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ROCKWELL AUTOMATION INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Results of Operations Forward Looking Statement This Quarterly Report contains statements (including certain projections and business trends) that are "forward looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Words such as "believe", "estimate", "project", "plan", "expect", "anticipate", "will", "intend" and other similar expressions may identify forward looking statements. Actual results may differ materially from those projected as a result of certain risks and uncertainties, many of which are beyond our control, including but not limited to: • macroeconomic factors, including global and regional business conditions, the availability and cost of capital, the cyclical nature of our customers' capital spending, sovereign debt concerns and currency exchange rates; • laws, regulations and governmental policies affecting our activities in the countries where we do business; • the successful development of advanced technologies and demand for and market acceptance of new and existing products; • the availability, effectiveness and security of our information technology systems; • competitive products, solutions and services and pricing pressures, and our ability to provide high quality products, solutions and services; • a disruption of our business due to natural disasters, acts of war, strikes, terrorism, social unrest or other causes; • intellectual property infringement claims by others and the ability to protect our intellectual property; • our ability to address claims by taxing authorities in the various jurisdictions where we do business; • our ability to attract and retain qualified personnel; • our ability to manage costs related to employee retirement and health care benefits; • the uncertainties of litigation, including liabilities related to the safety and security of the products, solutions and services we sell; • our ability to manage and mitigate the risks associated with our solutions and services businesses; • a disruption of our distribution channels; • the availability and price of components and materials; • the successful integration and management of acquired businesses; • the successful execution of our cost productivity and globalization initiatives; and • other risks and uncertainties, including but not limited to those detailed from time to time in our Securities and Exchange Commission (SEC) filings. These forward looking statements reflect our beliefs as of the date of filing this report. We undertake no obligation to update or revise any forward looking statement, whether as a result of new information, future events or otherwise. See Item 1A, Risk Factors of our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 for more information. Non-GAAP Measures The following discussion includes organic sales, total segment operating earnings and margin, Adjusted Income, Adjusted EPS, Adjusted Effective Tax Rate and free cash flow, which are non-GAAP measures. See Supplemental Sales Information for a reconciliation of reported sales to organic sales and a discussion of why we believe this non-GAAP measure is useful to investors. See Results of Operations for a reconciliation of income before income taxes to total segment operating earnings and margin and a discussion of why we believe these non-GAAP measures are useful to investors. See Results of Operations for a reconciliation of income from continuing operations, diluted EPS from continuing operations and effective tax rate to Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate and a discussion of why we believe these non-GAAP measures are useful to investors. See Financial Condition for a reconciliation of cash flows from operating activities to free cash flow and a discussion of why we believe this non-GAAP measure is useful to investors. 20-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Overview We are a leading global provider of industrial automation power, control and information solutions that help manufacturers achieve a competitive advantage for their businesses. Overall demand for our products, services and solutions is driven by: • investments in manufacturing, including upgrades, modifications and expansions of existing facilities or production lines, and new facilities or production lines; • investments in basic materials production capacity, which may be related to commodity pricing levels; • our customers' needs for faster time to market, lower total cost of ownership, improved asset utilization and optimization, and enterprise risk management; • industry factors that include our customers' new product introductions, demand for our customers' products or services, and the regulatory and competitive environments in which our customers operate; • levels of global industrial production and capacity utilization; • regional factors that include local political, social, regulatory and economic circumstances; and • the spending patterns of our customers due to their annual budgeting processes and their working schedules. Long-term Strategy Our vision of being the most valued global provider of innovative industrial automation and information products, services and solutions is supported by our growth and performance strategy, which seeks to: • achieve growth rates in excess of the automation market by expanding our served market and strengthening our competitive differentiation; • diversify our sales streams by broadening our portfolio of products, solutions and services, expanding our global presence and serving a wider range of industries and applications; • grow market share by gaining new customers and by capturing a larger share of existing customers' spending; • enhance our market access by building our channel capability and partner network; • make acquisitions that serve as catalysts to organic growth by adding complementary technology, expanding our served market, enhancing our domain expertise or continuing our geographic diversification; • deploy human and financial resources to strengthen our technology leadership and our intellectual capital business model; • continuously improve quality and customer experience; and • drive annual cost productivity. By implementing the strategy above, we seek to achieve our long-term financial goals that include revenue growth of 6-8 percent, double-digit EPS growth, return on invested capital in excess of 20 percent and free cash flow equal to about 100 percent of Adjusted Income. Acquisitions Our acquisition strategy focuses on products, solutions and services that will be catalytic to the organic growth of our core offerings. In January 2014, we acquired Jacobs Automation, a leader in intelligent track motion control technology. This technology improves performance across a wide range of packaging, material handling, and other applications for the global machine builder market. In November 2013, we acquired vMonitor LLC and its affiliates, a global technology leader for wireless solutions in the oil and gas industry. This acquisition is expected to strengthen our ability to deliver end-to-end projects for the oil and gas sector and accelerate our development of similar process solutions and remote monitoring services for water / wastewater, mining and other industries globally. In October 2012, we acquired certain assets of the medium voltage drives business of Harbin Jiuzhou Electric Co., Ltd., a leading manufacturer of medium voltage drives, direct current power supplies, switch gear and wind inverters, headquartered in Harbin, China. The acquisition strengthened our presence in the Asia Pacific motor control market by adding significant capabilities in design, engineering and manufacturing of medium voltage drive products. We believe these acquisitions will help us expand our served market and deliver value to our customers. 21-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. U. S. Industrial Economic Trends In the third quarter of 2014, sales to U.S. customers accounted for 51 percent of our total sales. The various indicators we use to gauge the direction and momentum of our served U.S. markets include: • The Industrial Production Index (IP), published by the Federal Reserve, which measures the real output of manufacturing, mining, and electric and gas utilities. The Industrial Production Index is expressed as a percentage of real output in a base year, currently 2007. Historically there has been a meaningful correlation between the changes in the Industrial Production Index and the level of automation investment made by our U.S. customers in their manufacturing base. • The Manufacturing Purchasing Managers' Index (PMI), published by the Institute for Supply Management (ISM), which is an indicator of the current and near-term state of manufacturing activity in the U.S. According to the ISM, a PMI measure above 50 indicates that the U.S. manufacturing economy is generally expanding while a measure below 50 indicates that it is generally contracting. • 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. This measure over the longer term has proven to demonstrate a reasonable correlation with our domestic growth. • Capacity Utilization (Total Industry), which is an indicator of plant operating activity published by the Federal Reserve. Historically there has been a meaningful correlation between Capacity Utilization and levels of U.S. industrial production. The table below depicts the trends in these indicators since the quarter ended September 2012. The PMI improved in the third quarter of fiscal 2014 and remains above 50, indicating expansion in the U.S. manufacturing sector. IP and Capacity Utilization continued to improve after a stable fiscal 2013. Consistent with forecasts for these key macroeconomic indicators, we expect market conditions in the U.S. to continue to improve in the fourth quarter of fiscal 2014. Industrial Industrial Equipment Capacity Production Spending Utilization Index PMI (in billions) (percent) Fiscal 2014 Quarter ended: June 2014 103.6 55.3 233.7 79.1 March 2014 102.2 53.7 222.7 78.6 December 2013 101.3 56.5 214.5 78.4 Fiscal 2013 Quarter ended: September 2013 100.1 56.0 213.6 77.9 June 2013 99.4 52.5 205.4 77.8 March 2013 99.0 51.5 205.7 77.7 December 2012 98.0 50.4 204.6 77.3 Fiscal 2012 Quarter ended: September 2012 97.4 52.2 200.9 77.2 Note: Economic indicators are subject to revisions by the issuing organizations. 22-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Non-U.S. Economic Trends In the third quarter of 2014, sales to non-U.S. customers accounted for 49 percent of our total sales. These customers include both indigenous companies and multinational companies with expanding global presence. In addition to the global factors previously mentioned in the "Overview" section, international demand, particularly in emerging markets, has historically been driven by the strength of the industrial economy in each region, investments in infrastructure and expanding consumer markets. We use changes in the respective countries' Gross Domestic Product (GDP) and Industrial Production as indicators of the market conditions in each region where we do business. Outside the U.S., we expect overall market conditions to improve in the fourth quarter with mixed performance among and within regions. European macroeconomic conditions are slowly improving with strength in the U.K., but tepid growth on the continent has raised deflationary concerns and led the European Central Bank to lower interest rates. Asia Pacific's Industrial Production improved in the quarter and is expected to remain stable for the fourth quarter of fiscal 2014. Government stimulus in China is helping to offset the negative impacts of a declining housing and construction sector. In India, recent electoral results have boosted optimism for long-term economic reforms, but current economic conditions remain weak. Latin America's reported Industrial Production in the third quarter declined from the prior year due to weakness in Brazil and deepening recessions in Venezuela and Argentina as a result of their fiscal and currency crises. Mexico's outlook is improving due to strength in North American demand and higher levels of direct investment. We continue to expect that emerging markets in aggregate will be the fastest growing automation markets over the long term. 23-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Summary of Results of Operations Sales in the third quarter of 2014 increased 2 percent compared to the third quarter of 2013. Organic sales also increased 2 percent year over year in the quarter. Oil and gas continued to be the strongest performing industry. The following is a summary of our results related to key growth initiatives: • Logix sales increased 7 percent year over year in the third quarter of 2014. Logix organic sales also increased 7 percent, with the highest growth in Canada. • Sales related to our process initiative increased approximately 6 percent year over year in the third quarter of 2014. • Sales in emerging markets decreased 5 percent year over year in the third quarter of 2014. Organic sales decreased 2 percent year over year compared to very strong sales in our solutions and services businesses in the third quarter of 2013. Acquisitions increased sales in emerging markets by 1 percentage point, and currency translation reduced sales in emerging markets by 4 percentage points. Organic sales in emerging markets increased 6 percent year over year in the nine months ended June 30, 2014, led by China, Brazil, and Mexico. 24-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. The following table reflects our sales and operating results for the three and nine months ended June 30, 2014 and 2013 (in millions, except per share amounts): Three Months Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Sales Architecture & Software $ 715.2 $ 671.0 $ 2,097.9 $ 1,967.7 Control Products & Solutions 934.3 953.2 2,743.8 2,668.5 Total sales (a) $ 1,649.5 $ 1,624.2 $ 4,841.7 $ 4,636.2 Segment operating earnings1 Architecture & Software $ 204.8 $ 188.6 $ 606.9 $ 541.7 Control Products & Solutions 121.3 129.2 349.3 337.3 Total segment operating earnings2 (b) 326.1 317.8 956.2 879.0 Purchase accounting depreciation and amortization (5.5 ) (4.6 ) (15.9 ) (14.8 ) General corporate - net (18.1 ) (20.9 ) (58.7 ) (57.5 ) Non-operating pension costs (14.1 ) (19.6 ) (42.1 ) (59.0 ) Interest expense (14.4 ) (15.3 ) (44.3 ) (46.0 ) Income before income taxes (c) 274.0 257.4 795.2 701.7 Income tax provision (74.3 ) (53.7 ) (217.1 ) (160.7 ) Net income $ 199.7 $ 203.7 $ 578.1 $ 541.0 Diluted EPS $ 1.43 $ 1.45 $ 4.12 $ 3.83 Adjusted EPS3 $ 1.49 $ 1.54 $ 4.32 $ 4.09 Diluted weighted average outstanding shares 139.6 140.4 140.0 141.1 Total segment operating margin2 (b/a) 19.8 % 19.6 % 19.7 % 19.0 % Pre-tax margin (c/a) 16.6 % 15.8 % 16.4 % 15.1 % (1) See Note 13 in the Condensed Consolidated Financial Statements for the definition of segment operating earnings. (2) Total segment operating earnings and total segment operating margin are non-GAAP financial measures. We believe that these measures are useful to investors as measures of operating performance. We use these measures to monitor and evaluate the profitability of our operating segments. Our measures of total segment operating earnings and total segment operating margin may be different from measures used by other companies. (3) Adjusted EPS is a non-GAAP earnings measure that excludes the non-operating pension costs and their related income tax effects. See Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate Reconciliation for more information on this non-GAAP measure. 25-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC.Purchase accounting depreciation and amortization and non-operating pension costs are not allocated to our operating segments because these costs are excluded from our measurement of each segment's operating performance for internal purposes. If we were to allocate these costs, we would attribute them to each of our segments as follows (in millions): Three Months Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Purchase accounting depreciation and amortization Architecture & Software $ 1.1 $ 0.9 $ 3.0 $ 3.0 Control Products & Solutions 4.2 3.5 12.2 11.0 Non-operating pension costs Architecture & Software 5.2 6.9 15.5 20.7 Control Products & Solutions 8.1 11.7 24.3 35.1 The decreases in non-operating pension costs in both segments in the three and nine months ended June 30, 2014 were primarily due to the increase in our U.S. discount rate used to measure net periodic pension cost from 4.15 percent in 2013 to 5.05 percent in 2014. 26-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC.Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate Reconciliation Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate are non-GAAP earnings measures that exclude non-operating pension costs and their related income tax effects. We define non-operating pension costs as defined benefit plan interest cost, expected return on plan assets, amortization of actuarial gains and losses and the impact of any plan curtailments or settlements. These components of net periodic pension cost primarily relate to changes in pension assets and liabilities that are a result of market performance; we consider these costs to be unrelated to the operating performance of our business. We believe that Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate provide useful information to our investors about our operating performance and allow management and investors to compare our operating performance period over period. Our measures of Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate may be different from measures used by other companies. These non-GAAP measures should not be considered a substitute for income from continuing operations, diluted EPS and effective tax rate. The following are the components of operating and non-operating pension costs for the three and nine months ended June 30, 2014 and 2013 (in millions): Three Months Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Service cost $ 19.7 $ 22.9 $ 59.0 $ 69.0 Amortization of prior service credit (0.7 ) (0.6 ) (2.1 ) (1.9 ) Operating pension costs 19.0 22.3 56.9 67.1 Interest cost 43.6 40.0 130.8 120.2 Expected return on plan assets (54.5 ) (56.5 ) (163.5 ) (169.7 ) Amortization of net actuarial loss 25.0 36.1 74.8 108.5 Non-operating pension costs 14.1 19.6 42.1 59.0 Net periodic pension cost $ 33.1 $ 41.9 $ 99.0 $ 126.1 The following are reconciliations of income from continuing operations, diluted EPS from continuing operations, and effective tax rate to Adjusted Income, Adjusted EPS and Adjusted Effective Tax Rate for the three and nine months ended June 30, 2014 and 2013 (in millions, except per share amounts): Three Months Ended Nine Months Ended June 30, June 30, 2014 2013 2014 2013 Income from continuing operations $ 199.7 $ 203.7 $ 578.1 $ 541.0 Non-operating pension costs 14.1 19.6 42.1 59.0 Tax effect of non-operating pension costs (5.1 ) (7.2 ) (15.1 ) (21.5 ) Adjusted Income $ 208.7 $ 216.1 $ 605.1 $ 578.5 Diluted EPS from continuing operations $ 1.43 $ 1.45 $ 4.12 $ 3.83 Non-operating pension costs per diluted share, before tax 0.10 0.14 0.30 0.42 Tax effect of non-operating pension costs per diluted share (0.04 ) (0.05 ) (0.10 ) (0.16 ) Adjusted EPS $ 1.49 $ 1.54 $ 4.32 $ 4.09 Effective tax rate 27.1 % 20.9 % 27.3 % 22.9 % Tax effect of non-operating pension costs 0.5 % 1.1 % 0.4 % 1.1 % Adjusted Effective Tax Rate 27.6 % 22.0 % 27.7 % 24.0 % 27-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC.Three and Nine Months Ended June 30, 2014 Compared to Three and Nine Months Ended June 30, 2013 Three Months Ended June 30, Nine Months Ended June 30, (in millions, except per share amounts) 2014 2013 Change 2014 2013 Change Sales $ 1,649.5 $ 1,624.2 $ 25.3 $ 4,841.7 $ 4,636.2 $ 205.5 Income before income taxes 274.0 257.4 16.6 795.2 701.7 93.5 Diluted EPS 1.43 1.45 (0.02 ) 4.12 3.83 0.29 Adjusted EPS 1.49 1.54 (0.05 ) 4.32 4.09 0.23 Sales Our sales increased 2 percent and 4 percent in the three and nine months ended June 30, 2014, respectively, compared to the three and nine months ended June 30, 2013. Organic sales increased 2 percent and 5 percent year over year in the three and nine months ended June 30, 2014, respectively. The net effect of currency translation and acquisitions reduced sales by 1 percentage point in the nine months ended June 30, 2014. Pricing contributed approximately 1 percentage point to sales growth in the three and nine months ended June 30, 2014. 28-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. The tables below present our sales, attributed to the geographic regions based upon country of destination, for the three and nine months ended June 30, 2014 and the change from the same period a year ago (in millions, except percentages): Change in Organic Change vs. Sales1 vs. Three Months Three Months Ended Ended June 30, Three Months Ended June 30, 2014 2013 June 30, 2013 United States $ 845.9 5 % 5 % Canada 113.3 (14 )% (8 )% Europe, Middle East and Africa (EMEA) 336.7 6 % 1 % Asia Pacific 220.5 (1 )% - % Latin America 133.1 (7 )% - % Total Sales $ 1,649.5 2 % 2 % Change in Organic Change vs. Sales vs. Nine Months Ended Nine MonthsEnded Nine Months Ended June June 30, 2014 June 30, 2013 30, 2013 United States $ 2,515.2 7 % 7 % Canada 321.0 (9 )% (3 )% Europe, Middle East and Africa (EMEA) 1,001.1 7 % 3 % Asia Pacific 627.8 3 % 5 % Latin America 376.6 (5 )% 4 % Total Sales $ 4,841.7 4 % 5 % 1 Organic sales are sales excluding the effect of changes in currency exchange rates and acquisitions. See Supplemental Sales Information for information on this non-GAAP measure. • Solid sales growth in the United States in the three and nine months ended June 30, 2014 was realized broadly across industries, with the highest growth in the oil and gas industry. • Sales in Canada declined in the three and nine months ended June 30, 2014 due to the unfavorable impact of foreign currency translation and continued weakness in solutions and services in resource-based industries, partially offset by growth in our product businesses. • EMEA sales in the three and nine months ended June 30, 2014 grew as a result of both the favorable impact of foreign currency translation and organic sales growth. Organic sales growth in the three and nine months ended June 30, 2014 included strong product sales to OEM customers. Organic sales in the three months ended June 30, 2014 were negatively impacted by variability in our solutions and services businesses. • Asia Pacific sales declined in the three months ended June 30, 2014 due to the unfavorable impact of foreign currency translation. Organic sales in Asia Pacific were flat in the three months ended June 30, 2014 due to sales declines in the solutions and services businesses compared to very strong sales in those businesses in the third quarter of 2013. The declines were offset by strength in the Architecture & Software segment this year. Sales growth in the nine months ended June 30, 2014 was driven by strength in our product businesses, led by China. • Latin America sales declined in the three and nine months ended June 30, 2014 due to the unfavorable impact of foreign currency translation. Latin America organic sales were flat in the three months ended June 30, 2014 due to sales declines in the solutions and services businesses compared to very strong sales in those businesses in the third quarter of 2013. The declines were offset by strength in the Architecture & Software segment this year. Organic growth in the region for the nine months ended June 30, 2014 was driven by strong sales in Brazil and Mexico that more than offset sales declines in the rest of the region. 29-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Three and Nine Months Ended June 30, 2014 Compared to Three and Nine Months Ended June 30, 2013 General Corporate - Net General corporate - net expenses were $18.1 million and $58.7 million in the three and nine months ended June 30, 2014, respectively, compared to $20.9 million and $57.5 million in the three and nine months ended June 30, 2013, respectively. Income before Income Taxes Income before income taxes increased 6 percent and 13 percent year over year in the three and nine months ended June 30, 2014, respectively, primarily due to an increase in segment operating earnings and lower non-operating pension costs. Total segment operating earnings increased 3 percent and 9 percent year over year in the three and nine months ended June 30, 2014, respectively, primarily due to higher sales and favorable mix, partially offset by increased spending and variable compensation expense. Income Taxes The effective tax rate in the three months ended June 30, 2014 was 27.1 percent compared to 20.9 percent in the three months ended June 30, 2013. Our Adjusted Effective Tax Rate in the three months ended June 30, 2014 was 27.6 percent compared to 22.0 percent in the three months ended June 30, 2013. The increases in the effective tax rate and the Adjusted Effective Tax Rate were primarily due to the non-recurrence of favorable prior period tax matters recognized in the third quarter of 2013. The effective tax rate in the nine months ended June 30, 2014 was 27.3 percent compared to 22.9 percent in the nine months ended June 30, 2013. Our Adjusted Effective Tax Rate in the nine months ended June 30, 2014 was 27.7 percent compared to 24.0 percent in the nine months ended June 30, 2013. The increases in the effective tax rate and the Adjusted Effective Tax Rate were primarily due to prior period tax matters, the retroactive extension of the U.S. federal research and development tax credit (U.S. research tax credit) in the second quarter of 2013, and the expiration of the U.S. research tax credit on December 31, 2013. Architecture & Software Three Months Ended June 30, Nine Months Ended June 30, (in millions, except percentages) 2014 2013 Change 2014 2013 Change Sales $ 715.2 $ 671.0 $ 44.2 $ 2,097.9 $ 1,967.7 $ 130.2 Segment operating earnings 204.8 188.6 16.2 606.9 541.7 65.2 Segment operating margin 28.6 % 28.1 % 0.5 pts 28.9 % 27.5 % 1.4 pts Sales Architecture & Software sales increased 7 percent in the three and nine months ended June 30, 2014 compared to the three and nine months ended June 30, 2013. Architecture & Software organic sales also increased 7 percent year over year in the three and nine months ended June 30, 2014. All regions reported positive organic growth in the three and nine months ended June 30, 2014, led by strong performance in Canada and Latin America. Logix sales increased 7 percent and 6 percent year over year in the three and nine months ended June 30, 2014, respectively. Logix organic sales increased 7 percent year over year in the three and nine months ended June 30, 2014. Currency translation reduced Logix sales by 1 percentage point in the nine months ended June 30, 2014. Operating Margin Architecture & Software segment operating earnings were up 9 percent and 12 percent year over year in the three and nine months ended June 30, 2014, respectively. Segment operating margin increased to 28.6 percent and 28.9 percent in the three and nine months ended June 30, 2014, respectively, from 28.1 percent and 27.5 percent a year ago, primarily due to higher sales, partially offset by increased spending. 30-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Three and Nine Months Ended June 30, 2014 Compared to Three and Nine Months Ended June 30, 2013 Control Products & Solutions Three Months Ended June 30, Nine Months Ended June 30, (in millions, except percentages) 2014 2013 Change 2014 2013 Change Sales $ 934.3 $ 953.2 $ (18.9 ) $ 2,743.8 $ 2,668.5 $ 75.3 Segment operating earnings 121.3 129.2 (7.9 ) 349.3 337.3 12.0 Segment operating margin 13.0 % 13.6 % (0.6 ) pts 12.7 % 12.6 % 0.1 pts Sales Control Products & Solutions sales decreased 2 percent and increased 3 percent year over year in the three and nine months ended June 30, 2014, respectively. Organic sales decreased 2 percent and increased 4 percent year over year in the three and nine months ended June 30, 2014, respectively. Currency translation reduced sales by 1 percentage point in the nine months ended June 30, 2014. Excluding the impact of foreign currency translation, the U.S. was the best performing region for the segment in the three and nine months ended June 30, 2014. The balance of the regions reported sales declines in the three months ended June 30, 2014 compared to very strong sales in our solutions and services businesses in the third quarter of 2013. All regions with the exception of Canada experienced organic growth in the nine months ended June 30, 2014. Sales in our solutions and services businesses decreased 5 percent and increased 2 percent in the three and nine months ended June 30, 2014, respectively, compared to the three and nine months ended June 30, 2013. Organic sales in our solutions and services businesses decreased 4 percent and increased 3 percent year over year in the three and nine months ended June 30, 2014, respectively. Acquisitions contributed 1 percentage point to sales growth, and currency translation reduced sales by 2 percentage points in the three and nine months ended June 30, 2014. Product sales increased 2 percent and 4 percent in the three and nine months ended June 30, 2014, respectively, compared to the three and nine months ended June 30, 2013. Product organic sales increased 2 percent and 5 percent year over year in the three and nine months ended June 30, 2014, respectively. Currency translation reduced sales by 1 percentage point in the nine months ended June 30, 2014. Operating Margin Control Products & Solutions segment operating earnings were down 6 percent and up 4 percent year over year in the three and nine months ended June 30, 2014, respectively. Segment operating margin was 13.0 percent in the three months ended June 30, 2014, compared to 13.6 percent a year ago, primarily due to lower sales. Segment operating margin was 12.7 percent in the nine months ended June 30, 2014, compared to 12.6 percent a year ago, primarily due to higher sales, partially offset by increased spending. 31-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Financial Condition The following is a summary of our cash flows from operating, investing and financing activities, as reflected in the Condensed Consolidated Statement of Cash Flows (in millions): Nine Months Ended June 30, 2014 2013 Cash provided by (used for): Operating activities $ 707.4 $ 663.8 Investing activities (382.7 ) (197.6 ) Financing activities (351.4 ) (323.6 ) Effect of exchange rate changes on cash 0.9 (14.8 ) Cash (used for) provided by continuing operations $ (25.8 ) $ 127.8 The following table summarizes free cash flow (in millions), which is a non-GAAP financial measure: Nine Months Ended June 30, 2014 2013 Cash provided by continuing operating activities $ 707.4 $ 663.8 Capital expenditures (96.4 ) (86.9 ) Excess income tax benefit from share-based compensation 29.1 22.6 Free cash flow $ 640.1 $ 599.5 Our definition of free cash flow takes into consideration capital investments required to maintain the operations of our businesses and execute our strategy. Cash provided by continuing operating activities adds back non-cash depreciation expense to earnings but does not reflect a charge for necessary capital expenditures. Our definition of free cash flow excludes the operating cash flows and capital expenditures related to our discontinued operations. Operating, investing and financing cash flows of our discontinued operations are presented separately in our statement of cash flows. U.S. GAAP requires the excess income tax benefit from share-based compensation to be reported as a financing cash flow rather than as an operating cash flow. We have added this benefit back to our calculation of free cash flow in order to generally classify cash flows arising from income taxes as operating cash flows. In our opinion, free cash flow provides useful information to investors regarding our ability to generate cash from business operations that is available for acquisitions and other investments, service of debt principal, dividends and share repurchases. We use free cash flow as one measure to monitor and evaluate performance. Our definition of free cash flow may differ from definitions used by other companies. Cash provided by operating activities was $707.4 million for the nine months ended June 30, 2014 compared to $663.8 million for the nine months ended June 30, 2013. Free cash flow was a source of $640.1 million for the nine months ended June 30, 2014 compared to a source of $599.5 million for the nine months ended June 30, 2013. The increase in the cash flow provided by operating activities and the increase in free cash flow in the nine months ended June 30, 2014 as compared to the nine months ended June 30, 2013 are primarily due to higher earnings and improved working capital performance, partially offset by higher tax payments. We repurchased approximately 2.9 million shares of our common stock under our share repurchase program in the first nine months of 2014. The total cost of these shares was $343.8 million, of which $5.0 million was recorded in accounts payable at June 30, 2014 related to 40,000 shares that did not settle until July 2014. We also paid $6.4 million in the first quarter of 2014 for unsettled share repurchases outstanding at September 30, 2013. We repurchased approximately 3.8 million shares of our common stock in the first nine months of 2013. The total cost of these shares was $318.0 million, of which $6.3 million was recorded in accounts payable at June 30, 2013 related to 75,000 shares that did not settle until July 2013. We also paid $7.6 million in the first quarter of 2013 for unsettled share repurchases outstanding at September 30, 2012. Our decision to repurchase additional shares in the remainder of 2014 will depend on business conditions, free cash flow generation, other cash requirements and stock price. At June 30, 2014, we had approximately $191.4 million remaining for share repurchases under the $1.0 billion share repurchase authorization approved in 2012. On June 4, 2014, the Board of Directors authorized us to expend an additional $1.0 billion to repurchase shares of our common stock. See Part II, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds, for additional information regarding share repurchases. 32-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Financial Condition - (Continued) Given our extensive international operations, significant amounts of our cash, cash equivalents and short-term investments (funds) are held by non-U.S. subsidiaries where our undistributed earnings are permanently reinvested. Generally, these funds would be subject to U.S. tax if repatriated. The percentage of such non-U.S. funds can vary from quarter to quarter with an average of approximately 90 percent over the past eight quarters. As of June 30, 2014, approximately 90 percent of our funds were held in such non-U.S. subsidiaries. We have not encountered and do not expect to encounter any difficulty meeting the liquidity requirements of our domestic and international operations. In addition to cash generated by operating activities, we have access to existing financing sources, including the public debt markets and unsecured credit facilities with various banks. Commercial paper is our principal source of short-term financing. At June 30, 2014, commercial paper borrowings outstanding were $279.0 million, with a weighted average interest rate of 0.17 percent and weighted average maturity period of thirteen days. At September 30, 2013, commercial paper borrowings outstanding were $179.0 million, with a weighted average interest rate of 0.17 percent and weighted average maturity period of five days. Our debt-to-total-capital ratio was 30.3 percent at June 30, 2014 and 29.5 percent at September 30, 2013. At June 30, 2014 and September 30, 2013, our total current borrowing capacity under our unsecured revolving credit facility expiring in May 2018 was $750.0 million. We can increase the aggregate amount of this credit facility by up to $250.0 million, subject to the consent of the banks in the credit facility. We have not borrowed against this credit facility during the nine months ended June 30, 2014 and 2013. Borrowings under this credit facility bear interest based on short-term money market rates in effect during the period borrowings are outstanding. The terms of this credit facility contain covenants under which we would be in default if our debt-to-total-capital ratio was to exceed 60 percent. Separate short-term unsecured credit facilities of approximately $117.7 million were available to non-U.S. subsidiaries at June 30, 2014. Borrowings under our non-U.S. credit facilities during the nine months ended June 30, 2014 and 2013 were not significant. We were in compliance with all covenants under our credit facilities during the nine months ended June 30, 2014 and 2013. Among other uses, we can draw on our credit facility as a standby liquidity facility to repay our outstanding commercial paper as it matures. This access to funds to repay maturing commercial paper is an important factor in maintaining the short-term credit ratings set forth in the table below. Under our current policy with respect to these ratings, we expect to limit our other borrowings under our credit facility, if any, to amounts that would leave enough credit available under the facility so that we could borrow, if needed, to repay all of our then outstanding commercial paper as it matures. The following is a summary of our credit ratings as of June 30, 2014: Credit Rating Agency Short-Term Rating Long-Term Rating Outlook Standard & Poor's A-1 A Stable Moody's P-2 A3 Positive Fitch Ratings F1 A Stable Our ability to access the commercial paper market, and the related costs of these borrowings, is affected by the strength of our credit ratings and market conditions. We have not experienced any difficulty in accessing the commercial paper market to date. If our access to the commercial paper market is adversely affected due to a change in market conditions or otherwise, we would expect to rely on a combination of available cash and our unsecured committed credit facility to provide short-term funding. In such event, the cost of borrowings under our unsecured committed credit facility could be higher than the cost of commercial paper borrowings. We regularly monitor the third-party depository institutions that hold our cash and cash equivalents and short-term investments. Our emphasis is primarily on safety and liquidity of principal and secondarily on maximizing yield on those funds. We diversify our cash and cash equivalents among counterparties to minimize exposure to any one of these entities. We use foreign currency forward exchange contracts to manage certain foreign currency risks. We enter into these contracts to hedge our exposure to foreign currency exchange rate variability in the expected future cash flows associated with certain third-party and intercompany transactions denominated in foreign currencies forecasted to occur within the next two years. We also enter into these contracts to offset transaction gains or losses associated with some of our assets and liabilities resulting from intercompany loans or other transactions with third parties that are denominated in currencies other than our entities' functional currencies. Our foreign currency forward exchange contracts are usually denominated in currencies of major industrial countries. We diversify our foreign currency forward exchange contracts among counterparties to minimize exposure to any one of these entities. 33-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Financial Condition - (Continued) Information with respect to our contractual cash obligations is contained in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. We believe that at June 30, 2014, there has been no material change to this information. Supplemental Sales Information We translate sales of subsidiaries operating outside of the United States using exchange rates effective during the respective period. Therefore, changes in currency exchange rates affect our reported sales. Sales by businesses we acquired also affect our reported sales. We believe that organic sales, defined as sales excluding the effects of changes in currency exchange rates and acquisitions, which is a non-GAAP financial measure, provides useful information to investors because it reflects regional and operating segment performance from the activities of our businesses without the effect of changes in currency exchange rates and acquisitions. We use organic sales as one measure to monitor and evaluate our regional and operating segment performance. We determine the effect of changes in currency exchange rates by translating the respective period's sales using the same currency exchange rates that were in effect during the prior year. When we acquire businesses, we exclude sales in the current period for which there are no comparable sales in the prior period. Organic sales growth is calculated by comparing organic sales to reported sales in the prior year. We attribute sales to the geographic regions based on the country of destination. The following is a reconciliation of our reported sales to organic sales (in millions): Three Months Ended Three Months Ended June 30, 2014 June 30, 2013 Sales Excluding Effect of Effect of Changes in Changes in Effect of Organic Sales Currency Currency Acquisitions Sales Sales United States $ 845.9 $ 2.0 $ 847.9 $ (0.4 ) $ 847.5 $ 807.7 Canada 113.3 7.4 120.7 - 120.7 131.5 Europe, Middle East and Africa 336.7 (12.9 ) 323.8 (2.9 ) 320.9 318.6 Asia Pacific 220.5 2.6 223.1 - 223.1 223.1 Latin America 133.1 9.6 142.7 - 142.7 143.3 Total Company Sales $ 1,649.5 $ 8.7 $ 1,658.2 $ (3.3 ) $ 1,654.9 $ 1,624.2 Nine Months Ended Nine Months Ended June 30, 2014 June 30, 2013 Sales Excluding Effect of Effect of Changes in Changes in Effect of Organic Sales Currency Currency Acquisitions Sales Sales United States $ 2,515.2 $ 6.6 $ 2,521.8 $ (0.4 ) $ 2,521.4 $ 2,345.7 Canada 321.0 23.2 344.2 - 344.2 354.6 Europe, Middle East and Africa 1,001.1 (30.0 ) 971.1 (8.0 ) 963.1 931.8 Asia Pacific 627.8 14.4 642.2 - 642.2 608.8 Latin America 376.6 34.0 410.6 - 410.6 395.3 Total Company Sales $ 4,841.7 $ 48.2 $ 4,889.9 $ (8.4 ) $ 4,881.5 $ 4,636.2 34-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC.The following is a reconciliation of our reported sales by operating segment to organic sales (in millions): Three Months Ended Three Months Ended June 30, 2014 June 30, 2013 Sales Excluding Effect of Effect of Changes in Changes in Effect of Organic Sales Currency Currency Acquisitions Sales Sales Architecture & Software $ 715.2 $ 3.9 $ 719.1 $ (0.4 ) $ 718.7 $ 671.0 Control Products & Solutions 934.3 4.8 939.1 (2.9 ) 936.2 953.2 Total Company Sales $ 1,649.5 $ 8.7 $ 1,658.2 $ (3.3 ) $ 1,654.9 $ 1,624.2 Nine Months Ended Nine Months Ended June 30, 2014 June 30, 2013 Sales Excluding Effect of Effect of Changes in Changes in Effect of Organic Sales Currency Currency Acquisitions Sales Sales Architecture & Software $ 2,097.9 $ 14.8 $ 2,112.7 $ (0.4 ) $ 2,112.3 $ 1,967.7 Control Products & Solutions 2,743.8 33.4 2,777.2 (8.0 ) 2,769.2 2,668.5 Total Company Sales $ 4,841.7 $ 48.2 $ 4,889.9 $ (8.4 ) $ 4,881.5 $ 4,636.2 35-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. Critical Accounting Policies and Estimates We have prepared the Condensed Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the Condensed Consolidated Financial Statements and revenues and expenses during the periods reported. Actual results could differ from those estimates. Information with respect to our critical accounting policies that we believe could have the most significant effect on our reported results or require subjective or complex judgments by management is contained in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. We believe that at June 30, 2014, there has been no material change to this information. Environmental Information with respect to the effect on us and our manufacturing operations of compliance with environmental protection requirements and resolution of environmental claims is contained in Note 16 of the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, of our Annual Report on Form 10-K for the fiscal year ended September 30, 2013. We believe that at June 30, 2014, there has been no material change to this information. Recent Accounting Pronouncements See Note 1 in the Condensed Consolidated Financial Statements regarding recent accounting pronouncements. 36-------------------------------------------------------------------------------- Table of Contents ROCKWELL AUTOMATION, INC. |