associated with assets available for sale in the Condensed Consolidated Balance Sheet are:

The base tax rate determined as provided under Income Taxes in Note 1 (which excludes the effect of significant unusual or extraordinary items or items that are reported net of their related tax effects) for the full year is estimated at 31 percent based on our current forecast of pretax income, permanent book and tax differences and global tax planning strategies for our continuing operations. The effective tax rate for the first quarter of 2007 was 30 percent, which is lower than the base rate as it includes the resolution of various tax matters during the quarter.

The tax rate applied to our discontinued operations was approximately 33 percent. This rate reflects that most of the taxable income from discontinued operations is generated in higher tax jurisdictions. The income tax benefit of $264.0 million on pending divestiture represents recognition of a deferred tax asset on the difference between our tax basis in the stock of the Power Systems subsidiaries that are being sold and the book value of their net assets as well as the reversal of the deferred tax liabilities that will not be realized due to the stock sale. In accordance with the FASB Emerging Issues Task Force Issue 93-17, Recognition of Deferred Tax Assets for a Parent Company’s Excess Tax Basis in the Stock of a Subsidiary that Is Accounted for as a Discontinued Operation, the tax benefit is recognized upon classification of the subsidiaries as a discontinued operation.

Rockwell Automation is a provider of industrial automation control and information products and services. We determine our operating segments based on the information used by our chief operating decision maker, our Chief Executive Officer, to allocate resources and assess performance. Based upon these criteria, we are organized based upon products and services and have two operating segments: Architecture & Software and Control Products & Solutions.

The Architecture & Software segment contains all elements of our integrated control and information architecture capable of connecting the customer’s entire manufacturing enterprise.

Architecture & Software’s Integrated Architecture™ and Logix controllers perform multiple types of control and monitoring applications, including discrete, batch, continuous process, drive system, motion and machine safety across various industrial machinery, plants and processes, and supply real time information to supervisory software and plant-wide information systems.

Architecture & Software’s products include control platforms, software, I/O devices, communication networks, high performance rotary and linear motion control systems, electronic operator interface devices, condition based monitoring systems, sensors, industrial computers and machine safety components. These products are deployed widely across industries to end users and OEMs to reduce total cost of ownership, maximize asset utilization, improve time to market and reduce manufacturing business risk.

The Control Products & Solutions segment combines a comprehensive portfolio of intelligent motor control and industrial control products, with the customer support and application knowledge necessary to implement an automation or information solution on the plant floor. This comprehensive portfolio includes:

Low voltage and medium voltage electro-mechanical and electronic motor starters, motor and circuit protection devices, AC/DC variable frequency drives, push buttons, signaling devices, relays and timers and condition sensors.

Value-added packaged solutions, including configured drives, motor control centers and custom engineered panels for OEM and end-user applications.

Automation and information solutions, including custom-engineered hardware and software systems for discrete, process, motion, drives and manufacturing information applications.

Services designed to help to maximize a customer’s automation investment and provide total life-cycle support, including multi-vendor customer technical support and repair, asset management and training.

The following tables reflect the sales and operating results of our reportable segments (in millions):

Among other considerations, we evaluate performance and allocate resources based upon segment operating earnings before income taxes, interest expense, costs related to corporate offices, certain nonrecurring corporate initiatives, gains and losses from the disposition of businesses, earnings and losses from equity affiliates that are not considered part of the operations of a particular segment and incremental acquisition related expenses resulting from purchase accounting adjustments such as intangible asset amortization, depreciation, inventory and purchased research and development charges. Depending on the product, intersegment sales that are within a single legal entity are either at cost or cost plus a mark-up, which does not necessarily represent a market price. Sales between legal entities are at an appropriate transfer price. Costs incurred related to shared segment operating activities are allocated to the segments using a methodology consistent with the expected benefit.

Identifiable assets for each of our operating segments and Corporate were (in millions):

Identifiable assets at Corporate consist principally of cash, net deferred income tax assets, prepaid pension and property. Property shared by the segments and used in operating activities is also reported in Corporate identifiable assets. Corporate identifiable assets include shared net property balances of $170.9 million at December 31, 2006 and $144.4 million at September 30, 2006 for which depreciation expense has been allocated to segment operating earnings based on the expected benefit to be realized by each segment.

economic and political changes in global markets where we compete, such as currency exchange rates, inflation rates, interest rates, recession, policies of foreign governments and other external factors we cannot control, and U.S. and local laws affecting our activities abroad and compliance therewith;

successful development of advanced technologies and demand for and market acceptance of new and existing products;

general global and regional economic, business or industry conditions, including levels of capital spending in industrial markets;

the availability, effectiveness and security of our legacy and future information technology systems;

competitive product and pricing pressures;

disruption of our operations due to natural disasters, acts of war, strikes, terrorism, or other causes;

intellectual property infringement claims by others and the ability to protect our intellectual property;

the successful execution of our Power Systems divestiture strategy and redeployment of cash proceeds;

our ability to successfully address claims by taxing authorities in the various jurisdictions where we do business;

our ability to attract and retain qualified personnel;

the uncertainties of litigation;

disruption of our North American distribution channel;

the availability and price of components and materials; and

other risks and uncertainties, including but not limited to those detailed from time to time in our Securities and Exchange Commission filings.

investments in manufacturing capacity, including upgrades, modifications, and expansions of existing manufacturing facilities, and the creation of new manufacturing facilities;

our customers’ needs for greater productivity, cost reduction, quality, and overall global competitiveness;

industry factors that include our customers’ new product introductions, trends in the actual and forecasted demand for our customers’ products or services, and the regulatory and competitive environments in which our customers operate;

levels of global industrial production;

regional factors that include local political, social, regulatory and economic circumstances; and

the seasonal capital spending patterns of our customers due to their annual capital budgeting processes and their working schedules.

Industrial Equipment Spending, which is an economic statistic compiled by the Bureau of Economic Analysis (BEA). This statistic provides insight into spending trends in the broad U.S. industrial economy, which includes our primary customer base. This measure, over the longer term, has proven to have reasonable predictive value, and to be a good directional indicator of our growth trend.

Capacity Utilization, which is an indication of plant operating activity published by the Federal Reserve. Historically there has been a meaningful correlation between Capacity Utilization and the level of capital investment made by our customers in their manufacturing base.

The Purchasing Managers’ Index (PMI), published by the Institute for Supply Management (ISM), which is an indication of the level of manufacturing activity in the U.S. According to the ISM, a PMI measure above 50 indicates that the manufacturing economy is generally expanding while a measure below 50 indicates that it is generally contracting.

We attribute sales to the geographic regions based upon country of destination.

See Supplemental Information for information on this non-GAAP measure.

Successfully complete the divestiture of the principal businesses of our former Power Systems operating segment;

Execute our cost productivity initiatives;

Continue our globalization efforts with a particular focus on emerging markets; and

Sustain the growth of our integrated control and information architecture by accelerating the proliferation and adoption rate, enhancing features and functionality, aggressively pursuing growth in an expanded addressable market and enhancing our market access.