EMERSON ELECTRIC CO quarterly report, Q3 FY2011

Emerson Electric Co. — Form 10-Q summary

Business context and reporting period: Fiscal third quarter ended June 30, 2011; comparisons are with the three and nine months ended June 30, 2010. Emerson operates through Process Management, Industrial Automation, Network Power, Climate Technologies, and Tools and Storage. The 2010 comparative results reflect Motors and LANDesk as discontinued operations.

Financial performance

• Q3 sales increased 16%: underlying sales rose 10%, foreign currency translation added 4%, and acquisitions added 2%. Underlying growth comprised 9% volume and an estimated 1% pricing benefit.
• Nine-month sales increased 16%: underlying sales grew 12%, acquisitions contributed 3%, and currency translation added 1%. Pretax earnings rose 24% and continuing-operations diluted EPS rose 22%.
• Q3 gross profit increased 15%, but gross margin edged down as higher materials costs more than offset price increases. Management said materials-cost pressures were expected to persist through the rest of the year.
• Cash from operations was $1.978bn for nine months, versus $2.022bn; capital expenditures were $403m, yielding reported free cash flow of $1.575bn versus $1.722bn. Increased working-capital investment was a principal drag.
• At June 30, cash and equivalents were $1.781bn. Current assets were $9.283bn and current liabilities $6.308bn; working capital was $2.975bn and the current ratio 1.5:1.
• Short-term borrowings and current maturities were $862m, with long-term debt of $4.353bn. Total debt was therefore $5.215bn; total debt-to-capital was 32.5% and net debt-to-net capital 24.1%, down from 34.1% and 26.2% at September 30, 2010. Interest coverage was 14.3x, compared with 10.7x in the prior-year period.
• Nine-month cash uses included dividends of $781m, treasury-stock purchases of $495m, capital expenditures of $403m, and business purchases of $228m. Cash increased $189m over the period.

Segments and material changes

• Process Management: Q3 sales and earnings each rose 18% to $1.789bn and $366m. Nine-month sales rose 15% and earnings 24%, supported by demand in oil and gas, chemicals, power, and refining.
• Industrial Automation: Q3 sales rose 24% to $1.391bn and earnings 43% to $230m; margin improved to 16.6% from 14.4%. Nine-month earnings increased 56%, with higher volume, leverage, and prior cost savings.
• Network Power: Q3 sales rose 19% to $1.683bn, but earnings fell 3% to $176m and margin declined to 10.4% from 12.8%. Nine-month earnings fell 7% to $508m despite 20% sales growth, partly reflecting acquisitions. China pricing and labor costs, adverse mix, lower embedded-computing volume, investment spending, and acquisition amortization weighed on results.
• Climate Technologies: Q3 sales rose 6% and earnings 3%; nine-month sales rose 7% and earnings 8%. Temperature-controls share loss and materials costs offset some growth and savings.
• Tools and Storage: Q3 sales rose 4% and earnings 1%; nine-month sales rose 5% and earnings 6%. Weak U.S. residential construction and higher materials and freight costs were offsets.

Q3 reported growth reflected improving industrial end markets, acquisitions, and currency. Management also reported a weakening trend in U.S. and European business conditions, though it expected the industrial-led recovery to continue at a slower pace. Consumer and residential construction markets remained weak.

Outlook, risks, and unusual items

• Fiscal 2011 guidance: diluted EPS of $3.20–$3.30; sales of $24.3bn–$24.8bn, up 15%–18%; underlying sales growth of 10%–13%; operating cash flow of approximately $3.3bn–$3.5bn; and capital expenditures of approximately $600m. Underlying sales growth was tracking toward the low end of the range based on order trends in the preceding two months.
• Management estimated full-year rationalization expense of $80m–$90m, including $54m incurred in the first nine months. The nine-month period included facility consolidation, workforce reductions, shutdown, and start-up and moving costs.
• Fiscal 2011 effective tax rate was estimated at approximately 31%. Q3 tax rate was 30%; the nine-month rate was 31%, versus 29% a year earlier.
• Other deductions increased year over year, mainly due to acquired-intangible amortization and foreign-currency transaction impacts, partly offset by lower rationalization expense. Nine-month results included a $15m gain from obtaining full ownership of an Indian Process Management joint venture.
• Management cited economic and currency conditions, market demand, pricing, competition, and technology as forward-looking risks. Network Power challenges were expected to continue for the fiscal year, although sequential quarterly margin improvement was anticipated.
• Emerson reported a $2.75bn four-year revolving backup credit facility, with no financial covenants or change-in-rating termination provision; it said available resources were sufficient for foreseeable needs.

Important facts for investors to verify

1. Whether reported order trends and end-market conditions support the full-year sales and EPS ranges, particularly given growth tracking toward the low end of underlying-sales guidance.
2. Whether Network Power margins stabilize as expected and whether acquisition amortization, China competition, and product mix continue to pressure earnings.
3. Whether pricing actions adequately offset persistent materials-cost inflation without weakening volumes or market share.
4. Whether working-capital investment reverses sufficiently to meet the $3.3bn–$3.5bn operating-cash-flow target after nine-month free cash flow declined year over year.
5. How acquisition-related costs, rationalization spending, foreign-exchange movements, and the estimated 31% tax rate affect reported earnings and cash generation.