Why did reported earnings fall so sharply if operating earnings improved?

Net income dropped to $121 million from $305 million because of a $108 million after-tax charge from adopting SFAS 142, which required write-offs of a $56 million trademark and $73 million of goodwill in the Power Systems unit. Continuing operations income actually rose to $226 million, but that increase was supported by a $48 million tax benefit from resolving 1995-1999 tax matters, so underlying earnings were weaker than the headline increase suggests.

How strong is the company's cash generation and what drove the improvement?

Operating cash flow rose to $476 million from $335 million, and free cash flow reached $372 million versus $178 million a year earlier. Management attributed the gain primarily to working capital improvements, including receivables and inventory reductions, and to lower capital spending. Free cash flow was reduced by a $24 million pension contribution tied to the Rockwell Collins spinoff.

What is the outlook for fiscal 2003?

Management expects first-quarter EPS of $0.16 to $0.18 and full-year EPS of at least $1.05, representing 15% growth, even if soft conditions persist. If business conditions improve modestly, the company targets $1.15 per share (25% growth). The company also expects a 30% effective tax rate, versus 3.0% in 2002, which will weigh on reported earnings growth. Capital expenditures are expected to be $125 to $150 million.

Is the dividend safe and what capital return plans exist?

Dividends were $0.66 per share in 2002, down from $0.93 in 2001 after the Rockwell Collins spinoff reset the payout, and the company expects to maintain $0.66 in 2003. No shares were repurchased in 2002, though about $104 million remained on the $250 million authorization, and management anticipates buybacks in 2003 depending on business conditions. The $150 million 6.8% notes maturing in April 2003 are expected to be funded from cash, operating cash flow, and commercial paper.

What are the main risks and legal exposures disclosed?

Demand remains tied to industrial capital spending, with U.S. capacity utilization falling from 80.2% to 75.9% over the period, and the company notes competitive pricing pressure and possible component shortages. Legal exposures include long-running cases tied to former DOE-related operations at Rocky Flats and Hanford and PCB contamination claims in Russellville, Kentucky, where the company is generally indemnified or believes outcomes will not be material. Pension expense is also expected to rise by about $15 million in fiscal 2003 due to lower return and discount rate assumptions.

ROK 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed November 25, 2002. Cited figures are marked; the original filing is the authoritative source.

Rockwell Automation's fiscal 2002 10-K (year ended September 30, 2002) shows a company working through a prolonged industrial downturn while protecting cash generation and earnings.

Sales fell 9% to $3,909 million^a from $4,285 million, driven mainly by depressed automation demand, with Control Systems (79% of sales) down about 8%. Income from continuing operations before the accounting change rose to $226 million, or $1.20 per diluted share, from $125 million, but that improvement was helped by a $48 million tax benefit from resolving 1995-1999 tax matters. Reported net income fell to $121 million ($0.64 per diluted share) after a $108 million after-tax cumulative effect charge from adopting SFAS 142, which covered goodwill and trademark impairments.

Cash flow and the balance sheet were the strongest parts of the report. Operating cash flow rose to $476 million and free cash flow to $372 million^b, up from $178 million, mainly on working capital gains and lower capital spending. Shareowners' equity held at $1,609 million, the debt-to-capital ratio was 36.6%, and the company had no commercial paper outstanding at year end.

Management guided to first-quarter EPS of $0.16 to $0.18^c and full-year fiscal 2003 EPS of at least $1.05 (15% growth), or $1.15 if business conditions improve modestly. Dividends were held at $0.66 per share, and the company expected to repay a $150 million note due April 2003.

For investors, the central question is whether the cost actions and tax-driven earnings support can deliver the guided growth while the manufacturing economy remains weak. The filing also notes that the stock price excludes the value of the Rockwell Collins shares distributed in the 2001 spinoff, and that the company faces long-running legacy litigation tied to its former Rocky Flats, Hanford, and Russellville operations, although management does not expect material adverse outcomes.

02—Key points

Key Highlights

Sales declined 9% to $3,909 million (from $4,285 million), with Control Systems down 8% to $3,060 million and Power Systems down 4% to $716 million, reflecting depressed industrial automation demand.
Income from continuing operations before accounting change rose to $226 million ($1.20 per diluted share) from $125 million ($0.68), but included a $48 million tax provision reduction (about $0.26 per share) from resolving prior-period tax matters.
Net income fell to $121 million ($0.64 per diluted share) from $305 million, due to a $108 million after-tax ($0.58 per share) cumulative effect charge for goodwill and trademark impairments under SFAS 142.
Free cash flow more than doubled to $372 million (from $178 million), driven by working capital improvements and lower capital expenditures of $104 million.
Balance sheet remained solid, with total assets of $4,024 million, long-term debt reduced to $767 million, shareowners' equity of $1,609 million, and a debt-to-total-capital ratio of 36.6%.
Management guided fiscal 2003 EPS to at least $1.05 (15% growth) and up to $1.15 (25% growth) if business conditions improve, with first-quarter EPS expected at $0.16 to $0.18.
Ongoing legacy litigation includes the Rocky Flats (DOE plant), Hanford, and Russellville PCB matters, which management believes will not have a material adverse effect.

03—Questions

Frequently Asked Questions

Why did reported earnings fall so sharply if operating earnings improved?
Net income dropped to $121 million from $305 million because of a $108 million after-tax charge from adopting SFAS 142, which required write-offs of a $56 million trademark and $73 million of goodwill in the Power Systems unit. Continuing operations income actually rose to $226 million, but that increase was supported by a $48 million tax benefit from resolving 1995-1999 tax matters, so underlying earnings were weaker than the headline increase suggests.
How strong is the company's cash generation and what drove the improvement?
Operating cash flow rose to $476 million from $335 million, and free cash flow reached $372 million versus $178 million a year earlier. Management attributed the gain primarily to working capital improvements, including receivables and inventory reductions, and to lower capital spending. Free cash flow was reduced by a $24 million pension contribution tied to the Rockwell Collins spinoff.
What is the outlook for fiscal 2003?
Management expects first-quarter EPS of $0.16 to $0.18 and full-year EPS of at least $1.05, representing 15% growth, even if soft conditions persist. If business conditions improve modestly, the company targets $1.15 per share (25% growth). The company also expects a 30% effective tax rate, versus 3.0% in 2002, which will weigh on reported earnings growth. Capital expenditures are expected to be $125 to $150 million.
Is the dividend safe and what capital return plans exist?
Dividends were $0.66 per share in 2002, down from $0.93 in 2001 after the Rockwell Collins spinoff reset the payout, and the company expects to maintain $0.66 in 2003. No shares were repurchased in 2002, though about $104 million remained on the $250 million authorization, and management anticipates buybacks in 2003 depending on business conditions. The $150 million 6.8% notes maturing in April 2003 are expected to be funded from cash, operating cash flow, and commercial paper.
What are the main risks and legal exposures disclosed?
Demand remains tied to industrial capital spending, with U.S. capacity utilization falling from 80.2% to 75.9% over the period, and the company notes competitive pricing pressure and possible component shortages. Legal exposures include long-running cases tied to former DOE-related operations at Rocky Flats and Hanford and PCB contamination claims in Russellville, Kentucky, where the company is generally indemnified or believes outcomes will not be material. Pension expense is also expected to rise by about $15 million in fiscal 2003 due to lower return and discount rate assumptions.

04—Continue

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