Welcome to the Emerson Second Quarter 2023 Earnings Conference Call. Please note today's event is being recorded. I would now like to turn the conference to your host, Colleen Mettler, Vice President of Investor Relations at Emerson. Please go ahead.

Good morning. And thank you for joining us for Emerson's second quarter fiscal 2023 earnings conference call. Today, I'm joined by President and Chief Executive Officer, Lal Karsanbhai; Chief Financial Officer, Frank Dellaquila; and Chief Operating Officer, Ram Krishnan. Also joining us today is Mike Baughman, who was announced earlier this morning as our chief financial officer effective May 10. 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 uncertainties. Please take time to read the safe harbor statement and note on the non-GAAP measures. I will now pass the call over to Emerson's President and CEO, Lal Karsanbhai, for opening remarks.

Thank you, Colleen. And good morning. Please turn to slide 3. I'd like to begin by thanking the global Emerson team for a tremendous performance, our board of directors and shareholders for the trust that you place in us. It has been a busy first 26 months as CEO as we reinvented Emerson. The second quarter performance was exceptional. It was a quarter in which we significantly advanced our strategic agenda across the three dimensions of our value creation model. First, culture. In the last two months, we announced two important leadership changes. Vidya Ramnath was named as the company's chief marketing officer, replacing Kathy Button Bell, who had a distinguished career at Emerson and put Emerson's brand on the map while working for three different CEOs. Vidya is the right person to accelerate our journey as a pure play automation company. She brings deep technical knowledge and customer exposure, is an engineer, and for the last four years, has led Emerson's Middle East and Africa business. We believe this is a highly differentiating move for us as a company. Secondly, this morning, we announced Frank's planned retirement and Mike Baughman as Emerson's CFO. I'll say a few more words about this later in the presentation. Lastly, we completed our first digital employee engagement survey. We heard from 85% of our global employee base and received a high quartile net engagement score. This gives us a stake in the ground and now great perspective on the areas of strength and opportunities to better the talent experience at Emerson. Second, the portfolio. We will be finalizing the Climate transaction in the current quarter. The CEO for the joint venture has been named, Ross Shuster, and we are excited by what his leadership and experience brings to the business. I'd like to…

Thanks, Lal. And thanks to you and the board for giving me the opportunity to serve as Emerson's next chief financial officer. I'm very excited to get into the role. Good morning, everyone. I've had the opportunity to meet several of our investors and analysts, and I'm looking forward to meeting more of you and working with you in the future. And to my Emerson colleagues listening in, thank you for a fantastic quarter. As Lal just talked about, it's been a productive 26 months with respect to reshaping our portfolio and we're on track to achieve what we set out to do. The impressive result is a more cohesive $16 billion automation company expected to grow 4% to 7% through the cycle, with peer-leading margins and a more diversified end market exposure. I think of the portfolio transformation as a great start. And now we get to operate in this new environment. Execution has always been a hallmark of Emerson. And we're building on that to focus on accelerating profitable growth, integrating NI, and growing our cash flows as the supply chain normalizes. I certainly expect successful execution in these areas to result in increased shareholder value. While I'm excited about our future, transitioning to the CFO role is a little bittersweet for me personally. Frank was a major reason I joined Emerson a little over five years ago. And during that time, I've come to know Frank as a great finance professional, and more importantly, a wonderful person. I'm confident we'll have a smooth transition over the coming months.

Thanks, Mike. And now, I'll turn the call over to Frank.

Mike, thank you so much for the kind words. When I showed up here 32 years ago, I never – didn't really know what to expect and I never could have imagined the opportunities that I would have, the things I would get to do, and above all, the people I would have the privilege to work with. The last 13 years have truly been a privilege, leading a world class finance organization, who I respect, I trust implicitly, never let me down. And I thank them from the bottom of my heart. The last two years working with Lal and Ram and the people in this room and our extended team on the portfolio transformation have been truly special, and just a wonderful capstone to my career. And I will always be grateful for that opportunity. Thank you, Lal. I'm truly grateful for that. It's been a heck of a run. Emerson is well positioned for the future. This is a perfect time to turn it over to Mike who I've come to know well as a person, respect as a leader over the last five years. I am confident he's going to provide the right leadership for the challenges we have again. The future is very, very bright, and I'm so happy to have been a small part of it. I've enjoyed working with all of you over the last two years on the phone with our analysts and our investors, and I couldn't think of a better way to go out and I'm very grateful and I just am so thankful for that. Thanks everybody. And there is no crying on earnings calls.

Thanks, Frank. And to you on chart 9.

Okay. Here we go. Good morning again, everyone. Please turn to slide 9. Our second quarter financial results were outstanding, reflecting our strong end markets and operating execution. Lal summarized the results for you, so I'll provide a bit more color. Additional details are in the press release and in the slides and in the appendix to this presentation. Underlying sales growth exceeded our expectations at 14%. All world areas in both business groups were up double digits, reflecting the strength in our end markets, our positioning in them and our geographic presence. Demand was broad based, with later cycle process markets up high teens and hybrid markets also up double digits in the quarter. Discrete demand has begun to moderate after several quarters of strong growth, but sales were still strong in the quarter, up high-single digits. Safety and productivity returned to growth, up 3% in the quarter. Net sales also up 14% for the quarter, with a 3 point drag from currency which was essentially offset by acquisitions and divestitures. We did close our Russia divestiture in March and we now report the business we had on the divestiture line of our net sales bridge. Our businesses continue to realize significant price. In the quarter, price contributed approximately $150 million and 5 points of growth. Backlog also grew $300 million, reflecting the strong orders backlog of approximately $6.9 billion to end the quarter. AspenTech revenue was below expectations for reasons they explained on their call and I'll briefly summarize those here. Please keep in mind that AspenTech reports revenue under ASC 606. So the factors affecting GAAP revenue are complex, as explained on AspenTech's earnings call. There were three factors in play. The first was longer-than-planned project execution in the OSI business, which pushed out the recognition of…

[Operator Instructions]. And this morning's first question comes from Andrew Obin with Bank of America.

I guess my first question is a lot of debate with investors about the impact of improving lead times on orders, backlog, and free cash flows. Clearly, you're starting releasing working capital. But if you're releasing working capital, perhaps you're ordering less stuff. And if you're ordering less stuff, maybe somebody else is ordering less stuff. How do you think this dynamic will play out over the next 6 to 12 months?

Well, I'll start off with some comments just on the underlying environment, which we're still optimistic about, as you heard on the call, Andrew. Mid-single digit order run rates, we came out of the quarter at 7%, and expect that that range to continue through the remainder of the year. So the demand environment based on our see is strong. And as Frank outlined correctly, and there's some puts and takes out there, and we're watching those carefully, but as a whole, we feel very good about that. Having said that, we have a very robust backlog as well. We did build backlog in the quarter, and we continue to work through that which gives me further confidence, obviously, in the performance of the company for the second half. Naturally, with supply chain challenges largely alleviated, of course, there's still a few issues out there, but largely alleviated. Lead times have started to come down. But we haven't seen that reflected in any slow in orders. And very much, as you saw quarter-over-quarter and sequentially, our order pace continued to be very consistent. Ram, anything to add?

I would say again, Andrew, I think from a lead time perspective, distribution, for example, is less than 20% of our overall sales. So, we can – frankly, even with distributors, as our lead times have come down, we haven't seen any change in ordering patterns. Our KOB3 business, which is the other piece that is lead time dependent, continues to be strong. So no fundamental change for us as it relates to ordering patterns from our customers, as lead times across all categories of products for us have come down. Now, I know others have mentioned that. But to date, we haven't seen the impact.

Just maybe a follow-up question on aligning Aspen and Emerson sales channel. You guys clearly highlighted Golden Triangle's success of going to market together, you've affirmed the synergies. But I guess the question I have, as you work closer with Aspen, one of the opportunities to improve visibility at Emerson because you have access now to a lot of CIOs, but also what are the opportunities at Aspen to benefit from deep and broad relationships that Emerson has? Was there key clients, for example, in the chemical space, right? You said our relationships are much broader. What can you do to improve visibility at Aspen in key verticals?

It's a great question. And it goes back to the heart of the very robust commercial agreement that we have with AspenTech. There is world area alignment in leadership, there is sales force alignment and incentives, and very honestly joined pursuit in two areas, capital projects, which was the example that I shared with you and then a very robust analysis on an industry by industry basis of the whitespace opportunities that exist, particularly for our control system and for AspenTech. And that's more of a systematic approach by the selling organizations, but one that will prove to be – and is proving to be quite a large opportunity as well. Ram?

Just to add, I think the customer landscape is really the way we really want to drive more seat for AspenTech. Certainly, the momentum on projects is there early. But as we shared with you before, 70% of the control systems that we have, DeltaV innovation, don't have level three software capability at many of our customers. 9,000 of those are in markets like life sciences and metals and mining. So those are the unique type of opportunities, the AMS systems that we have where we can bring Aspen, that's the approach we're taking through our commercial agreement. We are very, very geographically focused as well, where we look at markets where Aspen doesn't have the strength, and that's really where a lot of the effort is being put. So we'll see that benefit come through. It's three quarters in, obviously, in the relationship. The momentum is early on projects, but more will come as it relates to the whitespace that I described over time.

And the next question comes from Deane Dray with RBC Capital Markets.

My first question is maybe take us through what you're seeing on the discrete side with some of the demand moderating? How did it progress through the quarter? Is it isolated to some specific verticals or geographies? Because we are hearing elsewhere slowing in Europe, especially on the chemical side, but appreciate the color there, please.

Deane, Ram here. From a discrete order activity – now the discrete business from a sales perspective, we had good strong growth in the quarter, 9.5%, close to 10% growth in the quarter from a sales perspective, which was driven by backlog reduction. Orders did go slightly negative this quarter, primarily driven by slowdown in Europe. Frankly, we haven't seen much of a slowdown in North America, but a slight slowdown in Europe, particularly in Germany and the segment around machine builders. We do serve the machine builder segment in Germany, which is both domestic German market as well as these machine builders export. So that's really probably the one segment, a little bit of slowdown in the UK. Frankly, Asia is holding up, and China remains good. So that's the color. We do expect discrete to get into tougher comparisons as we get through the second half of the year, and we expect orders to remain negative before they turn positive into 2024.

Just a follow up. And also, I just want to hear Frank one more time here. Free cash flow difference between GAAP and adjusted this year, that difference, how much of that is either working capital needs given kind of supply chain? Or is it more from climate?

No, none of these differences – the difference is simply the calculation, the denominator. Deane, we're just talking about the $2.2 billion guide of free cash flow and whether we use GAAP earnings or we use adjusted earnings as the denominator and that's the difference between the conversion ratio, there's no difference at all in the calculation of the cash flow itself.

And the next question comes from Scott Davis with Melius Research.

I don't want to fixate on AspenTech, we can do that later, perhaps, but I will anyways. The bulk chemical OpEx, is it typically that? Volatile? Is it something that they've experienced in the past and perhaps you might see in the future? Or is this a kind of an unusual circumstance?

No, I think the bulk chemical dynamic because you see many of the chemical customers say, at the end of the day, with a little bit of slowing demand there and the utilization rates being optimized, but the portion of the AspenTech business which typically gets impacted is their manufacturing and supply chain software suite. So in terms of new purchases or new contracts around that, which we have built into the forecast, that's where we're seeing slowdown. So that's pretty normal. Obviously, refining for them continues to remain strong, upstream and midstream continues to remain good. It's really the manufacturing and supply chain suite in bulk chemicals where we have seen the slowdown, and we've seen that in the past when the large chemical customers slow down spending on the OpEx side.

Guys, it's assuming your stock price works and I know AspenTech is down quite a bit from its highs, but is there any interest in – I know there's some restrictions, but those things can always be discussed in taking an even larger stake in the entity and perhaps, over time, integrating it fully into Emerson.

No, look, we're still very committed to the model that we set forward a year – closed it nearly a year ago now. It works. We're seeing the commercial value. We're working the technology piece as well. And like I've said in the past, it's at a point in time that changes and we have impetus to then address that through the change in the ownership structure of the vehicle. We'll think about it then, but not at this point. And then furthermore, as you know, and you noted, we are in a standstill period for another calendar year from now.

And the next question comes from Andy Kaplowitz with Citigroup.

Lal, could you give us a little more color into your incremental margin performance both for Q2 and 2023? I know the new Emerson is supposed to record higher incrementals well in the 30s, but what's changed for Emerson in 2022 that's allowing you to record low to mid 40s, over 50% in Q2, is it mostly the 5% price that Frank mentioned and much improved supply chain environment? Is maybe underlying Emerson able to sustain incrementals in the 40% plus excess over the longer term and how you're thinking about price versus cost moving forward?

I'll let Ram add some operating color. As we went through the quarter, we certainly believe in the strong guide that we put together on the 40 leverage for the full year given the early performance in the first six months. Look, there were a lot of things that were positive. Obviously, the execution was exceptional. I think the operating executives in the businesses performed very, very well and exact. The volume was important, as we noted, growing the underlying sales at 14%. But furthermore, mix and price cost were beneficial as well in the quarter. So a lot of things went our way there. But honestly, working within the management system that we've designed is a very important parameter that enables our businesses to perform at a very high level. Ram?

Other dynamics that certainly went our way is strong North America in the quarter, strong performance in our instrumentation and final control businesses and the leverage we got there. So dynamics are on mix, certainly the price-cost element that Lal mentioned, but, fundamentally, the 14% sales growth in the quarter does help leverage. So all of those dynamics went in our favor.

Maybe you can give us a little more color into what you're seeing by region. I think China was relatively weak for you in Q1. It seems like it's better in Q2. I think, Lal, you mentioned easy comparisons in Q3. So how do you think about regional demand moving forward for the rest of the year.

Really good. It was a very robust quarter globally for us in terms of sales performance, and very honestly orders, as Frank outlined. China flipped for us. It was down in the mid-single digits a quarter goes. It's up high single digits, and in sales in the mid-single digits. So we feel very good. And we feel good about what we see in China for the remainder of the year as well. So that's a positive. Look, North America, very robust growth, broad strength, a lot of it driven by the nearshoring elements and core strength in hybrid and processed, with growth of 15-ish percent in sales. Europe, that's been very honestly, Andy, the biggest surprise of the year. It continues to be very strong for us with growth in the mid-teens, 14% in the quarter in sales, and orders that are very strong. And very honestly, highlighted by energy, sustainability and life science investments. And then the rest of Asia, driven by India, Southeast Asia, and then an incredibly strong Middle East and Africa region as well, with significant investments in sustainability and LNG across the region. So at this point in time, with the exception of the discrete weaknesses that we've already talked through, continue to see very strong global momentum as we go through the quarter here into the rest of the year.

And the next question comes from Steve Tusa with J.P. Morgan.

What was price capture in the quarter? And what do you expect it to be for the year?

It was 5 points in the quarter and we expect to be 3% to 4% for the year.

Lal, I'm just curious from a governance perspective, the Aspen results, there's a lot going on there. I guess, I get a high level, some of it sounds like execution on some of these contracts. Perhaps in the, I guess, I call it, the integration phase of what they're doing, even though it's not really an acquisition by them, I guess, it seems like that there were a couple things that surprised them about the assets that you guys are contributing. How does that conversation work in the boardroom there because those are like assets that you guys knew. I'm not sure how surprising that was to you. But it was clearly surprising to the market the way this has played out. So, I'm just curious. Like, a little more color from your perspective on the integration that's going on there and perhaps how that kind of discussion and how to move forward plays out when that type of thing happens.

Yeah, no. Absolutely, Steve. I'll give you some color here. Maybe there's three or four here critical points. Let me first begin by saying that I continue to be and we collectively continue to be very optimistic about the business and the differentiation that it provides as a technology solution across a diverse customer base. That's very important. Secondly, the execution of both the commercial and the technology synergies is progressing ahead of pace. We have alignment across our selling organizations, the technology teams, and I highlighted a capital project that we worked on and we're working on many across the world, and we have a joint funnel of pursuits. So what happened in the Q? And I think they're important dimensions here to talk about. The first, the company continues to perform extremely strongly. It's a rule of 50 software business, with ACV growth exceeding 11% and strong cash flow. But there were three challenges in the quarter. And these are challenges that we have a robust communication process, not just at the board level, but at an operating level. And we speak with Antonio and Chantelle who's the CFO on a regular basis. The first is shorter term contracts on subscriptions at SSE, which obviously was one of the one of the assets that we contributed to. The assumption in the plan was on a three to four year basis of subscriptions, that was we converted – AspenTech converted those from perpetual license to subscription. The reality is that they came in more in the one year level. So that had an impact on revenue recognition, just the nature of that conversion journey and as those customers in that market space accept subscription contracts over the perpetual traditional licenses. The second, you also referenced is OSI. It is…

Are you assuming a bounce back in your fourth quarter in those results?

Of course. No, look, I think we've embedded their perspective, which they shared with their investors on their call into our guide.

The next question comes from Nigel Coe with Wolfe Research.

Maybe just picking up off Steve's question there. Maybe this is a question to you, Frank. Maybe just talk about some of the moving pieces in the guide. Clearly, the bulk of the uplift is driven by much better revenue conversion, margin conversion, but maybe some of the moving pieces. AspenTech, how's that changed in the guide? Maybe stock comp. Any of the sort of major discrete lumps would be helpful.

The main driver is obviously the improved outlook for operations. The uplift in the sales as well as the operational execution with strong price realization, all the things that drove the strong leverage in the second quarter, we expect to have in the third quarter and throughout the rest of the year. So, that is mainly the story. And that is strong enough to overcome the reduced AspenTech guide. As Lal said, we essentially incorporate their guide into our numbers. And they took the guide down for the year. So we've overcome that headwind as we move from the February to the current guidance and those are those are the main pieces.

And that's what, $0.06, $0.07, mark-to-market on AspenTech?

For the year roughly, yeah, in that range.

Maybe picking up off Ram's comment on the sort of installed base of DCS. You said 70% don't have level three software capability. Does that precipitate in an upgrade cycle? I know we've talked about upgrade cycles in the past, but are we at the threshold now where we might see an install base upgrade cycle? Was it more just patching around that with some of the capabilities around software?

I don't know if we're planning for a major upgrade wave. But I think it's more a disciplined approach with each one of our customers to address the optimization benefits and the APM benefits and some of the capabilities that Aspen brings to improve the performance of the overall automation system that is installed in many of these customers. And we're going across the board, across industries, power and life sciences being the focus area. Everybody is very interested in digitally transforming their assets. And we're seeing more and more interest from our customers to launch digital transformation programs across the automation stack where level three software has an important role to play, primarily around optimization on the manufacturing suite, and then more the asset performance management and the reliability software on uptime of assets in their infrastructure. So that's the journey. I think you're going to see more and more of that. Sustainability is another area where software gets deployed. But I don't think it's a big wave. I think it's more a disciplined wave over time, and we have the opportunity to drive it.

And the next question comes from Jeff Sprague with Vertical Research.

A lot of ground covered. I just wanted to touch back on capital deployment. And Lal has just said the big moves are done and that certainly makes sense. But you did indicate that you're working bolt-ons and it looks like you also maybe have a six month gap or so between the Climate proceeds and National Instruments closing. Just wonder how that might play out over that timeframe? Is there room for some more share repurchase? Are there actionable bolt-ons that could be happening kind of over the summer period? Or just what we should expect there?

I'll let Frank comment as well here. But, no, look, we obviously work towards the closing of National Instruments over those six months aggressively. It may come sooner. We'll see. Depends on the regulatory approvals. That's going to be the key pacing items, as you know, Jeff. The bolt-ons, we work them aggressively within the businesses. And some are competitive processes, others not. And we have two or three of those that we're looking at at any given point in time. It will continue to do so. These are sub billion dollar purchase price type of deals, and we have a small number we're looking at right now and evaluating. Look, we will continue to be very committed to return cash to our shareholders, whether that's through the dividends or share repurchase. And as we go into 2024, we'll lay out what the appropriate plan there is, and communicate that. Frank, anything to add?

Jeff, I wouldn't view share repurchase decisions in the context of kind of the gaps between closing Climate and closing NI. I would view it more broadly as part of the capital allocation strategy. After we close NI, we'll have a balance sheet that's well below 2 debt to EBITDA and a tremendous amount of financial flexibility. So we'll just continue to make those decisions in that context.

Just back to chem and I do understand you have a more diverse business than Aspen, but why shouldn't we kind of view this as an early warning sign of pressure in the core business in chem. And maybe just a little bit more color what you're seeing there because there are. obviously, CapEx and profitability issues kind of across a lot of that industry right now.

For us, the capital cycle in chemical, particularly specialty chemical, is as good as we have seen it, particularly in Middle East, Asia Pacific and ethylene and methanol investments in North America. So, for us, we haven't seen the capital cycle slow. However, what Aspen is referencing is the OpEx spend in chemical customers as they throttle their production in response to slowing demand, and therefore that translates to MSC purchases, the manufacturing supply chain suite purchases, is really the dynamic that's impacting them. It's a small impact to them at this point, but given it's 18% of their sales mix, I think they've referenced that. But to be honest, we haven't really seen any KOB3 slowdown or KOB2 in chemical. And then certainly many of our major project wins to date that we have been sharing with you have been in the chemical/petrochemical space, particularly in the emerging markets. So at this point, we don't see that as an inflection point or a slowdown in the industry, despite the higher feedstock costs.

The next question comes from Joe O'Dea with Wells Fargo.

I wonder just on the discrete, if you could elaborate a little bit on North America and the interplay between some of the structural and it sounds like continued strength that you're seeing in sort of battery electric and semiconductors. But then the flip side of that, anything that you're just seeing from sort of a general industrial cyclical standpoint, whether the macro uncertainty is having any impact or whether it's more just kind of natural digestion of what's been ordered over the last few years?

In North America, to be honest, on the discrete side, we haven't seen – we obviously don't play in a big way in semiconductors and batteries yet. We play in a smaller fashion with our DeltaV business. But obviously, we'll get a lot more exposure to that dynamic with National Instruments. In the core machine automation business that we play in North America, we haven't seen a significant slowdown to date, but it is obviously slower than the momentum we're seeing in the process markets.

Also, just wanted to ask about Natty and integration planning and sort of what efforts are currently underway that you're standing up, say, over the next six months to ensure a successful launch of the integration process there.

This is Lal. We kicked that off last week in Austin over a day and a half with the management team. We've assembled a team with steering committee. And then we have functional integration leadership across the eight value drivers or so that have been identified. Obviously, on the steering committee basis, I participate as does Eric Starkoff and we've each named a leader on the integration team. In our case, Vincent Cervello [ph]. So that's off and running. Meetings are taking place. We will have a in-person kickoff with a large group here in St. Louis coming up, and then we'll be off and running on all the full integrations. But really good start. Great organizational discussions already have taken place. And now we are excited about this work ahead of us as we head to close.

Thank you. This concludes both the question-and-answer session as well as the event itself. Thank you so much for attending today's presentation. You may now disconnect your lines.