Emerson Electric Co. — Q2 FY2016 Form 10-Q
Business context and period: The filing covers the quarter and six months ended March 31, 2016. Emerson operates across Process Management, Industrial Automation, Network Power, Climate Technologies, and Commercial & Residential Solutions. Management cited weak oil and gas and industrial markets, soft emerging-market demand, and adverse currency effects. All dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Net sales | $4,928 | $5,400 | $9,641 | $10,987 |
| Net earnings attributable to common shareholders | $369 | $973 | $718 | $1,498 |
| Diluted EPS | $0.57 | $1.42 | $1.10 | $2.17 |
| Gross margin | 40.5% | 40.1% | 40.3% | 40.5% |
| Operating cash flow | Not separately reported for the quarter | Not separately reported for the quarter | $1,206 | $929 |
Q2 underlying sales declined 5% (volume down 4%, price down 1%); currency and net divestitures each reduced reported sales by 2%. Six-month underlying sales declined 7%, with currency reducing sales 3% and net divestitures reducing sales 2%. Q2 reported net earnings fell 62%, largely reflecting the absence of the prior-year divestiture gain and current-year separation costs. Excluding those items, Q2 EPS was $0.66 versus $0.65, while six-month adjusted EPS was $1.22 versus $1.40.
Q2 SG&A was $1,218, or 24.8% of sales (24.4% a year earlier). Six-month SG&A was $2,444, or 25.4% of sales (24.8%). Q2 interest expense, net, was $46; six-month expense was $92. The six-month effective tax rate was 34%, versus 36% a year earlier; management estimated a 31% full-year rate before portfolio-separation costs and 36%–37% including them.
Cash, liquidity, and debt: Six-month operating cash flow was $1,206; capital expenditures were $247, yielding free cash flow of $959. Operating cash flow funded capital expenditures, $616 of dividends, and $253 of long-term debt repayments; share purchases of $555 were supported by short-term borrowings. Cash and equivalents were $3,322 at March 31, 2016, versus $3,054 at September 30, 2015. Short-term borrowings and current maturities were $3,232 and long-term debt was $4,062, for total debt of $7,294. Working capital was $1,731, current ratio 1.2, total debt-to-total capital 48.7%, and net debt-to-net capital 34.1%. Management said available operating cash, existing resources, debt capacity, and credit lines should meet foreseeable funding needs.
Material changes and segment trends
- Process Management: Q2 sales declined 11% to $1,828 and earnings declined 11% to $265; oil and gas spending reductions weighed on results.
- Industrial Automation: Q2 sales declined 16% to $870 and earnings declined 19% to $116, reflecting weak industrial demand, oil and gas softness, and divestitures.
- Network Power: Q2 sales declined 4% to $1,018, but earnings rose to $83 from $34, supported by cost reductions and lower rationalization expense.
- Climate Technologies: Q2 sales increased 1% to $995 and earnings increased 11% to $188, with higher volume and cost savings.
- Commercial & Residential Solutions: Q2 sales declined 15% to $394, primarily due to the commercial storage divestiture; earnings were $92 versus $91.
Gross margin improved 0.4 percentage points in Q2 on cost savings, but declined 0.2 points for the six-month period due to lower-volume deleverage and mix. The prior-year comparison included a $932 pretax ($528 after-tax, $0.77 per share) gain from selling the power transmission solutions business. Current-year portfolio repositioning separation costs were $56 in Q2 ($0.09 per share) and $78 year to date ($0.12 per share). Q2 adjusted net earnings were $425, down 5% from $445; six-month adjusted net earnings were $796, down 18% from $970.
Outlook, commentary, and risks
- For FY2016, management forecast underlying sales down 2%–5%, with currency reducing sales about 1% and completed divestitures about 2%; reported sales were expected to decline 5%–8%.
- Adjusted FY2016 EPS guidance was $3.05–$3.25; reported EPS guidance was $2.61–$2.88, including estimated separation costs of $250–$300 ($0.37–$0.44 per share). Operating cash flow was expected to be about $2.8 billion, or more than $3 billion excluding roughly $0.3 billion of separation-cost impact.
- For Q3, management expected underlying sales approximately flat, reported sales down about 2%, adjusted EPS around $0.85, and reported EPS around $0.63, including estimated separation costs of $145 ($0.22 per share).
- Emerson planned a tax-free spin-off of Network Power systems and was evaluating strategic alternatives, including possible sales, for power generation and motors, drives, and residential storage businesses. The filing cautions that transactions are uncertain and that goodwill impairment or a loss on sale could result.
- Other notable items: FY2016 rationalization expense was forecast at $70–$80, including $28 incurred through March. A revised U.S. pension-cost estimation method was expected to reduce FY2016 pension expense by $38 ($0.04 per share). The company also disclosed foreign-currency and commodity hedges; management expected most deferred hedge gains and losses to enter earnings over the next 12 months.
- Risks cited include economic and currency conditions, demand, pricing, competition, technology, intellectual-property protection, and successful completion and financial effects of the portfolio actions. Management reported disclosure controls effective and no material change in internal control over financial reporting during the period.
Important facts for investors to verify
- Whether underlying demand, order trends, and the expected second-half improvement materialize, particularly in oil and gas and industrial markets.
- Actual separation costs versus the $250–$300 FY2016 estimate, and their effect on reported EPS, cash flow, and tax rate.
- Progress, terms, timing, and potential impairment or disposition losses for the planned Network Power spin-off and other portfolio reviews.
- Cash conversion and leverage, especially given higher short-term borrowings, share repurchases, and the increase in debt-to-capital ratios.
- Whether cost reductions and margin improvements can offset lower volume, unfavorable mix, currency effects, and warranty costs.