Emerson Electric Company

Good afternoon and welcome to the Emerson third quarter 2020 earnings conference call. All participants will be in a listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Peter Lilly, Investor Relations. Please go ahead.

Good afternoon. Thank you and welcome, everyone, to Emerson's third quarter 2020 earnings conference call. I hope everyone is staying safe and healthy. Today, I am joined by David Farr, Chairman and Chief Executive Officer, Frank Della Flora, Senior Executive Vice President and Chief Financial Officer, Lal Karsanbhai, Executive President of Emerson Automation Solutions, and Bob Sharpe, Executive President of Emerson Commercial and Residential Solutions. As usual, I encourage you to follow along in the slide presentation, which is available on our website. Starting with the cover slide. In the era of COVID-19, safety and health have been rightfully brought to the forefront of the global conversation. At Emerson, safety is a core value, and in June, our employees celebrated Global Safety Day to reflect on the importance and personal responsibility of each individual to foster healthy and safe behavior. Additionally, Emerson has a passion for STEM education and innovative thinking as critical enablers for the needs of business and society, both today and in the future. Emerson recently hosted a virtual STEM competition in cooperation with our impact partner here in North America, Spartan Controls. The winners designed wearable devices that gave alerts when within a six-foot social distance barrier. Congrats to the winners, Kayden and Caleb Manji. Please join me in turning to slide three. I'd like to briefly highlight the Emerson Corporate Social Responsibility Report, which is also available on our website. This document highlights in detail all of Emerson's aspirations and accomplishments within the environmental, social, and governance realms. COVID-19 and the ongoing social discussions are catapulting many of these important ESG topics to the forefront. As problem solvers at our core, Emerson strives to advance the discussion, share our own progress and strategies, and also to be a valued resource for our customers as they embark on their own ESG journeys. Emerson takes very seriously our role as a critical enabler and partner for digital monitoring, measurement, optimization, and efficiency management across our broad customer base. Please turn with me to slide four. Despite the challenges presented by COVID-19 in the quarter, there were also many reasons for cautious optimism. I'd like to briefly share a few. First, Emerson remains steadfast in our commitment to health and safety for our employees, customers, and communities. Business continuity, disciplined cost control, and positioning to outperform as we emerge from COVID-19 remain our additional key thematic priorities. Our regionalized supply chain and operations remain resilient and stable in the current environment, and we continue to work hard to ensure we can serve our customers and their essential industries. In the quarter, the team was able to exceed adjusted EPS guidance by 20 cents, with 16 cents being attributable to strong operational executions. A lower effective tax rate also contributed to the overall adjusted EPS beat. Cash flow was strong in the quarter, representing 181% conversion of net earnings. Additionally, the team was able to manage decremental margins to the mid-20s level at adjusted EBITDA. Despite the uncertainty and continuing challenge to the demand environment, sales and orders finished in line with guidance given in April. As expected, China is leading the emergence from the downturn with positive sales growth of 3%. Additionally, we are seeing trailing three-month orders starting to stabilize, highlighted by commercial and residential solutions month of June year-over-year orders turning positive. Finally, based on current recovery trends, we expect sales to turn positive in either Q2 or Q3 of next year. Moving to slide six, which summarizes results of the quarter. Underlying sales growth was within guidance, down 15%. Trailing three-month underlying orders were also within expectations, down 19%, reflective of the ongoing challenging demand environment. Gap earnings per share were down 31% to 67 cents, and adjusted earnings per share were down 18% to 80 cents, which was 20 cents above guidance. Despite lower sales, both platforms executed well on profitability, due to COVID-19-related cost control measures, in addition to the ongoing aggressive restructuring reset actions. Automation solutions underlying sales were down 13%. However, China sales were up 9% as it emerged from lockdown. Trailing three-month underlying orders were down 19%. Commercial and residential solutions underlying sales and orders were both down 19%. However, as previously mentioned, June orders turned positive, which continued a positive trend in month-over-month orders. Cash flow performance was solid in the quarter, with operating cash flow of $842 million and free cash flow of $738 million. Year-to-date operating cash flow and free cash flow of $1.85 billion and $1.53 billion were up 3% and 8% over prior year, respectively. Lastly, the company continued to build upon its aggressive cost reset plan, initiating a total of $94 million of restructuring actions in the quarter. Turning to slide seven, we will bridge adjusted EPS. Beginning with third quarter of 2019 adjusted EPS of $0.97, you will see that non-operational items of foreign exchange effects, stock price effects, and pension detracted 9 cents, which was offset by a more favorable tax rate than expected due to R&D credits and other items. The net effect was a 1-cent tailwind. Operations contained the deleverage to 20 cents, and share repurchases added 2 cents for a net 18-cent headwind. Overall, we finished the quarter at 80 cents, which was 20 cents above previous guidance. Additionally, total segment adjusted EBIT and EBITDA margins of 16.8% and 21.9% exceeded their respective guidance ranges of 15 to 15.5% and 20 to 20.5%. Slide 8 depicts the key elements and magnitude of operational performance on adjusted EPS. Starting with adjusted EPS guidance of 60 cents, we saw both business platforms as well as corporate contribute to the SG&A containment. Automation Solutions contributed $0.10, Commercial and Residential Solutions $0.02, and Corporate $0.04 for a total effect of $0.16. Additionally, the effective tax rate came in at 11% compared to the guided 18%, which provided a $0.05 tail end. Subtracting a cent for other items the adjusted EPS landed at $0.80. The leverage was contained to 26% at adjusted EBITDA. Moving to slide 9, we will review the P&L. Starting with gross margin, we saw a reduction of 140 basis points to 41.3% as the leverage and unfavorable mix were partially offset by favorable price cost. Importantly, SG&A as a percent of sales declined by 20 basis points, as aggressive cost control actions went into effect as volume declined. Adjusted EBIT and adjusted EBITDA margins, which exclude restructuring and related costs, increased 240 basis points and 150 basis points, respectively. This outcome reflected deleverage from the decline in revenue being offset by restructuring savings and cost containment actions. Lastly, our effective tax rate dropped from 20.3% to 11.2%, driven by non-recurring tax items, including R&D credits. Overall, the adjusted EPS decline of 18% from $0.97 to $0.80 was in line with the revenue decline of 16%. Turning to slide 10, we will look at underlying sales by geography. The Americas showed the steepest declines, down 20%, with the United States down 20%, driven by broad-based weakness in all industries except medical and life sciences. Europe and Middle East, Africa, and Asia were both down 9%. China, however, grew at 3% as the economy was the first to broadly reemerge from lockdown. Please turn now to slide 11, and we will discuss total business segment performance. Total segment adjusted EBIT margin decreased 170 basis points to 16.8%. reflecting aggressive cost control measures and strong operational execution as sales declined. And as previously mentioned, total segment adjusted EBITDA deleverage was 26%. Stock price-related costs increased 20 million as the stock price improved from lows at the end of the prior quarter. Adjusted corporate and other costs dropped by 14 million as aggressive cost controls, travel restrictions, salary reductions, and other measures took effect. Adjusted pre-tax earnings dropped 270 basis points to 14.1%. However, 180 basis points of that movement can be explained by pension, stock price, and foreign exchange losses. Q3 cash flow performance was solid given the challenging environment. Operating cash flow and free cash flow both decreased by 11% to $842 million and $738 million, respectively. Free cash flow represented 181% conversion of net earnings. Lastly, the drop in net sales resulted in an increase in ending inventory and lower payables. Turning to slide 13, we will review the business platforms. Automation Solutions' underlying sales finished down 13% for the quarter as broad-based declines in most end markets were only slightly offset by life sciences, medical, and food and beverage. North America saw the steepest declines, down 20%. Meanwhile, China led the recovery, growing by 9%. The final control and systems businesses were down high single digits and mid-single digits, respectively. Trailing three-month underlying orders remained within expectations at down 19%, again reflecting broad-based demand challenges. Aggressive restructuring actions totaled 80 million across the platform, which brought the total to $192 million year-to-date. The platform delivered on profitability in a very challenging demand environment, with adjusted EBIT and adjusted EBITDA margins down 120 basis points and 30 basis points, respectively, reflecting the aggressive cost actions taking effect. Decremental margins were held to 22% at adjusted EBITDA. Of note, sequential backlog was unchanged at 5.1 billion. Turning to slide 14. Commercial and residential solutions underlying sales were down 19%, also reflective of the broadly weak demand environment due to COVID-19. North America led the declines down over 20%, while Europe dropped 12% as momentum in the heat pump business was more than offset by declines in professional tools and cold chain. Asia, Middle East, and Africa was down 18%, with China down 9%. Order rates varied dramatically during the quarter, from down 35% in April year over year to positive 1% in June. Trailing three-month underlying orders were down 19%, driven by weakness across the distribution and OEM-based businesses. In contrast, businesses exposed to big-box retail and do-it-yourself markets fared better and were down mid-single digits. Asia orders dropped by 20%, while China was down 7%. For the quarter, our structuring actions totaled $12 million, which brought the total figure to $31 million year-to-date. Commercial and residential solutions also delivered solid profitability given the demand environment, with adjusted EBIT and adjusted EBITDA down 270 basis points and 160 basis points, respectively. Decremental margins at adjusted EBITDA were 32%. Turning to slide 16, we will review the updated guidance. The impact of COVID-19 certainly continues to present a challenging demand environment. However, we are raising guidance due to early signs of stabilization and good momentum in cost containment and restructuring actions. First, we assume demand will continue to stabilize and gradually improve. There are no major operational or supply chain disruptions, no changes in discrete tax items, and oil prices remain in the $35 to $45 range. With those assumptions in mind, we now expect underlying sales to be down 9 to down 7.5% and net sales down 10 to down 9% for the year, only slight refinements from previous guidance. We are raising expected adjusted EPS to the range of $3.20 to $3.35, an increase of approximately 6% from the previous midpoint of $3.10 to the new midpoint of $3.27. Expected total restructuring spend has increased by approximately $20 million to $300 million, with approximately $235 coming from automation solutions, $55 coming from commercial and residential solutions, and the balance from corporate. Please note that we will review the updated restructuring reset spend and savings plan as well as the COVID-19 related cost savings in detail later during the presentation. We expect operating cash flow to come in at approximately $2.8 billion and capex spending expectations remain $515 million, resulting in a free cash flow target of approximately $2.25 billion. Lastly, Our share repurchase program remains complete for the fiscal year. And now please turn to slide 18, and I will hand the call over to Mr. David Clark.

Thank you very much, Pete. Appreciate your input. Pete wants to be called Commander Pete, and he's got a new name from the military background. I didn't have to deal with this with Tim, but Pete, I do. By the way, I did see Tim today. We had a board call, and Tim was in Germany with our German director and His family has arrived in Germany. He's the president of Professional Tools in Germany. He's doing well, and his family are now there. And his kids will be going to school live. And so it's good to see Tim. They seem to be pretty happy today. And never had to call him commander, but, again, then again, he couldn't kill me with two fingers like you. With that, on the order trend chart, as I would say – The trends for orders were pretty much in line to what we thought would happen in the quarter from month-by-month basis. Clearly, you can see the commercial residential has found the bottom in the month of June. I think you'll see that that has improved again in the month of July. I'll let Bob talk about that. Lyle continues to seem to be stabilizing around this bottom, and I'll let him talk a little bit about his businesses. But overall, month by month, we saw the quarter unfold exactly like we thought it was going to unfold relative to orders, relative to sales. Margins came in much better, as you've seen, from the cost reset actions and what we call the COVID-related savings. Therefore, cash flow came in better, too. Overall, execution was extremely good. And I really want to thank the global leaders relative to their strength of operation throughout the quarter i want to thank the whole team around the world as you know the oce and the and top 10 or 15 other people in this building the corporate court never left the building we now have the whole building back we have our campus back obviously from time to time we might lose somebody but we're all here operations are working around the world we have not had really many hiccups we've lost a couple days here and there in bob's case and lyle's case but overall great execution by the team around the world I share that with the board and we are acting and we're running this company live in person in our offices as best that we can not everywhere but as much as we can and I really thank them for what they have done because it's been a very challenging quarters you know we laid out our forecasts in April mid-april we went out early we executed around the plan from a order standpoint sales manufacturing, and we really, really did a great job around the cost reductions, both from the reset actions, which we started last June, which have accelerated, and we'll talk a little bit more about those, to the COVID-related adjusted savings from the one-time cut, the furloughs, the late salaries, obviously no travel, entertainment, all those things, and we'll talk more about those. All those came in very well and helped us from a profitability standpoint. But in particular, what I was extremely pleased to see is as we laid out that detailed major cost reduction reset program back in February to the shareholders but to the board last year in August time period, They really have stayed ahead of it, and they've actually increased the numbers. You'll see that in the charts coming up. And that's not easy to do in an environment where you're not able to travel. You have hard times having meetings. But these guys have done a phenomenal job relative to really driving those programs forward. We're in a different phase right now. We're in the phase of actual consolidation of facilities, shutdown facilities, new facilities. We're moving stuff at this point in time versus the initial phase. A lot tougher phase. And both of the businesses are on track and I think are doing extremely well. And I'm very pleased with that. With the effort in the quarter, which was better than I thought from the earnings, better than I thought from a cash flow, we have raised the year. We have confidence in the year. And I'll let Bob and Lyle talk a little bit about that. But really, from the execution on operations, we really did a great job. And from that perspective, we're But I just was pleased to see from the standpoint of that execution and what we saw. And we'll see as we go into the quarter. I think from my standpoint, I think that we will see some strength emerge from the businesses. I think the profitability will continue to do well. And I think that we're going to have a very good order from the standpoint. And what I'd like Bob and Lyle to talk about briefly here first about the orders first. And then we're going to go in to talk a little bit about the quarters. But Bob, why don't you give them a little cover of what you're seeing right now in orders. And Lyle, you do the same thing. And then we'll go into a couple other charts here.