Emerson Electric Co. — Q2 FY2020 Form 10-Q
Business context and period: Global manufacturer of technology and engineering solutions. This unaudited quarterly report covers the three and six months ended March 31, 2020; the fiscal second quarter ended March 31. Results were affected by COVID-19-related demand declines and lower oil prices.
Financial performance
| Metric | Three months ended March 31, 2020 | Six months ended March 31, 2020 |
|---|---|---|
| Net sales | $4.162 billion, down 9% year over year; underlying sales down 7% | $8.313 billion, down 5%; underlying sales down 4% |
| Gross margin | 42.1%, unchanged | 42.2%, down 0.1 percentage point |
| Pretax earnings | $689 million, up 2% | $1.112 billion, down 12% |
| Net earnings attributable to common stockholders | $517 million, down 1% | $843 million, down 14% |
| Diluted EPS | $0.84, unchanged | $1.37, down 13% |
| Operating cash flow | $1.012 billion for the six months, versus $856 million in the prior-year period | |
| Free cash flow | $787 million for the six months, versus $582 million; defined as operating cash flow less capital expenditures |
Second-quarter SG&A was $983 million, or 23.7% of sales, versus $1.145 billion, or 25.0%. Management cited lower stock-based compensation and cost-reduction savings. Lower volume and unfavorable mix were offset by favorable price-cost, keeping quarterly gross margin flat. For the first six months, other deductions rose to $220 million from $107 million, principally due to higher restructuring costs.
Segment results for Q2: Automation Solutions sales were $2.709 billion, down 10%, and earnings were $391 million, down 12%; margin was 14.4%, down 0.4 percentage point. Commercial & Residential Solutions sales were $1.458 billion, down 7%, and earnings were $306 million, down 7%; margin was flat at 21.0%.
Financial position and liquidity
At March 31, 2020, cash and equivalents were $2.583 billion. Short-term borrowings and current maturities of long-term debt were $3.741 billion, and long-term debt was $3.960 billion. Working capital was $92 million, versus $1.163 billion at September 30, 2019; the current ratio was 1.0 versus 1.2. Total debt-to-total capital rose to 50.6% from 41.0%, and net debt-to-net capital rose to 40.5% from 33.9%.
Operating cash flow increased partly because operating working capital declined amid lower business levels. Cash from financing included a $2.076 billion net increase in short-term borrowings; the company said it increased short-term borrowing and cash holdings by more than $1 billion versus normal planned levels to support liquidity. Its $3.5 billion revolving backup credit facility was undrawn. Long-term debt ratings remained A2 (Moody’s) and A (S&P).
Material changes, outlook, and risks
- COVID-19 and oil: Management said pandemic-related restrictions sharply weakened demand across many markets, particularly China, the U.S., and Europe, while the oil-price decline further affected results. Conditions accelerated into April and were expected to be more pronounced in Q3. Most sites were operating, though some were below capacity and supply-chain disruption had occurred.
- FY2020 guidance: Net sales expected to decline 9%–11%, with underlying sales down 7%–9%. EPS guidance was $2.62–$2.82; adjusted EPS, excluding $0.38 per share of restructuring actions and related costs, was $3.00–$3.20. Operating cash flow was expected to be approximately $2.75 billion and free cash flow approximately $2.2 billion, with targeted capital spending of $550 million.
- Guidance assumptions: Management assumed significant demand deterioration for the rest of FY2020, particularly Q3, with demand remaining negative through the first half of 2021, and oil prices stabilizing at $20–$30. Longer disruption, renewed spread, government shutdowns, or slower economic recovery could worsen results.
- Capital allocation and restructuring: The company suspended share repurchases for the rest of FY2020; it had repurchased $942 million of shares in the first six months. It made no change to its FY2020 dividend plan. FY2020 restructuring expense and related costs were expected to be approximately $280 million, $65 million above the prior estimate; initiatives included workforce reductions of about 1,800 employees.
- Other items: Adoption of lease accounting resulted in approximately $500 million of operating lease assets and liabilities at October 1, 2019, without material earnings or cash-flow impact. The CARES Act was expected to benefit the company through payroll-tax deferrals. Balance-sheet items included $305 million of asbestos litigation liabilities and $105 million of related insurance receivables.
- Additional risks: The filing highlights uncertainty around pandemic duration and effects on demand, operations, supply chains, customers, suppliers, and financing markets. Management also noted oil-market volatility and ongoing Brexit negotiations; it expected direct Brexit-related costs to be immaterial.
Important facts for investors to verify
- Whether actual demand, oil prices, and backlog reduction tracked the assumptions underlying FY2020 sales and EPS guidance.
- Whether liquidity remained adequate as short-term borrowings rose and working capital and the current ratio declined.
- Whether restructuring costs, savings, and the expected margin benefits developed as planned.
- Whether cash-flow guidance and planned capital spending were achieved, and whether the buyback suspension and dividend plan changed.
- How COVID-19-related operating, supply-chain, customer-credit, and market risks evolved after the reporting date.