Emerson Electric Co. — Q3 FY2014 Form 10-Q
Business context and reporting period. The quarter and nine months ended June 30, 2014; dollar amounts are in millions except per-share data. Emerson reported five operating segments. Comparisons are affected by the 2013 Artesyn goodwill impairment and the subsequent divestiture of Artesyn.
Financial performance
| Metric | Q3 FY2014 | Q3 FY2013 | Nine months FY2014 | Nine months FY2013 |
|---|---|---|---|---|
| Net sales | $6,312 | $6,344 | $17,730 | $17,857 |
| Gross margin | 41.8% | 40.5% | 41.0% | 40.0% |
| Earnings before income taxes | $1,072 | $511 | $2,532 | $2,015 |
| Net earnings attributable to common stockholders | $728 | $194 | $1,737 | $1,209 |
| Diluted EPS | $1.03 | $0.27 | $2.45 | $1.66 |
- Management said Q3 underlying sales grew 3%: U.S. growth was 5% and international growth 1%. The Artesyn divestiture reduced reported sales by about 5 percentage points; acquisitions added 1 percentage point.
- Q3 gross margin improved 1.3 percentage points, reflecting the divestiture’s favorable comparison, cost containment, cost reductions and lower pension expense; unfavorable mix and pricing partly offset these benefits. SG&A was 22.6% of sales versus 22.0%.
- Reported earnings growth substantially reflects the prior-year $503 pretax ($475 after-tax) Artesyn impairment and a separate $33 tax charge. Excluding the prior-year Artesyn charges, management reported Q3 net earnings growth of 4% and EPS growth of 6%. Nine-month comparisons likewise benefited substantially from the absence of those charges; current-year results included a $34 Artesyn investment loss.
- Q3 effective tax rate was 31%, versus 58% in the prior-year quarter; the prior rate reflected impairment-related and other tax charges. The nine-month effective rates were 30% and 38%, respectively.
Segments
| Q3 FY2014 segment | Sales | Sales change | Earnings | Margin |
|---|---|---|---|---|
| Process Management | $2,317 | +6% | $473 | 20.4% |
| Industrial Automation | $1,289 | +1% | $214 | 16.6% |
| Network Power | $1,237 | -18% | $107 | 8.7% |
| Climate Technologies | $1,191 | +6% | $250 | 21.0% |
| Commercial & Residential Solutions | $492 | +4% | $108 | 22.1% |
Network Power’s reported decline primarily reflected the Artesyn divestiture. Process Management sales benefited from acquisitions; its margin fell 110 basis points. Climate Technologies and Commercial & Residential Solutions grew earnings, while Industrial Automation earnings increased 4%.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $2,284, up from $2,203. Capital expenditures were $573, making reported free cash flow $1,711 versus $1,766. Dividends paid were $910; share purchases were $783.
- At June 30, cash and equivalents were $3,049. Short-term borrowings and current maturities were $2,975, and long-term debt was $3,565; total debt was therefore $6,540. Working capital was $2,280 and the current ratio was 1.3, compared with $3,374 and 1.4 at September 30, 2013.
- Total debt-to-total capital rose to 37.7% from 34.8%; net debt-to-net capital rose to 24.4% from 18.3%. The reported interest coverage ratio was 16.3x, versus 14.6x at fiscal year-end; management attributed the improvement partly to higher pretax earnings and lower interest expense.
- Operating cash flow and cash on hand, together with a $1,133 increase in short-term borrowings, funded acquisitions, the Appleton Group minority-interest purchase, debt payments, dividends and repurchases. Emerson entered a new $3.5 billion five-year revolving backup credit facility; it reported no borrowings under this or the prior facility.
Material changes, outlook and risks
- Emerson acquired Virgo and Enardo for $506 net cash and assumed $76 of debt; it also acquired four smaller businesses. It bought the remaining 44.5% of EGS Electrical Group (renamed Appleton Group) for $574. The company agreed to sell Connectivity Solutions for $98; the sale closed in the fourth quarter. Emerson was evaluating strategic alternatives for Power Transmission Solutions, with plans expected by year-end.
- Management expected Q4 underlying sales growth of 5%–7%, while noting gradual but uneven improvement in global markets. For FY2014, it projected underlying sales growth of 3%–5%, net sales change of -1% to +1%, diluted EPS of $3.68–$3.80, and operating cash flow of approximately $3.5 billion. Management said results were trending toward the low end of its previously communicated expectations.
- Management identified European Network Power as a focus of the annual goodwill impairment review: the business had about $1 billion of goodwill and faced integration challenges, weak European end markets and political instability. The filing does not report an impairment charge for this business in the quarter.
- Other disclosed uncertainties include uneven economic and end-market demand, currency conditions, pricing, competition, technology and intellectual-property protection. Emerson was defending a patent-infringement suit brought by Invensys; the filing said it was too early to assess potential financial impact. Full-year 2014 rationalization expense was expected to be approximately $70.
Important facts for investors to verify
- Separate underlying operating trends from reported results affected by the Artesyn divestiture, acquisitions and the prior-year impairment and tax charges.
- Track debt, working capital and cash conversion as acquisition, minority-interest purchase and repurchase activity affected financing needs; verify progress against the $3.5 billion cash-flow outlook.
- Review the fourth-quarter goodwill impairment assessment for European Network Power and any updates on its operating performance.
- Check delivery against FY2014 sales and EPS guidance, and the status and financial effects of the Connectivity Solutions sale and Power Transmission Solutions strategic review.
- Monitor the Invensys litigation and the risks identified by management, including market demand, pricing, currencies and competition.