EX-13 3 v132847_ex13.htm Unassociated Document
Exhibit 13
 
[ 16 ] Emerson 2008
 
FINANCIAL REVIEW
 
Report of Management
 
The Companys management is responsible for the integrity and accuracy of the financial statements. Management believes that the financial statements for the three years ended September 30, 2008, have been prepared in conformity with U.S. generally accepted accounting principles appropriate in the circumstances. In preparing the financial statements, management makes informed judgments and estimates where necessary to reflect the expected effects of events and transactions that have not been completed. The Companys disclosure controls and procedures ensure that material information required to be disclosed is recorded, processed, summarized and communicated to management and reported within the required time periods.
 
In meeting its responsibility for the reliability of the financial statements, management relies on a system of internal accounting control. This system is designed to provide reasonable assurance that assets are safeguarded and transactions are executed in accordance with managements authorization and recorded properly to permit the preparation of financial statements in accordance with U.S. generally accepted accounting principles. The design of this system recognizes that errors or irregularities may occur and that estimates and judgments are required to assess the relative cost and expected benefits of the controls. Management believes that the Companys accounting controls provide reasonable assurance that errors or irregularities that could be material to the financial statements are prevented or would be detected within a timely period.
 
The Audit Committee of the Board of Directors, which is composed solely of independent Directors, is responsible for overseeing the Companys financial reporting process. The Audit Committee meets with management and the internal auditors periodically to review the work of each and to monitor the discharge by each of its responsibilities. The Audit Committee also meets periodically with the independent auditors who have free access to the Audit Committee and the Board of Directors to discuss the quality and acceptability of the Companys financial reporting, internal controls, as well as non-audit-related services.
 
The independent auditors are engaged to express an opinion on the Companys consolidated financial statements and on the Companys internal control over financial reporting. Their opinions are based on procedures that they believe to be sufficient to provide reasonable assurance that the financial statements contain no material errors and that the Companys internal controls are effective.
 
Managements Report on Internal Control Over Financial Reporting
 
The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. With the participation of the Chief Executive Officer and the Chief Financial Officer, management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework and the criteria established in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management has concluded that internal control over financial reporting was effective as of September 30, 2008.
 
The Companys auditor, KPMG LLP, an independent registered public accounting firm, has issued an audit report on the effectiveness of the Companys internal control over financial reporting.

/s/ David N. Farr
 
/s/ Walter J. Gavin
David N. Farr
 
Walter J. Galvin
Chairman of the Board,
Chief Executive Officer,
and President
 
Senior Executive Vice President
and Chief Financial Officer
 


A Powerful Force for Innovation [ 17 ]
 
Results of Operations
Years ended September 30 | Dollars in millions, except per share amounts
   
   
2006
 
2007
 
2008
 

CHANGE
2006 - 2007
 
CHANGE
2007 - 2008
 
Net sales
 
$
19,734
   
22,131
   
24,807
   
12
%
 
12
%
Gross profit
 
$
7,129
   
8,065
   
9,139
   
13
%
 
13
%
Percent of sales
   
36.1
%
 
36.4
%
 
36.8
%
           
SG&A
 
$
4,076
   
4,569
   
5,057
             
Percent of sales
   
20.6
%
 
20.6
%
 
20.3
%
           
Other deductions, net
 
$
173
   
175
   
303
             
Interest expense, net
 
$
207
   
228
   
188
             
Earnings from continuing operations before income taxes
 
$
2,673
   
3,093
   
3,591
   
16
%
 
16
%
Earnings from continuing operations
 
$
1,839
   
2,129
   
2,454
   
16
%
 
15
%
Net earnings
 
$
1,845
   
2,136
   
2,412
   
16
%
 
13
%
Percent of sales
   
9.4
%
 
9.7
%
 
9.7
%
             
EPS – Continuing operations
 
$
2.23
   
2.65
   
3.11
   
19
%
 
17
%
EPS – Net earnings
 
$
2.24
   
2.66
   
3.06
   
19
%
 
15
%
Return on equity
   
23.7
%
 
25.2
%
 
27.0
%
           
Return on total capital
   
18.4
%
 
20.1
%
 
21.8
%
             

OVERVIEW
 
Emerson achieved record sales, earnings and earnings per share in the fiscal year ended September 30, 2008. For fiscal 2008 net sales were $24.8 billion, an increase of 12 percent; earnings from continuing operations and earnings from continuing operations per share were $2.5 billion and $3.11, increases of 15 percent and 17 percent, respectively; net earnings and net earnings per share were $2.4 billion and $3.06, increases of 13 percent and 15 percent, respectively, over fiscal 2007. Four of the five business segments generated higher sales and earnings compared with the prior year. The Process Management, Network Power and Industrial Automation businesses drove gains, while growth in the Climate Technologies and Appliance and Tools businesses was moderated by weakness in the U.S. consumer appliance and residential end-markets. Strong growth in Asia, Latin America and Middle East/Africa, favorable foreign currency translation, and acquisitions contributed to these results. Profit margins remained at high levels, primarily because of leverage on higher sales volume and benefits derived from previous rationalization actions. Emersons financial position remains strong and the Company generated substantial operating cash flow in 2008 of $3.3 billion, an increase of 9 percent, and free cash flow (operating cash flow less capital expenditures) of $2.6 billion, an increase of 10 percent. Emerson maintains a conservative financial structure to provide the strength and flexibility necessary to achieve our strategic objectives.

NET SALES
 
Net sales for fiscal 2008 were a record $24.8 billion, an increase of approximately $2.7 billion, or 12 percent, over fiscal 2007, with international sales leading the overall growth. The Network Power, Process Management and Industrial Automation businesses drove sales growth, while the Appliance and Tools and Climate Technologies businesses continued to be impacted by the U.S. consumer slowdown. The consolidated results reflect increases in four of the five business segments with an approximate 7 percent ($1,523 million) increase in underlying sales (which exclude acquisitions, divestitures and foreign currency translation), a 4 percent ($809 million) favorable impact from foreign currency translation and a 1 percent ($344 million) contribution from acquisitions, net of divestitures. The underlying sales increase for the fiscal 2008 year was driven by a total international sales increase of more than 10 percent and a 3 percent increase in the United States. The international sales increase primarily reflects growth in Asia (17 percent), Latin America (18 percent), Middle East/Africa (17 percent) and Europe (3 percent). The Company estimates that the underlying sales growth of approximately 7 percent primarily reflects an approximate 6 percent gain from volume, which includes an approximate 2 percent impact from penetration gains, and an approximate 1 percent impact from higher sales prices.



[ 18 ] Emerson 2008
 
Net sales for fiscal 2007 were $22.1 billion, an increase of approximately $2.4 billion, or 12 percent, over fiscal 2006, with international sales leading the overall growth. The consolidated results reflect increases in all five business segments with an approximate 7 percent ($1,349 million) increase in underlying sales, a nearly 3 percent ($566 million) contribution from acquisitions, net of divestitures, and a more than 2 percent ($482 million) favorable impact from foreign currency translation. The underlying sales increase for fiscal 2007 was driven by international sales growth of 13 percent and a 2 percent increase in the United States. The U.S. results reflect a modest decline in the first quarter with moderate growth during the remainder of the year. The international sales increase primarily reflects growth in Asia (16 percent) and Europe (9 percent). The Company estimates that the underlying sales growth of approximately 7 percent primarily reflects an approximate 5 percent gain from volume, which includes an approximate 2 percent impact from penetration gains, and an approximate 2 percent impact from higher sales prices.
 
INTERNATIONAL SALES
 
International destination sales, including U.S. exports, increased approximately 20 percent, to $13.5 billion in 2008, representing 54 percent of the Companys total sales. U.S. exports of $1,537 million were up 20 percent compared with 2007, reflecting strong growth in the Network Power, Process Management and Climate Technologies businesses aided by the weaker U.S. dollar, as well as the benefit from acquisitions. International subsidiary sales, including shipments to the United States, were $12.0 billion in 2008, up 19 percent over 2007. Excluding the net 8 percent favorable impact from acquisitions, divestitures and foreign currency translation, international subsidiary sales increased 11 percent compared with 2007. Underlying destination sales grew 17 percent in Asia during the year, driven mainly by 21 percent growth in China, while sales grew 18 percent in Latin America, 17 percent in Middle East/Africa and 3 percent in Europe.
 
International destination sales, including U.S. exports, increased approximately 22 percent including acquisitions, to $11.2 billion in 2007, representing 51 percent of the Companys total sales. U.S. exports of $1,277 million were up 13 percent compared with 2006, aided by the weaker U.S. dollar. International subsidiary sales, including shipments to the United States, were $10.1 billion in 2007, up 22 percent over 2006. Excluding the net 6 percent favorable impact from acquisitions, divestitures and foreign currency translation, international subsidiary sales increased 16 percent compared with 2006. Underlying destination sales grew 16 percent in Asia during the year, driven mainly by 11 percent growth in China, while sales grew 44 percent in the Middle East, 11 percent in Latin America and 9 percent in Europe.
 
ACQUISITIONS AND DIVESTITURES
 
The Company acquired Motorola Inc.s Embedded Computing business (Embedded Computing) and several smaller businesses during 2008. Embedded Computing provides communication platforms and enabling software used by manufacturers of equipment for telecommunications, medical imaging, defense and aerospace, and industrial automation markets. Total cash paid for these businesses (net of cash and equivalents acquired of approximately $2 million) was approximately $561 million. Annualized sales for acquired businesses were $665 million in 2008.
 
In the first quarter of fiscal 2008, the Company divested the Brooks Instrument flow meters and flow controls unit (Brooks), which had sales for the first quarter of 2008 of $21 million and net earnings of $1 million. The Company received $100 million from the sale of Brooks, resulting in a pretax gain of $63 million ($42 million after-tax). The net gain and results of operations for fiscal 2008 were classified as discontinued operations; prior year results of operations were inconsequential. In fiscal 2008, the Company received approximately $101 million from the divestiture of the European appliance motor and pump business, resulting in a loss of $92 million. The European appliance motor and pump business had total annual sales of $453 million, $441 million and $399 million and net earnings, excluding the loss, of $7 million, $7 million and $6 million in 2008, 2007 and 2006, respectively. The loss and results of operations were classified as discontinued operations for all periods presented.
 
The Company acquired Damcos Holding AS (Damcos) and Stratos International, Inc. (Stratos), as well as several smaller businesses during 2007. Damcos supplies valve remote control systems and tank monitoring equipment to the marine and shipbuilding industries. Stratos is a designer and manufacturer of radio-frequency and microwave interconnect products. Total cash paid for these businesses (net of cash and equivalents acquired of approximately $40 million, and debt assumed of approximately $56 million) was approximately $295 million. Annualized sales for acquired businesses were $240 million in 2007.


 
A Powerful Force for Innovation [ 19 ]
 
In 2007, the Company divested two small business units that had total annual sales of $113 million and $115 million for fiscal years 2006 and 2005, respectively. These businesses were not reclassified as discontinued operations because of immateriality. See Note 3 for additional information regarding acquisitions and divestitures.
 
COST OF SALES
 
Costs of sales for fiscal 2008 and 2007 were $15.7 billion and $14.1 billion, respectively. Cost of sales as a percent of net sales was 63.2 percent for 2008, compared with 63.6 percent in 2007. Gross profit was $9.1 billion and $8.1 billion for fiscal 2008 and 2007, respectively, resulting in gross profit margins of 36.8 percent and 36.4 percent. The increase in the gross profit margin primarily reflects leverage on higher sales volume and benefits realized from productivity improvements, which were partially offset by negative product mix. Higher sales prices, together with the benefits received from commodity hedging of approximately $42 million, were more than offset by higher raw material and wage costs. The increase in the gross profit amount primarily reflects higher sales volume and foreign currency translation, as well as acquisitions.
 
Costs of sales for fiscal 2007 and 2006 were $14.1 billion and $12.6 billion, respectively. Cost of sales as a percent of net sales was 63.6 percent for 2007, compared with 63.9 percent in 2006. Gross profit was $8.1 billion and $7.1 billion for fiscal 2007 and 2006, respectively, resulting in gross profit margins of 36.4 percent and 36.1 percent. The gross profit margin improvement was diminished as higher sales prices, together with the benefits received from commodity hedging of approximately $115 million, were substantially offset by higher material costs and wages. The increase in the gross profit amount primarily reflects higher sales volume, acquisitions, foreign currency translation and savings from cost reduction actions.
 
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
 
Selling, general and administrative (SG&A) expenses for 2008 were $5.1 billion, or 20.3 percent of net sales, compared with $4.6 billion, or 20.6 percent of net sales for 2007. The increase of approximately $0.5 billion was primarily due to an increase in variable costs on higher sales volume, acquisitions and foreign currency translation, partially offset by a $103 million decrease in incentive stock compensation reflecting the overlap of two performance share programs in the prior year and the decrease in Emersons stock price in the current year (see Note 14). The reduction in SG&A as a percent of sales was primarily the result of lower incentive stock compensation, leveraging fixed costs on higher sales and benefits realized from cost reduction actions, particularly in the Process Management and Network Power businesses.
 
SG&A expenses for 2007 were $4.6 billion, or 20.6 percent of net sales, compared with $4.1 billion, or 20.6 percent of net sales for 2006. The increase of approximately $0.5 billion was primarily due to an increase in variable costs on higher sales volume, acquisitions, foreign currency translation and a $104 million increase in incentive stock compensation reflecting the increase in Emersons stock price and the overlap of two performance share programs (see Note 14).
 
OTHER DEDUCTIONS, NET
 
Other deductions, net were $303 million in 2008, a $128 million increase from the $175 million in 2007. The increase reflects numerous items including a $31 million impairment charge related to the North American appliance control business due to a slow economic environment for consumer appliance and residential end-markets and a major customers strategy to diversify suppliers and transition to and internalize the production of electronic controls. As a result, the operations of this business will be restructured and integrated into the North American appliance motors business to leverage the combined cost structure and improve profitability on the lower volume, including elimination of redundant manufacturing capacity and a substantial reduction in overhead.
 
Higher rationalization costs of $17 million in 2008 also contributed to the increase in other deductions, net. Rationalization expense, including amounts reported in discontinued operations, was $98 million, $83 million and $84 million in 2008, 2007 and 2006, respectively, or a total of $265 million over the three-year period. The Company continuously makes investments in the rationalization of operations to improve operational efficiency and remain competitive on a global basis, and to position the Company for difficult economic conditions that may arise. These actions include relocating facilities to best cost locations and geographic expansion to serve local markets. During the past three years, approximately 45 production, warehouse or office facilities have been exited and more than 6,000 positions have been eliminated. Based on the current economic conditions, the Company expects rationalization expense, including start-up and moving, severance and shutdown costs, to be approximately $125 million to $150 million in 2009.
 
The increase in other deductions, net in 2008 also includes higher amortization of intangibles related to acquisitions of $18 million, a $12 million charge for in-process research and development in connection with the acquisition of Embedded Computing, $12 million of additional losses on foreign exchange transactions compared with 2007, lower gains of $10 million and other items. Gains in 2008 included the following items. The Company received $54 million and recognized a gain of $39 million ($20 million after-tax) on the sale of an equity investment in Industrial Motion Control Holdings, LLC, a manufacturer of motion control components for automation equipment. The Company also recorded a gain of $18 million related to the sale of a facility.


 
[ 20 ] Emerson 2008
 
Other deductions, net were $175 million in 2007, a $2 million increase from the $173 million in 2006. Gains in 2007 included approximately $32 million related to the sale of the Companys remaining shares in MKS Instruments, Inc. and approximately $24 million related to a payment received under the U.S. Continued Dumping and Subsidy Offset Act (Offset Act). Ongoing costs for the rationalization of operations were $75 million in 2007, compared with $80 million in 2006. The higher gains and lower other costs were more than offset by higher amortization of intangibles related to acquisitions. See Notes 4 and 5 for further details regarding other deductions, net and rationalization costs.
 
INTEREST EXPENSE, NET
 
Interest expense, net was $188 million, $228 million and $207 million in 2008, 2007 and 2006, respectively. The decrease of $40 million from 2007 to 2008 was primarily due to lower interest rates and lower average borrowings.
 
INCOME TAXES
 
Income taxes were $1,137 million, $964 million and $834 million for 2008, 2007 and 2006, respectively, resulting in effective tax rates of 32 percent, 31 percent and 31 percent.
 
EARNINGS FROM CONTINUING OPERATIONS
 
Earnings from continuing operations were $2.5 billion and earnings from continuing operations per share were $3.11 for 2008, increases of 15 percent and 17 percent, respectively, compared with $2.1 billion and $2.65 for 2007. These earnings results reflect increases in four of the five business segments, including $240 million in Process Management, $149 million in Network Power and $62 million in Industrial Automation. The higher earnings also reflect leverage from higher sales, benefits realized from cost containment, and higher sales prices, partially offset by higher raw material and wage costs. See Business Segments discussion that follows for additional information.
 
Earnings from continuing operations were $2.1 billion and earnings from continuing operations per share were $2.65 for 2007, increases of 16 percent and 19 percent, respectively, compared with $1.8 billion and $2.23 for 2006. These earnings results reflect increases in all five business segments, including $188 million in Process Management, $161 million in Network Power and $96 million in Industrial Automation. The higher earnings also reflect leverage from higher sales, benefits realized from cost containment, and higher sales prices, partially offset by higher raw material and wage costs.
 
DISCONTINUED OPERATIONS
 
The loss from discontinued operations of $42 million, or $0.05 per share, in fiscal 2008 included a gain of $42 million related to the divestiture of the Brooks unit, a loss of $92 million related to the divestiture of the European appliance motor and pump business, as well as $8 million of operating results related to these divestitures. Discontinued operations for fiscal 2007 and 2006 related to the European appliance motor and pump business were $7 million, or $0.01 per share, and $6 million, or $0.01 per share, respectively. See previous discussion under Acquisitions and Divestitures and Note 3 for additional information regarding discontinued operations.
 
NET EARNINGS, RETURN ON EQUITY AND RETURN ON TOTAL CAPITAL
 
Net earnings were a record $2.4 billion and earnings per share were a record $3.06 per share for 2008, increases of 13 percent and 15 percent, respectively, compared with net earnings and earnings per share of $2.1 billion and $2.66, respectively, in 2007. Net earnings as a percent of net sales were 9.7 percent in 2008 and 2007. Net earnings in 2008 included a net loss from discontinued operations of $42 million, or $0.05 per share, related to the divestitures of the Brooks unit and the European appliance motor and pump business. The 15 percent increase in earnings per share also reflects the purchase of treasury shares. Return on stockholders equity (net earnings divided by average stockholders equity) reached 27.0 percent in 2008 compared with 25.2 percent in 2007. The Company achieved return on total capital of 21.8 percent in 2008 compared with 20.1 percent in 2007 (net earnings excluding interest income and expense, net of taxes, divided by average stockholders equity plus short- and long-term debt less cash and short-term investments).


 
A Powerful Force for Innovation [ 21 ]
 
Net earnings were $2.1 billion and earnings per share were $2.66 for 2007, increases of 16 percent and 19 percent, respectively, compared with net earnings and earnings per share of $1.8 billion and $2.24, respectively, in 2006. Net earnings as a percent of net sales were 9.7 percent in 2007 compared with 9.4 percent in 2006. The 19 percent increase in earnings per share also reflects the purchase of treasury shares. Return on stockholders equity reached 25.2 percent in 2007 compared with 23.7 percent in 2006. The Company achieved return on total capital of 20.1 percent in 2007 compared with 18.4 percent in 2006. The Company consummated a two-for-one stock split in December 2006. All share and per share data have been restated to reflect this split.
 
Business Segments
 
PROCESS MANAGEMENT
   
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 

CHANGE
06 - ‘07
 
CHANGE
07 - ‘08
 
Sales
 
$
4,875
   
5,699
   
6,652
   
17
%
 
17
%
Earnings
 
$
878
   
1,066
   
1,306
   
21
%
 
23
%
Margin
   
18.0
%
 
18.7
%
 
19.6
%
               
 
2008 vs. 2007 - The Process Management segment sales were $6.7 billion in 2008, an increase of $953 million, or 17 percent, over 2007, reflecting higher volume and foreign currency translation. These results reflect the Companys continued investment in next-generation technologies and expanding the global reach of the solutions and services businesses, as well as the strong worldwide growth in energy and power markets. All of the businesses reported higher sales, with sales particularly strong for the valves, measurement and systems businesses. Underlying sales increased approximately 14 percent, reflecting 13 percent from volume, which includes an estimated 3 percent from penetration gains, and approximately 1 percent from higher sales prices. Foreign currency translation had a 4 percent ($225 million) favorable impact and the Brooks divestiture, net of acquisitions, had an unfavorable impact of 1 percent ($35 million). The underlying sales increase reflects growth in all geographic regions, Asia (21 percent), the United States (12 percent), Europe (7 percent), Latin America (22 percent), Canada (13 percent) and Middle East/Africa (14 percent), compared with the prior year. Earnings (defined as earnings before interest and taxes for the business segments discussion) increased 23 percent to $1,306 million from $1,066 million in the prior year, reflecting the higher sales volume, savings from cost reductions and material containment and the benefit from foreign currency translation. The margin increase primarily reflects leverage on the higher volume, increase in sales prices and cost containment actions, which were partially offset by higher wage costs, unfavorable product mix and strategic investments to support the growth of these businesses.
 
2007 vs. 2006 - The Process Management segment sales were $5.7 billion in 2007, an increase of $824 million, or 17 percent, over 2006, reflecting higher volume and acquisitions. Nearly all of the businesses reported higher sales, with sales and earnings particularly strong for the measurement, systems and valves businesses, reflecting very strong worldwide growth in oil and gas and power projects, and expansion in the Middle East. Underlying sales increased 11 percent, reflecting approximately more than 10 percent from volume, which includes approximately 3 percent from penetrating global markets, and approximately less than 1 percent from slightly higher sales prices. Foreign currency translation had a 4 percent ($169 million) favorable impact and the Bristol and Damcos acquisitions contributed 2 percent ($120 million). The underlying sales increase reflects growth in nearly all of the major geographic regions, including the United States (10 percent), Asia (12 percent), Europe (6 percent) and Latin America (6 percent), as well as the Middle East (63 percent), compared with the prior year. Earnings increased 21 percent to $1,066 million from $878 million in the prior year, primarily reflecting the higher sales volume and prices, as well as acquisitions. The margin increase reflects leverage on the higher sales and cost containment actions, which were partially offset by higher wages and an $11 million adverse commercial litigation judgment.
 
INDUSTRIAL AUTOMATION
   
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 

CHANGE
06 - ‘07
 
CHANGE
‘07 - ‘08
 
Sales
 
$
3,767
   
4,269
   
4,852
   
13
%
 
14
%
Earnings
 
$
569
   
665
   
727
   
17
%
 
9
%
Margin
   
15.1
%
 
15.6
%
 
15.0
%
           
 

 
[ 22 ] Emerson 2008
 
2008 vs. 2007 - The Industrial Automation segment increased sales by 14 percent to $4.9 billion in 2008, compared with $4.3 billion in 2007. Sales growth was strong across the businesses with increased global demand for capital goods and foreign currency contributing to the increase. Sales grew in all of the businesses and in nearly all of the geographic regions, reflecting the strength in the power generating alternator, fluid automation, electronic drives, electrical distribution and materials joining businesses. Underlying sales growth was 7 percent and favorable foreign currency translation contributed 7 percent ($278 million). Underlying sales grew 8 percent in the United States and 6 percent internationally. The U.S. growth particularly reflects the alternator business, which was driven by increased demand for backup generators. The international sales growth primarily reflects increases in Europe (4 percent) and Asia (17 percent). The underlying growth reflects 6 percent from volume, as well as an approximate 1 percent positive impact from price. Earnings increased 9 percent to $727 million for 2008, compared with $665 million in 2007, reflecting higher sales volume and the benefit from foreign currency translation. The margin decrease reflects a lower payment received by the power transmission business from dumping duties related to the Offset Act. A $24 million payment was received in fiscal 2007, while only a $3 million payment was received in fiscal 2008. The Company does not expect to receive any significant payments in the future. The margin was positively impacted by leverage on the higher sales volume and benefits from prior cost reductions efforts. Higher sales prices were substantially offset by higher material and wage costs, as well as unfavorable product mix, which negatively impacted the margin.
 
2007 vs. 2006 - The Industrial Automation segment increased sales by 13 percent to $4.3 billion in 2007, compared with $3.8 billion in 2006. Nearly all of the businesses reported higher sales in 2007, with particular strength in the power generating alternator, the electrical distribution and the electronic drives businesses, as the favorable economic environment for capital goods continued. The very strong growth in the U.S. and European alternator businesses was driven by increased demand for backup generators and alternative power sources, such as wind turbines. The underlying sales growth of 10 percent and the favorable impact from foreign currency translation of 4 percent ($143 million) was slightly offset by an unfavorable impact of 1 percent from divestitures, net of acquisitions. Underlying sales grew 13 percent internationally and 5 percent in the United States. The international sales growth primarily reflects increases in Europe (12 percent) and Asia (19 percent). The underlying growth reflects approximately 7 percent from volume, including slight penetration gains, caused by increased global industrial demand and an approximate 3 percent positive impact from price. Earnings increased 17 percent to $665 million for 2007, compared with $569 million in 2006, reflecting leverage from higher sales volume and benefits from cost containment, as nearly all of the businesses reported higher earnings. The margin increase was primarily due to leverage on higher sales volume. The earnings increase was also aided by an approximate $24 million payment received by the power transmission business from dumping duties related to the Offset Act in 2007, compared with an $18 million payment received in 2006. Sales price increases were offset by higher material and wage costs, as well as unfavorable product mix.
 
NETWORK POWER
   
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 

CHANGE
‘06 - ‘07
 
CHANGE
‘07 - ‘08
 
Sales
 
$
4,350
   
5,150
   
6,312
   
18
%
 
23
%
Earnings
 
$
484
   
645
   
794
   
33
%
 
23
%
Margin
   
11.1
%
 
12.5
%
 
12.6
%
           
 
2008 vs. 2007 - Sales in the Network Power segment increased 23 percent to $6.3 billion in 2008 compared with $5.2 billion in 2007. The increase in sales reflects continued very strong growth in the precision cooling, global services, uninterruptible power supply and inbound power businesses, as well as growth in the power systems businesses. Underlying sales grew 11 percent, while the Embedded Computing and Stratos acquisitions contributed approximately 9 percent ($449 million) and favorable foreign currency translation had a 3 percent ($156 million) favorable impact. The underlying sales increase of 11 percent reflects higher volume, which includes an approximate 4 percent impact from penetration gains. Geographically, underlying sales reflect a 17 percent increase in Asia, an 8 percent increase in the United States, a 14 percent increase in Latin America, a 55 percent increase in Middle East/Africa and a 2 percent increase in Europe. The U.S. growth reflects continued demand for data room construction and non-residential computer equipment as well as in the telecommunications power market. Internationally, the Company continues to penetrate the Chinese, Indian and other Asian markets. Earnings increased 23 percent, or $149 million, to $794 million, compared with $645 million in 2007, primarily because of the higher sales volume and savings from cost reduction actions. The margin increase reflects these savings and leverage on the higher volume, partially offset by a nearly 1 percentage point dilution from the Embedded Computing acquisition and higher wage costs.


 
A Powerful Force for Innovation [ 23 ]
 
2007 vs. 2006 - Sales in the Network Power segment increased 18 percent to $5.2 billion in 2007 compared with $4.4 billion in 2006. The sales increase was driven by continued strong demand in the uninterruptible power supply, precision cooling and inbound power businesses and the full year impact of the Artesyn and Knürr acquisitions. Underlying sales grew 9 percent, while acquisitions, net of divestitures, contributed approximately 7 percent ($332 million) and favorable foreign currency translation had a 2 percent ($98 million) favorable impact. The underlying sales increase of 9 percent reflects an estimated 9 percent gain from higher volume, which includes 3 percent from penetration gains, partially offset by a slight decline in sales prices. Geographically, underlying sales reflect a 20 percent increase in Asia, a 7 percent increase in the United States, while sales in Europe were flat compared with the prior year. The Companys market penetration gains in China and other Asian markets continued. The U.S. growth reflects strong demand for data room and non-residential computer equipment. Earnings increased 33 percent, or $161 million, to $645 million, compared with $484 million in 2006, primarily because of the Artesyn and Knürr acquisitions and the higher sales volume. The margin increase reflects leverage on higher sales volume, savings from integrating acquisitions and improvement over the prior year in the DC power business. These benefits were partially offset by higher material and wage costs.
 
CLIMATE TECHNOLOGIES
   
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 

CHANGE
06 - ‘07
 
CHANGE
‘07 - ‘08
 
Sales
 
$
3,424
   
3,614
   
3,822
   
6
%
 
6
%
Earnings
 
$
523
   
538
   
551
   
3
%
 
2
%
Margin
   
15.3
%
 
14.9
%
 
14.4
%
             
 
2008 vs. 2007 - The Climate Technologies segment reported sales of $3.8 billion for 2008, representing a 6 percent increase over 2007. Underlying sales increased approximately 3 percent and foreign currency translation had a 3 percent ($110 million) favorable impact. The underlying sales increase of 3 percent reflects an approximate 2 percent positive contribution from sales price increases and an approximate 1 percent gain from higher volume, which includes a 2 percent impact from penetration gains. The underlying sales increase was led by the water-heater controls business, which primarily reflects penetration in the U.S. water-heater market. The compressors business grew modestly, primarily in the refrigeration and the U.S. and Asian air-conditioning markets; while the temperature sensors and flow controls businesses declined. The growth in refrigeration was driven by the transport container market. The underlying sales increase reflects a 2 percent increase in the United States and 4 percent growth internationally. Asia grew 9 percent and Europe declined 6 percent. Earnings increased 2 percent to $551 million in 2008 compared with $538 million in 2007. The margin was diluted as higher sales prices were more than offset by material inflation and higher restructuring costs of $13 million. The Company continued its capacity expansion begun in 2006 in Mexico where the next generation scroll compressor design and hermetic motors for the North American market will be produced.
 
2007 vs. 2006 - The Climate Technologies segment reported sales of $3.6 billion for 2007, representing a 6 percent improvement over 2006. Underlying sales increased approximately 1 percent, while acquisitions contributed 3 percent ($86 million) and foreign currency translation had a 2 percent ($53 million) favorable impact. Lower sales volume of approximately less than 2 percent, which includes a positive 2 percent from penetration gains, was more than offset by an approximate 3 percent positive impact from sales price increases. The underlying sales growth reflects a 16 percent increase in international sales, led by growth in Europe (18 percent) and Asia (17 percent). This growth was partially offset by a 7 percent decline in U.S. sales, which is primarily attributable to difficult comparisons to a very strong prior year for the air-conditioning compressor business, as well as an impact from the downturn in the U.S. housing market. The volume decline in the U.S. air-conditioning business was only partially offset by a modest increase in U.S. refrigeration sales. The very strong growth in Europe and Asia reflects overall favorable market conditions, penetration in the European heat pump market, and penetration gains in Asia, particularly in digital scroll compressor products. Earnings increased 3 percent to $538 million in 2007 compared with $523 million in 2006, primarily because of savings from cost reduction efforts and lower restructuring costs of $5 million. The profit margin declined as the result of deleverage on the lower volume and an acquisition, while higher sales prices were offset by higher material and wage costs.
 
APPLIANCE AND TOOLS
   
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 
 
CHANGE
06 - ‘07
 
CHANGE
‘07 - ‘08
 
Sales
 
$
3,914
   
4,006
   
3,861
   
2
%
 
(4
%)
Earnings
 
$
539
   
564
   
527
   
5
%
 
(7
%)
Margin
   
13.8
%
 
14.1
%
 
13.6
%
           
 

 
[ 24 ] Emerson 2008
 
2008 vs. 2007 - Sales in the Appliance and Tools segment were $3.9 billion in 2008, a 4 percent decrease from 2007. The results of 2008 were mixed reflecting the different sectors served by these businesses. The professional tools, commercial storage and hermetic motor businesses showed strong increases, while the residential storage, appliance components, and appliance and commercial motors businesses declined. The strong growth in the professional tools business was driven by U.S. non-residential and Latin American markets. The declines in the residential storage and appliance-related businesses primarily reflect the continued and ongoing downturn in the U.S. consumer appliance and residential end-markets. The U.S. markets represent more than 80 percent of sales for this segment. Underlying sales in the United States were down 6 percent from the prior year, while international underlying sales increased 13 percent in total. The sales decrease reflects a 3 percent decline in underlying sales, an unfavorable impact from divestitures of 2 percent ($65 million) and a favorable impact from foreign currency translation of 1 percent ($40 million). The underlying sales decrease of 3 percent reflects an estimated 7 percent decline in volume and an approximate 4 percent positive impact from higher sales prices. Earnings for 2008 were $527 million, a 7 percent decrease from 2007. Earnings decreased because of deleverage on the lower sales volume and an impairment charge of $31 million in the appliance control business (see Note 4), which was partially offset by savings from cost reduction actions. The increase in sales prices was substantially offset by higher material (copper and other commodities) and wage costs. The 2007 sale of the consumer hand tools product line favorably impacted the margin.
 
2007 vs. 2006 - Sales in the Appliance and Tools segment were $4.0 billion in 2007, a 2 percent increase from 2006. The sales increase reflects a 1 percent increase in underlying sales and a contribution from acquisitions of 1 percent ($37 million). The underlying sales increase of 1 percent reflects an estimated 4 percent decline in volume, which includes a positive 1 percent impact from penetration gains, and an approximate 5 percent positive impact from higher sales prices. The results were mixed across the businesses for this segment. The tools and storage businesses showed moderate growth, while sales increased slightly in the motors businesses when compared with 2006. These increases were partially offset by declines in the appliance controls businesses. The growth in the tools businesses was driven by the professional tools and disposer businesses, reflecting the success of new product launches. The volume declines in the appliance controls and certain motors and storage businesses were primarily caused by the downturn in U.S. residential construction. International underlying sales increased 13 percent in total, while underlying sales in the United States were down 1 percent from the prior year. Earnings for 2007 were $564 million, a 5 percent increase from 2006. The earnings increases in tools and motor businesses were partially offset by declines in appliance component and certain storage businesses. Overall, the slight margin improvement primarily reflects the benefits from prior year actions, as well as lower restructuring inefficiencies and costs compared with the prior year. Sales price increases were offset by higher material and wage costs, as well as deleverage from the lower volume.
 
Financial Position, Capital Resources and Liquidity
 
The Company continues to generate substantial cash from operations and is in a strong financial position with total assets of $21 billion and stockholders equity of $9 billion, and has the resources available for reinvestment in existing businesses, strategic acquisitions and managing the capital structure on a short- and long-term basis.
 
CASH FLOW
    
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 
Operating Cash Flow
 
 
$2,512
   
3,016
   
3,293
 
Percent of sales
   
12.5
%
 
13.4
%
 
13.3
%
Capital Expenditures
 
 
$601
   
681
   
714
 
Percent of sales
   
3.0
%
 
3.0
%
 
2.9
%
Free Cash Flow (Operating Cash Flow Less Capital Expenditures)
 
 
$1,911
   
2,335
   
2,579
 
Percent of sales
 
9.5
%
 
10.3
%
 
10.4
%
Operating Working Capital
 
 
$2,044
   
1,915
   
2,202
 
Percent of sales
   
10.1
%
 
8.5
%
 
8.9
%
 
Emerson generated operating cash flow of $3.3 billion in 2008, a 9 percent increase from 2007, driven by higher net earnings. Cash flow in 2008 also reflects continued improvements in operating working capital management. Operating cash flow was $3.0 billion in 2007, a 20 percent increase from 2006, driven by higher net earnings. At September 30, 2008, operating working capital as a percent of sales was 8.9 percent, compared with 8.5 percent and 10.1 percent in 2007 and 2006, respectively. Operating cash flow also reflects pension contributions of $135 million, $136 million and $124 million in 2008, 2007 and 2006, respectively.


 
A Powerful Force for Innovation [ 25 ]
 
Free cash flow (operating cash flow less capital expenditures) was $2.6 billion in 2008, compared with $2.3 billion and $1.9 billion in 2007 and 2006, respectively. The 10 percent increase in free cash flow in 2008 compared with 2007 and the 22 percent increase in 2007 compared with 2006 reflect the increases in operating cash flow, partially offset by higher capital spending. Capital expenditures were $714 million, $681 million and $601 million in 2008, 2007 and 2006, respectively. The increase in capital expenditures during 2008 compared with the prior year was primarily due to capacity expansion in the Process Management and Industrial Automation segments and construction of a corporate technology facility, while the increase in 2007 compared with 2006 included capacity expansion in the Process Management and Climate Technologies segments. In 2009, the Company is targeting capital spending of approximately 3 percent of net sales. Cash paid in connection with Emersons acquisitions was $561 million, $295 million and $752 million in 2008, 2007 and 2006, respectively.
 
Dividends were $940 million ($1.20 per share, up 14 percent) in 2008, compared with $837 million ($1.05 per share) in 2007, and $730 million ($0.89 per share) in 2006. In November 2008, the Board of Directors voted to increase the quarterly cash dividend 10 percent to an annualized rate of $1.32 per share. In 2008, the Board of Directors approved a new program for the repurchase of up to 80 million additional shares. In 2008, 22,404,000 shares were repurchased under the fiscal 2002 and 2008 Board of Directors authorizations; in 2007, 18,877,000 shares were repurchased under the 2002 authorization, and in 2006, 21,451,000 shares were repurchased under the 2002 authorization; 72.4 million shares remain available for repurchase under the 2008 authorization and none remain available under the 2002 authorization. Purchases of treasury stock totaled $1,128 million, $849 million and $871 million in 2008, 2007 and 2006, respectively.
 
LEVERAGE/CAPITALIZATON
   
(DOLLARS IN MILLIONS)
 
2006
 
2007
 
2008
 
Total Assets
 
 
$18,672
   
19,680
   
21,040
 
Long-term Debt
 
 
$3,128
   
3,372
   
3,297
 
Stockholders Equity
 
 
$8,154
   
8,772
   
9,113
 
                     
Total Debt-to-Capital Ratio
   
33.1
%
 
30.1
%
 
33.1
%
Net Debt-to-Net Capital Ratio
   
28.1
%
 
23.6
%
 
22.7
%
Operating Cash Flow-to-Debt Ratio
   
62.4
%
 
79.9
%
 
72.9
%
Interest Coverage Ratio
   
12.9
   
12.9
   
15.7
 
 
Total debt was $4.5 billion, $3.8 billion and $4.0 billion for 2008, 2007 and 2006, respectively. During 2008, the Company issued $400 million of 5.250% notes due October 2018, under a shelf registration statement filed with the Securities and Exchange Commission and $250 million of 5½% notes matured. During 2007, the Company issued $250 million of 5.125%, ten-year notes due December 2016 and $250 million of 5.375%, ten-year notes due October 2017. During 2006, $250 million of 6.3% notes matured. The total debt-to-capital ratio was 33.1 percent at year-end 2008, compared with 30.1 percent for 2007 and 33.1 percent for 2006. At September 30, 2008, net debt (total debt less cash and equivalents and short-term investments) was 22.7 percent of net capital, compared with 23.6 percent of net capital in 2007 and 28.1 percent of net capital in 2006. The operating cash flow-to-debt ratio was 72.9 percent, 79.9 percent and 62.4 percent in 2008, 2007 and 2006, respectively. The Companys interest coverage ratio (earnings before income taxes and interest expense, divided by interest expense) was 15.7 times in 2008, compared with 12.9 times in 2007 and 2006. The increase in the interest coverage ratio from 2007 to 2008 reflects higher earnings and lower interest rates. See Notes 3, 8 and 9 for additional information. The Companys strong financial position supports long-term debt ratings of A2 by Moodys Investors Service and A by Standard and Poors.
 
At year-end 2008, the Company maintained, but has not drawn upon, a five-year revolving credit facility effective until April 2011 amounting to $2.8 billion to support short-term borrowings. The credit facility does not contain any financial covenants and is not subject to termination based on a change in credit ratings or a material adverse change. In addition, as of September 30, 2008, the Company could issue up to $1.35 billion in debt securities, preferred stock, common stock, warrants, share purchase contracts and share purchase units under the shelf registration statement filed with the Securities and Exchange Commission. The Company intends to file a new shelf registration statement prior to the expiration of the existing registration in December 2008.
 
The credit markets, including the commercial paper sector in the United States, have recently experienced adverse conditions. Continuing volatility in the capital markets may increase costs associated with issuing commercial paper or other debt instruments, or affect the Companys ability to access those markets. Notwithstanding these adverse market conditions, the Company has been able to issue commercial paper and currently believes that sufficient funds will be available to meet the Companys needs in the foreseeable future through existing resources, ongoing operations and commercial paper (or backup credit lines). However, the Company could be adversely affected if the credit market conditions deteriorate further or continue for an extended period of time and customers, suppliers and financial institutions are unable to meet their commitments to the Company.

 

 
[ 26 ] Emerson 2008

CONTRACTUAL OBLIGATIONS
 
At September 30, 2008, the Companys contractual obligations, including estimated payments due by period, are as follows:
   
   
PAYMENTS DUE BY PERIOD
 
       
LESS THAN
         
MORE THAN
 
(DOLLARS IN MILLIONS)
 
TOTAL
 
1 YEAR
 
1-3 YEARS
 
3-5 YEARS
 
5 YEARS
 
Long-term Debt
(including interest)
 
 
$5,024
   
654
   
941
   
990
   
2,439
 
Operating Leases
   
649
   
194
   
231
   
108
   
116
 
   
1,616
   
1,185
   
313
   
114
   
4
 
Total
 
 
$7,289
   
2,033
   
1,485
   
1,212
   
2,559
 
 
Purchase obligations consist primarily of inventory purchases made in the normal course of business to meet operational requirements. The above table does not include $2.1 billion of other noncurrent liabilities recorded in the balance sheet, as summarized in Note 17, which consist primarily of deferred income tax (including unrecognized tax benefits) and retirement and postretirement plan liabilities, because it is not certain when these liabilities will become due. See Notes 10, 11 and 13 for additional information.
 
FINANCIAL INSTRUMENTS
 
The Company is exposed to market risk related to changes in interest rates, copper and other commodity prices and European and other foreign currency exchange rates, and selectively uses derivative financial instruments, including forwards, swaps and purchased options, to manage these risks. The Company does not hold derivatives for trading purposes. The value of market risk sensitive derivative and other financial instruments is subject to change as a result of movements in market rates and prices. Sensitivity analysis is one technique used to evaluate these impacts. Based on a hypothetical ten-percent increase in interest rates, ten-percent decrease in commodity prices or ten-percent weakening in the U.S. dollar across all currencies, the potential losses in future earnings, fair value and cash flows are immaterial. This method has limitations; for example, a weaker U.S. dollar would benefit future earnings through favorable translation of non-U.S. operating results and lower commodity prices would benefit future earnings through lower cost of sales. See Notes 1, 7, 8 and 9.
 
Critical Accounting Policies
 
Preparation of the Companys financial statements requires management to make judgments, assumptions and estimates regarding uncertainties that affect the reported amounts of assets, liabilities, stockholders equity, revenues and expenses. Note 1 of the Notes to Consolidated Financial Statements describes the significant accounting policies used in preparation of the Consolidated Financial Statements. The most significant areas involving management judgments and estimates are described in the following paragraphs. Actual results in these areas could differ materially from managements estimates under different assumptions or conditions.
 
REVENUE RECOGNITION
 
The Company recognizes nearly all of its revenues through the sale of manufactured products and records the sale when products are shipped and title passes to the customer and collection is reasonably assured. In certain instances, revenue is recognized on the percentage-of-completion method, when services are rendered, or in accordance with AICPA Statement of Position No. 97-2, Software Revenue Recognition. Sales sometimes include multiple items including services such as installation. In such instances, revenue assigned to each item is based on that items objectively determined fair value, and revenue is recognized individually for delivered items only if the delivered items have value to the customer on a standalone basis and performance of the undelivered items is probable and substantially in the Companys control, or the undelivered items are inconsequential or perfunctory. Management believes that all relevant criteria and conditions are considered when recognizing sales.
 
INVENTORIES
 
Inventories are stated at the lower of cost or market. The majority of inventory values are based upon standard costs that approximate average costs, while the remainder are principally valued on a first-in, first-out basis. Standard costs are revised at the beginning of each fiscal year. The effects of resetting standards and operating variances incurred during each period are allocated between inventories and cost of sales. The Companys divisions regularly review inventory for obsolescence, make appropriate provisions and dispose of obsolete inventory on an ongoing basis. Various factors are considered in making this determination, including recent sales history and predicted trends, industry market conditions and general economic conditions.


 
A Powerful Force for Innovation [ 27 ]
 
LONG-LIVED ASSETS
 
Long-lived assets, which include primarily goodwill and property, plant and equipment, are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable, as well as annually for goodwill. If the Company determines that the carrying value of the long-lived asset may not be recoverable, a permanent impairment charge is recorded for the amount by which the carrying value of the long-lived asset exceeds its fair value. Fair value is generally measured based on a discounted cash flow method using a discount rate determined by management to be commensurate with the risk inherent in the Companys current business model. The estimates of cash flows and discount rate are subject to change depending on the economic environment, including such factors as interest rates, expected market returns and volatility of markets served, particularly if the current downturn continues for an extended period of time. Management believes that the estimates of future cash flows and fair value are reasonable; however, changes in estimates could materially affect the evaluations. The slowdown in consumer appliance and residential end-markets over the past two years, along with strategic decisions in connection with two businesses, resulted in a $31 million impairment in the North American appliance control business and a $92 million loss on the divestiture of the European appliance motor and pump business. See Notes 1, 3, 4 and 6.

RETIREMENT PLANS
 
The Company continues to focus on a prudent long-term investment strategy. Defined benefit plan expense and obligations are dependent on assumptions used in calculating such amounts. These assumptions include discount rate, rate of compensation increases and expected return on plan assets. In accordance with U.S. generally accepted accounting principles, actual results that differ from the assumptions are accumulated and amortized over future periods. While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect the Companys retirement plan obligations and future expense. The discount rate for the U.S. retirement plans was 6.50 percent as of June 30, 2008. As of June 30, 2008, the U.S. retirement plans were overfunded by $331 million and non-U.S. plans were underfunded by $224 million. Unrecognized losses, which will be recognized in future years, were $804 million as of June 30, 2008. Subsequent to the June 30 measurement date, asset values have declined as a result of recent volatility in the capital markets, while pension liabilities have decreased with higher interest rates. The Company estimates that retirement plans in total were underfunded by approximately $400 million as of October 31, 2008. The Company contributed $135 million to defined benefit plans in 2008 and expects to contribute approximately $200 million in 2009. Defined benefit pension plan expense is expected to decline slightly in 2009.
 
Effective September 30, 2007, the Company adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (FAS 158). This statement requires employers to recognize the funded status of defined benefit plans and other postretirement plans in the balance sheet and to recognize changes in the funded status through comprehensive income in the year in which they occur. The incremental effect of adopting FAS 158 resulted in a pretax charge to accumulated other comprehensive income of $522 million ($329 million after-tax). Also see Notes 10 and 11 for additional disclosures. Effective for fiscal year 2009, FAS 158 requires plan assets and liabilities to be measured as of year-end, rather than the June 30 measurement date that the Company presently uses.
 
INCOME TAXES
 
Income tax expense and deferred tax assets and liabilities reflect managements assessment of actual future taxes to be paid on items reflected in the financial statements. Uncertainty exists regarding tax positions taken in previously filed tax returns still under examination and positions expected to be taken in future returns. Deferred tax assets and liabilities arise because of differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred income taxes are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. Generally, no provision is made for U.S. income taxes on the undistributed earnings of non-U.S. subsidiaries. These earnings are permanently invested or otherwise indefinitely retained for continuing international operations. Determination of the amount of taxes that might be paid on these undistributed earnings if eventually remitted is not practicable. See Note 13.
 
Effective October 1, 2007, the Company adopted the recognition and disclosure provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement 109 (FIN 48). FIN 48 addresses the accounting for uncertain tax positions that a company has taken or expects to take on a tax return. As of October 1, 2007, the Company had total unrecognized tax benefits of $149 million before recoverability of cross-jurisdictional tax credits (U.S., state and non-U.S.) and temporary differences, and including amounts related to acquisitions that would reduce goodwill. If none of these liabilities is ultimately paid, the tax provision and tax rate would be favorably impacted by $90 million. As a result of adoption, the Company recorded a charge of $6 million to beginning retained earnings. See Note 13 for additional disclosures regarding the adoption.
 

 
[28 ] Emerson 2008
 
NEW ACCOUNTING PRONOUNCEMENTS
 
In September 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157). FAS 157 defines fair value, establishes a formal framework for measuring fair value and expands disclosures about fair value measurements. The Company believes FAS 157, which is required to be adopted in the first quarter of fiscal 2009, will not have a material impact on the financial statements.
 
In March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities (FAS 161). FAS 161 requires additional derivative disclosures, including objectives and strategies for using derivatives, fair value amounts of and gains and losses on derivative instruments, and credit-risk-related contingent features in derivative agreements. The Company believes FAS 161, which is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, will not have a material impact on the financial statements.
 
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141(R), Business Combinations (FAS 141(R)). FAS 141(R) requires assets acquired and liabilities assumed to be measured at fair value as of the acquisition date, acquisition related costs incurred prior to the acquisition to be expensed and contractual contingencies to be recognized at fair value as of the acquisition date. FAS 141(R) is effective for acquisitions completed after October 1, 2009.

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51 (FAS 160). FAS 160 requires an entity to separately disclose non-controlling interests as a separate component of equity in the balance sheet and clearly identify on the face of the income statement net income related to non-controlling interests. FAS 160 is effective for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of FAS 160 to have a material impact on the financial statements.
 
In June 2008, the Financial Accounting Standards Board issued FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1). FSP EITF 03-6-1 clarifies whether instruments granted in share-based payment transactions should be included in the computation of EPS using the two-class method prior to vesting. The Company is in the process of analyzing the impact of FSP EITF 03-6-1, which is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company does not expect the adoption of FSP EITF 06-3-1 to have a material impact on the financial statements.
 

 
A Powerful Force for Innovation [ 29 ]
 
CONSOLIDATED STATEMENTS OF EARNINGS
 
EMERSON ELECTRIC CO. & SUBSIDIARIES
Years ended September 30 | Dollars in millions, except per share amounts
   
   
2006
 
2007
 
2008
 
Net sales
 
$
19,734
   
22,131
   
24,807
 
Costs and expenses:
                   
Cost of sales
   
12,605
   
14,066
   
15,668
 
Selling, general and administrative expenses
   
4,076
   
4,569
   
5,057
 
Other deductions, net
   
173
   
175
   
303
 
Interest expense (net of interest income: 2006, $18; 2007, $33; 2008, $56)
   
207
   
228
   
188
 
Earnings from continuing operations before income taxes
   
2,673
   
3,093
   
3,591
 
Income taxes
   
834
   
964
   
1,137
 
Earnings from continuing operations
 
$
1,839
   
2,129
   
2,454
 
Discontinued operations, net of tax
   
6
   
7
   
(42
)
Net earnings
 
$
1,845
   
2,136
   
2,412
 
Basic earnings per common share:
                   
Earnings from continuing operations
 
$
2.25
   
2.68
   
3.14
 
Discontinued operations
   
0.01
   
0.01
   
(0.05
)
                     
Basic earnings per common share
 
$
2.26
   
2.69
   
3.09
 
Diluted earnings per common share:
                   
Earnings from continuing operations
 
$
2.23
   
2.65
   
3.11
 
Discontinued operations
   
0.01
   
0.01
   
(0.05
)
                     
Diluted earnings per common share
 
$
2.24
   
2.66
   
3.06
 
 
 
 
See accompanying Notes to Consolidated Financial Statements.

 
[ 30 ] Emerson 2008

CONSOLIDATED BALANCE SHEETS

EMERSON ELECTRIC CO. & SUBSIDIARIES
September 30 | Dollars in millions, except per share amounts
   
ASSETS
 
2007
 
2008
 
 
             
Current assets
             
Cash and equivalents
 
$
1,008
   
1,777
 
Receivables, less allowances of $86 in 2007 and $90 in 2008
   
4,260
   
4,618
 
Inventories:
             
Finished products
   
884
   
884
 
Raw materials and work in process
   
1,343
   
1,464
 
Total inventories
   
2,227
   
2,348
 
Other current assets
   
570
   
588
 
Total current assets
   
8,065
   
9,331
 
               
Property, plant and equipment
             
Land
   
199
   
201
 
Buildings
   
1,683
   
1,737
 
Machinery and equipment
   
6,138
   
6,296
 
Construction in progress
   
414
   
457
 
     
8,434
   
8,691
 
Less accumulated depreciation
   
5,003
   
5,184
 
Property, plant and equipment, net
   
3,431
   
3,507
 
               
Other assets
             
Goodwill
   
6,412
   
6,562
 
Other
   
1,772
   
1,640
 
Total other assets
   
8,184
   
8,202
 
   
$
19,680
   
21,040
 
 
 
See accompanying Notes to Consolidated Financial Statements.

 
A Powerful Force for Innovation [ 31 ]
 
   
LIABILITIES AND STOCKHOLDERS EQUITY
 
2007
 
2008
 
             
Current liabilities
             
Short-term borrowings and current maturities of long-term debt
 
$
404
   
1,221
 
Accounts payable
   
2,501
   
2,699
 
Accrued expenses
   
2,337
   
2,480
 
Income taxes
   
304
   
173
 
Total current liabilities
   
5,546
   
6,573
 
Long-term debt
   
3,372
   
3,297
 
Other liabilities
   
1,990
   
2,057
 
               
Stockholders equity
             
Preferred stock of $2.50 par value per share
             
Authorized 5,400,000 shares; issued - none
   
-
   
-
 
Common stock of $0.50 par value per share
             
Authorized 1,200,000,000 shares; issued 953,354,012 shares; outstanding 788,434,076 shares in 2007 and 771,216,037 shares in 2008
   
477
   
477
 
Additional paid-in capital
   
31
   
146
 
Retained earnings
   
12,536
   
14,002
 
Accumulated other comprehensive income
   
382
   
141
 
     
13,426
   
14,766
 
 
             
Less cost of common stock in treasury, 164,919,936 shares in 2007 and 182,137,975 shares in 2008
   
4,654
   
5,653
 
Total stockholders equity
   
8,772
   
9,113
 
    $ 19,680     21,040  


 
[ 32 ] Emerson 2008
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

EMERSON ELECTRIC CO. & SUBSIDIARIES
Years ended September 30 | Dollars in millions, except per share amounts
   
   
2006
 
2007
 
2008
 
Common stock
                
Beginning balance
 
$
238
   
238
   
477
 
Adjustment for stock split
   
-
   
239
   
-
 
Ending balance
   
238
   
477
   
477
 
Additional paid-in capital
                   
Beginning balance
   
120
   
161
   
31
 
Stock plans and other
   
41
   
31
   
115
 
Adjustment for stock split
   
-
   
(161
)
 
-
 
Ending balance
   
161
   
31
   
146
 
Retained earnings
                   
Beginning balance
   
10,199
   
11,314
   
12,536
 
Net earnings
   
1,845
   
2,136
   
2,412
 
Cash dividends (per share: 2006, $0.89; 2007, $1.05; 2008, $1.20)
   
(730
)
 
(837
)
 
(940
)
Adjustment for stock split
   
-
   
(77
)
 
-
 
Adjustment for adoption of FIN 48
   
-
    -     (6 )
Ending balance
   
11,314
   
12,536
   
14,002
 
Accumulated other comprehensive income
                   
Beginning balance
   
(65
)
 
306
   
382
 
Foreign currency translation
   
175
   
459
   
(30
)
Pension and postretirement adjustments (net of tax of: 2006, $(71); 2007, $(1); 2008, $51)
   
121
   
2
   
(144
)
Cash flow hedges and other (net of tax of: 2006, $(43); 2007, $29; 2008, $51)
   
75
   
(56
)
 
(67
)
Adjustment for adoption of FAS 158 (net of tax of: 2007, $193)
   
-
   
(329
)
 
-
 
Ending balance
   
306
   
382
   
141
 
Treasury stock
                   
Beginning balance
   
(3,092
)
 
(3,865
)
 
(4,654
)
Acquired
   
(871
)
 
(849
)
 
(1,128
)
Issued under stock plans and other
   
98
   
60
   
129
 
Ending balance
   
(3,865
)
 
(4,654
)
 
(5,653
)
Total stockholders equity
 
$
8,154
   
8,772
   
9,113
 
                     
Comprehensive income
                   
Net earnings
 
$
1,845
   
2,136
   
2,412
 
Foreign currency translation
   
175
   
459
   
(30
)
Pension and postretirement adjustments
   
121
   
2
   
(144
)
Cash flow hedges and other
   
75
   
(56
)
 
(67
)
Total
 
$
2,216
   
2,541
   
2,171
 
 
See accompanying Notes to Consolidated Financial Statements.

 
A Powerful Force for Innovation [ 33 ]
CONSOLIDATED STATEMENTS OF CASH FLOWS

EMERSON ELECTRIC CO. & SUBSIDIARIES
Years ended September 30 | Dollars in millions
   
   
2006
 
2007
 
2008
 
Operating activities
                   
Net earnings
 
$
1,845
   
2,136
   
2,412
 
Adjustments to reconcile net earnings to net cash provided by operating activities:
                   
Depreciation and amortization
   
607
   
656
   
707
 
Changes in operating working capital
   
(152
)
 
137
   
(22
)
Pension funding
   
(124
)
 
(136
)
 
(135
)
Other
   
336
   
223
   
331
 
Net cash provided by operating activities
   
2,512
   
3,016
   
3,293
 
Investing activities
                   
Capital expenditures
   
(601
)
 
(681
)
 
(714
)
Purchases of businesses, net of cash and equivalents acquired
   
(752
)
 
(295
)
 
(561
)
Other
   
137
   
106
   
203
 
Net cash used in investing activities
   
(1,216
)
 
(870
)
 
(1,072
)
Financing activities
                   
Net increase (decrease) in short-term borrowings
   
89
   
(800
)
 
521
 
Proceeds from long-term debt
   
6
   
496
   
400
 
Principal payments on long-term debt
   
(266
)
 
(5
)
 
(261
)
Dividends paid
   
(730
)
 
(837
)
 
(940
)
Purchases of treasury stock
   
(862
)
 
(853
)
 
(1,120
)
Other
   
32
   
5
   
(54
)
Net cash used in financing activities
   
(1,731
)
 
(1,994
)
 
(1,454
)
Effect of exchange rate changes on cash and equivalents
   
12
   
46
   
2
 
Increase (decrease) in cash and equivalents
   
(423
)
 
198
   
769
 
Beginning cash and equivalents
   
1,233
   
810
   
1,008
 
Ending cash and equivalents
 
$
810
   
1,008
   
1,777
 
                     
Changes in operating working capital
                   
Receivables
 
$
(246
)
 
(349
)
 
(293
)
Inventories
   
(274
)
 
96
   
(90
)
Other current assets
   
36
   
36
   
19
 
Accounts payable
   
324
   
104
   
199
 
Accrued expenses
   
71
   
200
   
154
 
Income taxes
   
(63
)
 
50
   
(11
)
   
$
(152
)
 
137
   
(22
)
 
See accompanying Notes to Consolidated Financial Statements.


[ 34 ] Emerson 2008
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
EMERSON ELECTRIC CO. & SUBSIDIARIES
Years ended September 30 | Dollars in millions, except per share amounts
 
(1) Summary of Significant Accounting Policies
 
PRINCIPLES OF CONSOLIDATION
 
The consolidated financial statements include the accounts of the Company and its controlled affiliates. Intercompany transactions, profits and balances are eliminated in consolidation. Other investments of 20 percent to 50 percent are accounted for by the equity method. Investments in nonpublicly-traded companies of less than 20 percent are carried at cost. Investments in publicly-traded companies of less than 20 percent are carried at fair value, with changes in fair value reflected in accumulated other comprehensive income.
 
FOREIGN CURRENCY TRANSLATION
 
The functional currency of a vast majority of the Companys non-U.S. subsidiaries is the local currency. Adjustments resulting from the translation of financial statements are reflected in accumulated other comprehensive income.
 
CASH EQUIVALENTS
 
Cash equivalents consist of highly liquid investments with original maturities of three months or less.
 
INVENTORIES
 
Inventories are stated at the lower of cost or market. The majority of inventory values are based upon standard costs that approximate average costs, while the remainder are principally valued on a first-in, first-out basis. Standard costs are revised at the beginning of each fiscal year. The effects of resetting standards and operating variances incurred during each period are allocated between inventories and cost of sales.
 
PROPERTY, PLANT AND EQUIPMENT
 
The Company records investments in land, buildings, and machinery and equipment at cost. Depreciation is computed principally using the straight-line method over estimated service lives. Service lives for principal assets are 30 to 40 years for buildings and 8 to 12 years for machinery and equipment. Long-lived assets are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. Impairment losses are recognized based on fair value if expected future undiscounted cash flows of the related assets are less than their carrying values.
 
GOODWILL AND INTANGIBLE ASSETS
 
Assets and liabilities acquired in business combinations are accounted for using the purchase method and recorded at their respective fair values. Substantially all goodwill is assigned to the reporting unit that acquires a business. A reporting unit is an operating segment as defined in Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, or a business one level below an operating segment if discrete financial information is prepared and regularly reviewed by the segment manager. The Company conducts a formal impairment test of goodwill on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Under the impairment test, if a reporting units carrying amount exceeds its estimated fair value, a goodwill impairment is recognized to the extent that the reporting units carrying amount of goodwill exceeds the implied fair value of the goodwill. Fair values of reporting units are estimated using discounted cash flows and market multiples.
 
All of the Companys intangible assets (other than goodwill) are subject to amortization. Intangibles consist of intellectual property (such as patents and trademarks), customer relationships and capitalized software and are amortized on a straight-line basis. These intangibles are also subject to evaluation for potential impairment if an event occurs or circumstances change that indicate the carrying amount may not be recoverable.
 
WARRANTY
 
The Companys product warranties vary by each of its product lines and are competitive for the markets in which it operates. Warranty generally extends for a period of one to two years from the date of sale or installation. Provisions for warranty are determined primarily based on historical warranty cost as a percentage of sales or a fixed amount per unit sold based on failure rates, adjusted for specific problems that may arise. Product warranty expense is less than 1 percent of sales.
 
REVENUE RECOGNITION
 
The Company recognizes nearly all of its revenues through the sale of manufactured products and records the sale when products are shipped and title passes to the customer and collection is reasonably assured. In certain instances, revenue is recognized on the percentage-of-completion method, when services are rendered, or in accordance with AICPA Statement of Position No. 97-2, Software Revenue Recognition. Sales sometimes include multiple items including services such as installation. In such instances, revenue assigned to each item is based on that items objectively determined fair value, and revenue is recognized individually for delivered items only if the delivered items have value to the customer on a standalone basis and performance of the undelivered items is probable and substantially in the Companys control, or the undelivered items are inconsequential or perfunctory. Management believes that all relevant criteria and conditions are considered when recognizing sales.


 

A Powerful Force for Innovation [ 35 ]
 
FINANCIAL INSTRUMENTS
 
All derivative instruments are reported on the balance sheet at fair value. The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as a hedge and on the type of hedge. For each derivative instrument designated as a cash flow hedge, the effective portion of the gain or loss on the derivative is deferred in accumulated other comprehensive income until recognized in earnings with the underlying hedged item. For each derivative instrument designated as a fair value hedge, the gain or loss on the derivative and the offsetting gain or loss on the hedged item are recognized immediately in earnings. Currency fluctuations on non-U.S. dollar obligations that have been designated as hedges on non-U.S. net asset exposures are included in accumulated other comprehensive income. Regardless of type, a fully effective hedge will result in no net earnings impact while the derivative is outstanding. To the extent that any hedge is ineffective at offsetting cash flow or fair value changes in the underlying hedged item, there could be a net earnings impact. Gains and losses from the ineffective portion of any hedge, as well as the gains and losses on derivative instruments not designated as a hedge, are recognized in the income statement immediately.
 
INCOME TAXES
 
No provision has been made for U.S. income taxes on the undistributed earnings of non-U.S. subsidiaries of approximately $3.6 billion at September 30, 2008. These earnings are permanently invested or otherwise indefinitely retained for continuing international operations. Determination of the amount of taxes that might be paid on these undistributed earnings if eventually remitted is not practicable.
 
COMPREHENSIVE INCOME
 
Comprehensive income is primarily comprised of net earnings and changes in foreign currency translation, pension and postretirement adjustments and changes in cash flow hedges. Accumulated other comprehensive income, after-tax, consists of foreign currency translation credits of $698 and $728, pension and postretirement charges of $528 and $384, and cash flow hedges and other charges of $29 and credits of $38 at September 30, 2008 and 2007, respectively.
 
FINANCIAL STATEMENT PRESENTATION
 
The preparation of the financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates.
 
On December 11, 2006, a two-for-one split of the Companys common stock was effected in the form of a 100 percent stock dividend (shares began trading on a post-split basis on December 12, 2006). This stock split resulted in the issuance of approximately 476.7 million additional shares of common stock and was accounted for by the transfer of approximately $161 from additional paid-in capital and $77 from retained earnings to common stock. All share and per share data have been retroactively restated to reflect this split.
 
Effective September 30, 2007, Emerson adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans (FAS 158). This statement requires employers to recognize the over- or under-funded status of defined benefit plans and other postretirement plans in the balance sheet and to recognize changes in the funded status in the year in which the changes occur through comprehensive income. The incremental effect of adopting FAS 158 was a reduction in other assets of $425, an increase in other liabilities of $97 and an after-tax charge to accumulated other comprehensive income of $329 (See Notes 10 and 11).
 
Effective October 1, 2007, the Company adopted the recognition and disclosure provisions of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement 109 (FIN 48). FIN 48 addresses the accounting for uncertain tax positions that a company has taken or expects to take on a tax return. As a result of adoption, the Company recorded a charge of $6 to beginning retained earnings (See Note 13).
 
Certain prior year amounts have been reclassified to conform to the current year presentation. The operating results of the European appliance motor and pump business are classified as discontinued operations for all periods presented. The operating results of Brooks are classified as discontinued operations for 2008.



[ 36 ] Emerson 2008
 
(2) Weighted Average Common Shares
 
Basic earnings per common share consider only the weighted average of common shares outstanding while diluted earnings per common share consider the dilutive effects of stock options and incentive shares. Options to purchase approximately 3.6 million, 1.1 million and 1.0 million shares of common stock were excluded from the computation of diluted earnings per share in 2008, 2007 and 2006, respectively, because their effect would have been antidilutive. Reconciliations of weighted average common shares for basic earnings per common share and diluted earnings per common share follow:
    
(SHARES IN MILLIONS)
 
2006
 
2007
 
2008
 
Basic
   
816.5
   
793.8
   
780.3
 
Dilutive shares
   
8.0
   
10.1
   
9.1
 
Diluted
   
824.5
   
803.9
   
789.4
 
 
(3) Acquisitions and Divestitures
 
The Company acquired Motorola Inc.s Embedded Computing business (Embedded Computing) during the first quarter of 2008. Embedded Computing provides communication platforms and enabling software used by manufacturers of equipment for telecommunications, medical imaging, defense and aerospace, and industrial automation markets and is included in the Network Power segment. In addition to Embedded Computing, the company acquired several smaller businesses during 2008 mainly in the Process Management and Network Power segments. Total cash paid for these businesses was approximately $561 (net of cash and equivalents acquired of approximately $2) and their annualized sales were approximately $665. Goodwill of $273 ($214 of which is expected to be deductible for tax purposes) and identifiable intangible assets (primarily technology and customer relationships) of $191, which are being amortized on a straight-line basis over a weighted-average life of eight years, were recognized from these transactions in 2008. Third-party valuations of assets are in-process; purchase price allocations are subject to refinement for fiscal year 2008 acquisitions.
 
In the first quarter of 2008, the Company divested the Brooks Instrument flow meters and flow controls unit (Brooks), which had sales for the first quarter of 2008 of $21 and net earnings of $1. The Company received $100 from the sale of Brooks, resulting in a pretax gain of $63 ($42 after-tax). The net gain and results of operations for fiscal 2008 were classified as discontinued operations; prior year results of operations were inconsequential. This business was previously included in the Process Management segment. In fiscal 2008, the Company completed the divestiture of the European appliance motor and pump business and received approximately $101 from the sale, resulting in a total loss of $92. In connection with a long-term strategy to divest selective slower-growth businesses, the Company had been actively pursuing the sale of this business. The forecast for this business was lower than originally planned due to a slow economic environment for the consumer appliance market, increasing competition from Asia, higher commodity costs, and loss of a customer. As a result, the carrying value of this business exceeded its estimated realizable value, and a loss of $52 was recorded for goodwill impairment in the second quarter of 2008. The Company entered into a definitive agreement to sell the business which resulted in an additional loss of $36 (including goodwill of $31) during the third quarter of 2008. A $4 loss was recorded when the transaction closed in the fourth quarter of 2008. The European appliance motor and pump business had total annual sales of $453, $441 and $399 and net earnings, excluding the loss, of $7, $7, and $6, in 2008, 2007 and 2006, respectively. The results of operations were classified as discontinued operations for all periods presented. This business was previously included in the Appliance and Tools segment.
 
The Company acquired Damcos Holding AS (Damcos) during the second quarter of fiscal 2007, and Stratos International, Inc. (Stratos) during the fourth quarter of fiscal 2007. Damcos supplies valve remote control systems and tank monitoring equipment to the marine and shipbuilding industries and is included in the Process Management segment. Stratos is a designer and manufacturer of radio-frequency and microwave interconnect products and is included in the Network Power segment. In addition to Damcos and Stratos, the Company acquired several smaller businesses during 2007 mainly in the Process Management and Appliance and Tools segments. Total cash paid for these businesses was approximately $295 (net of cash and equivalents acquired of approximately $40 and debt assumed of approximately $56) and their annualized sales were $240. Goodwill of $189 (none of which is expected to be deductible for tax purposes) and identifiable intangible assets (primarily technology and customer relationships) of $106, which are being amortized on a straight-line basis over a weighted-average life of nine years, were recognized from these transactions in 2007.



A Powerful Force for Innovation [ 37 ]
 
In 2007, the Company divested two small business units that had total annual sales of $113 and $115 for fiscal years 2006 and 2005, respectively. In the fourth quarter of 2006, the Company received approximately $80 from the divestiture of the materials testing business, resulting in a pretax gain of $31 ($22 after-tax). The materials testing business represented total annual sales of approximately $58 and $59 in 2006 and 2005, respectively. These businesses were not reclassified as discontinued operations because of immateriality.
 
The Company acquired Artesyn Technologies, Inc. (Artesyn) during the third quarter of fiscal 2006, and Knürr AG (Knürr) and Bristol Babcock (Bristol) during the second quarter of fiscal 2006. Artesyn is a global manufacturer of advanced power conversion equipment and board-level computing solutions for infrastructure applications in telecommunication and data-communication systems and is included in the Network Power segment. Knürr is a manufacturer of indoor and outdoor enclosure systems and cooling technologies for telecommunications, electronics and computing equipment and is included in the Network Power segment. Bristol is a manufacturer of control and measurement equipment for oil and gas, water and wastewater, and power industries and is included in the Process Management segment. In addition to Artesyn, Knürr and Bristol, the Company acquired several smaller businesses during 2006 mainly in the Industrial Automation and Appliance and Tools segments. Total cash paid for these businesses was approximately $752 (net of cash and equivalents acquired of approximately $120 and debt assumed of approximately $90) and their annualized sales were $920. Goodwill of $481 ($54 of which is expected to be deductible for tax purposes) and identifiable intangible assets (primarily technology and customer relationships) of $189, which are being amortized on a straight-line basis over a weighted-average life of nine years, were recognized from these transactions in 2006.
 
The results of operations of these businesses have been included in the Companys consolidated results of operations since the respective dates of acquisition and prior to the respective dates of divestiture.
 
(4) Other Deductions, Net
 
Other deductions, net are summarized as follows:
    
   
2006
 
2007
 
2008
 
Rationalization of operations
 
$
80
   
75
   
92
 
Amortization of intangibles (intellectual property and customer relationships)
   
47
   
63
   
81
 
Other
   
114
   
111
   
194
 
Gains, net
   
(68
)
 
(74
)
 
(64
)
Total
 
$
173
   
175
   
303
 
 
Other is comprised of several items that are individually immaterial, including minority interest expense, foreign currency gains and losses, bad debt expense, equity investment income and losses, as well as one-time items, such as litigation and disputed matters, insurance recoveries and interest refunds. Other increased from 2007 to 2008 primarily because of an additional $12 loss on foreign currency exchange transactions, an approximate $12 charge for in-process research and development in connection with the acquisition of the Embedded Computing business and a $31 goodwill impairment charge related to the North American appliance control business due to a slow economic environment for consumer appliance and residential end-markets and a major customers strategy to diversify suppliers and transition to and internalize the production of electronic controls. The customers strategy will result in a reduction of volume and potential elimination of the appliance control business as a supplier. As a result, sales and profits for this business are forecasted to decline. The Company considered the potential sale of this business and two strategic buyers expressed preliminary interest in the third quarter of 2008. Both subsequently decided not to pursue the acquisition of this business. Therefore, the decision was made to restructure these operations and integrate them with the North American appliance motors business.
 
Gains, net for 2008 includes the following items. The Company received $54 and recognized a gain of $39 ($20 after-tax) on the sale of an equity investment in Industrial Motion Control Holdings, LLC, a manufacturer of motion control components for automation equipment. The Company also recorded a gain of $18 related to the sale of a facility.
 
Gains, net for 2007 includes the following items. The Company recorded gains of approximately $32 in 2007 related to the sale of its remaining 4.5 million shares of MKS Instruments, Inc. (MKS), a publicly-traded company. The Company also recorded a gain of approximately $24 in 2007 for payments received under the U.S. Continued Dumping and Subsidy Offset Act (Offset Act).
 
Gains, net for 2006 includes the following items. The Company recorded gains of approximately $26 in 2006 related to the sale of 4.4 million shares of MKS. In the fourth quarter of 2006, the Company recorded a pretax gain of approximately $31 related to the divesture of the materials testing business. Also during the fourth quarter of 2006, the Company recorded a pretax charge of $14 related to the write-down of two businesses that were sold in 2007 to their net realizable values. The Company also recorded a gain of approximately $18 in 2006 for payments received under the Offset Act.


 
[ 38 ] Emerson 2008
 
(5) Rationalization of Operations
 
The change in the liability for the rationalization of operations during the years ended September 30 follows:
    
   
2007
 
EXPENSE
 
PAID / UTILIZED
 
2008
 
Severance and benefits
 
$
28
   
49
   
44
   
33
 
Lease/contract terminations
   
8
   
3
   
6
   
5
 
Fixed asset write-downs
   
   
4
   
4
   
 
Vacant facility and other shutdown costs
   
1
   
8
   
8
   
1
 
Start-up and moving costs
   
   
34
   
33
   
1
 
   
$
37
   
98
   
95
   
40
 
    
   
2006
 
EXPENSE
 
PAID / UTILIZED
 
2007
 
Severance and benefits
 
$
31
   
40
   
43
   
28
 
Lease/contract terminations
   
12
   
4
   
8
   
8
 
Fixed asset write-downs
   
   
2
   
2
   
 
Vacant facility and other shutdown costs
   
1
   
8
   
8
   
1
 
Start-up and moving costs
   
1
   
29
   
30
   
 
   
$
45
   
83
   
91
   
37
 

Expense includes $6, $8 and $4 in 2008, 2007 and 2006, respectively, related to the European appliance motor and pump business classified as discontinued operations.

Rationalization of operations by segment is summarized as follows:
    
   
2006
 
2007
 
2008
 
Process Management
 
$
14
   
15
   
12
 
Industrial Automation
   
12
   
14
   
19
 
Network Power
   
19
   
23
   
28
 
Climate Technologies
   
14
   
9
   
22
 
Appliance and Tools
   
21
   
14
   
11
 
Total
 
$
80
   
75
   
92
 
 
Rationalization of operations comprises expenses associated with the Companys efforts to continuously improve operational efficiency and to expand globally in order to remain competitive on a worldwide basis. These expenses result from numerous individual actions implemented across the divisions on a routine basis. Rationalization of operations includes ongoing costs for moving facilities, starting up plants from relocation as well as business expansion, exiting product lines, curtailing/downsizing operations because of changing economic conditions, and other items resulting from asset redeployment decisions. Shutdown costs include severance, benefits, stay bonuses, lease/contract terminations and asset write-downs. Start-up and moving costs include employee training and relocation, movement of assets and other items. Vacant facility costs include security, maintenance and utility costs associated with facilities that are no longer being utilized.
 
During 2008, rationalization of operations primarily related to the exit of approximately 10 production, distribution, or office facilities, including the elimination of approximately 2,300 positions, as well as costs related to facilities exited in previous periods. Noteworthy rationalization actions during 2008 are as follows. Process Management included start-up costs related to capacity expansion in China to serve the Asian market and severance related to consolidation of certain production facilities in Europe to obtain operational efficiencies. Industrial Automation included severance and start-up and moving costs related to the consolidation of certain power transmission and valve facilities in North America to obtain operational efficiencies. Network Power included severance and start-up and moving costs related to the consolidation of certain production in North America to remain competitive on a global basis and start-up and moving costs related to the transfer of certain embedded computing production in Asia. Climate Technologies included severance and shutdown and start-up and moving costs related to the shifting of certain production in the United States to Mexico, and severance and shutdown costs related to the consolidation of certain production facilities in Europe to obtain operational efficiencies. Appliance and Tools included severance and start-up and moving costs related to the shifting of certain production from Canada to the United States and severance related to the closure of certain motor production in Europe to remain competitive on a global basis. The Company expects rationalization expense for 2009 to be approximately $125 to $150, including the costs to complete actions initiated before the end of 2008 and actions anticipated to be approved and initiated during 2009.



A Powerful Force for Innovation [ 39 ]
 
During 2007, rationalization of operations primarily related to the exit of approximately 25 production, distribution, or office facilities, including the elimination of approximately 2,200 positions, as well as costs related to facilities exited in previous periods. Noteworthy rationalization actions during 2007 are as follows. Process Management included start-up costs related to capacity expansion in China to serve the Asian market, as well as severance and start-up and moving costs related to the movement of certain operations in Western Europe to Eastern Europe and Asia to improve profitability. Industrial Automation included severance and start-up and moving costs related to the consolidation of certain power transmission facilities in Asia and North America to obtain operational efficiencies and serve Asian and North American markets. Network Power included severance related to the closure of certain power conversion facilities acquired with Artesyn, as well as severance and start-up and moving costs related to the shifting of certain power systems production from the United States and Europe to Mexico to remain competitive on a global basis. Climate Technologies included start-up costs related to capacity expansion in Mexico and Eastern Europe to improve profitability and to serve these markets, and start-up and moving costs related to the consolidation of certain production facilities in the United States to obtain operational efficiencies. Appliance and Tools included severance and start-up and moving costs related to the consolidation of certain North American production, and severance related to the closure of certain motor production in Europe to remain competitive on a global basis.
 
During 2006, rationalization of operations primarily related to the exit of approximately 10 production, distribution, or office facilities, including the elimination of approximately 1,700 positions, as well as costs related to facilities exited in previous periods. Noteworthy rationalization actions during 2006 are as follows. Process Management included severance related to the shifting of certain regulator production from Western Europe to Eastern Europe. Industrial Automation included start-up and moving costs related to shifting certain motor production in Western Europe to Eastern Europe, China and Mexico to leverage costs and remain competitive on a global basis and to serve these markets. Network Power included severance related to the closure of certain power conversion facilities acquired with Artesyn, severance, start-up and vacant facility costs related to the consolidation of certain power systems operations in North America and the consolidation of administrative operations in Europe to obtain operational synergies. Climate Technologies included severance related to the movement of temperature sensors and controls production from Western Europe to China and start-up and moving costs related to a new plant in Eastern Europe in order to improve profitability. Appliance and Tools included primarily severance and start-up and moving costs related to the shifting of certain tool and motor manufacturing operations from the United States and Western Europe to China and Mexico in order to consolidate facilities and improve profitability.
 
(6) Goodwill and Other Intangibles
 
Acquisitions are accounted for under the purchase method, with substantially all goodwill assigned to the reporting unit that acquires the business. Under the annual impairment test, if a reporting units carrying amount exceeds its estimated fair value, a goodwill impairment is recognized to the extent that the reporting units carrying amount of goodwill exceeds the implied fair value of the goodwill. Fair values of reporting units are estimated using discounted cash flows and market multiples.

The change in goodwill by business segment follows:
    
   
PROCESS
 
INDUSTRIAL
 
NETWORK
 
CLIMATE
 
APPLIANCE
     
   
MANAGEMENT
 
AUTOMATION
 
POWER
 
TECHNOLOGIES
 
AND TOOLS
 
TOTAL
 
Balance, September 30, 2006
 
$
1,778
   
1,016
   
2,162
   
408
   
649
   
6,013
 
Acquisitions
   
146
   
1
   
26
   
3
   
13
   
189
 
Divestitures
               
(5
)
             
(5
)
Impairment
         
(7
)
                   
(7
)
Foreign currency translation and other
   
61
    60     76     9    
16
   
222
 
Balance, September 30, 2007
 
$
1,985
   
1,070
   
2,259
   
420
   
678
   
6,412
 
Acquisitions
   
87
   
24
   
162
               
273
 
Divestitures
                           
(83
)
 
(83
)
Impairment
                           
(31
)
 
(31
)
Foreign currency translation and other
   
(29
)
 
13
   
11
   
(8
)
 
4
   
(9
)
Balance, September 30, 2008
 
$
2,043
   
1,107
   
2,432
   
412
   
568
   
6,562
 

See Notes 3 and 4 for further discussion of changes in goodwill related to acquisitions, divestitures and impairment.


 
[ 40 ] Emerson 2008
 
The gross carrying amount and accumulated amortization of intangibles (other than goodwill) by major class follow:
    
   
GROSS CARRYING AMOUNT
 
ACCUMULATED AMORTIZATION
 
NET CARRYING AMOUNT
 
   
2007
 
2008
 
2007
 
2008
 
2007
 
2008
 
Intellectual property and customer relationships
 
$
925
   
985
   
381
   
358
   
544
   
627
 
Capitalized software
    729    
805
   
558
   
613
   
171
   
192
 
   
$
1,654
   
1,790
   
939
   
971
   
715
   
819
 

Total intangible amortization expense for 2008, 2007 and 2006 was $150, $131 and $107, respectively. Based on intangible assets as of September 30, 2008, amortization expense will approximate $148 in 2009, $130 in 2010, $112 in 2011, $87 in 2012 and $62 in 2013.
 
(7) Financial Instruments
 
The Company selectively uses derivative financial instruments to manage interest costs, commodity prices and currency exchange risk. The Company does not hold derivatives for trading purposes. No credit loss is anticipated as the counterparties to these agreements are major financial institutions with high credit ratings.
 
To efficiently manage interest costs, the Company utilizes interest rate swaps as cash flow hedges of variable rate debt or fair value hedges of fixed rate debt. Also as part of its hedging strategy, the Company utilizes purchased option and forward exchange contracts and commodity swaps as cash flow or fair value hedges to minimize the impact of currency and commodity price fluctuations on transactions, cash flows, fair values and firm commitments. Hedge ineffectiveness during 2008, 2007 and 2006 was immaterial. At September 30, 2008, substantially all of the contracts for the sale or purchase of European and other currencies and the purchase of copper and other commodities mature within two years; contracts with a fair value of approximately $56 of losses mature in 2009 and $6 of losses mature in 2010.
 
Notional transaction amounts and fair values for the Companys outstanding derivatives, by risk category and instrument type, as of September 30, 2008 and 2007, are summarized as follows. Fair values of the derivatives do not consider the offsetting underlying hedged item.
                   
   
2007
 
2008
 
   
NOTIONAL
 
FAIR VALUE
 
 NOTIONAL
 
 FAIR VALUE
 
   
AMOUNT
 
GAIN (LOSS)
 
 AMOUNT
 
 GAIN (LOSS)
 
Foreign currency:
 
 
                
Forwards
 
$
1,922
   
35
   
1,835
   
(24
)
Options
 
$
266
   
2
   
243
   
8
 
Interest rate swaps
 
$
113
   
(3
)
 
122
   
(2
)
Commodity contracts
 
$
509
   
45
   
324
   
(44
)
 
Fair values of the Companys financial instruments are estimated by reference to quoted prices from market sources and financial institutions, as well as other valuation techniques. The estimated fair value of long-term debt (including current maturities) was in excess of (less than) the related carrying value by ($12) and $2 at September 30, 2008 and 2007, respectively. The estimated fair value of each of the Companys other classes of financial instruments approximated the related carrying value at September 30, 2008 and 2007.
 
(8) Short-Term Borrowings and Lines of Credit
 
Short-term borrowings and current maturities of long-term debt are summarized as follows:
    
   
2007
 
2008
 
Current maturities of long-term debt
 
$
251
   
467
 
Commercial paper
   
113
   
665
 
Payable to banks
   
19
   
17
 
Other
   
21
   
72
 
Total
 
$
404
   
1,221
 
Weighted-average short-term borrowing interest rate at year-end
   
3.2
%
 
2.6
%



A Powerful Force for Innovation [ 41 ]
 
In 2000, the Company issued 13 billion Japanese yen of commercial paper and simultaneously entered into a ten-year interest rate swap, which fixed the rate at 2.2 percent.
 
At year-end 2008, the Company maintained a five-year revolving credit facility effective until April 2011 amounting to $2.8 billion to support short-term borrowings and to assure availability of funds at prevailing interest rates. The credit facility does not contain any financial covenants and is not subject to termination based on a change in credit ratings or a material adverse change. There were no borrowings against U.S. lines of credit in the last three years.
 
(9) Long-Term Debt
 
Long-term debt is summarized as follows:
    
   
2007
 
2008
 
5 ½% notes due September 2008
 
$
250
   
 
5% notes due October 2008
   
175
   
175
 
5.85% notes due March 2009
   
250
   
250
 
7 % notes due August 2010
   
500
   
500
 
5.75% notes due November 2011
   
250
   
250
 
4.625% notes due October 2012
   
250
   
250
 
4 ½% notes due May 2013
   
250
   
250
 
5 % notes due November 2013
   
250
   
250
 
5% notes due December 2014
   
250
   
250
 
4.75% notes due October 2015
   
250
   
250
 
5.125% notes due December 2016
   
250
   
250
 
5.375% notes due October 2017
   
250
   
250
 
5.250% notes due October 2018
   
   
400
 
6% notes due August 2032
   
250
   
250
 
Other
   
198
   
189
 
     
3,623
   
3,764
 
Less current maturities
   
251
   
467
 
Total
 
$
3,372
   
3,297
 
 
During the second quarter of 2008, the Company issued $400 million of 5.250% notes due October 2018, under a shelf registration statement filed with the Securities and Exchange Commission. During the first and third quarters of 2007, the Company issued $250 of 5.125%, ten-year notes, and $250 of 5.375%, ten-year notes, respectively, under a shelf registration statement filed with the Securities and Exchange Commission. In 1999, the Company issued $250 of 5.85%, ten-year notes that were simultaneously swapped to U.S. commercial paper rates. The Company terminated the swap in 2001, establishing an effective interest rate of 5.7 percent.
 
Long-term debt maturing during each of the four years after 2009 is $599, $30, $256 and $500, respectively. Total interest paid related to short-term borrowings and long-term debt was approximately $235, $242 and $214 in 2008, 2007 and 2006, respectively.
 
As of September 30, 2008, the Company could issue up to $1.35 billion in debt securities, preferred stock, common stock, warrants, share purchase contracts and share purchase units under the shelf registration statement filed with the Securities and Exchange Commission. The Company may sell securities in one or more separate offerings with the size, price and terms to be determined at the time of sale. The net proceeds from the sale of the securities will be used for general corporate purposes, which may include, but are not limited to, working capital, capital expenditures, financing acquisitions and the repayment of short- or long-term borrowings. The net proceeds may be invested temporarily until they are used for their stated purpose. The Company intends to file a new shelf registration statement prior to the expiration of the existing registration in December 2008.


 
[ 42 ] Emerson 2008
 
(10) Retirement Plans
 
Retirement plan expense includes the following components:
   
   
U.S. PLANS
 
NON-U.S. PLANS
 
   
2006
 
2007
 
2008
 
2006
 
2007
 
2008
 
Defined benefit plans:
                                     
Service cost (benefits earned during the period)
 
$
58
   
43
   
48
   
19
   
21
   
23
 
Interest cost
   
145
   
159
   
167
   
32
   
38
   
45
 
Expected return on plan assets
   
(202
)
 
(211
)
 
(230
)
 
(32
)
 
(38
)
 
(45
)
Net amortization
    100     87    
86
   
16
   
11
   
11
 
Net periodic pension expense
   
101
   
78
   
71
   
35
   
32
   
34
 
Defined contribution and multiemployer plans
    85     94    
104
   
25
   
27
   
34
 
Total retirement plan expense
 
$
186
   
172
   
175
   
60
   
59
   
68
 

The reconciliations of the actuarial present value of the projected benefit obligations and of the fair value of plan assets for defined benefit pension plans follow:
   
   
U.S. PLANS
 
NON-U.S. PLANS
 
   
2007
 
2008
 
2007
 
2008
 
Projected benefit obligation, beginning
 
$
2,464
   
2,678
   
711
   
837
 
Service cost
   
43
   
48
   
21
   
23
 
Interest cost
   
159
   
167
   
38
   
45
 
Actuarial loss (gain)
   
127
   
(64
)
 
10
   
21
 
Benefits paid
   
(129
)
 
(136
)
 
(36
)
 
(35
)
Acquisitions/divestitures, net
   
-
   
-
   
18
   
21
 
Foreign currency translation and other
   
14
   
6
   
75
   
(69
)
Projected benefit obligation, ending
 
$
2,678
   
2,699
   
837
   
843
 
                           
Fair value of plan assets, beginning
 
$
2,785
   
3,204
   
555
   
690
 
Actual return on plan assets
   
475
   
(102
)
 
50
   
(42
)
Employer contributions
   
71
   
63
   
62
   
73
 
Benefits paid
   
(129
)
 
(136
)
 
(36
)
 
(35
)
Acquisitions/divestitures, net
   
-
   
-
   
1
   
4
 
Foreign currency translation and other
   
2
   
1
   
58
   
(71
)
Fair value of plan assets, ending
 
$
3,204
   
3,030
   
690
   
619
 
                           
Plan assets in excess of (less than) benefit obligation as of June 30
 
$
526
   
331
   
(147
)
 
(224
)
Adjustment for fourth quarter contributions
   
1
   
-
   
4
   
4
 
Net amount recognized in the balance sheet
 
$
527
   
331
   
(143
)
 
(220
)
                           
The amounts recognized in the balance sheet as of September 30 consisted of:
                         
Noncurrent asset
 
$
630
   
431
   
19
   
5
 
Noncurrent liability
 
$
(103
)
 
(100
)
 
(162
)
 
(225
)
Accumulated other comprehensive income (loss)
 
$
(365
)
 
(551
)
 
(185
)
 
(253
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