Emerson Electric Co. (EMR) F3Q13 Earnings Conference Call August 6, 2013 2:00 PM ET
Patrick Fitzgerald – Director-Investor Relations
David N. Farr – Chairman and Chief Executive Officer
Frank J. Dellaquila – Senior Vice President and Chief Financial Officer
Mike Wood – Macquarie Capital, Inc.
Steven Winoker – Sanford C. Bernstein & Co., LLC
John G. Inch – Deutsche Bank Securities, Inc.
Christopher Glynn – Oppenheimer Securities
Jeffrey Sprague – Vertical Research Partners LLC
Shannon O'Callaghan – Nomura Securities International, Inc.
Deane M. Dray – Citigroup Global Markets Inc.
Rich M. Kwas – Wells Fargo Securities LLC
Julian C. H. Mitchell – Credit Suisse Securities
Stephen C. Tusa – JPMorgan & Co.
Andrew Obin – Bank of America Merrill Lynch
Joseph A. Ritchie – Goldman Sachs & Co.
John Quealy – Canaccord Genuity Inc.
Nigel Cole – Morgan Stanley
Good day ladies and gentlemen. Thank you for standing by. Welcome to Emerson 's Investor Conference Call. During today's presentation by Emerson management, all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (Operator Instructions) This conference is being recorded today August 06, 2013.
Emerson's commentary and responses to your questions may contain forward-looking statements, including the Company's outlook for the remainder of the year. Information and factors that could cause actual results to vary materially from those discussed today is available at Emerson's most recent Annual Report on Form 10-K as filed with the SEC.
I would now like to turn the conference over to our host Patrick Fitzgerald, Director of Investor Relations at Emerson. Please go ahead, sir.
Thank you, Camille. I am joined today by David Farr, Chairman and Chief Executive Officer of Emerson; and Frank Dellaquila, Executive Vice President and Chief Financial Officer.
Today's call will summarize Emerson's third quarter 2013 results. Our conference call slide presentation will accompany my comments and is available on Emerson's website at emerson.com. A replay of this conference call and slide presentation will be available on the website after the call for next three months.
I'll start with the highlights of the quarter as shown on page two of the conference call slide presentation. Third quarter sales declined modestly to $6.3 billion underlying sales decreasing 1%. While this macroeconomic conditions continued through the quarter with cautious levels of business investment globally.
Sales growth is also affected by the difficult comparison mainly from the Thailand flooding recovery in the prior year. Emerging markets grew 2%, which was more than offset by material market leading us. We announced this morning than an agreement as been signed to sell the 51% stake in the embedded computing and power business to Platinum Equity. The transaction nearly monetizes the business and shifts focus to our core businesses.
Transaction proceeds of approximately $300 million and repatriated cash to be deployed for incremental share repurchase of $600 million. Charges related to business were recognized in the quarter totaling $0.70 of EPS. Excluding these charges earnings per share were $0.97. Strong cash generation continued with free cash flow up 20%.
Moving to slide three, P&L summary. As we mentioned the slow macroeconomic environment limited growth. Gross profit margin was flat as cost containment offset unfavorable product mix and volume deleverage. Operating profit margin declined to the higher stock compensation and pension expense as well as mainly high leverage in the prior year from the flooding recovery. Goodwill impairment was recognized in the embedded computing and power business.
Other deductions increased to $37 million, non-recurring dumping duty gain in the prior year. EBIT decreased sharply due to these items, leading to reported earnings per share of $0.27, and $0.97, excluding the goodwill impairment of $0.65 and income tax charges of $0.05 related to earnings repatriation.
Moving to slide four, underlying sales by geography. By geography, underlying sales have decreased in the U.S. by 3%, in Europe by 6% and in Asia by 3%, including a 4% reduction in China. Sales grew in Latin America by 8%, in Canada by 4% and in Middle East and Africa by 18%. Total underlying sales declined 1% divestitures and currency deducted 1%, while reported sales declined 2%. Excluding the embedded computing and power business, underlying sales were essentially flat with modest growth in China.
Next slide, cash flow and balance sheet. Cash generation was robust with operating cash flow up 17% and free cash flow up 20% which represents the conversion from earnings to 121%. Working capital as a percent of sales increase from prior year due to high receivables, but improved sequentially by 120 basis points.
Moving to slide six business segment details. Business segment margin declined to 130 basis points due to flooding recovery and dumping duties in the prior year, as well as higher pension expense. The increase in corporate expense is due to the previously mentioned impairment and higher stock compensation expense. And tax rate reflects one time income tax expense repatriate earnings from the embedded computing and power business. Excluding this impact the tax rate would have been 29%.
Next slide Process Management. Process Management sales grew 3% with an approximately 7% point impact in the Thailand flooding recovery in the prior year. By region, North America declined 4%, Asia grew 8%, Europe was flat, Latin America grew 17% and Middle East and Africa grew 24%. Oil and gas, power and chemical end markets continue to grow. Underlying orders were up 8% led by double-digit growth in systems and solutions, improvement in North America and 13% growth in China.
Segment margin declined 160 basis points, which was also effected by flooding recovery comparisons. Global project activity remains robust including solid growth momentum in the next year.
Moving to slide eight, Industrial Automation. Industrial Automation sales decreased 7% with North America down 5%, Asia flat, Europe down 13%, Latin America down 4% and Middle East and Africa down 2%. Industrial goods and markets remained weak globally especially in Europe. Business was most pronounced in the power generating alternators business with channel inventory destocking is beginning to slow, and orders are expected to turn positive soon.
Excluding $37 million in dumping duties received in the prior year, margin remained unchanged as cost containment offset volume deleverage. Demand for industrial goods appears to be stabilizing, but is expected to remain slow in the near term, particularly in Europe.
Next slide Network Power. Network power sales declined 5% with North America down 2%; Asia down 13%; Europe down 4%; Latin America up 6% and Middle East and Africa up 19%. Slow demand continued in global information technology and telecommunications end markets. And Network Power systems business declined slightly as growth and data center infrastructure was offset by telecommunications weakness.
Embedded computing and power business declined at a double-digit rate. Segment margin contracted 220 basis points primarily due to volume deleverage and unfavorable price. End markets appear to be improving, with difficult comparisons from prior years (inaudible) project in Australia will limit near-term growth.
Next slide, Climate Technology. Climate technology sales decreased 2% with North America down 4%; Asia down 2%; Europe down 5%; Latin America up 3% and Middle East and Africa up 21%. U.S. Air conditioning business declined modestly as the residential markets paused due to mild weather and inventory destocking. Asia sales declined as China decreased after double-digit growth in the previous quarter. Europe market conditions remained weak. The global refrigeration business improved for both recovery and the transportation business. Segment margin expanded 80 basis point as cost containment offset unfavorable mix. Growth is expected to resume in the refrigeration businesses in the near-term.
Moving to slide 11 Commercial and Residentials solutions sales declined 2% reflecting a (inaudible) adverse impact from divestitures. Underlying sales grew 4% with North America up 6%, Asia up 3%, Europe down 4%, Latin America down 1% and Middle-East and Africa down 11%.
Residential investment in North America continues to grow more than offsetting slower commercial demand. Segment margin remained unchanged from prior year. We expect growth to continue the solid residential and improving non-residential demand in the U.S. as well as stabilization in Europe.
Moving to slide 12, consistent with previously communicated intentions, today we announced an agreement to divest the 51% stake in the Embedded Computing and Power business to Platinum Equity, the terms allow us to immediately monetize the asset focused on our core business, while also participating an upsize from repositioning of business.
Emerson will receive approximately 300 million in cash and retain a 49% non-controlling interest. The transaction is expected to close in the next three to six months. The $300 million of transaction proceeds and approximately $300 million in repatriated Embedded Computing and Power earnings will be used for $600 million of additional share repurchase to offset EPS dilution. The businesses sales and earnings will continue to be reported in Emerson's consolidated results until the transaction close.
Next slide full year outlook. The economic environment is beginning to stabilize and improve, but orders growth resuming in June after declines since February. We are expecting, near-term business investment will remain cautious but slowly improve.
Specifically we anticipate energy and residential markets to remain solid with slow but improving demand for industrial growth and information technology and telecommunications infrastructure.
Based on current conditions the revised 2013 outlook is as follows; reported and underlying sales growth of approximately 1%; EBIT and pretax margin approximately equal to prior year, excluding the goodwill charge in each year; earnings per share excluding goodwill and tax charges trending toward the lower end of $3.48 to $3.55 or $2.78 to $2.85 excluding charges; operating cash flow of approximately $3.4 billion and free cash flow of approximately $2.7 billion.
With that I'll turn over to David Farr.
David N. Farr
Thank you very much, Pat. Welcome everybody to our third quarter earnings call. I also want to thank all the operating executives out there for delivering what I would call very solid operating margins and some very strong cash flow and a very difficult quarter from the standpoint of comparisons from last year which we’ve referred to a couple of times in the press release at the Thailand flood. We always knew this was going to be our most challenging quarter given what, ho we recovered last year.
On the negative side throughout the quarter, prior to the last four or five months, we've seen weakening of the global economies and that weakness really start to coming true as we move through this quarter. And the good news though, if you look at where we stand right now, June orders were positive. Early indication right now July orders are also going to be positive. So it looks to us that things are starting to shape up with a little bit upward trend to finish the year with a strong operating performance in Q4, to get through well I call, it challenging fiscal 2013, but overall it was a tough quarter.
We had a lot of moving parts. Several of the businesses are doing well. As you can see, coming up our electrical products group meeting. The big exception clearly is Network Power systems which continues to see weaker sales coming from a weakening China, other parts of Asia Pacific, also very weak IT demand both coming out of Europe and the United States. Companies have not really increased their spending at any significant levels yet to see that market place pick back up.
We also had some very bad mix throughout the quarter, through different business in particular China which is a high margin business for us is really weak. And our repositioning and restructuring continues to take hold and it’s starting to pay off.
In fact I just came back from Europe and we saw our European business is stabilizing and actually start to see positive order growth in our Network Power Systems business, a very important, we’ve signed restructuring of all the restructuring and the new management team we have put in place up, a good first sign that things are starting to turn.
Negative side also of this business, was weak government spending. We have a government spending arm here and that business was down obviously with a pullback in the government spending.
Overall, the business did not turn out what we thought it would at the electrical products group. Clearly the margin for the whole year will be weaker than we said before. Well I am starting to see as you've seen in orders , we're starting to see the Network Power Systems business pick back up and I feel we will be going out this quarter, fourth quarter doing better and then really going into a stronger 2014 as the economy continues to I think moderately improve but not robustly.
But relative to the other businesses, we're all operating pretty well, pretty much along the line if we thanks a lot about EPG. Process management has been continued strong order growth, with some very difficult comparisons last year. Underlying sales and orders were up close double-digits this quarter. When you take out the impact the Thailand flood, we’re seeing a good business coming around the world. We’re not really seeing any delays at this point in time, and the technology investment continue to go forward. The other good sign there is we’re continuing to work a lot of nice bolt-on acquisitions in the space, which will help as again as we finish this year and going into next year.
On the Climate Technology, it is a little bit more volatile than we normally would see. We had a very good quarter last quarter, a little bit weaker this quarter, but net-net, the orders have turned up and what we’re seeing coming out of Europe, out of Asia, the United States is the trend line is positive and I expect setting up for a pretty good fourth fiscal quarter and hopefully a strong first quarter going into the next fiscal year.
Industrial Automation clearly continues to be impacted by. One of our large customers out there continues to do a lot of inventory destocking, but overall, again, I’m starting to see a little bit more improvement there and I feel better. As we come through this quarter, and get into the fourth quarter and go into next year that will eventually turn to positive growth. Even when you look at the business, underlying business where the volume down, they were able to protect their profitability once you exclude the impact of the one-time pick-up we had last year from the Byrd Amendment callback.
So, that business is doing really well. North America business in commercial residential, as we’ve said, the housing market is still strong, people are spending a little bit of money and the business is still growing in that 4%, 5% range, which is very good.
Very positively, over the last six months we’ve been working extremely hard. I’m trying to come with an appropriate exit strategy for our computer and power business, which has had four extremely challenging years. It is good to get this behind us, and moving forward we’ve got a solution that’s right for the management team, right for the business and right for the Company. And I feel good about where we sit right now. We need to get the approvals from the governments around the world, which should not be problem, but that takes time.
Most importantly, as a management team and the Board, we want to return back with $600 million that we’re getting out of this business and returning it back to our shareholders and share repurchase. And that’s very, very important from the perspective of giving money back to our shareholders.
From the cash flow standpoint, we are going to have a very strong year and a very strong quarter with almost $1 billion in operating cash flow. And what we see this year is pretty record levels of operating cash flow, over $3.4 billion and hopefully $2.7 billion of free cash flow. With the share repurchase of $850 million we’ve already have planned, the $600 million is an incremental number to go back to the shareholders. So this year we’ll be – we are obviously doing a lot more share repurchase on the next 12 months.
Acquisitions are very moderate this year. We’re only be doing about $100 million. However, with the pipeline and the deals we are working on right now, I would expect that number to bump up on bolt-on type of acquisitions to about $1 billion level when we get into 2014. We do not have any large strategic acquisitions at this time on the table and we’re working very, very diligent on the bolt-on acquisitions in our core space to strengthen our Company.
A tough quarter, but certain things are starting to turn relative to orders, the cash. I think that you are going to see a stronger operating execution here in the fourth quarter and we are setting up for a solid fourth quarter with a good movement going into 2014.
It’s good to get this from behind us. It’s really good get the agreement with the sales of computer power system business and it will be good to see return to positive top line growth and solid order growth as we go forward during the coming months. It’s been a very difficult three or four years here with very moderate growth environment, which has created a lot of pressure relative to the growth. But the business is in very good shape from the restructuring standpoint, cash standpoint and the position of the business at this point in time.
So with that, I want to open the phone line up for questions and I want to thank everyone for joining us today and again I want to thank operating executives for working hard and delivering a good quarter in a very challenging environment.
Earnings Call Part 2: