Business context and reporting period
Emerson Electric Co.’s Form 10-Q covers the first quarter of fiscal 2018, the three months ended December 31, 2017, compared with the three months ended December 31, 2016. Amounts are in millions of dollars except per-share data. Emerson supplies automation, climate technology, tools, and related solutions. The quarter’s reported growth reflects acquisitions, favorable currency translation, and underlying demand, partly offset by a business divestiture.
Financial results and condition
| Metric | Q1 FY2017 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $3,216 | $3,816 | +19% |
| Gross profit / margin | $1,365 / 42.4% | $1,621 / 42.5% | Margin +0.1 percentage point |
| SG&A / percent of sales | $822 / 25.5% | $992 / 26.0% | |
| Continuing-operations pretax earnings | $464 | $503 | +9% |
| Continuing-operations earnings attributable to common shareholders | $364 | $392 | +8% |
| Diluted EPS from continuing operations | $0.56 | $0.61 | +9% |
| Net earnings attributable to common shareholders / diluted EPS | $309 / $0.48 | $392 / $0.61 | +27% each |
| Operating cash flow, continuing operations | $410 | $447 | +$37 |
| Capital expenditures / free cash flow, continuing operations | $100 / $310 | $96 / $351 | Free cash flow +$41 |
Underlying sales increased 7% overall, with acquisitions contributing 12%, currency translation 3%, and the residential storage divestiture reducing sales 3%. The company reported a 22% effective tax rate versus 20% in the prior-year quarter; reported tax expense was $109 versus $94. The quarter included a $43 tax-reform benefit, or $0.07 per share, and management’s EPS discussion also identifies a $0.03 per-share benefit from the lower federal tax rate on quarterly earnings.
At December 31, 2017, cash and equivalents were $3,096, versus $3,062 at September 30, 2017. Current assets were $8,152 and current liabilities $6,192; working capital was $1,960 and the current ratio 1.3, versus $3,207 and 1.6 at fiscal year-end. Short-term borrowings and current maturities of long-term debt were $2,093, and long-term debt was $3,375, for total reported debt of $5,468. Total debt-to-total capital was 39.6% (34.8% at September 30); net debt-to-net capital was 22.1% (15.4%). Cash from continuing operations funded $311 of dividends and $96 of capital expenditures. Acquisition payments of $513 and share purchases of $500 were funded in part by $235 of divestiture proceeds and increased short-term borrowing.
Material changes versus the prior comparable period
- Sales rose $600, with Automation Solutions accounting for most of the increase: segment sales increased 31% to $2,572 and earnings increased 18% to $386. Its margin declined from 16.6% to 15.0%, including 2.8 percentage points of dilution from the valves and controls acquisition.
- Commercial & Residential Solutions sales were flat at $1,252; earnings rose 1% to $252 and margin improved from 19.9% to 20.1%. Climate Technologies sales increased 7%, while Tools & Home Products sales decreased 16%, primarily reflecting the residential storage sale.
- Other deductions increased to $88 from $33, including higher intangible and backlog amortization, restructuring costs, and unfavorable foreign-currency transactions. SG&A rose to 26.0% of sales from 25.5%, partly due to $40 of higher incentive stock compensation.
- Operating cash flow from continuing operations improved to $447 from $410. Prior-year total cash flows were affected by discontinued operations and their sale proceeds; those activities did not recur in the current quarter.
Outlook, commentary, risks, and unusual items
- For fiscal 2018, management expected consolidated sales growth of 11%–13%, underlying sales growth of 5%–7%, and EPS of $3.05–$3.15. The EPS outlook includes stated effects of tax reform, the residential storage divestiture, and first-year acquisition accounting charges.
- Management forecast operating cash flow of approximately $2.9 billion and capital spending of approximately $575 million. For fiscal Q2, it expected sales growth of approximately 18%, including underlying growth of approximately 7%.
- Management cited improving energy-related and general industrial markets and favorable HVAC and refrigeration markets. It expected fiscal 2018 restructuring expense of approximately $85, including $15 incurred in Q1.
- The December 2017 U.S. tax law produced a provisional net $43 benefit: a $98 deferred-tax remeasurement benefit and $185 expense for deemed repatriation and withholding taxes, partly offset by $130 accrued previously for planned repatriation. The company cautioned that final effects may differ as guidance and its assessment evolve. It forecast an effective tax rate of approximately 25%–27% for fiscal 2018 and approximately 25% in 2019 and thereafter.
- Emerson acquired Paradigm for $505 net of cash acquired, recognizing $304 of goodwill and $248 of identifiable intangible assets; acquired-business valuations remained subject to refinement. It also completed the $247 Cooper-Atkins acquisition after quarter-end. The prior-year valves and controls acquisition generated $25 of first-year pretax inventory and backlog accounting charges in this quarter.
- The residential storage business sale resulted in a $24 after-tax loss, or $0.04 per share, due to tax on nondeductible goodwill; expected after-tax cash proceeds were approximately $150. A specific Climate Technologies product issue generated $10 of higher warranty costs.
- Forward-looking statements are subject to risks including economic and currency conditions, market demand, pricing, competition, technology, intellectual property, and uncertainties associated with tax reform. Management reported disclosure controls were effective at quarter-end and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether underlying demand supports management’s full-year sales and EPS outlook, apart from acquisition and currency effects.
- The final tax-reform effects, including repatriation costs and the expected effective tax rate, as provisional estimates are updated.
- Acquisition integration, purchase-price accounting, and the effect of acquisition-related margin dilution and amortization.
- Debt, working-capital, and liquidity trends following acquisition and share-repurchase spending, including the increase in current borrowings.
- The duration and financial impact of the Climate Technologies warranty issue and the planned restructuring program.