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Emerson Electric (NYSE:EMR)

Q3 2011 Earnings Call

August 02, 2011 3:00 pm ET

Executives

Unknown Speaker -

Frank Dellaquila - Chief Financial Officer and Senior Vice President

David Farr - Chairman, Chief Executive Officer and Chairman of Executive Committee

L. Maxeiner - Director of Investor Relations and Assistant Treasurer

Analysts

Richard Kwas - Wells Fargo Securities, LLC

Terry Darling - Goldman Sachs Group Inc.

Eli Lustgarten - Longbow Research LLC

Shannon O'Callaghan - Nomura Securities Co. Ltd.

Steven Winoker - Sanford C. Bernstein & Co., Inc.

Nicole Parent - Credit Suisse

Julian Mitchell

Deane Dray - Citigroup Inc

Christopher Glynn - Oppenheimer & Co. Inc.

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Emerson Third Quarter Fiscal 2011 Results Conference Call. [Operator Instructions] This conference is being recorded today, Tuesday, August 2, 2011. 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 on 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, Ms. Lynne Maxeiner, Director of Investor Relations. Please go ahead.

L. Maxeiner

Thank you, Brittany. I am joined today by David Farr, Chairman and Chief Executive Officer of Emerson; and Frank Dellaquila, Senior Vice President and Chief Financial Officer. Today's call will summarize Emerson's third quarter 2011 results. A conference call slide presentation will accompany my comments and is available in the Investor Relations section of Emerson's corporate website at emerson.com. A replay of this conference call and slide presentation will be available on the website after the call for the next 3 months. I will start with the highlights of the quarter as shown on Page 2 of the conference call slide presentation.

Third quarter sales were up 16% to $6.3 billion with increases in all segments. Underlying sales growth was 10%, led by strong emerging market growth. Operating profit margin declined 30 basis points to 18.1% and was negatively impacted by acquisitions made in the last 12 months and growth investments versus minimal levels in the prior year quarter.

Earnings per share was $0.90, up 17% compared to $0.77 in the prior year quarter. Strong operating cash flow of $903 million and free cash flow of $708 million. Our free cash flow to net earnings conversion was 104%.

Our balance sheet continues to strengthen. Operating cash flow to total debt is strong at 62%, and we've increased the pace of share repurchase in Q3.

Emerson is well positioned as the global economic environment becomes more uncertain, and we will deliver record operating margin and earnings in fiscal 2011.

Slide 3, the P&L. Again, sales increased 16% with underlying sales up 10%. Currency added 4 points, and acquisitions added 2 points. Operating profit, up 14% to $1.135 billion or 18.1% of sales, the increase driven by volume leverage and cost reduction benefits, partially offset by higher material cost, acquisitions and growth investments. Earnings from continuing ops up 18% to $683 million. We repurchased 6 million shares for $329 million in the quarter, which gets you to an EPS of $0.90.

Next slide, underlying growth by geography. In the third quarter, the U.S. was up 6%, and total international increased 13%, with Europe up 9%, Asia up 12%, Latin America up 17% and Middle East/Africa up 26%. Again, total underlying sales up 10%, currency adding 4 points, acquisitions adding 2 points get you to the consolidated sales up 16%.

Slide 5, some income statement detail. Gross profit of $2.498 billion or 39.7% of sales. Higher material costs were partially offset by cost reductions, price increases and volume leverage. SG&A of 21.6% gets you to operating profit of $1.135 billion, which includes the impact of acquisitions and growth investments. Other deductions net of $87 million includes increased amortization of $20 million. Interest expense of $56 million gets you to pretax earnings of $992 million or 15.8% of sales. Taxes of $294 million for a tax rate of 29.6%. We still expect full year fiscal 2011 tax rate of approximately 31%.

Slide 6, cash flow and balance sheet. Operating cash flow of $903 million, up 29%, driven by higher earnings. Capital spending of $195 million gets you free cash flow of $708 million, an increase of 22%. Trade working capital balances are noted at the bottom of the slide, which does include some inventory due to Japanese supply concerns. We'll continue to strengthen the balance sheet as the recovery continues.

Next slide, business segment P&L. Business segment EBIT of $1.097 billion or 16.9% of sales, up 13%. Margin declined 40 basis points. We saw benefits from volume leverage, price increases and cost reductions, which were more than offset by material and wage inflation, increased amortization from acquisitions and growth investments. Difference in accounting methods of $60 million. Corporate and other of $109 million. We had higher stock compensation expense of $13 million. Interest expense of $56 million gets you to the pretax earnings of $992 million.

We'll review the business segments next, starting with Process Management. Sales in the quarter of $1.789 billion, up 18%. Underlying sales were up 13%, and currency added 5 points. By region, the U.S. was up 16%, Asia up 17%, Europe down 1% and Latin America up 6%. We continued to see broad strength across the segments. EBIT of $366 million or 20.4% of sales, up 18%, with cost reduction benefits and volume leverage offset by cost inflation, business development investments and unfavorable foreign currency impact of $7 million. Backlog for process was $3.4 billion, up 27% from the prior year quarter.

Slide 9, Industrial Automation. Sales in the quarter of $1.391 billion, up 24%. Underlying sales were up 18%. Currency added 5 points, and acquisitions added one point. By Region, the U.S. was up 11%; Europe was up 21%; and Asia was up 20%. Continued broad strength across the portfolio and very strong growth continued in the power-generating alternators business. EBIT dollars of $230 million or 16.6% of sales, an increase of 43% driven by volume leverage and cost reduction benefits. Material inflation was offset by price increases. Revenue growth will continue to moderate from these very high levels as comparisons get more difficult.

Slide 10, Network Power. Sales in the quarter of $1.683 billion, up 19%. Underlying sales were up 7%. Acquisitions added 9 points, and currency added 3 points. By region, the U.S. was up 5%; Asia was up 7%; and Europe was up 4%. Network Power Asia resumed double-digit growth, and the global network power systems business was strong, including strong growth in our global UPS and precision cooling businesses, which were up over 15%. EBIT of $176 million or 10.4% of sales, a decrease of 3%.

We had increased Chloride amortization of $16 million, also unfavorable price, China labor-related inflation, embedded computing volume decrease and technology investment spending, which was partially offset by volume leverage. Our EBIT margin did improve sequentially 110 basis points from second quarter. EBIT margins are expected to continue to strengthen sequentially from third quarter to fourth quarter as our aggressive actions start taking hold.

Slide 11, Climate Technologies. Sales in the quarter of $1.171 billion, an increase of 6%. Underlying sales were up 3%. Currency added 2 points, and acquisitions added one point. By region, the U.S. was down 3%; Europe was up 7%; and Asia was up 9%. We saw a weaker North American resi market due to a cooler and wet May and July -- I'm sorry, May and June and the inventory in the channel. Our China business was up 10% but is expected to weaken in Q4 due to government fiscal tightening.

EBIT of $229 million or 19.6% of sales, an increase of 3% driven by benefits from cost reduction actions. We saw a significant material inflation, which was substantially offset by price. The U.S. market is expected to remain weak for the remainder of the year.

Slide 12, Tools and Storage. Sales in the quarter of $472 million, an increase of 4%. Underlying sales were up 3%, and currency added a point. By region, the U.S. was up 2%; Europe was up 8%; and Asia was up 4%. We saw a growth in the non-res construction-related businesses and a decrease in the consumer- and residential-related businesses. EBIT of $96 million or 20.2% of sales, up 1%, driven by benefits from cost containment actions. Consumer confidence remains low, and recovery in consumer and residential end markets continues to be pushed out.

Next slide, the summary and outlook. We had a strong third quarter performance, with underlying sales growth of 10%, operating profit margin of 18.1% and strong cash flow performance. We are entering a period of more macroeconomic uncertainty in the second half of calendar year 2011. However, Emerson is well positioned for the uncertain climate, with a strong global footprint, a good mix of businesses and end markets and financial strength.

For fiscal 2011, guidance remains unchanged as follows: earnings per share of $3.20 to $3.30; underlying sales up 10% to 13%, and we are tracking to the lower end of that range; net sales up 15% to 18%; operating profit margin, 17.4% to 17.6%; operating cash flow in the range of $3.3 billion to $3.5 billion; and free cash flow in the range of $2.7 billion to $2.9 billion.

So with that, I'll turn it over to David Farr.

David Farr

Thank you very much, Lynne. Welcome, everybody, for joining us today on our third quarter conference call and our results.

The quarter came in what I would say strong. Not as good as we had expected just 60 days ago; however, still very strong results with sales up 16%, earnings up 18%, strong cash flow and high levels of operating margins in excess of 18%. And after 9 months, our sales at $17.8 billion are up over 16%; our operating profit at $3 billion, up over 20% and a record OP level of 16.8%; our net income at $1.8 billion plus 21% and a 9.9% margin; and EPS at $2.26 at 22% growth for the first 9 months. Those are outstanding results and based on investments we've been making the last couple of years and based on performance of a strong operating team.

I want to thank the global team for getting the job done. These are extremely uncertain and challenging times with the Japanese earthquake and tsunami, a global material inflation, dysfunctional governments in the U.S. and Europeans not able to deal with the tough issues of debt and excess spending. I going to thank the business leaders and the operating leaders for getting the job done in very difficult and challenging times.

Now why did we call out last week in our orders that things are getting weaker? Because they are. They are weaker. We have always been very open in our communication to our shareholders and to our investors, and when we see fundamental change, we call it out. There's no reason to hide it. It's a fact, and we did it. Our underlying orders grew only 6.5% the last 3 months. That is outside the range that I have been talking about for several months, in the 7% to 10% range. And yes, it's against tough comps, but I saw a fundamental weakness happening over the last 60 days.

And then a couple of days later, they announced GDP. GDP in the U.S. grew in the first half less than 1%. Let's get that said: less than 1%. You look at all the facts that have been coming out the last couple of weeks and the economics have been weakening. It's not new news. We have to deal with it. We have a tradition in the company to deal with those things.

Then we have a government situation, their inability to deal with the real gut issues of excess spending and debt. All we hear out of government is: We're going to raise taxes. We don't like corporate planes. We're going to sue Boeing, one of the most strategic companies we have in this country, for building a new plant in South Carolina. We have no desire to really go after corporate tax reform, which would fundamentally change this country and encourage people to invest and reinvest and create jobs in this country but rather, demigods -- and go after people that actually create those jobs, be it corporations and people that are successful.

We have a difficult issue right now to deal with in this country, and the same hack is going on in Europe. They are in no better conditions. So as I look at what's coming at us in the second half of this year, I do not see the catalyst that would say the economy will be fundamentally different in the second half than we saw in the first half. Maybe the gross GDP will grow a little bit more in the second half. But fundamentally, there's nothing going on in the U.S. right now that would encourage corporations to ignore the excessive regulations coming at us, not to mention the new Dodd-Frank bill relative to whistleblowers or producing or mentioning what we had to do with minerals. We have to publish now what minerals we use. You look at new healthcare bill. You look at the last week. We decided in Washington to raise the CAFE standards for the second time within 3 years on the day that we announced less than 1% first half GDP growth in the U.S. economy.

I would say Washington is arranging the chairs on the Titanic, the way look at it. So we're dealing with realism here in this company. We're looking at slower growth. We don't know exactly what that growth is. We will manage accordingly. Our orders in the industrial world will stay up. I can't tell you right now what the second half will be. I can't tell you what 2012's going to be. So don't bother to ask me, because I will not tell you. If you tell me what -- if you ask me what 2012 is, the first thing I'm going to ask you is, "What is your forecast for the second half of GDP? And what is your forecast for the GDP in the first half of 2012?" Let me know and then I'll tell you what my forecast will be.

As a company, we have strong operating cash flow. Our balance sheet's been in great shape. We've made strategic acquisitions. We are integrating those acquisitions. We don't have a lot of acquisitions underway right now. I do not see a lot of acquisitions underway right -- in the near term. We're using our cash to pay back a dividend. We just announced today a record 55 years of increasing dividend. We've increased our share repurchase. We're now on track to do over $900 million of share repurchase, returning cash back to our shareholders. And we will continue to generate the earnings and the best growth we can in a very difficult market on a global basis and reinvest for future growth in creating shareholder value.

The company will perform in a very difficult environment as we have. We'll set record levels of cash. We'll set record levels of earning -- margins, and we'll continue to drive forward. That's where we are right now. We are dealing with very uncertain times, and we will manage those accordingly.

I feel good about where the company sits right now. We are performing at very high levels. All companies have issues we have to deal with, but we're dealing with them. Our price cost is close to being equilibrium, and we will be there in the fourth quarter. Our margins right now are running at very high levels, and we will set a record this year. And our earning growth is good, as is our cash.

So I want to commend the operating executives and the corporate executives for what they're doing in this very difficult time period. And we will play with the hand we're dealt with, and we'll play the best hand we can. And that's where we sit.

So now, we can open up for questions, but I will not talk about 2012, because I have no visibility into 2012 at this point in time given what's going on around this world, both in Japan, in the U.S. and in Western Europe. And that's where I sit. Thank you very much. The floor is yours.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Julian Mitchell with Credit Suisse.

Julian Mitchell

I guess the first question was on your own business, as you see the order growth decelerate, I noticed that your SG&A growth accelerated year-on-year from March to June even though your revenue growth went from 18% year-on-year down to 16%. So could you talk a little bit about how you guys are managing your own sort of hiring on your own sort of plans on investments? Obviously, you're investments been going up. But if you're seeing orders decelerate, why are you pushing up investments so much? And at what point do you start to scale back those investments assuming the order flow is deteriorating?

David Farr

That's very good and relevant. We had an OCE business leader meeting about 10 days ago, a private meeting on this very issue. We will modulate our spending right now. We already started it. I think that our underlying growth rate will modulate downward a little bit. And I would have thought for the whole -- for the second half we would have been double digit. We're basically around 10% right now. We could be anywhere between 9% and 12% in the fourth quarter. So right now, we are already modulating and putting things on hold relative to our spending as I look at the weakening global economies, and we'll keep it that way for the time being. On the industrial side, the process side, we're not doing that yet, because the growth rate is still there, and we still feel -- our backlogs are at record levels. I just -- more, I would say on the -- what I saw, the near-term, mid-tier cycle type business, I'm starting to modulate spending back here at corporate. I'm actually modulating back, as Frank Dellaquila knows. I've asked Scott to take a relook at the last couple of months of the budget. And as we move into 2012, I want to have a more conservative budget plan. So Julian, to your point, we are starting to modulate that back. You just look at the facts around the world, and the growth rates are slowing, and you need to get ready for that.

Julian Mitchell

Sure. And then just a follow-up just on the sort of the current order intake rates. I mean, is it the case that your -- that the standalone month, July, will be materially a lot worse than what you had in May? Or is it more sort of a gentle decline, but you're seeing more later on the decline will intensify? Or is it actually the case that the July sales growth rate will be a lot lower than what you had in May?

David Farr

No. No, I don't see that at all, Julian. I don't see the -- it don't see it accelerating down further. I just don't see it -- I mean, I would have thought we've been riding the 7% to 10% range, and I think right now you're going to see a general weakening. I don't think it's going to go -- it's not going to drop dramatically. Based on what we saw in July, we had the call around the board meetings and then I talked with the business leaders. It's pretty much trending, and there's probably now 5% to 8% range from our underlying order standpoint. I think that's where it's going to go. I think we shifted down let's say 1 or 2 percentage points in growth sooner than I thought, and I think that's where we are right now. I just don't see where the re-acceleration happens in the economies around the world in the second half of the year. There's no motivation for that as I see it right now.

Operator

Our next question comes from the line of Steven Winoker with Sanford Bernstein.

Steven Winoker - Sanford C. Bernstein & Co., Inc.

Just a quick follow-up first on the last question. The growth investments you had talked about for Accelerate 2012 I think were in the $40 million range sort of...

David Farr

They're still protected. They are still protected. I think we'll -- right now, we're on a pace just trying the right people, probably closer to the low $30 million, and we will carry it over into the first quarter, and I may add to that next year. These are very strategic relative to technology in emerging markets in some of our growth areas. So we will not curtail those. I'm being more selective in other areas, what I would call non-strategic growth investment areas that we really can cut back on.

Steven Winoker - Sanford C. Bernstein & Co., Inc.

So there are -- I mean, just because you guys already are known to run lean elsewhere, are you talking what -- just additional G&A that's volume based? Or. . .

David Farr

No, just -- we just won't spend -- rather than spending a 5% increase, I'll try to cut people back to 3% or 4% and top off increases. We're not talking about gigantic cuts, because we're still growing.

Steven Winoker - Sanford C. Bernstein & Co., Inc.

Okay. And then secondly, on the point around order rates sort of starting to decelerate, what -- on the pricing impact of that inside your market, are you yet seeing any lack of pricing discipline as things start to decelerate? Remember, last -- this last cycle, we didn't see as much pricing deceleration as we thought we might. And if we're heading into a slower environment, I'm just wondering would that hold up again? Are you seeing any weakness here?

David Farr

I really haven't seen any weakness yet at all relative to price and our ability to get price. As you know, we went out after the last quarter and raised prices in a couple of areas. And we're already seeing the impact of that relative to our order pace. We're walking away from business, so that hurts our orders. So we're able to get the price we need, and if we don't get it, we walk away from the business.

Steven Winoker - Sanford C. Bernstein & Co., Inc.

Okay. And on Network Power, maybe you could just go a little bit into the action, these aggressive actions. Do you talk about, particularly on the DC power outside plant, China, India and mobile charger, sort of any that changed in dynamics over the last couple of months there, competition too?

David Farr

No, no change. I don't think the competition in that has changed at all. I mean the business is moving forward. We are actually taking the necessary price actions that we need. We're making sure we win where we want to win, and we're going to walk away from the business we don't want. I mean, basically, what we laid out at EPG and during conversations in the last conference call, we're executing right now -- it's going to be over the next, as I've said, 3 to 4 quarters. We're already seeing the initial work impact relative to our order pace in some sales and in some of the early cycle what I call the embedded power area, but nothing unusual moving forward. Our margins were better in the third quarter, and they'll be better in the fourth quarter. The volume would drop off a little bit. And so we expect that, but we'll get our profitability back in line where it should be.

Steven Winoker - Sanford C. Bernstein & Co., Inc.

And last thing, just to put myself out there for you. You said you're not going to give anything on 2012 but just what multiple of GDP? Since you're just saying we should pick the GDP numbers, so that means you're picking the multiple? What multiple...

David Farr

No, I'm not picking the multiple. I mean, I don't know where it's going to go. I don't -- right now, the reason we don't know, it's really hard to pick 2012, because where is the underlying growth going to be for the U.S. economy and the European economy? They're definitely decelerating right now, and the question is where does that go. You're in a -- what I would call a transition mode right now in the 2 biggest economies of the world, be it the European economy and the U.S. economy. So it's extremely difficult to say, okay, where 2012's going to be. I think it's a mistake for us to sit here and say, "Okay. I think the growth next year is going to be 2% or 3% in underlying GDP. And based on that, I know our GFI will be this, this and this." I think -- what I want to see is where this economy goes this quarter and in the fourth quarter and then I'll have a -- obviously, a much better view of what things are going to transpire as we go into 2012. I'm just basically grabbing stars right now, and I don't think that's appropriate for me to do it. I'm running a business based on what I see right now, and I don't want to sit here and try to forecast 2012.

Operator

Our next question comes from the line of Christopher Glynn with Oppenheimer.

Christopher Glynn - Oppenheimer & Co. Inc.

Just on the Network Power with the he sort of customer selection, I'm wondering if you could talk first about what the impact on sales and orders was? And then also, it was mentioned as having an impact on the operating margin with the lower volume, but it's a strategic move. So I'm thinking there's a pathway that by eliminating this business, it's ultimately positive to margin.

David Farr

Correct. I mean, I'm not going to sit here and quantify the dollar level, how much it is. But at a -- from the standpoint of you -- we will see a margin improvement -- part of our margin improvement products as we go into the fourth -- our fourth fiscal quarter will be an elimination of customers at low margin business. And the customers that do take their appropriate pricing for the cost structure and what these products should be and obviously, will help us too. I mean, that's where we are right now. It will have a minor impact in sales. It will -- short term, it obviously always has an impact on your cost structure, but over time, we will adjust. And by the fourth quarter, we'll start getting that back in line, and the margins will start coming back up. It's part of our improvement that we're expecting sequentially as we go from third to fourth quarter. But I'm not going to sit here and tell you how much it is.

Christopher Glynn - Oppenheimer & Co. Inc.

Okay. And then just update on the Chloride integration. It looks like the sales were a little lighter than last quarter, so just wondering how that's all trending.

David Farr

Within our -- within the Chloride Liebert-related businesses, our orders and sales were up very nicely, up versus prior year. They were up over 15%. So they -- that business was not worse off, I mean, if from that standpoint. If you look at the Chloride Liebert business, we had very strong orders and sales quarter, and that business continues to trend pretty well on a global basis. And so the integration's going well there. The businesses that were modulating back that would cause the lower growth would be in the telecom space and some of the mobile space and embedded power and computing space, where as we realign our portfolio of businesses, we find unacceptable margin. That's where the dropoff in sales is, not on the reliable power and the Liebert and ASCO switch or the Chloride business.

Operator

Our next question comes from the line of Eli Lustgarten with Longbow Securities.

Eli Lustgarten - Longbow Research LLC

A couple of quick -- one quick clarification. The $16 million Chloride amortization step-up, that's permanent, I assume, for a few years.

David Farr

That will be over...

Frank Dellaquila

Yes, that's correct. I mean, that was year -- that was quarter-over-quarter, but there's a permanent step-up in the amortization.

David Farr

Correct, but that will scale -- that will step down after 7 or 8 years.

Eli Lustgarten - Longbow Research LLC

Yes. We have to factor that into the next couple -- for the rest of the quarters and in this year or next year?

Frank Dellaquila

This year.

David Farr

Yes, for all of this year. Yes, exactly right, Eli. And as you go forward, I think price steps down in year 7 or 8 or something like that. I mean, that's one of the big benefits of this new approach is that you do step down some of your goodwill and amortization out there. So...

Frank Dellaquila

Absolutely.

Eli Lustgarten - Longbow Research LLC

Absolutely. And then one internal question. I guess I'm not used to seeing Emerson with negative margin comparisons in 4 out of 5 sectors.

David Farr

Yes, correct.

Eli Lustgarten - Longbow Research LLC

So that -- is that -- so I assume -- we know some of the steps are being taken to improve it a bit sequential that we just talked about in Network Power. But can you go through what's going that caused the division as far as stabilizing the improving profitability? Especially with next year being uncertain, I assume you want to have favorable margin comparisons next year.

David Farr

Yes. I mean the big issue, Eli, is the fourth -- the third quarter margins last year were pretty much an all-time high. The third quarter last year, we grew -- that was the first underlying growth rate with 7%. So we took off, and clearly, coming out of it, we had not added any cost. And so what you have this year is you have a third quarter -- and this is ignoring the fact -- the impact of chloride, which is a big chunk of the margin of the Network Power business. But we had a quarter this year where -- if you look at the third quarter last year, they're down a tad, but if you look at the first half of this year, our third quarter margins are running substantially ahead of the first half of this year. So you got to be careful as you look at it quarter-over-quarter, because last year was a very unusual quarter. You're exactly right. I mean, we talked about the full board today, about where we see this is going, and we want to get ourself back in line as we go into the fourth quarter. But there's not -- it's not because there's a cost issue here. I mean, clearly, we have a little bit of price cost from -- material is still negative around $15 million, Frank, from the price cost in the quarter.

Frank Dellaquila

Correct, in the quarter.

David Farr

$15 million, that -- as I said, we will get that back. We started getting positive as we go in the fourth quarter. Not for the whole year but for the quarter, we'll get it back to positive. And so there's a lot of things going on as -- I mean, it's -- we're running at very high levels of operating profit in that third quarter. I mean, operating profit was still 18.1% as absorbing a very large acquisition which we made about 6 or 7 months ago. So I -- would I be happy if they're all up? Yes. But they're up over the first half, and they will -- we will end up this year at very level -- high levels or up profitability, and we will drive forward to make even more records next year. So one quarter, I wouldn't get too nervous about, Eli. But I do -- we do watch it very carefully.

Eli Lustgarten - Longbow Research LLC

And just as a follow-up. Nobody wants to talk about for forecast for '12, but parts of your business should have some visibility into '12, like particularly process.

David Farr

Correct.

Eli Lustgarten - Longbow Research LLC

Where you can look at it -- forget GDP. Process should have a better year. The question, I was still looking to double-digit gain in process next year here and even further strength in profitability. I mean that's the kind of thing that I think is important that we find out about at this point in time and not worry about something that I'm going to take care of.

David Farr

I think that if you take a look at the big backlog businesses between process and Industrial Automation, we should have another good year going into 2012. Our backlog has -- and process is at record levels. The order pace remains as -- even in last month and this month, it remains solid in the 12% to 15%, 16% range on an underlying basis. We will go into next year looking at a very good growth rate, my opinion in process, assuming nothing -- you don't have a sudden surge of cancellations, which I see no reason for that. So from a process standpoint, you are exactly right. I would expect us to have very strong underlying growth next year in process. The order pace is still there, and I would expect our profitability will continue to improve. Though, as you know, when I get to a certain level, I want to make sure we do not -- we're not jeopardizing our long-term investment growth, because we do run a very profitable process business, the most profitable in the industry. And then Industrial Automation, based on their order pace, it -- as comparisons are getting tougher, I would expect the Industrial Automation sales and orders do reasonably well as we go into 2012. So I would say those 2 segments will do pretty well. I would expect our reliable power business to also have another very good year as we got the integration underway, and we see that going forward. The big issue for me is, though, the difference between a very good year and what I would say above average year right now is really based on what happens to the underlying economy more than anything else. There are some fundamental parts of Emerson that will still have a very good year next year now, but I just don't want to get into are we going to grow this company next year at 7%, 8%, 9% or 10%. I'm not in that mode right now.

Operator

Our next question comes from the line of Terry Darling with Goldman Sachs.

Terry Darling - Goldman Sachs Group Inc.

So Dave, can you talk a little bit about China across your businesses? From a top line perspective, a lot of concerns about slowing growth there. There was a comment in the climate -- on the climate slide about expectation for weaker growth in Q4 on fiscal pricing. Maybe take us through some of the other businesses as well.

David Farr

All right. From our perspective, China is still performing very well. In total, we had a very good quarter. We were up 11%, which was higher than we were in the second quarter, and we're expecting a very strong solid double-digit growth in the fourth quarter and again, for the whole year. We are -- the climate issue -- you have to understand, climate issue had a huge surge growth last year. They were growing 30%, 40% in China last year, because the government had picked on changing the standards and -- energy standards, and we got a big growth surge last year. So from my perspective right now, as I look across the businesses, our businesses will still do reasonably well. If you look at what they're trying to slow down and where we are impacted, I would expect us to grow this year somewhere between 13% and 14% totally, and I would expect us to have a 12-plus percent -- pick a number, 12% to 15% in China next year. A lot of our strategic A12 investments are very much focused on that. A lot of new products are coming out. The economy in China, yes, it will be slower, but maybe it's going to grow between 8% and 9%. I tell you what. I'd take that than the United States in a heartbeat right now. So I -- the China marketplace has clearly slowed. There are pockets that are slowing, and the governments are slowing. I -- right now, where we're sitting right now in our new product program and our investments, we're still doing okay, and I would expect us to have another good year in 2012 relative to China.

Terry Darling - Goldman Sachs Group Inc.

And just a little bit more color there, Dave, in terms of your expectations on '12 through the segments. I mean, presumably, you got some easy comps in Network Power. Process remains strong, as you've talked about.

David Farr

The backlog's there.

Terry Darling - Goldman Sachs Group Inc.

What do you see in some of the other business in China, Industrial Automation and climate?

David Farr

Industrial Automation is running the best it's ever had because of the productivity investments going on China right now. So I would expect industrial, Network Power, process -- I would say the climate one, we'd be a little bit uncertain about where that goes, but I would say that one has the -- has the most uncertainty right now, but industrial, Network Power and process should be pretty good in China next year.

Terry Darling - Goldman Sachs Group Inc.

Okay. And then when you look at your CapEx plans for next year at this point, have you got any additional color there? And then on the other side, how are you thinking about restructuring at this point? Just overall levels of restructuring in '12 relative to '11?

David Farr

Okay. Relative to capital, our capital will be -- this has stopped this year. Our capital is going to up a little bit this year as we've made some strategic investments. The Middle East has held up and continued to expand. If you noticed, we had a very strong quarter. I'm expecting another good year. So we've had to add 2 facilities, and we're building them ourselves. We've also -- we're expanding in Brazil. And I've just built -- we're building and -- or buying and retrofitting a new building down in Austin. So capital this year will be up in the mid-600 range, maybe a tad higher based on where things stand. Right now, I would expect our capital will be up. If we finish this year at around $640 million, I would add $100 million for next year. I think that's where we're going to be. I mean, we're probably around -- the number you want to use -- if you think of our sales, I would use somewhere around 2.8% of our sales. We are in that cycle right now. We're going to grow next year. I don't know exactly what rate we're going to grow, but our capital spending is going to be around that 2.8% level. When we start growing where we are right now, we'll have 2 or 3 years in that 2.8%. This year, Frank, we had 2.8% or 2.7%.

Frank Dellaquila

It'd be just around 2.7%

David Farr

2.7%. So I think if you look at that, Terry, think around 2.8%, which will probably put us about $100 million. I mean, that's where I'm thinking next year.

Terry Darling - Goldman Sachs Group Inc.

Okay. Then just lastly, on restructuring, then I'll get off the call here.

David Farr

I think restructuring this year is going to probably be at the low end of the range we've given. And then -- and next year, we're -- as I've told people, we're going to -- we have the Chloride. So I would say we'd go up a little bit from this year, so -- but it's not going to be. We're not going to go up from -- let's say, it's 85 to 150. We're going to go from 85 to 110, okay? That gives you ballpark.

Operator

Our next question comes from the line of Shannon O'Callaghan with Nomura Securities.

Shannon O'Callaghan - Nomura Securities Co. Ltd.

Dave, on the comment about growth getting cut in half from the budget discourse and European debt, I mean, it sounds like this is a sort of last 60 days for you in terms of deciding, you know what? We're going to throttle back the spending. We've seen enough. I mean, what particularly triggered you? And what have you heard from customers to support seeing others do the same thing?

David Farr

I just look at the order pace. I think the biggest issue that I'm watching right now is they're not really -- either in the U.S. or Europe, really addressing the gut issues. I mean, in the U.S., we have enormous regulations coming at us right now. There's -- the incentive to invest in the United States is negative. And from my perspective, people talk about -- we want clarity. I got all the clarity I need. They're spending. They're regulating us. The tax rate -- they're talking about raising the tax rates. Our tax rate this year will be around -- in the U.S. will be around 36%. We'll pay in U.S. taxes this year over $500 million, actually pay the U.S. government over $500 million, and they say they want to raise it even more. And so I'm looking at that as a -- I run a company. I have a lot of money to invest. And I look at that and say, "I'm not going to invest it here." And I think customers -- I think a lot of customers have the same concern. And then when you have a company like Boeing, you're talking about one of the iconic U.S. companies, gets sued by the federal government. If that doesn't get your attention, nothing will. They get sued for investing $2 billion in South Carolina. Last time I saw South Carolina, it was a part of the United States of America, and you get sued for that. I tell you, as a CEO, you get my attention. And so from my perspective, I think people are very nervous about all the regulations. We have no idea how much more healthcare costs we're going to get thrown at us, and all I see everyday things come at me. I mean, just take the new whistleblower rule, or you take to the new commodity rules, or you take a look at everything that's coming at us. And it's just you're sitting there going and saying, "How much can you burden companies that do invest and try and create jobs?" And the answer is I guess it's never ending, because they think that we're going to take it all, and we're going to sit around. So I think the environment right now is not very good, and I think Washington doesn't understand how to create jobs. I mean they're talking about basically raising taxes or getting rid of corporate planes or -- I mean, it's amazing -- or doubling the CAFE standards. That's going to create a lot of jobs. That's my opinion. And I have to control a lot of money to invest in this country, and we employ 140,000 people worldwide, including 35,000 people in the United States.

Shannon O'Callaghan - Nomura Securities Co. Ltd.

Okay. Just a little more on Network Power. I mean I know -- it still sounds, obviously, UPS and cooling still looking good. Network Power did okay in the quarter, but you're trying to foot that all with -- organically, like 1% order growth. I mean, it seems like it's more than just pricing yourself out of some of this business. I mean are there other parts where you've seen pauses in spending?

David Farr

No. I think right now there's, in the -- on the what I would say the reliable power side, the business is very good and very strong and improving. You have parts of the embedded power side that we're backing down because of aggressive pricing. And also, the other issue there is the material time -- material availability's back in line, so the lead times are dropping off. So people are more careful about how fast the order of things. And you just have pockets of telecom through the company. One quarter will be very strong. The next quarter will be very weak. It's just -- I would say, generally, we're trying to back things down in certain businesses right now that we find strategically are acceptable for us in margins and returns, and that has an impact. As I told you in June or May, it would have a very quick. And we're starting to impact that already, and that will flush out over 6 to 9 months. So it will happen, and we'll have a more profitable and healthier segment, which we'll grow off of as we go into 2012.

Shannon O'Callaghan - Nomura Securities Co. Ltd.

Okay. I mean -- and just as you -- factoring that in, I know it takes time to play out, but do you expect Network Power to improve from sort of the organic growth you saw in June even accounting for that, or no?

David Farr

I would say -- well, that's a tough call. I would say it's going to be -- it's possible that in the 3-month roll, I mean -- and if you look at the tall orders, because we bring them on every month, it's possible that we'd have a positive underlying growth rates in the 3-month roll, but I would say it's going to stay around 0 until we flush it out over the next couple of months. That's where my gut tells right now. I mean, I don't know that but just my gut.

Operator

Our next question comes from the line of Rich Kwas with Wells Fargo Securities.

Richard Kwas - Wells Fargo Securities, LLC

On process, how are you thinking about incremental margins as we move forward? You did about 20 this quarter with projects picking up, MRO toning it down. How should we think about that as we move into the next few quarters?

David Farr

My feeling is where we are in the cycle right now on process, we should run anywhere between 20% and 25%. That means, depending on the mix of project, you'd go as low as 18%, but it should be running let's say 18% to 25% incremental margins. The big issue for me is our process business is going to probably hit $7 billion this year in sales. The key thing for me is we're now getting into a critical mass. So if you'll look at some of the facilities we're having to expand globally right now, I'm having to build the expansion of my European operations. I'm doing one in -- I'm doing a big expansion in Brazil. I'm doing an expansion in Texas. And so I'm having to put some infrastructure back into it as we set ourself up to make a run for $8 billion. So we're in that phase right now that I'm going to have to make some investment both in people and infrastructure as we go from this $7 billion to $8 billion. So we're still going to be very profitable, but I wouldn't be surprised if you see us having to put more money into that as we go to the next level of other sides of the business. That's where I think we are right now.

Richard Kwas - Wells Fargo Securities, LLC

That's okay. Okay. And then I assume something similar for Industrial Automation as we think about that business moving forward.

David Farr

Well, one of the things about industrial, we are going to probably have to put out some capacity and in particular, in Asia, and we have been doing that. But you'll also understand that we actually had added some capacity right before the downturn came, and so I think that have we flushed out some of the capacity there. So I would say we're going to have to continue to add capacity in some of the emerging markets, but we are in better shape relative to the infrastructure, I think, in IA than we were in the process.

Richard Kwas - Wells Fargo Securities, LLC

Okay. And then on pricing, how do you feel about the businesses? Do you feel -- I mean in climate, you've had to put another one through. What do you see in the other businesses with material inflation toning down a little bit?

David Farr

The material inflation is definitely toned down, but the issue really boils on as you look at it. We're going to still have a situation as we go into 2012 where pricing's going to have to be somewhere around 1% positive as a total corporation. So net pricing is still going to have to be positive as we go into 2012 at the current levels of commodities. If you look at the global commodities, there's -- they are -- there are -- they're toning down from where they were 3 or 4 months ago, but they're still running at pretty high levels. And I would say, basically, what I see right now, the material -- net material inflation is going to be there, and we're going to have to have somewhere around 1% pricing as I go into 2012 looking at it today. Now that could change in 3 or 4 months depending on how much the economy slowed down around the world.

Richard Kwas - Wells Fargo Securities, LLC

Is that Network Power dominating that? Or is that pretty much spread across?

David Farr

We spread it across the company, and it's pretty well spread. I mean, some will be higher than others. But in total, if you think about Emerson, we're going to have around 1% this year. I would say we're going to be pretty close to 1%, maybe a tad less next year but not huge less.

Operator

Our next question comes from the line of Deane Dray with the Citi Investment Research.

Deane Dray - Citigroup Inc

So climate, my question is on the issues in temperature control. You called that out I think back in May as an issue. Just take us through the dynamics there.

David Farr

I mean, we have some customers that when we started moving out of, let's say, our appliance components business, we have some situations where some of our customers, they're not -- let's say they're not strategic to us anymore. So we look at that and say, "Hey, we're going to move on to a different location and move." And that's basically what's going on there. And we anticipated that, but it's not something that we -- we have to manage that over time. So that's what's going on in that standpoint. As that -- as our -- as that customer shifts supply away from us, that's something that happens in this industry from time to time, and we can adjust.

Deane Dray - Citigroup Inc

So we're just going to have to wait till that anniversaries?

David Farr

Pardon.

Deane Dray - Citigroup Inc

We just have to wait till that anniversaries?

David Farr

It's -- it pretty much -- it's almost done now. I mean, it would be done by the end of the fiscal year. [indiscernible] the shifting of...

Deane Dray - Citigroup Inc

I'm sorry.

David Farr

Yes. It'll be done by the end of this fiscal year.

Deane Dray - Citigroup Inc

And then you called out in Japan the effects of you're carrying a bit more inventory. Can you just -- has that run its course? Can you size the inventory? And...

David Farr

Well, it's around $50 million. It's around $50 million, Deane, and we'll have to work that off over time. Clearly, one of the things that based on my communications so far I would say are -- if I look at our sales right now and as we said in our press release, at one time, I thought we'd be closer to $24.8 billion of sales. Now I think it's going to be closer to $24.4 billion. So we have 2 things working against us at this point in time. Sales, the economies are a little bit weaker, in particular, in the mature countries. And we had, to actually -- to protect our customer base, we had brought inventory on. So now we're going to have to eat some of that off, and that will take us -- it would take us probably the rest of this calendar year to do that.

Operator

Our next question comes from the line of Jeffrey Sprague with Vertical Research.

Nicole Parent - Credit Suisse

Dave, it's actually Nicole, and I'm sitting in a conference room with a large number of investors. First question would be how would you rate your organization's execution at Network Power this quarter?

David Farr

I'll give them a 7 out of 10. It's better than last quarter, but 7 out of 10.

Nicole Parent - Credit Suisse

Where did they fall short relative to your expectations?

David Farr

I mean, I think that from the standpoint of getting some of the efforts done and relative to just sorting through, let's say, the consolidation between our acquisitions recently, also sorting through some of the issues relative to getting product in the -- so gone and out the door. I just think we've had a slow execution relative to operations built from a product standpoint and a consolidation standpoint at this point in time. It should be -- we -- I don't grade people at 10s very often, so I would say 7. And my feeling is right now, we're running higher than that. I think the team is really getting their act together. We've had several one-on-one sessions, and I think the team now is running better. As I move into the fourth quarter, they're running better. And that's -- we need that to happen.

Nicole Parent - Credit Suisse

When you think about sort of the challenges in that business over the next 6 months, is the biggest challenge sort of extricating yourself from the embedded power business successfully? Is it the consolidation of the acquisitions?

David Farr

The most value creation for our shareholders is the execution of the integration of Chloride and Liebert and the [indiscernible] and the whole Avocent. That is the #1 issue for creating value for my shareholders, and it's a #1 priority for the business leaders in that area there, both Scott Barbour, who has taken over and for obvious -- Ed Feeney and all those guys, Stephen Lanning [ph], everyone around the world. That is the #1 issue, #2 issue, #3 issue. That's how we'll create value.

Nicole Parent - Credit Suisse

And I think we may have another question in the room.

David Farr

Okay.

Unknown Speaker

This is Martin Tanky [ph]. I know you don't wish to give any real indication of 2012. It's clear, as we've gone through the course of our conversation during your conference call back there, there are some businesses that you have a few worries about than others. But most importantly, where do you see the pressure points in terms of businesses with bureaucracies as we go into 2012?

David Farr

I think that's a good question, Martin. The pressure points -- first of all, I think the longer lead time businesses -- as we right now sit with a backlog and the order pace is holding up, those business, I have less pressure points given where we sit right now. The pressure points I see right now are fundamentally in the U.S. and fundamentally in Western Europe. I think those market places are still uncertain. The governments are having to struggle with this question of the debt and struggling with the spending, and there's huge ramifications on the investment profile relative to how long will business continue to invest with that type of uncertainty and concerns going around those 2 key marketplaces. So I would say the #1 issue for me is what happens relative to the investment profile in Western Europe, what happens to the investment profile in the U.S. My global emerging market business, I think, will have a very good year next year. It will be impacted by what happens to the U.S. and Western Europe. But I think, overall, I believe quite strongly the emerging markets will continue to do well, and that will drive a lot of our growth. And as you know, it's -- emerging markets right now is quickly approaching 40% of our sales. So my pressure points are what happens in the U.S., and how do the people get scared, and they start curtailing spending and investment in this country and the same thing in Western Europe. Those are the pressure points that we must watch both from my standpoint and you as an investor.

Unknown Speaker

As a follow-on to that, so would it be fair to say you are more concerned about the consumer-facing businesses held within...

David Farr

The consumer businesses are pretty well dead. There's not been much recovery there. I don't think the -- I don't know how much lower the consumer can go. I'm more concerned about just the overall investment profile. I mean will businesses continue to invest in expansion, which has an impact? Will businesses still invest in sort of energy assets? And those are my concerns in the short term, so that's where I am.

We need to cut it off here folks, and I'm looking forward to seeing people in the coming weeks. So I want to thank everybody for joining the call today. I mean, the one thing to say about Emerson, Emerson's in a very good position right now. We're extremely strong. We had a great 9 months. I believe the company is operating well. We have some issues, but we'll deal with those issues. And I feel very good about where we're going here in the next 3 to 6 months. And we will deal with the uncertain economies, and we'll continue to grow and invest where appropriately. And we'll continue to keep our cost structure, and we'll -- we will set record levels of earnings, and we will set record levels of profitability this year. And I want to thank everybody for joining us today.

Operator

Thank you. Ladies and gentlemen, that concludes the Emerson Third Quarter Fiscal 2011 Results Conference Call. If you would like to listen to a replay of today's call, please dial (303) 590-3030 or 1 (800) 406-7325 and enter the access code of 4457238 followed by the pound sign. Thank you for your participation. You may now disconnect.

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