Business context and reporting period
Emerson Electric Co. is a global manufacturer providing technology and engineering solutions. This unaudited Form 10-Q covers the second quarter and first six months of fiscal 2019, ended March 31, 2019; comparisons are with the corresponding 2018 periods. Amounts below are in U.S. dollars unless noted.
Financial performance and position
| Metric | Three months ended March 31, 2019 | Six months ended March 31, 2019 |
|---|---|---|
| Net sales | $4.570 billion, up 8% | $8.717 billion, up 8% |
| Underlying sales growth | 4% | 4% |
| Net earnings attributable to common stockholders | $520 million, up 8% | $985 million, up 13% |
| Diluted EPS | $0.84, up 11% | $1.58, up 15% |
| Gross margin | 42.1%, down 0.7 percentage points | 42.3%, down 0.2 percentage points |
| SG&A as a percentage of sales | 25.0%, up 0.6 percentage points | 25.5%, up 0.4 percentage points |
| Pretax earnings | $675 million, up 3% | $1.266 billion, up 9% |
Second-quarter sales growth included a 6% contribution from acquisitions and a 2% negative impact from currency; underlying sales rose on higher volume and slightly higher prices. For the first half, acquisitions added 6% and currency reduced sales by 2%. The six-month effective tax rate was 22%, versus 24% in 2018; the current period benefited from discrete tax items. The quarter’s 22% rate included a $13 million tax benefit related to final regulations on deemed repatriation.
Six-month operating cash flow was $856 million, down from $944 million. Capital expenditures were $274 million, resulting in free cash flow of $582 million, down from $750 million. Working capital changes used $530 million of cash, compared with $363 million in the prior-year period. Dividends paid were $607 million and share repurchases were $1.0 billion.
At March 31, 2019, cash and equivalents were $1.384 billion. Short-term borrowings and current maturities were $2.551 billion, and long-term debt was $3.786 billion. Total debt-to-capital was 42.6%, versus 34.7% at September 30, 2018; net debt-to-net capital was 36.7%, versus 29.1%. Management attributed the higher ratios primarily to short-term borrowings supporting accelerated share repurchases. Working capital was $438 million and the current ratio was 1.1. Interest coverage for the first six months was 13.3x, versus 12.7x for the comparable period.
Material changes and operating segments
- Automation Solutions: Second-quarter sales increased 9% to $3.010 billion and earnings rose 2% to $444 million; margin declined from 15.7% to 14.8%. Six-month sales rose 9% to $5.809 billion and earnings rose 4% to $851 million; margin declined from 15.4% to 14.7%. Acquisitions supported growth, while acquisition dilution, investment spending and mix weighed on margins.
- Commercial & Residential Solutions: Second-quarter sales rose 5% to $1.561 billion, but earnings fell 6% to $328 million and margin declined from 23.6% to 21.0%. For six months, sales rose 6% to $2.899 billion while earnings fell 6% to $565 million; margin declined from 22.0% to 19.5%. Softer Climate Technologies demand, particularly in Asia and China, and acquisition dilution and unfavorable mix affected results. Tools & Home Products sales growth was substantially acquisition-driven.
- Six-month sales growth was broadest in the Americas; Asia, Middle East & Africa was down 1% overall, with China down 1%. Management cited softer discrete manufacturing conditions and slower-than-expected recovery in Commercial & Residential Solutions in that region.
- During the first half, Emerson acquired six Automation Solutions businesses for $243 million net of cash acquired; their combined annual sales were approximately $240 million. Acquisitions completed in 2018 also contributed to current-period sales and expenses.
Outlook, commentary, risks and unusual items
- For fiscal 2019, management expects consolidated sales growth of 7%–8.5%, including approximately 5% from acquisitions and a 2% currency headwind; underlying growth is expected to be 4%–5.5%. It forecasts reported EPS of $3.60–$3.70, operating cash flow of approximately $3.2 billion and free cash flow of approximately $2.5 billion. Free cash flow excludes targeted capital spending of $650 million.
- Management expects growth to improve modestly in the second half, citing energy investment and a possible improvement in Commercial & Residential Solutions demand in Asia, Middle East & Africa. It expects a full-year tax rate of approximately 23%.
- Backlog for unsatisfied or partially unsatisfied performance obligations was approximately $5.6 billion; the company expects to recognize about 85% as revenue over the next 12 months.
- Reported results included $20 million of restructuring costs in the first half. Other deductions declined year over year, partly because of lower acquisition/divestiture costs; intangibles amortization increased, mainly related to acquisitions. Fiscal 2019 adoption of ASC 606 increased opening retained earnings by $25 million and did not materially affect current-period statements.
- In January 2019, Emerson issued €500 million of 1.25% notes due 2025 and €500 million of 2.0% notes due 2029, using proceeds to reduce commercial paper and for general corporate purposes. The fair value of long-term debt exceeded carrying value by $306 million at March 31.
- Management identifies economic and currency conditions, demand, pricing, intellectual-property protection, cybersecurity, tariffs, competition and technology as risks to forward-looking statements. It considered direct Brexit-related tariff, logistics and other costs immaterial; UK sales were less than 2% of consolidated sales.
Important facts for investors to verify
- Whether underlying demand and the forecast second-half recovery materialize, especially in China and the wider Asia, Middle East & Africa region.
- Whether acquisition contributions translate into sustainable growth and improved segment margins, given current acquisition-related dilution and higher debt levels.
- Whether operating cash flow and free cash flow meet guidance after working-capital needs and planned capital spending, while funding dividends and repurchases.
- The composition and persistence of favorable tax items, and the assumptions underlying the approximately 23% full-year tax-rate outlook.
- Developments in disclosed contingencies: asbestos-related liabilities were $328 million and related insurance receivables were $118 million at March 31, 2019; confirm subsequent changes and coverage assumptions in later filings.