Emerson Electric Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2023

There are 15 speakers on the call.

Operator

Morning, and welcome to Emerson Third Quarter 2023 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. Now I'd like to turn the conference over to Colleen Mettler, Vice President, Investor Relations.

Operator

Please go ahead.

Speaker 1

Good morning, and thank you for joining us For Emerson's Q3 fiscal 2023 earnings conference call. Today, I am joined by President and Chief Executive Officer, Lal Khartzenby Chief Financial Officer, Mike Bachman and Chief Operating Officer, Ram Krishnan. As always, I encourage everyone to follow along with the Slide presentation, which is available on our website. Please join me on Slide 2. This presentation may include forward looking statements, which contain a degree of business risk and uncertainty.

Speaker 1

Please take time to read the Safe Harbor statement and note our non GAAP measures. I will now pass the call over to Emerson President and CEO, Lal Cardenbei, for his opening remarks.

Speaker 2

Thank you, Colleen, and good morning. This quarter's results are a testament to the tremendous people of Emerson. I am humbled by what you do every day. Thank you for the passion and energy and the effort you bring to our great company every single day. 2.5 years ago, when I became CEO, we expressed our vision for accelerated value creation, culture, portfolio and execution.

Speaker 2

I am proud today more than ever before of the progress we have made. The Emerson management system has empowered our leaders and open the world of possibilities for our company in the field of innovation and commercial excellence with a higher growth, More cohesive portfolio. But above all, the Emerson Management System is the tool that enables our team to continue to deliver differentiated financial results. The work never ends, but I am proud of how far we have journeyed And a clear road ahead. Please turn to Slide 3.

Speaker 2

Q3 was an exceptional quarter, And our teams continue to perform well and deliver for our shareholders. We made tremendous progress on our strategic priorities, Closing the Copeland transaction, launching new to the world products and winning several key projects In our organic growth platforms, Energy Transition, Industrial Software and Priority Discrete and Hybrid Markets. We have once again increased our expectations for the year based on our continued operational execution. We now expect double digit underlying sales growth, approximately 50% operating leverage and over 20% adjusted EPS growth for 2023, top quartile performance. As we look ahead, we are energized by our value creation opportunities.

Speaker 2

Emerson is and will continue to benefit from our significant exposure to secular growth trends Like energy affordability and security, sustainability and decarbonization, digital transformation and near shoring. Over 30% of our sales are directly aligned to these trends as we discussed at our investor conference in November. Our technology and solutions are highly differentiated in these spaces, positioning our business for growth. We are also innovating for these markets, Helping customers solve their toughest challenges with disruptive technology and solutions. Our portfolio transformation It's paying off as we have aligned our cohesive portfolio to these secular trends.

Speaker 2

And our favorable value drivers Combined with our Emerson management system provide the road map for future success at Emerson. Turning to Slide 4. This quarter exceeded expectations across the board. Underlying orders were up 3%, led by high single digit process and hybrid demand growth. We continue to see secular trends driving the demand strength.

Speaker 2

As an example, LNG projects continue to move forward and customers' energy transition and sustainability budgets are growing, improving resilient, both for greenfield projects and hydrogen, clean fuels and renewables and for brownfield, Decarbonization opportunities like emissions reductions and carbon capture. Renewables is a particular area of strength Near shoring is also driving incremental investments around the globe in areas like life sciences and metals and mining. It is still early stages of global stimulus, but programs like the United States IRA, CHIPS And IIJA are driving additional conversations with our customers, which we expect to turn into funded projects down the road. Our strong performance in Process and Hybrid was partially offset by demand in Discrete, which continues to slow. Orders were down in Q3 against tougher comparisons for this piece of the business.

Speaker 2

As we mentioned previously, Europe, especially Germany, continues to slow and we have seen some softening in the U. S. And Asia. Looking at the overall business and given continued robust demand and strong underlying growth drivers, we still expect Mid single digit full year order growth. The continued demand and improving supply chain environment, Which includes improved availability of electronic components enabled 14% underlying sales growth in the quarter, above our expectations.

Speaker 2

The Americas and Europe were up 11% 13%, respectively, while Asia, Middle East and Africa were up 20%. Strong performance of last year's impact of the Shanghai COVID shutdowns. Intelligent devices and software and control were both up double digits. It is clear when we speak to customers and compete for projects That our technology is winning in the marketplace. We are proud of what we have built and confident this will continue.

Speaker 2

Software and control growth of 19% is a testament to our leading control systems, Delta V Innovation, which are well positioned where our customers are spending areas like life sciences, metals and mining, hydrogen, Clean fuels and renewables. Within the quarter, we won large projects in life sciences, metals and mining, including lithium And LNG. Intelligent Devices grew 13%. Final control and measurement and analytical are the de facto standards For traditional energy, transition energy, chemical and power markets across the globe. This later cycle exposure and the business' continued technology leadership in areas like control valves, actuators, Regulators, pressure, temperature, flow, level and wireless are differentiators for Emerson And are leading to strong financial returns.

Speaker 2

This strong sales performance and the continued operational execution of our teams led to 59% operating leverage in the quarter, excluding AspenTech. Favorable impacts from price cost and mix Also drove accretive margin performance. Adjusted EPS was $1.29 beating our guidance, Again, driven by the strong sales and operational performance. Free cash flow was up 83% year over year and is up 47% year to date. Please turn to Slide 5.

Speaker 2

We continue to accelerate progress on our strategic priorities. On May 31, we closed the Copeland transaction. Emerson received $9,700,000,000 in upfront cash or approximately $8,000,000,000 after tax for the transaction. We also have the future proceeds from the $2,250,000,000 Copeland note receivable And our 40% common equity ownership with a transaction value of $1,700,000,000 Post closing, Emerson has a net cash position And taking into consideration the NI acquisition, Emerson expects to have a net debt to EBITDA ratio of less than 2. I also want to provide a quick update on our corporate and platform rightsizing activities we announced at the beginning of the year.

Speaker 2

As planned, we did not have any stranded costs due to the Copeland sale and are well on track to achieve our $100,000,000 Annualized cost savings by 2024. We also released our ESG report in June, highlighting a 42% reduction in greenhouse gas emission intensity from our 2018 baseline. This achievement surpasses our 20% target 6 years ahead of schedule. In the report, We also highlight numerous examples of how Emerson is helping customers navigate the energy transition and the application of our technology Lastly, before moving on to some exciting innovation and customer wins, I wanted to provide a quick update on the NI acquisition. We remain on track to close the acquisition in the first half of our fiscal 2024 and the teams are actively working on integration planning as we prepare to be ready for day 1.

Speaker 2

In late June, NI shareholders voted in favor of our acquisition. HSR was once again approved And all necessary regulatory filings have been made. NI released their earnings last week with another record sales quarter, up 5% year on year and strong margin performance. They too are seeing supply chain constraints easing, Which helped drive their sales performance by converting backlog despite the negative orders environment, which was down 17%. The demand environment for the business is playing out largely as we expected with discrete and semiconductor weakness Expected to improve as the calendar year goes on.

Speaker 2

Please turn to Slide 6. As the rate of our customer sustainability and digital investments continue to accelerate, Emerson is ensuring And we are positioned to capture this spend. Part of this is through our strong dedication to innovation and new to the world products. Recently, Emerson has had numerous impactful innovations. First, AspenOne V14 is the next step In helping customers on the sustainability journey, not only does v14 offer more than 100 Sustainability specific models.

Speaker 2

It also provides solutions to help customers manage emissions and design new hydrogen processes. V14 also further incorporates artificial intelligence, which when combined with first principle models, Helps users reach optimal production, increasing profitability while reducing emissions. Emerson also recently launched enhancements to our AMS device management software platform, now aligned for more seamless integration With AspenTech solutions like Mtell, this allows users to have more access to critical intelligent device data for use in advanced analytics and models. This example shows the differentiation of the Emerson plus AspenTech portfolio And technology synergy opportunities together. Emerson has long been a trusted partner of utilities around the globe, As evidenced by the fact that Ovation controls approximately 50% of the electricity generated in the United States.

Speaker 2

This leadership uniquely positions Emerson to support our customers' transition to renewables, and we are doing so Through our new integrated renewable energy control solution, Ovation Green. Ovation Green Allows customers to manage their renewables assets like solar, wind, hydro and hydrogen all in one platform. And we are already seeing early success with some of the largest utilities in the United States. Lastly, our measurement and analytical business Recently launched a new to the world non contacting radar device that is ideally suited for a range of applications In chemical, life sciences and food and beverage. With advanced capabilities like Bluetooth And a built in historian to store process data and insights, the transmitter is optimized for ease of use and simplicity.

Speaker 2

This device incorporates radar technology, a fast growing technology in the measurement space. As we look at continued growth in our measurement business, this innovation will serve as a foundation to building level as the next technology pillar, accompanying our leadership in pressure, temperature and flow. As one of our key drivers growth drivers, Emerson is committed to accelerating innovation and meeting the rapidly evolving needs of our customers like the ones highlighted here. Turning to Slide 7. At our November investor conference, we outlined our through the cycle growth strategy, which includes Our strategic focus on organic growth platforms.

Speaker 2

These markets, including life sciences, metals and mining, factory automation, Industrial software and energy transition are areas closely aligned to the secular growth trends that are driving incremental customer investment. This is demonstrated in the evolution of our funnel over the past 9 months. Not only have we successfully expanded our funnel to $9,700,000,000 over this time frame, up from $7,100,000,000 but nearly all of this growth Can be attributed to our growth markets, namely Energy Transition, Life Sciences and Metals and Mining. Our energy transition funnel is now nearly $5,000,000,000 up from $3,500,000,000 in November. This expanded funnel is driven by new project announcements in hydrogen, clean fuels, carbon capture and EV batteries, All where we are actively engaged and our technology is well suited.

Speaker 2

We have also continued to Expand our Metals and Mining and Life Science funnel, and we are now capturing additional strategic projects in our funnel as we dedicate more time and resources towards pursuing these engagements. In the 3rd quarter alone, We added over 300 projects to the funnel and were awarded a content in over 50. This indicates a solid pace of project announcements As near shoring and sustainability trends spread globally. We expect these organic growth platforms will grow double digits through the cycle, And we are off to an excellent start in 2023. Please turn to Slide 8, where we'll highlight a few key wins across these segments, which underscore the power of Emerson's highly differentiated portfolio of solutions and the opportunity ahead for Emerson.

Speaker 2

The LNG wave continues to progress and Emerson is winning our share of opportunities. Of the projects that have moved forward over the past 2 years, Emerson has been awarded content in 7, demonstrating our continued leadership in this space. These are large projects with ample automation opportunity. On average, approximately $10,000,000 of automation opportunity Per million ton per annum of liquefaction. Our unmatched portfolio of measurement devices, valves, Control Systems and now optimization software differentiates Emerson as the only automation company Customers expedite project timelines and reduce project costs, key measures to reaching profitability faster.

Speaker 2

One of these 7 projects was the Port Arthur LNG project. Emerson is excited to announce it will be supporting Bechtel Energy And Sempra Infrastructure in the automation of the Port Arthur LNG Phase 1 project. This liquefaction and export terminal in Southeast Texas is a premier LNG project designed for safe, reliable and efficient operations, Delivering LNG to global markets through 2 trains capable of producing up to 13 500,000 metric tons per annum. Emerson was chosen as a key automation partner for Bechtel Energy, Providing our leading Delta V control system, final control valves and measurement technology. Further, on Slide 9, the next market we'd like to highlight is the Battery Valley chain.

Speaker 2

This is an area where we are winning projects based on the breadth, depth and strength of Emerson's end to end capabilities From the mining of lithium and copper to refining and processing and finally to EV battery manufacturing, assembly and recycling. In 2022, Emerson Technology helped produce over 65% of global electric vehicles. We are excited to continue supporting companies around the world as production expands across each of these high growth segments. Recently, Emerson was selected to automate 2 very strategic projects in mining. First, the Ganfeng Lithium Project in Argentina.

Speaker 2

Emerson's Delta V control system was selected to automate the large scale lithium mine, a strategic win in the lithium triangle Between Argentina, Chile and Bolivia that holds much of the world's lithium reserves. Delta V was selected because of its differentiated And flexible architecture and commissioning savings with charms. The next project success was for Codelco And the Andina copper mine in Chile, Codelco is the world's largest producer of copper and Andina site will represent Over 10% of Codelco's overall output. Emerson's Delta V and control software We're selected to help automate the treatment of water on the site, allowing Codelco to accurately control water quality, efficiency and recycling. Emerson recently won a contract with 1 of the largest EV manufacturers because of our unique ability to support Production across multiple processes in the value chain.

Speaker 2

With this project, Emerson will be the Trusted automation partner to support 2 facilities, a lithium refining project and cathode production facility in Texas. Delta V was chosen for both projects due to its robust software architecture and ability to bring together previous Islands of automation. As the customer continues to grow operations globally with numerous expansions and new operations, Emerson is well positioned to be the supplier of choice given the unique nature and value of the capabilities that we can deliver. Emerson was also recently awarded a large project to the leading German EV manufacturer to help automate battery cell assembly process. As we look at future opportunities, NI has a leadership position with many of the largest EV And battery manufacturers in the world.

Speaker 2

NI's differentiated hardware and software solutions help customers The R and D, testing and validation of batteries and vehicles, and we look forward to leveraging those relationships to expand our current factory automation business and build upon our recent successes. As you can tell, we are energized by these projects And our relevance with customers, we will share our progress as Emerson continues to partner with leading EV manufacturers around the world and benefit from the strength and differentiation of our portfolio of assets. I'll now turn the call over

Speaker 3

to Mike Bachman. Thanks, Lal, and good morning, everyone. Please turn to Slide 11. Our 3rd quarter financial results were Standing. And before talking about that, I want to thank our global teams for their hard work and execution.

Speaker 3

Our Emerson Management

Speaker 4

Our system is driving value as

Speaker 3

evidenced by our continued sales growth, margin expansion, earnings growth and free cash flow performance. Turning to the results, underlying sales growth exceeded our expectations at 14%. GAAP sales were also up 14% for Quarter and price contributed approximately 5 points of growth. Backlog of $6,900,000,000 remained flat quarter over quarter. Software and control performed better than we expected growing underlying sales 19% due to increased availability of electronic components And our ability to convert more of the backlog in this business.

Speaker 3

Intelligent Devices grew 13%, led by process and hybrid exposed businesses, mainly Measurement and Analytical and Final Control. These two businesses are leaders in later cycle markets and have a large installed base, which Along with the continued backlog conversion contributed to strong growth in the quarter. From an industry perspective, Process and hybrid remain healthy with double digit growth in the quarter. As Lal mentioned, discrete activity has continued to slow, but still exhibited mid single digit sales growth due to backlog conversion. Emerson adjusted EBITDA margin improved 370 basis points to 26.9%.

Speaker 3

Leverage excluding AspenTech was 59%. Strong sales growth, margin accretive price cost and favorable product and project mix All reflect the excellent execution by our operations teams and contributed to the margin improvement. Adjusted EPS grew 40 percent to $1.29 and I will discuss the details of that growth on the next chart. Lastly, free cash flow of $769,000,000 was up 83% versus the prior year quarter. For the quarter, free cash flow conversion of adjusted earnings was 97%.

Speaker 3

The strong earnings growth Capital improvement helped contribute to the free cash flow growth. Please turn to Slide 11 for the details of adjusted EPS And bridge from the prior year. Most importantly, the strong 14% underlying sales growth and 59% segment level Operating leverage contributed $0.29 of EPS growth year over year. Stock compensation was a $0.06 headwind due to lower stock comp expense in the prior year, but that was more than offset by other corporate items and tax, Which were an $0.08 tailwind. The reduced share count resulting from the $2,000,000,000 share repurchase completed in the 1st quarter Contributed 0 point 0 $4 to adjusted EPS.

Speaker 3

Lastly, now that the Copeland transaction is closed, We are including the interest from the Copeland note receivable and adjusted results and guidance moving forward. The Copeland note interest contributed $0.02 to adjusted EPS in the 3rd quarter and it is important to note this was not included in our May guidance. Overall, adjusted EPS grew 40% year over year to $1.29 Turning to Slide 12 and as we look ahead to the rest of the year, I'd like to highlight a few key things. In general, end markets remain resilient. We have increased our expectations for process to double digit sales growth with meaningful contribution from secular growth segments, Energy Transition and Energy Security.

Speaker 3

With continued strength in life sciences and metals and mining, we now expect hybrid to grow low double digits in 2023. We are discussing near sharing initiatives with more and more customers. This is not just a trend in the United States and we see near and long term benefits around the globe. For example, our team recently visited Australia and China where we spoke to customers about their plans to make investments in new markets like life sciences. As a global leader for providing automation for this market, these customers are tapping Emerson to support their investments.

Speaker 3

Discrete demand is continuing to slow, especially in Europe, and we are beginning to see the impacts in the United States and Asia. Sales growth expectations when combined with our safety and productivity commercial exposure are in the low single digit to mid single digit range as we have worked through backlog. The supply chain environment has continued to improve allowing us to work through our backlog as we head into Q4. Price cost has been a significant tailwind in 2023, a reflection of our commercial excellence. We expect price for the year to approach 4 points and We will remain diligent on price as a key performance lever.

Speaker 3

As we look to the future, we are excited by our growth opportunities. Emerson is uniquely positioned to support our customers' investments in key areas we expect to grow double digits through the cycle. We've demonstrated our leadership in energy transition markets like LNG, nuclear, hydrogen, clean fuels, carbon capture and renewables. We are well positioned to capture the long term investments driven by nearshoring. And finally, we have a leading and differentiated software portfolio that is Expected to have double digit ACV growth through the cycle.

Speaker 3

These are all trends we expect to continue to augment Emerson's growth for the foreseeable Please turn to Slide 13. As this chart shows, our performance this year has been exceptional. We have successfully executed on our portfolio transformation, while continuing to drive strong results across the business and exceed on our commitments. Strong operational performance, improved price cost management and more favorable mix as we went through the year gave us the ability to increase our For 2023, underlying sales growth is now expected to be toward the top end of our previous 8.5% to 10% guidance range. We expect both Intelligent Devices and Software and Control to be on par with this overall updated guidance.

Speaker 3

As a reminder, AspenTech will begin rolling into our underlying sales in Q4 as we lap a year of ownership. We are also increasing our expectation for segment operating leverage based on the strong Q3 results, sales strength, favorable price cost and continued Strong operational performance. We now expect segment operating leverage to be approximately 50%, excluding AspenTech. Adjusted EPS has been raised to $4.40 to 4.45 dollars a 22% year over year increase at the midpoint. Please note this includes $0.06 of interest from the Copeland note receivable that we are now including in our adjusted results, Expected to contribute approximately $0.25 for the year.

Speaker 3

Post Copeland transaction close, please note we have now included an estimate For the Copeland Equity loss and our GAAP guidance numbers, which in addition to the undeployed proceeds is being removed from our adjusted results And guidance, we have also adjusted our expected tax rate to approximately 22% for the year. Free cash flow is expected to be $2,200,000,000 to $2,300,000,000 for the year, of which FinTech is contributing approximately $300,000,000 Thanks for your attention. I will now turn back to Nick to open the call for questions.

Operator

Thank you. This time, we'll pause momentarily to assemble the roster. First question will be from Nigel Coe, Wolfe Research, please go ahead.

Speaker 5

Thanks. Good morning. Thanks for the question.

Speaker 4

Good morning.

Speaker 5

Good morning. Good morning,

Speaker 4

Nigel.

Speaker 5

Good morning. Just I thought maybe just to start off on the obviously very strong operating performance, but margins were the real Standout. So I'm just wondering as we go into 'twenty four, I mean is there anything we should think about in terms of maybe some headwinds to margins? I'm thinking here about measurement analytics very strong sequentially up to 20.7%. Are you confident you can grow off these margins going forward?

Speaker 3

Hey, Nigel. Yes, we're very excited about the leverage that we've had with 40%, 53% and then 59% in the quarter. You do see that operating leverage Tipped down a little bit in the Q4 and we're going to exit the year around 50%. So yes, we feel good about the operating leverage and we're not really in a position We're going to talk about 24 at this point, but we certainly are pleased with the current year performance.

Speaker 2

And I'll just add a little bit of color. Thanks, Mike. I do believe that the underlying work that we've been doing around price, cost management, thinking about how we bring our differentiated technology To market, we'll be sustainable into through this cycle as we talked about. And we look at the leverage Targets as we go to 'twenty four, and we'll talk about that later in the fall. But I feel very good about the momentum in the business and the executional Elements that are going to impact our ability to deliver differentiated margins on a go forward basis.

Speaker 5

That's great. Thanks. And then my follow-up question is on the Control Systems organic growth in the high teens. That's a longer cycle business and I don't really think about that as necessarily cycling up big or down big. So I mean how much of that is coming from sort of accelerated backlog conversion with lead Times maybe some chip lead times coming down and sort of how do we think about that going forward?

Speaker 5

Do you think you can maintain above average growth rates in Control Systems and Software?

Speaker 6

Yes. Hey, Nigel, Ram here. Yes, I think this particular quarter and this year, I think in the second half, the lead times catching up And better supply chains and shipping backlog is what is driving the significant growth in our systems business. But With that said, the project funnel is very good. The KOB 3 is very good.

Speaker 6

So our expectations are the momentum in that business should continue Into 2024.

Speaker 5

Great. Thanks, Ram.

Operator

Thank you. Next Question will be from Andy Kaplowitz of Citigroup. Please go ahead.

Speaker 7

Hey, good morning, everyone.

Speaker 2

Hi, Andy.

Speaker 7

Well, so you reiterated your mid single digit order growth forecast for this year and you came in at 3% this quarter despite the Discrete market slowdown, you obviously gave us the new funnel of opportunities with mid-twenty percent organic growth. So does that mean that Emerson's order Could we accelerate from here? Or how do you think about that given the market that you laid out?

Speaker 2

Yes. Certainly, Andy, we feel confident in that Mid single digit guide that we laid out a quarter ago and believe we'll exit the year in that rate. The process and hybrid orders are in the high single digits As we exited the quarter, and that's where a significant amount of the momentum lies, not just in the capital expansion but related to just everyday business Activity. Of course, offset by the discrete markets that we talked about through the quarter, We're still very confident that we'll inch up from where we ended the quarter here slightly.

Speaker 7

Lal, and then maybe I could ask you a more philosophical Jen on AspenTech, I know at this point it announced its guidance for FY 'twenty four, low double digit ACV growth and then agreed not to By MicroMine and announced the big repurchase. Are there any lessons learned as you and Antonio have worked together now for a little over a year? And Given AspenTech's FY 'twenty four guidance, do you see a nice uptick in AZPM's contribution to your EPS in 'twenty four?

Speaker 2

No. Look, we continue to deliver on the synergy plan. I think that's step that's point number 1, not just in terms of Pursuit of business, collaboration between the selling organizations, but most importantly, as I highlighted in the presentation around technology. And it's that Technology tie in that ultimately will differentiate our offerings in the marketplace. Number 2, look, over the quarter, we did a lot of work together.

Speaker 2

I think I feel really good about the plan that AspenTech laid out, the way it was communicated yesterday. I thought it was very succinct and clear. And I think they'll execute very well as we go through the quarter. There's a lot of collaboration ongoing Between our joint teams and momentum, it continues to build a year into a little over a year into this.

Speaker 7

Thanks a lot. Appreciate it.

Speaker 2

Thanks, Andy.

Speaker 4

Thank you.

Operator

Next question will be from Josh Bob Grozewinski of Morgan Stanley. Please go ahead.

Speaker 2

Hi, good morning guys. Hi, Josh.

Speaker 8

So, well, I'd love to Going to dig in a little bit on backlog here. So flat sequentially, you highlighted the funnel of activity growing pretty materially here. So Presumably, the conversion rate starts to pick up a little bit here. Do you think we're sort of in this backlog zone for a while? I think a lot of your other peers out Multi's are starting to dip into backlog with lead time normalization.

Speaker 8

Just wondering where you guys sit on that or anything you'd want to call out for the

Speaker 9

next few quarters?

Speaker 3

Hey, Josh. Yes, we certainly expect the backlog to come down a few 100,000,000 to the 4th quarter. And it's important to note that it's year over year, at the end of the year, we expect that to be up a little over double digits. So yes, the supply chain easing has certainly helped. But as we look ahead, we see that backlog Coming down a little bit in the Q4.

Speaker 8

Got it. That's helpful. And then just kind of going back to To Nigel's question, maybe thinking about some of the factors, whether it's 24 or maybe more broadly than that on mix, Seems like with a lot of these large projects, we're going to see more KOB 1, which I think maybe in the older days of Emerson Was a bigger mix headwind, but how do you guys think about that now given the change in project composition, etcetera?

Speaker 6

Yes. I think, first off, I think, just to add to what we said, related to Nigel, The KOB 3 business performance has been very strong. Right now, we're running at 65% plus KOB 3 rates with Strong performance in North America. So that has really contributed to the outsized leverage we saw in the 1st 3 quarters. And We don't expect that to materially change in the next 2 to 3 quarters.

Speaker 6

But you are right, as our project backlog has built up and we see Project shipments go into 'twenty four. That will throttle leverage down to the mid-30s or high-30s Great. We've guided to you in the past. So that's really a dynamic you should look for in 2024.

Speaker 2

Yes. I think you're absolutely right. I think there's a fixed handle on the MRO and replacement business. We don't expect that. I think you're absolutely right to change as we go through the year.

Speaker 2

There's a lot of positive activity there. So Feel good about that mix despite a very robust capital project funnel.

Speaker 3

Got it. Appreciate it. Best of luck.

Speaker 4

Thank you.

Operator

Next question will be from Steve Tusa, JPMorgan. Please go ahead.

Speaker 2

Hello. Hi,

Speaker 10

Steve. Hi. The incremental getting back to Nigel's question, I guess Given what happened this year, is there any view on how you view kind of the long term trajectory on those incrementals? Can you just remind us of What your long term view on that is and how that kind of plays out and maybe how the mix may impact that over the next couple of years as perhaps the MRO stuff slows and the project stuff comes on.

Speaker 2

Yes. Look, we guided in November, Steve, at 35 through the cycle. Obviously, we're in a very positive point in the cycle at this moment in time. And look, as we look at our mix of business, our tech, our geographical mix, as As we go into November, we may assess that, but that's the guide that we put out last November. Obviously, we're outperforming that number today.

Speaker 10

And then what is the contribution from kind of price cost this year just roughly?

Speaker 2

Yes. Well, on price in the quarter, we have 9 points of volume and 5 points of price. Price will moderate as we go into the 4th, I think for the year, 3 to 3 point Approaching 4 points of price in the full year guide of 10% underlying sales.

Speaker 10

Okay, great. Thanks a lot.

Speaker 2

Thank you.

Operator

Thank you. Next question will be from Andrew Obin, Bank of America. Please go ahead.

Speaker 4

Hi, guys. Good morning.

Speaker 2

Good morning, Andrew.

Speaker 9

I guess the KOB terminology just refuses to die.

Speaker 2

I'm trying to kill it.

Speaker 3

I'm aware of that.

Speaker 9

So just a question on Supply chain, are you guys some of your competitors are talking about deflation or disinflation. Are you seeing an opportunity to extract discounts from your supply chain? Just trying to understand, right, people are talking about inflation subsiding. Are we going to see bottom line benefit for a company like Emerson over the next 6 to 12 months?

Speaker 6

Simple answer is yes, Andrew, yes, and we look at obviously direct material, indirect material and logistics. So we are going to see deflation Positive NMI or favorable NMI, we are seeing that already in the second half of this year and should see that continue into next year. So it will be favorable for us. What I will say though is, if you go back to pre COVID levels, logistics costs for example are already there. So we've seen a lot of the logistics benefit already come through.

Speaker 6

On the direct material front, particularly castings, machine parts, electronics, We will see deflation in 'twenty four versus 'twenty three, but still not back to pre COVID level. So maybe There for us is continued deflation over the next several quarters as the market eases.

Speaker 9

Excellent. And just a question on Aspen and Emerson. Can you just talk a little bit more about channel integration Because we're hearing that you guys are driving Aspen and Emerson closer together and this relationship is evolving. Just trying to understand, how much upside do you think or how much margin of safety there is given that historically Emerson Sales force has been very, very commercial. You are incentivizing the salespeople.

Speaker 9

It seems like the relationship is going Outside the initial channel, just talk a little bit more about the opportunity. Thank you.

Speaker 6

Yes. So you are spot on. I think over the last And certainly in the last 6 months, the collaboration and the refinement of our go to market or joint go to market approach, Whether it's a project or the white spaces has certainly improved. Yes, you are correct. In certain markets, China, for example, we're collaborating a lot more in terms of having the channels work together.

Speaker 6

Incentive plans for both Channels to support each other have been put in place and that's really stimulating the right behavior, if you will, as both teams go out And pursue competitive displacement opportunities or Aspen, for example, selling on our Delta V installed base. So yes, I think we'll continue to evolve and progress that. We're being very careful and we're taking it market by market and Doing what makes sense. I don't think there is a one size fits all approach to every market, but Certainly, the collaboration and the incentives for sales organizations to collaborate have improved over the last 6 months.

Speaker 9

Thanks so much.

Operator

Thank you. Next question will be from Chris Snyder, UBS. Please go ahead.

Speaker 4

Thank you and congrats on a strong quarter. I guess I wanted to follow-up on some of the prior conversation and communication on margins. If our math right, the guide seems to imply a pretty material sequential decline in margins into the 4th quarter despite a Step up in revenue, I guess, is that right? And what's driving that? Thank you.

Speaker 3

Yes. We will The decline in margin in the 4th quarter, and if you think about the Q3 that was driven By price and leverage, both of those things will be a little bit lower in the Q4. As we mentioned, the pricing For the full year, it will be about 4 relative to the 5 in the 4th quarter or In the Q3 rather and the mix will also have an effect there as we close out the year.

Speaker 4

Thank you. I appreciate that. And then just maybe I was looking for some more color on the pipeline of big process Projects, there's some concern in the market that, with oil and gas kind of commodities Down pretty well off the high and that includes LNG, that there could be some slowdown or pressure on these projects. Seem to have really good momentum on there. So can you just maybe talk about what you're seeing there and particularly on the traditional energy and the LNG side?

Speaker 4

Thank you.

Speaker 2

Yes. I'll make a couple of comments and if Ram wants to add color here. Look, the bulk of what we're seeing is gas. It's not oil. Where we do see activity in the oil, it's around sustainability, conversions, carbon capture, etcetera, and emissions reduction.

Speaker 2

But it's the gas activity that I think is very relevant. And that is entirely tied to Europe, to energy security and affordability. And we have not seen any slowdown in the activity, as a matter of fact, an acceleration through the quarter in terms of funding Processes, there are 7 projects currently out of 9 funded and moving forward aggressively, and we've booked 7 of the 9 in 7 of the 9 already. So I haven't seen any evidence and we have not felt within the business any evidence of Any potential pullback in the gas infrastructure build out or LNG infrastructure build out. Ram?

Speaker 6

Yes. And just to add to that, as it relates to our traditional markets outside of LNG, as Lal mentioned, chemical is another area where we see Continued momentum on projects, certainly in markets like the Middle East, U. S. And China. In terms of our Through traditional energy business, FPSO activity in Brazil, Guyana and Asia still continues to be good and moving forward.

Speaker 6

And then obviously, as we've said, activities in metals and mining, life sciences and nuclear continue to progress. So The funnel is diversified. That's what we like about the funnel and it's not really dependent outside of LNG, not really dependent on one large market and we Feel very confident that on the LNG side, particularly in Qatar and in the U. S. And East Africa, those projects will move forward.

Speaker 4

Thank you for all that color. Appreciate it.

Operator

Thank you. Next question will be from Deane Dray, RBC BC Capital Markets, please go ahead.

Speaker 11

Thank you. Good morning, everyone.

Speaker 2

Good morning, Dean.

Speaker 11

Hey, I appreciate the spotlight you put on the Battery value chain, and we see this as linked to the whole array of these powerful mega projects that are going on now. In fact, Battery is one of the biggest there. But just can you give us and it's all tied to the REIT shoring, near shoring phenomenon. Give us a sense of what kind of win rates you're seeing there within battery, but also on other projects. There's more than 50 different projects over $1,000,000,000 Just if you cut across those, where else Are you winning like in the semiconductor side, other automation projects and so forth?

Speaker 2

Yes. No, Dean, I'll be happy 2. I'll start with LNG, which has been very important. We're winning at a rate higher than 50% So far, we feel really good about continued differentiation in the marketplace and really becoming a de facto automation supplier there. In the hydrogen space, 50% right now in terms of win rate to the funnel and across the battery ecosystem, I feel very, very strong that very, very confident that, that sits in the 45% to 55% range as well.

Speaker 2

In fields like life sciences, it's much higher. And that is due to the very strong position of Delta V And the various instrumentation technologies that we bring to bear. So overall, I feel really good about the execution to the projects in the funnel. The pursuits are funded by internal teams. There's multivariate calling points between engineering companies, end users and contractors.

Speaker 2

And it occurs at all levels within our organization from Ram and I down into the card carrying salespeople.

Speaker 11

Good to hear. And then second question would be for Mike. Just can you share with us some of the actions on the working Capital side, there was really good free cash flow in the quarter. I would imagine you're still in this sort of interim period prior to natty, There's only so much you can do on the working capital side, but just give us a sense of what actions near term, How that translates into free cash flow for the year and then into early 2024?

Speaker 3

Yes, Dean. We have been really focused on inventory with the supply chain challenges and we've seen some improvement and we expect to see some continued improvement As we move into the Q4 around inventory. On receivables, with 14% growth, there's Going to be a growth in receivables and I'll tell you that DSOs have stayed flat and the execution there has been really, really good. If we look ahead, we're expecting for the 4th quarter operating cash Slow around $800,000,000 to $900,000,000 and CapEx around $150,000,000 which should put us in around $2,200,000 to $2,300,000 for the year. So I feel good about the actions that we're taking.

Speaker 3

There's been a strong focus on inventory with the backdrop of The supply chain moving around and settling, which is good, but that's been our focus.

Speaker 11

That's great.

Speaker 6

The past due performance has continued to come down on

Speaker 3

the receivable side, which has been really helpful as well.

Speaker 11

Yes. But just let's be clear, A growth in accounts receivable is a high quality problem.

Speaker 2

That's true.

Speaker 12

Thank you.

Operator

Thank you. Next question will be from Jeff Frague, Vertical Research. Please go ahead.

Speaker 13

Good morning, everyone. I apologize if this was addressed. I was on a little late. But Well, can you just give us your updated thoughts on how we're progressing towards Regulatory approvals on National Instruments and I know your view on 2024 was more subdued than where the Street consensus was, but they did post Some soft orders here in Q2. So just any thoughts on maybe the trajectory of that business as you work towards close?

Speaker 2

Yes, Jeff. Yes, I did cover in my script, but I'd be happy to repeat the key points. So on the regulatory, we have HSR approval And all the filings have been made, some already obviously obtained. So we feel very confident on the time line To close in the first half of our fiscal twenty twenty four. In terms of the business performance, look, It's largely playing out as we built into our model.

Speaker 2

Orders are down 17% end of the Q. That's largely driven by weakness Semiconductor and Discrete, we expect that to improve as the calendar year goes on. And that's how we've built into Into the business case. Having said that, Jeff, they had another record quarter. Their sales were up 5% Year over year, the profitability continued to improve and is very strong, particularly GPs at very high levels.

Speaker 2

So we feel excellent about the execution in the business, And we'll continue to stay close on our collaboration to be in our integration planning so that we can hit the ground running on day

Speaker 3

1. Great.

Speaker 13

And then a few things I did hear on the Q and A was a lot of discussion here on margin, leverage, mix and etcetera. Just kind of drilling in Price costs specifically, I would imagine we're maybe at or near kind of peak positive gap On that metric, I just wonder if you could opine on that. And maybe more importantly, though, my question is Your ability to kind of maintain a positive spread between price and cost as we kind of look forward to hear the next several quarters?

Speaker 2

Yes. Ram, why don't you give a question?

Speaker 6

Yes. So I think we're very confident in maintaining price cost green going into next year. However, Price cost in terms of margin point contribution of the spread will be lower as we go forward. I mean, we've had an exceptionally good year here in terms of Price performance and obviously NMI coming down in the second half, that will continue. I mean, we will be green price cost, but The margin point contribution from it will be lower in 2024, which will have an impact on leverage rates.

Speaker 13

Great. Understand. Thank you.

Operator

Thank you. Next question will be from Tommy Moll, Stephens Inc. Please go ahead.

Speaker 14

Good morning and thanks for taking my questions.

Speaker 2

Hi, Tommy.

Speaker 14

Well, I think it was a quarter ago, maybe before you called out some of the softening on the discrete side. That was Originally, I think in Europe, primarily Germany, but then you highlighted some evolving trends in the U. S. And Asia as well. Can you give us any more insight there?

Speaker 2

Yes. We saw that develop through the quarter, Tommy. You're absolutely right. A quarter ago, we talked about weakness that we began to see, particularly in automotive And in packaging OEMs, which as you know in Germany, not only serve the German market, but export throughout the world, that did Spread into the United States and into parts of Asia, and that developed through the quarter that drove more weakness in that Street business, which again makes sense from a cycle perspective for us, but that really developed over the last 3 months.

Speaker 14

Thank you. I appreciate it. Well, I also wanted to ask about culture. It's something that you've Highlighted throughout your entire tenure as CEO at the same time, pro form a for Natty, you'll have a much larger organization, Including pieces that had their own cultures before they were folded into Emerson. So, situate us on that journey And give us some insight into what the consolidated approach will be once your portfolio is more mature?

Speaker 2

Yes. No, I appreciate the question, Tommy. And as you know, that's pillar number 1 and continues to be pillar number 1 for our organization. We're very excited about The journey we're on, as you know, culture is not something that you change immediately, but as you have to journey. And there's been a lot done in across Emerson.

Speaker 2

What I particularly am excited about is The culture that exists today at National Instruments, it is something that is familiar to us. It is a very attractive place to work, a culture based around learning, curiosity, and that is felt in every engagement that we've had with that They have moved ahead in many of the dimensions that we are looking to do here at Emerson, and we're going to be learning from NI And applying a lot of their lessons to what we implement here in our company. So I think there's an accretion there and an accelerator there from What they've done and but at the end of the day, it's a company of engineers who are curious, who've leaned forward and think about tech In differentiated ways, and that's essentially who we are today.

Speaker 14

Thank you, Lowell. I'll turn it back.

Operator

Thank you. Next question will be from Joe O'Dea of Wells Fargo. Please go ahead.

Speaker 12

Hi, thanks for taking my questions. I guess one more just related to the price cost dynamic, I think pretty clear in terms of what you're seeing on the cost opportunity side. But just overall, how you think that filters through on the price side. So I appreciate that still a positive margin spread even if narrowing. But in conversations you're having, are you seeing a little bit more discussion around that?

Speaker 12

Are you seeing areas where price is actually moving down?

Speaker 6

No. We expect price to remain positive. The magnitude of the price will be obviously, it's not as it won't the increases won't be as Positive as we saw in the inflationary times of the last couple of years. But our automation business, we have a leadership position in all the markets we play in. We bring a lot Technology to our customers, obviously, KOB 3, which is the replacement cycle is 65% of our sales.

Speaker 6

So we'll be positive price Going into 2024, even as we execute on the favorable deflation that we will see on purchases like electronics, castings, machine parts.

Speaker 12

Got it. And then also, wanted to circle back a couple of comments on near shoring And I think kind of a broadening out maybe of the trends there. And so if you could expand on that a little bit And just touch on sort of the evolution of what you've seen, maybe kind of led in North America, But just sort of what inning you think we're on? Are you seeing any kind of stabilization in those trends in the U. S, but you're Seeing kind of growth budding in other regions and so if you can touch on those regions and verticals a little bit more.

Speaker 2

I'll say a few comments and I'll ask Graeme to add a little color as well. Look, I think we're in the early innings. Certainly early innings in terms of the infrastructure, Chips, near shoring activities, and it's broad based. It's driven clearly in the EV battery value chain that I described in life sciences, semiconductor, which will benefit National Instruments significantly as well. But it's Australia, it's Europe, it's the United States with very robust activity across all world areas.

Speaker 2

But I have to say based on Just the pace of activity, I do believe there are many innings yet to be played here.

Speaker 4

Yes.

Speaker 12

Got it. Thank you.

Speaker 2

Thank you.

Operator

Thank you. This This concludes our conference today. Thank you for attending this presentation. You may now disconnect.

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Earnings Conference Call
Emerson Electric Q3 2023
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