Business context and reporting period
Emerson Electric Co. is a diversified industrial technology and manufacturing company, reporting five segments: Process Management, Industrial Automation, Network Power, Climate Technologies, and Commercial & Residential Solutions. This unaudited Form 10-Q covers the three and six months ended March 31, 2014, compared with the same 2013 periods. The fiscal year ends September 30.
Financial performance and position
| Metric | Three months ended March 31, 2014 | Six months ended March 31, 2014 |
|---|---|---|
| Net sales | $5.812 billion; down 2% | $11.418 billion; down 1% |
| Gross margin | 41.2%, versus 39.8% | 40.6%, versus 39.8% |
| Earnings before income taxes | $817 million; down 2% | $1.460 billion; down 3% |
| Net earnings attributable to common stockholders | $547 million; down 2% | $1.009 billion; down 1% |
| Diluted EPS | $0.77; flat | $1.42; up 2% |
Six-month operating cash flow was $1.266 billion, up 4%; capital expenditures were $397 million and reported free cash flow was $869 million, down from $916 million. Cash and equivalents were $2.724 billion at March 31, versus $3.275 billion at September 30, 2013.
Short-term borrowings and current maturities were $2.661 billion and long-term debt was $3.836 billion, for total debt of $6.497 billion, compared with $5.642 billion at September 30. Working capital was $2.371 billion, the current ratio 1.3, total debt-to-total capital 38.3%, and net debt-to-net capital 26.5%. Six-month interest coverage was 14.0x.
Material changes, segment results, and unusual items
- Underlying sales grew 2% in both the quarter and six-month period, but the divestiture of embedded computing and power reduced reported comparisons; acquisitions partly offset the impact. Foreign currency translation was also unfavorable.
- Quarterly segment sales/earnings: Process Management $2.108 billion/$383 million; Industrial Automation $1.232 billion/$187 million; Network Power $1.171 billion/$96 million; Climate Technologies $1.041 billion/$186 million; Commercial & Residential Solutions $460 million/$99 million. Network Power sales fell 21%, primarily due to the divestiture. Climate Technologies sales rose 5% and earnings rose 6%.
- Other deductions increased to $137 million for the quarter and $232 million year to date. The quarter included a $34 million loss on the Artesyn equity investment and $14 million in foreign-currency transaction losses, versus $21 million in gains in the prior-year quarter. The investment loss reduced quarterly EPS by $0.03.
- Emerson acquired Virgo and Enardo and two smaller businesses in the first quarter; cash paid for the larger acquisitions was $506 million, and combined annualized sales for Virgo and Enardo exceeded $300 million. In the second quarter, it paid $574 million for the remaining 44.5% interest in EGS Electrical Group (renamed Appleton Group).
- The company completed the sale of a 51% controlling interest in its embedded computing and power business in November 2013, receiving $268 million net of working-capital adjustments and retaining an interest valued at approximately $60 million. No pretax gain or loss was recorded.
- Rationalization expense was $34 million for the first six months. Management expected full-year 2014 rationalization expense of approximately $70–$80 million. Pension and postretirement expense declined to $70 million from $116 million year to date.
Outlook, risks, and contingencies
Management cited improving but uncertain global conditions, slower implementation of large process-industry projects, and harsh North American weather. Second-quarter orders growth of 9% provided positive momentum. For fiscal 2014, management expected underlying sales growth of 3%–5%, reported sales change of negative 1% to positive 1%, and reported EPS of $3.68–$3.80. The filing states that full-year operating cash flow was expected to be “$3.4 million”; the stated value is unclear and should be verified against the original filing. An April 2014 $3.5 billion, five-year revolving backup credit facility replaced a $2.75 billion facility; the company reported no borrowings under these facilities.
Risks identified include economic and currency conditions, demand, pricing, intellectual property, competition, and technology factors. Emerson and subsidiary Micro Motion are defending a patent-infringement lawsuit brought by Invensys concerning flowmeters; the company said it was too early to assess potential financial impact and considers the claims without merit. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the full-year operating cash flow guidance unit: the filing text says $3.4 million, despite reporting $1.266 billion for the first six months.
- Assess the sustainability of underlying growth and the effect of the embedded computing and power divestiture and acquisitions on reported sales and segment comparisons.
- Review the drivers and potential recurrence of Artesyn investment and foreign-currency losses, and the planned rationalization spending.
- Monitor debt and liquidity following acquisition spending, the Appleton Group buyout, dividends, and share repurchases.
- Track the Invensys patent litigation and any subsequent disclosure of its potential financial impact.