Business context and reporting period
Emerson Electric Co. filed this unaudited Form 10-Q for the quarter and nine months ended June 30, 2018, its fiscal 2018 third quarter. The company provides automation, climate technology, tools, and related industrial and consumer solutions. Comparisons below are with the three- and nine-month periods ended June 30, 2017, except balance-sheet comparisons, which are with September 30, 2017. Dollar amounts are in millions unless noted.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $4,456 | $4,039 | $12,520 | $10,829 |
| Gross profit / margin | $1,949 / 43.7% | $1,678 / 41.5% | $5,395 / 43.1% | $4,600 / 42.5% |
| Pretax earnings from continuing operations | $768 | $621 | $1,929 | $1,650 |
| Continuing earnings attributable to common stockholders | $712 | $407 | $1,586 | $1,147 |
| Diluted EPS from continuing operations | $1.12 | $0.63 | $2.49 | $1.77 |
| Net earnings attributable to common stockholders | $712 | $413 | $1,586 | $1,014 |
| Effective tax rate | 6% | 33% | 17% | 29% |
Q3 sales rose 10% (underlying sales +8%); continuing earnings attributable to common stockholders rose 75%. For the nine months, sales increased 16% (underlying sales +8%), and continuing earnings attributable to common stockholders increased 38%. Q3 continuing earnings margin was 16.0%; the nine-month figure was 12.7%. Results included significant tax benefits, so reported earnings growth does not reflect operating performance alone.
Cash flow: Nine-month cash provided by operating activities was $1,868, versus $1,058 in 2017; continuing-operations operating cash flow was $1,868 versus $1,785. Continuing-operations free cash flow, defined by the company as operating cash flow less capital expenditures, was $1.6 billion, up $69. Capital expenditures were $314; dividends paid were $924; share repurchases were $1,000. Cash and equivalents were $3,411 at June 30, up from $3,062 at September 30, 2017.
Liquidity and debt: Working capital fell to $1,622 from $3,207 and the current ratio declined to 1.2 from 1.6. Short-term borrowings and current maturities were $2,862 and long-term debt was $3,126, for total reported debt of $5,988, compared with $4,656 at September 30. Total debt-to-capital rose to 41.6% from 34.8%; net debt-to-net capital rose to 23.4% from 15.4%. Management attributed the higher ratios primarily to borrowing for acquisitions and share repurchases. Interest coverage was 14.0x for the first nine months, versus 11.9x for the comparable 2017 period.
Segments: Q3 Automation Solutions sales increased 18% to $2,870 and segment earnings increased 31% to $494; margin rose to 17.2% from 15.5%. Commercial & Residential Solutions sales declined 1% to $1,592 and earnings fell 4% to $387; margin declined to 24.3% from 25.1%. Nine-month Automation Solutions sales rose 26% to $8,213 and earnings rose 28% to $1,316. Commercial & Residential Solutions sales were essentially flat at $4,327, while earnings declined 1% to $988.
Material changes and unusual items
- Growth reflected stronger underlying demand as well as acquisitions and currency. For Q3, acquisitions added 3% to consolidated sales and currency added 1%; the residential storage divestiture reduced sales by 2%. Nine-month sales included an 8% acquisition contribution and 2% currency benefit, offset by a 2% divestiture impact.
- The federal Tax Cuts and Jobs Act reduced the U.S. corporate tax rate and changed taxation of foreign earnings. Emerson recorded a $150 tax benefit in Q3, primarily from increased foreign tax credit carryforwards; the net Act-related benefit was $193, or $0.30 per share, for the nine months. These estimates remain provisional and could change with further guidance and evaluation.
- Acquisitions included Paradigm (completed December 2017) and Cooper-Atkins (January 2018); cash paid for acquisitions during the nine months was $770. The company completed acquisitions of Textron’s tools and test equipment business for $807 and Aventics for $622 after quarter-end in July 2018; purchase accounting was not complete.
- Other deductions included $154 of nine-month intangible amortization and $38 of restructuring expense. Management expected full-year restructuring expense of approximately $80. A specific Climate Technologies product issue contributed $10 of higher warranty costs year to date.
- Foreign-currency translation reduced Q3 other comprehensive income by $273 and nine-month other comprehensive income by $118. The filing reports an asbestos litigation liability of $346 and related insurance receivables of $136.
- In 2017, discontinued operations included a nine-month net loss of $133 and cash-flow effects from divestitures; 2018 reported no discontinued-operations earnings. This affects year-over-year comparisons of net earnings and cash flow.
Guidance, outlook, and risks
For fiscal 2018, management expected consolidated sales growth of approximately 14%, with underlying growth of approximately 7.5%; Automation Solutions sales growth of approximately 21%, with underlying growth of approximately 9%; and Commercial & Residential Solutions sales growth of approximately 3%, with underlying growth of approximately 4.5%. Full-year EPS guidance was $3.30–$3.40, including the $0.30-per-share net tax benefit from the Act. The outlook included expected Q4 charges of $0.06 per share for Tools & Test and Aventics restructuring and acquisition accounting, plus $0.03 per share for a special retirement-account contribution to U.S. employees. Full-year operating cash flow was expected to be approximately $2.9 billion, with capital spending of approximately $575.
Management cited favorable demand across energy-related, general industrial, HVAC, and refrigeration markets and strong operating performance. Identified uncertainties include economic and currency conditions, market demand, pricing, competition and technology, intellectual-property protection, and the evolving effects of U.S. tax reform. Management stated it believed available operating cash flow, existing resources, debt capacity, and credit lines would meet foreseeable needs. A new $3.5 billion five-year revolving backup facility was entered into in May; the company reported no borrowings under the facility.
Important facts for investors to verify
- How much of the earnings improvement is attributable to operating growth versus the $150 Q3 tax benefit and other tax-reform effects, and whether the provisional tax estimates change.
- Whether the full-year sales, EPS, operating-cash-flow, and capital-spending outlook was achieved, including the anticipated Q4 charges.
- Acquisition integration, purchase accounting, and financing effects for the 2018 acquisitions, including the post-quarter Textron and Aventics transactions.
- Working-capital and liquidity trends, the increase in borrowings, and the company’s ability to sustain dividends and repurchases while funding acquisitions.
- Developments in asbestos litigation and insurance recoverability, restructuring obligations, and the Climate Technologies warranty issue.