Business context and reporting period
Emerson Electric Co. filed this Form 10-K for the fiscal year ended September 30, 2016. Emerson is a global industrial, commercial and consumer products and solutions company. Continuing operations comprised Process Management, Industrial Automation, Climate Technologies, and Commercial & Residential Solutions; the network power systems and power generation, motors and drives businesses were classified as discontinued operations.
Portfolio actions were central to the year: Emerson agreed to sell the network power systems business and the power generation, motors and drives businesses, and agreed to acquire Pentair’s Valves & Controls business. These transactions were pending at the filing date and subject to closing conditions and approvals.
Financial performance and position
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Continuing-operations net sales | $14.522 billion | $16.249 billion |
| Gross profit / gross margin | $6.262 billion / 43.1% | $7.008 billion / 43.1% |
| SG&A / percent of sales | $3.464 billion / 23.8% | $3.735 billion / 23.0% |
| Continuing-operations earnings attributable to common shareholders | $1.590 billion | $2.517 billion |
| Diluted EPS, continuing operations | $2.45 | $3.71 |
| Net earnings attributable to common shareholders | $1.635 billion | $2.710 billion |
| Operating cash flow, continuing operations | $2.499 billion | $2.040 billion |
| Free cash flow, continuing operations | $2.052 billion | $1.452 billion |
Underlying sales, excluding currency, acquisitions and divestitures, declined 7% (volume down 6%, price down 1%); currency reduced sales 2% and net divestitures reduced them 2%. Sales fell in every continuing segment. Process Management sales declined 12% and earnings 24%; Industrial Automation sales declined 15% and earnings 10%; Climate Technologies sales declined 2% while earnings rose 10%; Commercial & Residential Solutions sales declined 16% and earnings 5%. Segment comparisons were affected by prior-year divestitures.
Reported continuing-operations earnings fell 37% and diluted EPS fell 34%. Excluding 2015 divestiture gains, continuing-operations earnings declined 17% and diluted EPS declined 13%. The 2015 gains totaled $611 million after tax ($0.90 per share), materially elevating the comparison base. Consolidated net earnings for FY 2016 were $1.664 billion, including $45 million of discontinued-operations earnings.
At September 30, 2016, cash and equivalents were $3.182 billion, total debt was approximately $6.6 billion, long-term debt was $4.062 billion, and common shareholders’ equity was $7.568 billion. Total debt-to-capital was 46.8%, versus 45.8% a year earlier. Continuing-operations operating cash flow equaled 17.2% of sales; free cash flow equaled 14.1%. The company reported $2.9 billion of cash held outside the U.S. and a $3.5 billion undrawn revolving backup credit facility.
Quarterly information is unaudited. In Q4 FY 2016, sales were $3.932 billion, continuing-operations earnings attributable to common shareholders were $479 million, net earnings attributable to common shareholders were $438 million, and diluted EPS was $0.74 from continuing operations and $0.68 overall.
Changes, outlook, risks and unusual items
- Continuing-operations cash flow increased 23% year over year, partly because FY 2015 included $424 million of taxes paid on divestiture gains. Capital expenditures for continuing operations were $447 million, down from $588 million; the company targeted approximately $500 million for FY 2017.
- FY 2016 included $220 million of discontinued-business separation costs, a $103 million write-down of the power generation, motors and drives businesses, and a $24 million benefit from ceasing depreciation and amortization on businesses held for sale. Restructuring expense was $96 million; management expected approximately $50 million in FY 2017.
- The network power systems sale was agreed at $4.0 billion in cash, subject to adjustments, with Emerson retaining a subordinated interest in distributions. The power generation, motors and drives sale was valued at $1.2 billion, including cash and assumption of certain postretirement liabilities. Emerson preliminarily expected an approximately $500 million pretax gain and break-even after tax, subject to final costs and other matters; potential U.S. tax on repatriation of proceeds was estimated at approximately $200 million.
- The planned Pentair Valves & Controls acquisition was priced at approximately $3.15 billion, subject to adjustments; the business had approximately $1.6 billion of sales. The announced transactions were expected to close by year-end 2016 or shortly thereafter, subject to approvals and customary conditions.
- FY 2017 guidance: consolidated net and underlying sales expected to decline 1%–3%; reported continuing-operations EPS expected at $2.35–$2.50, excluding the pending Pentair acquisition. Automation Solutions sales were expected down 4%–7%; Commercial & Residential Solutions sales were expected up 2%–4%. Emerson cited weak industrial and energy spending, low growth and political uncertainty; it expected ongoing pressure in Process Management, particularly upstream oil and gas.
- Principal risks include competitive and cyclical end markets, commodity availability and pricing, foreign exchange and international operating risks, transaction execution and integration/separation, access to capital markets, cybersecurity, intellectual property, litigation and environmental exposure. Management said no known contingent liabilities were believed material to the financial statements, while noting litigation outcomes remain uncertain.
- Other items to monitor: pension plans were underfunded by $586 million in the U.S. and $411 million outside the U.S.; the company expected $40 million of pension contributions in FY 2017. It also announced a 1% dividend increase to an annualized $1.92 per share in November 2016. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether both divestitures and the Pentair acquisition closed on the expected terms, timing and costs, and the final after-tax proceeds and gains.
- How much of the reported earnings decline reflects recurring operating weakness versus prior-year gains and FY 2016 separation and sale-related items.
- Whether FY 2017 sales and EPS guidance was achieved, especially given the expected weakness in automation and upstream oil and gas.
- Cash conversion, debt and liquidity after transaction proceeds, acquisition funding, dividends and share repurchases; also assess offshore cash and any repatriation taxes.
- Whether restructuring savings, segment margins and pension funding assumptions remain consistent with management’s expectations.