Emerson Electric Company

Good day and welcome to the MSN fourth quarter 2021 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the start key followed by zero. After today's presentation, there will be an opportunity to ask a question. To ask a question, you may press start then one on your telephone keyboard. To withdraw your question, please press start then two. Please note that this event is being recorded. I would like to turn the conference over to Colleen Mettler. Please go ahead.

Thank you. Good morning and thank you for joining Emerson's fourth quarter and fiscal year end earnings conference call. Today I am joined by President and Chief Executive Officer, Lal Karzambai, Chief Financial Officer, Frank Delicola, and Chief Operating Officer, Ram Krishnan. I encourage everyone to follow along with the slide presentation, which is available on our website. Please join me on slide two. As always, this presentation may include forward-looking statements which contain a degree of business risk and uncertainty. Please take time to read the Safe Harbor Statement and note on non-GAAP measures. As I turn to slide three, I would like to highlight two areas where Emerson is making a difference. First, Mike Train, our Chief Sustainability Officer, will be attending this year's United Nations Climate Change Conference COP26 in Glasgow. Mike will be a panelist at the adjacent Sustainable Innovation Forum, participating in two notable discussions. The first discussion will be how to support small to medium enterprises to adopt net zero pathways, and the second on supporting breakthrough innovation to green hard-to-abate sectors. Mike has worked this year to drive many greening of, by, and with Emerson initiatives. One notable greening by example is in the recent announcement between Bayotech, and Emerson to accelerate production of distribution of low-cost, low-carbon hydrogen. In the agreement, Emerson will deliver advanced automation technology, software, and products in support of Bayotech building hundreds of fully autonomous hydrogen units to enable hydrogen fuel cell commercial trucking fleets and abatement projects in steel and cement. Another exciting initiative is our $100 million commitment to corporate venture capital, Emerson Ventures, designed to accelerate innovation by providing insights into cutting-edge technologies that have the potential to solve real customer challenges. The investment commitment will advance the development of disruptive, discrete automation solutions, environmentally sustainable technologies, and industrial software in key industries. A formal announcement and more information will be seen in tomorrow's press release. Finally, our investor conference historically has been in February. However, due to the recent announcement with Aspen Tech, we have decided to move our investor conference to May. It will be located at the New York Stock Exchange on May 17, 2022. I'd like to now turn the presentation over to Emerson's President and CEO, Lal Karzanbai, for his opening comments.

Thank you, Colleen, and good morning, everyone. 2021 was a phenomenal year for Emerson. It developed very differently, obviously, than we planned a year ago. For one, I was named CEO and brought a new value creation agenda to the table. But equally important, we operated in an environment which was both rewarding and challenging for the organization. Through it all, our teams around the world did a fabulous job. I want to express my sincere gratitude to all the Emerson employees around the world. Thank you. I would also like to thank Emerson's Board of Directors and our shareholders for your support and confidence in the management team. 2021 was characterized by strong demand in our residential air conditioning business, as well as our hybrid and discrete markets in automation. Furthermore, we have experienced a recovery in process automation markets. The automation KOB3 mix for 2021 was up two points to 59%. And Emerson's September three-month trailing orders were plus 16%. We grew 5.3% underlying and leveraged at 38% operationally, inclusive of a $140 million swing in our price-cost assumptions from November through to the end of the fiscal year. The earnings quality of this company continues to be excellent, with free cash flow conversion of 129%. The fourth quarter, however, was challenged significantly by supply chain, logistics, and labor challenges. And that is not dissimilar from anything you've heard before. This was experienced in the form of material cost inflation, notably steel, electronics, and resins, and lead time extensions. In addition, we experienced logistics challenges in availability of lanes and costs. And lastly, U.S. manufacturing labor, which was characterized by higher turnover rates, absenteeism, and overtime costs. In the quarter, we missed sales by $175 million. And alongside a challenging price-cost environment in our climate business, it resulted in a negative 14-cent impact to EPS for the quarter and a 19-cent impact to 2021 EPS. Having said that, the company grew 7% in the fourth quarter and had 19% operating leverage. Turning to 22 and some initial thoughts, the first half of the year will not look dissimilar from the fourth quarter with slight sequential improvements as we go to Q2. Price cost and supply chain challenges unwind in the second half of the year against the backdrop of continued strong demand. The price cost assumption in the year will be a positive $100 million for 2022. I'm very optimistic for 2022. The operating environment has unpredictability, but it is significantly more stable than a year ago and demand is much stronger. The residential AC cycle would moderate as we go through 2022. However, we expect automation markets to continue to strengthen, driven by digital transformation and modernizations, replacement and MRO markets, and select LNG and sustainability-driven KOB1. Most notably, methane emissions reduction projects and carbon capture. I have confidence that we will deliver 30% incrementals on our underlying sales in 2022. This addresses execution, and as you know, that's one of the three pillars we identify as a management team for accelerated value creation. We have equally taken significant steps in our journey to modernize our culture and advance ESG initiatives. The board named Jim Turley as the company's independent chair of the board. We named Mike Train as the company's first chief sustainability officer, and we hired Elizabeth Adefoye as Emerson's first chief people officer. I'm very proud of the diversity targets we set for the enterprise, the changes to our long-term compensation and annual bonus structure to include ESG measures, and the commitments we have made to accelerate greenhouse gas intensity reductions. Lastly, turning to the portfolio, please turn to slide four. We recently concluded a comprehensive portfolio review, which culminated in a two-day session with our board of directors in early October. We left the meeting with a defined portfolio roadmap and pathways. The key elements were as follows. Firstly, in terms of the portfolio today and how we are thinking about it, diversification is critical. we will continue to divest upstream oil and gas hardware assets. Secondly, we will action low growth or commoditized businesses. And lastly, we will action disconnected assets. All three of these actions will take place over time with intentionality, but patience and a keen awareness of cycles and meeting the value creation proposition to our shareholders. Secondly, We identified four large, profitable, high-growth end markets, each with at least $20 billion of size and projected to grow higher than 4% a year into the future, supported by macros. The four end markets will be the hunting ground for our M&A activity. Lastly, we defined two possible end states for the portfolio and the journey that we'll embark on and have embarked on. One of the four markets is industrial software, a $60 billion segment that we identified growing at 9%. The Aspen Tech transaction is an exciting step for Emerson and a very important transformational step for this corporation. Aspen Tech is one of the best-run industrial software companies in the space with highly differentiated technology and a phenomenal leadership team led by Antonio Pietri. for whom I have the greatest personal admiration. The Aspen Tech Company will be a highly diversified business with transmission and distribution as its largest served market and it's uniquely positioned to enable our energy customers to transition to a lower carbon future. I'm optimistic of the synergy opportunities that exist and believe the new Aspen Tech which will be 55% owned by Emerson shareholders, will be a differentiated platform for future industrial software M&A. I'm very excited about this, as I hope you can tell. We expect to close the transaction in the second quarter of 2022, following the completion and approval of the customary regulatory items. With that, I will now turn the call over to Frank Dellaquilla, Emerson's Chief Financial Officer. Thank you, Lyle, and good morning, everyone. Please turn to slide six, if you would. So we're really pleased with financial results for fiscal 2021. As Lyle said, we ended the year with a great deal of uncertainty and far exceeded the expectations we had at the beginning of the year. The underlying demand environment developed much as we thought it would. There was continued strength in global discrete and hybrid automation markets, and the North America process markets began to gain momentum later in the year. The global demand in our commercial residential markets was strong and broad-based, particularly in the U.S. residential air conditioning market, and it far exceeded the expectations that we had going into the year. Our operations team successfully worked through labor and supply chain issues, particularly toward the end of the year, and delivered the strong results that we're able to report to you today. Toward the end of the year, the intensifying combination of rising material costs, supply chain challenges, and labor constraints in the U.S. did begin to weigh on sales volume and profitability. We worked through that in the fourth quarter, and we will continue to work through that in the first half of fiscal 2022. Despite these fourth quarter challenges, we're pleased to report that we achieved the key financial targets that we committed to you in August regarding underlying growth, adjusted EBIT margins, adjusted earnings per share, and cash flow, and you can see all of that in the table. This was achieved in the face of an unexpected increase in key raw materials, mainly steel and copper, that resulted in an unfavorable price-cost swing of $140 million during the year versus the expectation and the guidance that we gave you a year ago. We're very grateful for the extraordinary effort of our operations teams at every level and the manufacturing employees who made made this happen under some of the most challenging conditions that we have seen. Please turn to slide seven. This slide highlights our strong 2021 results. Continued recovery in our end markets drove strong full-year underlying growth with more than 5%. Net sales were up 9% year-over-year, including a one-point impact from acquisitions, mainly OSI, which closed at the beginning of the fiscal year. Adjusted segment EBIT benefited from strong leverage in operations, 38%, as Wal just mentioned, that adjusted EBIT from underlying volume and the benefit of cost reset actions that were begun two years ago. These cost reductions more than offset price-cost headwinds, which, as I said, were $140 million versus our expectation at the beginning of the year, and the supply chain challenges that raised costs and reduced availabilities. Cash flow was robust, up 18% year-over-year, attributable to the strong earnings growth and working capital efficiency. Free cash flow conversion of net earnings was 129%. Adjusted earnings per share was $4.10, exceeding our guide by 3 cents at the midpoint and up 19% for the year. Automation solutions underlying growth was flat year-over-year. Growth turned positive in the second half. driven by strong discrete and hybrid markets while the later cycle process automation markets delivered sequential improvement as we move through the year. Adjusted even increased 230 basis points due to the strong leverage driven by cost reset benefits. Commercial and residential saw exceptional growth of 16% underlying year-over-year due to broad strength across the residential and commercial markets with new teams growth in all world areas. Adjusted EBIT increased 20 basis points versus prior year. Price-cost headwinds worsened in the second half, particularly in the fourth quarter, as we anticipated on the call in August, but were offset for the full year by strong underlying leverage and spending restraints. Please turn to slide 8. Operational performance was strong throughout the year, adding 59 cents to adjusted EPS, overcoming a 19-cent headwind in from supply chain and $90 million of unfavorable price costs. Operations leveraged at more than 35% on volume and cost actions. Non-operating items contributed $0.02 net, overcoming a significant headwind from the stock comp mark-to-market accounting. Share repurchase totaled $500 million as we guided and added about $0.03. In total, adjusted EPS was $4.10, as I said, an increase of 19%. Please turn to slide nine. Regarding the fourth quarter, strong end market demand drove underlying growth of 7% with net sales up 9%. This growth was achieved despite a $175 million impact from supply chain, logistics, and labor constraints that affected both platforms in somewhat different ways. Adjusted segment even dropped 10 basis points, reflecting a 200 basis point impact from supply chain volume constraints across the company and from the increasingly negative price-cost headwinds in commercial and residential. Free cash flow declined 39%, mainly due to higher working capital to support the growth versus the prior year. Adjusted earnings per share was $1.21, exceeding the guidance midpoint by 3 cents and up 10% versus the prior year. Automation Solutions underlying sales were up 3%, with strong recovery in the Americas, particularly in the power generation and chemical markets, partially offset by declines in other world areas. Sales were reduced by about $125 million, or four points, due to supply chain constraints. Our backlog was up 16% year-to-date, and now sits at $5.4 billion, $100 million less than at the end of the third quarter. Typically, our backlog would reduce more in Q4. However, due to strong orders and supply chain constraints, backlog remained elevated above the levels we would otherwise have expected. Strong leverage and cost reductions drove a 170 basis point improvement in adjusted EBIT. Commercial and residential underlying sales increased 13%, driven by continued strength in North America residential HVAC and home products, as well as heat pump demand in Europe. Sales were reduced by about $50 million, or three points, due to supply chain constraints, which together with sharply increasing material cost headwinds, which were expected, perhaps a little worse than we expected in August, but were expected, drove a 340 basis points decline in adjusted even. With that, I'm going to turn it over to Ron to provide color around the price cost and some of the other operational issues that we're dealing with.