Emerson Electric Co. (EMR) Earnings Call Transcript & Summary

Good morning, and welcome to the Emerson Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Colleen Mettler, Vice President of Investor Relations at Emerson. Please go ahead.

Thank you. Good morning, and welcome to Emerson's conference call to discuss our proposal to acquire National Instruments. We are in New York this morning, and I am joined by Lal Karsanbhai, our President and Chief Executive Officer; Ram Krishnan, our Chief Operating Officer; and Frank Dellaquila, our Chief Financial Officer. I will now pass the call over to Lal.

Thanks, Colleen, good morning. Thank you for joining us to discuss our proposal to acquire National Instruments for $53 per share in cash. Today, we'll speak in detail about our numerous attempts to engage with NI, and our belief that NI shareholders have an opportunity to realize immediate and significant value. Our proposal represents a 32% premium to NI's closing price on January 12, 2023, the day before they announced a public strategic review process and a 45% premium to NI's closing price on November 3, 2022, the day our $53 per share proposal was submitted. It is also a 38% premium to the 30-day VWAP as of January 12, 2023, and a 23% premium to NI's 52-week high intraday share price of $43.12 prior to its strategic review announcement. Beyond the compelling premium and all cash value for NI shareholders, we have no financing contingency or expected regulatory concerns, and we are eager to pursue an expedited time line where we can be ready to sign and announce quickly. We have been at this since May with repeated attempts since, which we outlined in our announcement this morning. Despite these efforts, our attempts to engage privately have only been met with limited engagement by NI over the last 8 months. In November, after months of delay, NI told us that it had formed a working group of its Board to evaluate Emerson's proposal and strategic options. And then last Friday, more than 2 months later, NI publicly announced that it is initiating a review and evaluation of strategic options with its advisers and adopted a poison pill. Emerson urges NI shareholders to engage with their Board to ensure this public strategic review process is not merely another delayed tactic. While NI has refused to meaningfully engage with us, we remain confident about this transaction and the compelling value that it would deliver for NI shareholders. So today, we are taking our interest directly to the NI shareholders who stand to significantly benefit from such a transaction. During today's call, alongside Ram, I will outline the benefits of the transaction, the time line of events that led us to this point, and importantly, how well a combination of Emerson and NI aligns with our strategy and what it could bring to all stakeholders. Please turn to Slide 3. As I noted earlier, our $53 all-cash proposal offers immediate and compelling value for all NI shareholders. In May, we proposed an initial all-cash offer of $48 per share and we were rebuffed. In the interim, we reiterated our offer and requested access to information, but were rejected. In November, we increased our all-cash offer to $53 per share, providing NI shareholders with even greater value and again, saw no engagement from NI despite its claims about forming a strategic transaction committee to evaluate Emerson's proposals and NI's strategic focus -- strategic options, I should say. In January, NI gave the illusion of engagement, only to provide high-level responses to reasonable questions and then publicly announced a strategic review. Leading up to NI's strategic review announcement, we received no update on our proposal or the options the Board was supposedly evaluating. Meanwhile, over the past 8 months, NI shareholders have been unaware of this opportunity to realize an immediate cash premium. Underscoring our commitment to consummating a transaction, we have purchased 2.3 million shares of NI stock and have received HSR approval to increase our stake. We are prepared to nominate directors for election to NI's Board. Emerson has organized the resources to work expeditiously towards a transaction with NI. We have shared a merger agreement with NI, and with engagement would be prepared to transact promptly. We urge NI shareholders to contact their Board and encourage them to engage with Emerson. Let's turn to Slide 4. It's worth reflecting on the certain value NI has been ignoring in our offer, while its performance continues to lag. Since its March 2018 high, NI share price has dropped 24%, while the stock of its key peer, Keysight, has grown 226%. Nearly every day since this all-time high was reached almost 5 years ago, NI has traded below our offer. NI's total shareholder return over the last 10, 5 years, and since its March 2018 high, has materially lagged NASDAQ and Keysight. Under the current management team, NI total shareholder return has continued to underperform, falling short of the NASDAQ by 46% and Keysight by 196%. For NI shareholders who have endured this underperformance, our premium proposal will bring clear and realizable value. After receiving Emerson's initial offer last May at $48 in cash, NI not only refused to engage with us, it repurchased more than 2 million shares at an average weighted price of $40.25 in the third quarter. This is the largest quarterly repurchase in NI's history on a dollar basis and was done at a price significantly below our offer, depriving NI shareholders of meaningful value. Now turning to Slide 5. I want to talk a little more about our offer and our ability to work quickly towards a transaction. Emerson's all-cash proposal provides credit for significant future earnings, including NI's updated guidance it provided after receiving our initial offer. Beyond representing a significant premium to NI shareholders, our $53 cash offer effectively removes the execution risk and uncertainty of NI achieving their plan. Our offer is not subject to any financing conditions. We have performed due diligence with publicly available information and would have only limited and specific confirmatory due diligence requirements. We do not anticipate any significant regulatory risks or delays given the complementary nature of our 2 businesses and, as mentioned earlier, we have received HSR approval. And as I mentioned, we are prepared to engage immediately and believe we would be able to announce the transaction quickly if NI is willing to seriously evaluate our proposal and engage with us. Please turn to Slide 6. We think it is important for NI shareholders to understand the time line and our numerous attempts to engage with NI to reach a friendly transaction agreement. Over the last 8 months, NI has consistently delayed and refused to engage with Emerson and then has rejected our approaches. NI has also tried to buy time as they materially increase their guidance in an apparent attempt to support the stock despite deteriorating market conditions. As I mentioned in November, NI claimed it had formed a working group of the Board to examine our proposal, as well as other strategic options and potential transaction partners. Despite claims of running a process, NI did not engage with Emerson until mid-December, at which point it agreed to a January 4 meeting. While initially, we were encouraged by NI's offer of a meeting, during these discussions, NI shared only high-level information about its business and refused to respond to key diligence questions provided ahead of the meeting. NI then told us that this will be the extent of their engagement and asked us for a revised view of value, after which we reiterated our $53 per share proposal. The strategic review process NI announced continues the track record of delay and evasion. What was NI's Board doing privately for 2 months as it evaluated options and continued to avoid engagement with Emerson? Why did NI choose to wait until now to announce the review publicly? We feel that NI shareholders are due the transparency their Board has denied them. So today, we are disclosing all of our correspondence with NI beginning in May 2022 to make public our sustained track record of attempted engagement with NI without any meaningful or constructive response. You can read all of our letters and NI's responses on our transaction website, MaximizingValueAtNI.com. On the next slide, Slide 7, we believe our proposal adds important context to the significant increases in guidance NI has provided in recent months. In July 2022 with knowledge of Emerson's approach, which was not shared with NI shareholders, NI substantially increased its 2023 outlook. After lowering its 2022 revenue guidance at the end of April, just 3 months later, NI guided to a mid-teens top line growth rate and adjusted its 2023 margin improvement to 3x larger than its prior guidance. This came even as NI demonstrated continued challenges expanding its margins. We question NI's motivations for this revised guidance and saw a disconnect between current performance and NI's updated outlook, particularly in light of a challenging macroeconomic environment and continued supply chain challenges. Then at its September 15, 2022 Investor Day, NI reaffirmed this guidance and said it would achieve a further 200 bps operating margin expansion by 2025. NI shares fell 3% on the day, underperforming the market as investors and analysts continue to doubt NI's ability to execute and deliver these results. With its third quarter earnings results reported on October 27, NI announced record quarterly revenue but also reported decelerating order rates, pushing its share price down the next day 3% again, even as the NASDAQ Index was up nearly 3%. Factoring in continued uncertainty, almost all of NI's sell-side analysts have revised their estimates for both the fourth quarter and fiscal 2023 downwards, as well as their target prices. Clearly, the market is concerned about NI's ability to achieve its targets. We think the existence of our offer and our numerous engagement attempts are important context for investors to have to understand NI's guidance. I'll now pass the call over to Ram on Slide 8 to talk about how NI fits into our strategy and portfolio of transformations.

Thank you, Lal. While we are disappointed with the lack of engagement to date, we remain confident about the compelling benefits of bringing our companies together and the long-term value creation opportunities in the test and measurement space. As you know, over the past 1.5 years, Emerson has announced and completed a series of value-creating strategic transactions to align our business towards key secular macro trends. We have been clearly advancing our efforts to create a higher value, cohesive industrial technology portfolio, divesting noncore businesses and pursuing acquisition opportunities that will help expand and reinforce our capabilities across the automation space. We recently highlighted this progress at our investor conference in November, where we spoke about plans to further build on our global automation focus. This proposal to acquire NI is the next step in that journey. Emerson has long admired NI as a leader in electronic test and measurement, and we believe combining our 2 companies is fully aligned with our portfolio transformation and would advance our position as a premier global automation company. The test and measurement market is one of the four priority target adjacencies we presented at our recent investor conference along with industrial software, factory automation and smart grid solutions. With favorable long-term trends, attractive and diversified end markets and an estimated priority TAM of $35 billion, it is a fast-growing complement to Emerson's portfolio. Please turn to Page 9. NI is a $1.7 billion electronic test and measurement business with 70-plus percent gross margins serving 35,000-plus customers across diverse end markets. NI's hardware and software solutions help customers constantly evolve and bring state-of-the-art electronic components to market faster and at a lower cost. NI provides flexible and modular system level test solutions with an open and interoperable software platform that enables customers to automate their test processes in increasingly complex and fast-changing end markets. As you can see in the pie charts, NI's end market mix is well balanced between semiconductors and electronics, aerospace and defense, transportation markets and its portfolio segment that serves many industries like medical, life sciences, energy and academia. NI is well positioned to capitalize on key secular growth trends in these market verticals that offer compelling growth vectors over the next several years. Much like us, they also have a strong international presence with more than 50% of their sales outside of the Americas. Please turn to Slide 10. Clearly, the acquisition of NI would further advance our global automation focus by giving us exposure to a favorable strategic adjacency through a business with an attractive financial profile and a complementary technology stack of intelligent devices, controls and software. Combining our 2 businesses would enable Emerson to further expand and diversify its customer base with highly attractive and diversified end markets with strong secular tailwinds. NI has an attractive financial profile with clear opportunities to streamline R&D and SG&A costs through Emerson's operating discipline. Furthermore, we're confident this combination would generate significant value to our stakeholders as we expand and diversify the segments and markets we serve, and accelerate the development of innovative offerings for our customers. Now please turn to Slide 11. With NI, Emerson would gain a strong complementary portfolio of differentiated electronic test and measurement product and software offerings that aligns with our technology stack in the core automation markets. NI's test and measurement technology is truly best-in-class and would enable Emerson to further expand and diversify our customer base and strengthen our automation portfolio with highly attractive end markets. In markets like semiconductors and electric vehicle manufacturing, NI expands Emerson's reach into the design and validation phase of the life cycle, providing critical early access to customers. NI also brings a unique and industry-leading software capability that helps customers automate their test processes and analyze results to drastically improve product designs and enhance production yields. Please turn to Slide 12. We believe NI has an opportunity to significantly improve its track record of innovation operating under the Emerson management system. The execution on LabVIEW NXG, the successor to LabVIEW, is an example of NI's innovation challenges. This was a major software development program to revamp a flagship product 30 years after the original release of LabVIEW, the required significant nonrecurring engineering and R&D investment totaling hundreds of millions of dollars, but it failed to gain traction. And only 3 years after its 2017 release, NI announced it would stop releasing new versions after 2021. This misstep occurred during a time of exceptional growth and innovation by peers such as Keysight who successfully launched products tailored to the 5G transition. In contrast, Emerson has a proven track record of innovation and successfully launching new products across our portfolio. With that, I will turn the call back over to Lal.

Thanks, Ram. As you can see on Slide 13, NI is a high gross margin company, however, has an inflated operating cost structure compared to peers. NI's SG&A is 18 points higher than peers and R&D is 10 points higher. With this elevated cost structure, NI's sales productivity has continued to significantly lag peers, with a peer medium more than double NI's. By applying the operational excellence principles of our management system and proven productivity levers, Emerson sees significant potential for profit and cash improvement across the NI business. Please turn to Slide 14. Our product innovation, management system and operational expertise continue to help Emerson outperform peers. Our underlying sales grew 9% in 2022 as we seized organic growth opportunities and the significant margin expansion we have achieved in recent years continued as we drove higher adjusted EBITDA and adjusted EPS margin. We have industry-leading margins across our portfolio. In addition, our strong free cash flow conversion continues to drive our disciplined capital allocation framework. As evidenced by Emerson's recent acquisitions, we are excited to leverage our scale and operational expertise as we bring our companies together and integrate our capabilities. As we continue our portfolio transformation, including the acquisition of NI, we are confident in our ability to grow faster, achieve higher margins and continue our excellent cash flow conversion. Turning to Slide 15, we believe this transaction would create significant value for our shareholders and, as mentioned earlier, we see opportunities to improve NI's operating margins, cash flow and innovation engine. The transaction would be accretive to Emerson's adjusted EPS in the first year, meets Emerson's communicated returns threshold and will improve Emerson's overall growth. Key areas for synergy targets, including R&D, where we can enhance the productivity of investment and streamline NI's products. We can use our scale in commercial excellence capabilities to drive more go-to-market efficiency for NI and accelerate shifting to a distribution model. We would seek to streamline NI's duplicative functions and adopt a regional best-cost model. To recap on Slide 16, we are prepared to work immediately to reach an agreement that delivers substantial value to NI shareholders. We have performed outside in due diligence on NI and we have only limited and specific confirmatory due diligence requirements. We are ready to immediately work towards signing and announcing a definitive agreement quickly. We have no financing contingency, and we do not anticipate any significant regulatory risks or delays given the complementary nature of our business. We have tried repeatedly to privately engage with NI and reach a friendly transaction. Our proposal provides a compelling premium, and we urge NI shareholders to encourage the Board to engage with Emerson and ensure its public strategic review process is not merely another delayed tactic. In closing, on Slide 17, we hope Emerson will have the opportunity to move towards a transaction with NI. We know that NI has announced the review process, and we felt NI's shareholders should understand the context of that review and our repeated attempts to engage. We look forward to engaging with NI and working towards a transaction. We are confident that our $53 cash offer is compelling for shareholders. NI shareholders should make their views heard to NI's Board and management. Thank you very much. That concludes our presentation this morning.

We will now turn to Q&A. Operator, I'll turn it to you.

[Operator Instructions] The first question is from Deane Dray of RBC Capital Markets.

I appreciate that you're going public here with the appeal directly to the shareholders, given the circumstances. So a couple of questions. And actually, a long time ago, I did cover National Instruments and I'm familiar with LabVIEW and how they fit into the test and measurement world. Maybe just -- can you touch on synergies? It's pretty clear that there are cost synergies there given the SG&A and R&D. But could you talk a bit about frame potential revenue synergies here?

No, I think you hit it on the nose. I think the more apparent synergies are clearly on the cost side as you outlined. But we do see opportunities, as I mentioned, Deane, around R&D, innovation acceleration, productivity in R&D, the use of best cost, which we have optimized both in Asia, Central America and Eastern Europe. And then the go-to-market strategies of NI, the evolution of their channel from tiering of accounts into distribution, I think those are areas that we can certainly drive synergies around.

Okay, that's helpful. And just one quick clarification. In Ram's remarks, it sounded as if it was National Instruments checks the test and measurement box. But doesn't it also check the industrial software box given LabVIEW and further penetration in that market?

Yes, certainly, arguable what the percent of software is within NI. It's not entirely clear to us. But it is a growing and relevant part of their business. So I agree with you, Deane.

The next question is from Steve Tusa of JPMorgan.

Slide 11 is helpful, just like it's kind of unclear how much is software. How does the revenue break out between the kind of control layer and the intelligent devices?

Yes. So I mean, I think -- Steve, Ram here. Software and services is around 20% approximately. That's what we know. And then frankly, the rest is hardware. Now that ultimately is -- a lot of it is in the intelligent device layer, their PXI modules, 600-plus modules. So most of it is there, but they do have a substantial data acquisition business. I mean how much is split between control and intelligent devices, we don't quite know. But the approximate split between control intelligent devices and software is 80/20.

And then where do you guys actually -- do you guys actually like see them out there in the field? And then when it comes to distribution, are you currently -- I know that kind of a big part of their business goes direct, but do you actually overlap at all with any distributors. I'm just curious, it's kind of like where you bump into these guys because I know they're kind of in different disciplines, right? You guys are a bit more on the op side and they're more on the test side, if you will.

Correct, correct. So we don't necessarily bump into them either at customers or distribution. So it is truly an adjacency that moves us into the test space in end markets we like. So I think the -- obviously, the technology stack is consistent with what we do, but we are in completely different end markets.

Okay. And then one last one. How much of the high gross margin here is a function of the actual, I guess, is a function of how much they're spending in -- on the SG&A and the R&D side? And is there risk as you cut into that spending, the value that the customer is ultimately going to see, they are essentially spending to get that gross margin. Any risk that, that's kind of structurally dependent on the level of spending, the business model kind of is what it is?

Yes. I mean we'll be obviously careful in evaluating that. But our estimates say that I think we can still maintain the gross margins while driving productivity in the R&D. I mean I think that's the thesis, and I think we're pretty confident about that. I mean we like -- listen, I think the fact that they sell to 35,000 customers, they have a wide broad array of technology that they sell to these customers is reflective of the gross margins. And many of the end markets they serve, particularly their portfolio business, lends itself to high GP. So they've done a great job there. The complexity of their product offering and the number of modules they offer is a function of the price and GPs they command. But with all that said, I think we can certainly drive efficiency in the R&D spend while protecting the GPs, which is going to be important in our thesis.

The next question is from Julian Mitchell of Barclays.

Maybe just one question for Lal, perhaps looking at that Slide 6 and kind of the time line there. You've raised the offer price once during that sort of 9 months of negotiations. I just wondered, from the perspective of sort of Emerson shareholders, how do you characterize the sort of valuation discipline from here on Emerson's part, let's say, in the event that someone else comes into the picture, looking at NI? Any sort of context around your perspectives on that? And I suppose the degree to which you really want this specific asset as opposed to others that may be available in the T&M arena?