Notes to Consolidated Financial Statements
EMERSON ELECTRIC CO. & SUBSIDIARIES
Years ended September 30
(Dollars in millions, except per share amounts or where noted)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Statement Presentation
The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (U.S. GAAP) requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from these estimates. Certain prior year amounts have been reclassified to conform with current year presentation to reflect the business combination with AspenTech (see Note 4), which is reported as a new segment and includes the historical results of Open Systems International, Inc. and the Geological Simulation Software business. These businesses were previously reported in the Automation Solutions segment (see Note 18).
Effective October 1, 2021, the Company adopted three accounting standard updates which had an immaterial or no impact on the Company's financial statements for the year ended September 30, 2022. These included:
•Updates to Accounting Standards Codification ("ASC") 805, Business Combinations, which clarify the accounting for contract assets and liabilities assumed in a business combination. In general, this will result in contract liabilities being recognized at their historical amounts under ASC 606, rather than at fair value in accordance with the general requirements of ASC 805.
•Updates to ASC 740, Income Taxes, which require the recognition of a franchise tax that is partially based on income as an income-based tax with any incremental amount as a non-income based tax. These updates also make certain changes to intra-period tax allocation principles and interim tax calculations.
•Updates to ASC 321, Equity Securities, ASC 323 Investments - Equity Method and Joint Ventures, and ASC 815, Derivatives and Hedging, which clarify how to account for the transition into and out of the equity method of accounting when evaluating observable transactions.
In fiscal 2021, the Company adopted two accounting standard updates and one new accounting standard, and in fiscal 2020 adopted updates to ASC 815, all of which had an immaterial impact on the Company's financial statements. These included:
•Updates to ASC 350, Intangibles - Goodwill and Other, which eliminate the requirement to measure impairment based on the implied fair value of goodwill compared to the carrying amount of a reporting unit’s goodwill. Instead, goodwill impairment will be measured as the excess of a reporting unit’s carrying amount over its estimated fair value.
•Updates to ASC 350, Intangibles - Goodwill and Other, which align the requirements for capitalizing implementation costs incurred in a software hosting arrangement with the requirements for costs incurred to develop or obtain internal-use software.
•Adoption of ASC 326, Financial Instruments - Credit Losses, which amends the impairment model by requiring entities to use a forward-looking approach to estimate lifetime expected credit losses on certain types of financial instruments, including trade receivables.
•Updates to ASC 815, Derivatives and Hedging, which permit hedging certain contractually specified risk components. The updates also eliminate the requirement to separately measure and report hedge ineffectiveness and simplify hedge documentation and effectiveness assessment requirements.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its controlled affiliates. Intercompany transactions, profits and balances are eliminated in consolidation. Investments of 20 percent to 50 percent of the voting shares of other entities are accounted for by the equity method. Investments in publicly traded
companies of less than 20 percent are carried at fair value, with changes in fair value reflected in accumulated other comprehensive income. Investments in nonpublicly traded companies of less than 20 percent are carried at cost, minus impairment, and adjusted for observable price changes in orderly transactions.
Foreign Currency Translation
The functional currency for most of the Company's non-U.S. subsidiaries is the local currency. Adjustments resulting from translating local currency financial statements into U.S. dollars are reflected in accumulated other comprehensive income.
Cash Equivalents
Cash equivalents consist of highly liquid investments with original maturities of three months or less.
Inventories
Inventories are stated at the lower of cost and net realizable value. The majority of inventory is valued based on standard costs, which are revised at the beginning of each year and approximate average costs, while the remainder is principally valued on a first-in, first-out basis. Following are the components of inventory as of September 30:
| | | | | | | | | | | | | | |
| | 2021 | | | 2022 | |
Finished products | | $ | 616 | | | 628 | |
Raw materials and work in process | | 1,434 | | | 1,563 | |
Total inventories | | $ | 2,050 | | | 2,191 | |
Fair Value Measurement
ASC 820, Fair Value Measurement, establishes a formal hierarchy and framework for measuring certain financial statement items at fair value, and requires disclosures about fair value measurements and the reliability of valuation inputs. Under ASC 820, measurement assumes the transaction to sell an asset or transfer a liability occurs in the principal or at least the most advantageous market for that asset or liability. Within the hierarchy, Level 1 instruments use observable market prices for an identical item in active markets and have the most reliable valuations. Level 2 instruments are valued through broker/dealer quotation or other approaches using market-observable inputs for similar items in active markets, including forward and spot prices, interest rates and volatilities. Level 3 instruments are valued using inputs not observable in an active market, such as company-developed future cash flow estimates, and are considered the least reliable. Valuations for all of the Company's financial instruments fall within Level 2. The fair value of the Company's long-term debt is Level 2, estimated using current interest rates and pricing from financial institutions and other market sources for debt with similar maturities and characteristics.
Property, Plant and Equipment
The Company records investments in land, buildings, and machinery and equipment at cost. Depreciation is computed principally using the straight-line method over estimated service lives, which for principal assets are 30 to 40 years for buildings and 8 to 12 years for machinery and equipment. Long-lived tangible assets are reviewed for impairment whenever events or changes in business circumstances indicate the carrying value of the assets may not be recoverable. Impairment losses are recognized based on estimated fair values if the sum of estimated future undiscounted cash flows of the related assets is less than the carrying values.
The components of property, plant and equipment as of September 30 follow:
| | | | | | | | | | | | | | | | |
| | 2021 | | 2022 | | | |
Land | | $ | 359 | | | 317 | | | |
Buildings | | 2,493 | | | 2,364 | | | |
Machinery and equipment | | 6,097 | | | 5,678 | | | |
Construction in progress | | 478 | | | 459 | | | |
Property, plant and equipment, at cost | | 9,427 | | | 8,818 | | | |
Less: Accumulated depreciation | | 5,689 | | | 5,457 | | | |
Property, plant and equipment, net | | $ | 3,738 | | | 3,361 | | | |
Goodwill and Other Intangible Assets
Assets and liabilities acquired in business combinations are accounted for using the acquisition method and recorded at their respective fair values. Substantially all goodwill is assigned to the reporting unit that acquires a
business. A reporting unit is an operating segment as defined in ASC 280, Segment Reporting, or a business one level below an operating segment if discrete financial information for that business unit is prepared and regularly reviewed by the segment manager. The Company conducts annual impairment tests of goodwill in the fourth quarter. If an initial assessment indicates it is more likely than not goodwill might be impaired, it is evaluated by comparing the reporting unit's estimated fair value to its carrying value. An impairment charge would be recorded for the amount by which the carrying value of the reporting unit exceeds the estimated fair value. Goodwill is also tested for impairment between annual tests if events or circumstances indicate the fair value of a unit may be less than its carrying value. Estimated fair values of reporting units are Level 3 measures and are developed generally under an income approach that discounts estimated future cash flows using risk-adjusted interest rates, as well as earnings multiples or other techniques as warranted. Fair values are subject to changes in underlying economic conditions.
All of the Company's identifiable intangible assets are subject to amortization on a straight-line basis over their estimated useful lives. Identifiable intangibles consist of intellectual property such as technology, patents and trademarks, customer relationships and capitalized software. Identifiable intangibles are also subject to evaluation for potential impairment if events or circumstances indicate the carrying amount may not be recoverable. See Note 8.
Leases
The Company leases offices; manufacturing facilities and equipment; and transportation, information technology and office equipment under operating lease arrangements. Finance lease arrangements are immaterial. The Company determines whether an arrangement is, or contains, a lease at contract inception. An arrangement contains a lease if the Company has the right to direct the use of and obtain substantially all of the economic benefits of an identified asset. Right-of-use assets and lease liabilities are recognized at lease commencement based on the present value of lease payments over the lease term. Leases with an initial term of 12 months or less are not recognized on the balance sheet and are recorded as short-term lease expense. The discount rate used to calculate present value is the Company's incremental borrowing rate based on the lease term and the economic environment of the applicable country or region.
Certain leases contain renewal options or options to terminate prior to lease expiration, which are included in the measurement of right-of-use assets and lease liabilities when it is reasonably certain they will be exercised. The Company has elected to account for lease and non-lease components as a single lease component for its offices and manufacturing facilities. Some lease arrangements include payments that are adjusted periodically based on actual charges incurred for common area maintenance, utilities, taxes and insurance, or changes in an index or rate referenced in the lease. The fixed portion of these payments is included in the measurement of right-of-use assets and lease liabilities at lease commencement, while the variable portion is recorded as variable lease expense. The Company's leases typically do not contain material residual value guarantees or restrictive covenants.
Product Warranty
Warranties vary by product line and are competitive for the markets in which the Company operates. Warranties are largely offered to provide assurance that the product will function as intended and generally extend for a period of one to two years from the date of sale or installation. Provisions for warranty expense are estimated at the time of sale based on historical experience and adjusted quarterly for any known issues that may arise. Product warranty expense is less than one-half of one percent of sales.
Revenue Recognition
Emerson is a global manufacturer that designs and manufactures products and delivers services that bring technology and engineering together to provide innovative solutions for its customers, largely in the form of tangible products. The Company evaluates its contracts with customers to identify the promised goods or services and recognizes revenue for the identified performance obligations at the amount the Company expects to be entitled to in exchange for those goods or services. A performance obligation is a promise in a contract to transfer a distinct good or service to a customer. Revenue is recognized when, or as, performance obligations are satisfied and control has transferred to the customer, typically when products are shipped or delivered, title and risk of loss pass to the customer, and the Company has a present right to payment. The majority of the Company's revenues relate to a broad offering of manufactured products which are recognized at the point in time when control transfers, generally in accordance with shipping terms. A portion of the Company's revenues relate to the sale of software and post-contract customer support, parts and labor for repairs, and engineering services. In some circumstances,
contracts include multiple performance obligations, where revenue is recognized separately for each good or service, as well as contracts where revenue is recognized over time as control transfers to the customer.
Revenue is recognized over time for approximately 10 percent of the Company's revenues. The majority of these revenues relate to projects in the Systems & Software product offering within the Automation Solutions segment where revenue is recognized using the percentage-of-completion method to reflect the transfer of control over time, while a smaller amount is attributable to long-term maintenance and service contracts where revenue is typically recognized on a straight-line basis as the services are provided. Approximately 5 percent of revenues relate to sales arrangements with multiple performance obligations, principally in the Automation Solutions and AspenTech segments. Tangible products represent a large majority of the delivered items in contracts with multiple performance obligations or where revenue is recognized over time, while a smaller portion is attributable to installation, service and maintenance.
For projects where revenue is recognized over time, the Company typically uses an input method to determine progress and recognize revenue, based on costs incurred. The Company believes costs incurred closely correspond with its performance under the contract and the transfer of control to the customer.
In sales arrangements that involve multiple performance obligations, revenue is allocated based on the relative standalone selling price for each performance obligation. Observable selling prices from actual transactions are used whenever possible. In other instances, the Company determines the standalone selling price based on third-party pricing or management's best estimate. Generally, contract duration is short-term, and cancellation, termination or refund provisions apply only in the event of contract breach and are rarely invoked.
Payment terms vary but are generally short-term in nature. The Company's long-term contracts, where revenue is generally recognized over time, are typically billed as work progresses in accordance with the contract terms and conditions, either at periodic intervals or upon achievement of certain milestones. The timing of revenue recognition and billings under these contracts results in either unbilled receivables (contract assets) when revenue recognized exceeds billings, or customer advances (contract liabilities) when billings exceed revenue recognized. Unbilled receivables are reclassified to accounts receivable when an unconditional right to consideration exists, typically when a milestone in the contract is achieved. The Company does not evaluate whether the transaction price includes a significant financing component for contracts where the time between cash collection and performance is less than one year.
Certain arrangements with customers include variable consideration, typically in the form of rebates, cash discounts or penalties. In limited circumstances, the Company sells products with a general right of return. In most instances, returns are limited to product quality issues. The Company records a reduction to revenue at the time of sale to reflect the ultimate amount of consideration it expects to receive. The Company's estimates are updated quarterly based on historical experience, trend analysis, and expected market conditions. Variable consideration is typically not constrained at the time revenue is recognized. See Notes 2 and 18 for additional information about the Company's revenues.
Derivatives and Hedging
In the normal course of business, the Company is exposed to changes in interest rates, foreign currency exchange rates and commodity prices due to its worldwide presence and diverse business profile. The Company's foreign currency exposures relate to transactions denominated in currencies that differ from the functional currencies of its business units, primarily in euros, Mexican pesos, and Singapore dollars. Primary commodity exposures are price fluctuations on forecasted purchases of copper and aluminum and related products. As part of the Company's risk management strategy, derivative instruments are selectively used in an effort to minimize the impact of these exposures. Foreign exchange forwards and options are utilized to hedge foreign currency exposures impacting sales or cost of sales transactions, firm commitments and the fair value of assets and liabilities, while swap and option contracts may be used to minimize the effect of commodity price fluctuations on the cost of sales. Non-U.S. dollar obligations are utilized to reduce foreign currency risk associated with the Company's net investments in foreign operations. All derivatives are associated with specific underlying exposures and the Company does not hold derivatives for trading or speculative purposes. The duration of hedge positions is generally two years or less, except for the Company's net investment hedges.
All derivatives are accounted for under ASC 815, Derivatives and Hedging, and recognized at fair value. For derivatives hedging variability in future cash flows, any gain or loss is deferred in stockholders' equity and recognized when the underlying hedged transaction impacts earnings. The majority of the Company's derivatives
that are designated as hedges and qualify for hedge accounting are cash flow hedges. For derivatives hedging the fair value of existing assets or liabilities, both the gain or loss on the derivative and the offsetting loss or gain on the hedged item are recognized in earnings each period. Currency fluctuations on non-U.S. dollar obligations that have been designated as hedges of net investments in foreign operations are recognized in accumulated other comprehensive income (loss) and reclassified to income in the same period when a foreign operation is sold or substantially liquidated and the gain or loss related to the sale is included in income. To the extent that any hedge is not fully effective at offsetting changes in the underlying hedged item, there could be a net earnings impact.
The Company also uses derivatives to hedge economic exposures that do not receive hedge accounting under ASC 815. The underlying exposures for these hedges relate primarily to purchases of commodity-based components used in the Company's manufacturing processes, and the revaluation of certain foreign-currency-denominated assets and liabilities. In addition, in fiscal 2022 AspenTech entered into foreign currency forward contracts to mitigate the impact of foreign currency exchange associated with the Micromine purchase price. Gains or losses on derivative instruments not designated as hedges are recognized in the income statement immediately.
Counterparties to derivative arrangements are companies with investment-grade credit ratings. The Company has bilateral collateral arrangements with counterparties with credit rating-based posting thresholds that vary depending on the arrangement. If credit ratings on the Company's debt fall below pre-established levels, counterparties can require immediate full collateralization on all derivatives in net liability positions. The maximum amount that could potentially have been required was immaterial. The Company also can demand full collateralization of derivatives in net asset positions should any counterparty credit ratings fall below certain thresholds. No collateral was posted with counterparties and none was held by the Company at year end. Risk from credit loss when derivatives are in asset positions is not considered material. The Company has master netting arrangements in place with its counterparties that allow the offsetting of certain derivative-related amounts receivable and payable when settlement occurs in the same period. Accordingly, counterparty balances are netted in the consolidated balance sheet and are reported in other current assets or accrued expenses as appropriate, depending on positions with counterparties as of the balance sheet date. See Note 9.
Income Taxes
The provision for income taxes is based on pretax income reported in the consolidated statements of earnings and tax rates currently enacted in each jurisdiction. Certain income and expense items are recognized in different time periods for financial reporting and income tax filing purposes, and deferred income taxes are provided for the effect of temporary differences. The Tax Cuts and Jobs Act subjects the Company to U.S. tax on global intangible low-taxed income earned by certain of its non-U.S. subsidiaries. The Company has elected to recognize this tax as a period expense when it is incurred. The Company also provides for withholding taxes and any applicable U.S. income taxes on earnings intended to be repatriated from non-U.S. locations. No provision has been made for these taxes on approximately $6.0 billion of undistributed earnings of non-U.S. subsidiaries as of September 30, 2022, as these earnings are considered indefinitely invested or otherwise retained for continuing international operations. Recognition of withholding taxes and any applicable U.S. income taxes on undistributed non-U.S. earnings would be triggered by a management decision to repatriate those earnings. Determination of the amount of taxes that might be paid on these undistributed earnings if eventually remitted is not practicable. See Note 14.
(2) REVENUE RECOGNITION
The following table summarizes the balances of the Company's unbilled receivables (contract assets), which are reported in Other assets (current and noncurrent), and its customer advances (contract liabilities), which are reported in Accrued expenses and Other liabilities.
| | | | | | | | | | | | | | |
| | 2021 | | | 2022 | |
Unbilled receivables (contract assets) | | $ | 528 | | | 1,399 | |
Customer advances (contract liabilities) | | (730) | | | (879) | |
Net contract liabilities | | $ | (202) | | | 520 | |
The majority of the Company's contract balances relate to (1) arrangements where revenue is recognized over time and payments from customers are made according to a contractual billing schedule, and (2) revenue from term software license arrangements sold by Heritage AspenTech where the license revenue is recognized upfront upon delivery. The change in the net contract balance was due to the Heritage AspenTech acquisition, which added net contract assets of approximately $700, partially offset by an increase in net contract liabilities for the Company's existing businesses due to customer billings exceeding revenue recognized for performance completed during the period. Revenue recognized for 2022 included approximately $552 that was included in the beginning contract liability balance. Other factors that impacted the change in net contract liabilities were immaterial.
Revenue recognized for 2022 for performance obligations that were satisfied in previous periods, including cumulative catchup adjustments on the Company's long-term contracts, was not material. Capitalized amounts related to incremental costs to obtain customer contracts and costs to fulfill contracts are immaterial.
As of September 30, 2022, the Company's backlog relating to unsatisfied (or partially unsatisfied) performance obligations in contracts with its customers was approximately $8.1 billion, which includes approximately $700 related to the Heritage AspenTech acquisition. Heritage AspenTech's remaining performance obligations primarily relate to software maintenance in long-term contracts for unspecified future software updates provided on a when-and-if available basis. The Company expects to recognize approximately 80 percent of its remaining performance obligations as revenue over the next 12 months, with the remainder substantially over the subsequent two years thereafter.
See Note 18 for additional information about the Company's revenues.
(3) WEIGHTED-AVERAGE COMMON SHARES
Basic earnings per common share consider only the weighted-average of common shares outstanding while diluted earnings per common share also consider the dilutive effects of stock options and incentive shares. An inconsequential number of shares of common stock were excluded from the computation of dilutive earnings per share in 2022, 2021 and 2020 as the effect would have been antidilutive. Earnings allocated to participating securities were inconsequential for all years presented.
Reconciliations of weighted-average shares for basic and diluted earnings per common share follow (shares in millions):
| | | | | | | | | | | | | | | | | |
| 2020 | | | 2021 | | | 2022 | |
Basic shares outstanding | 602.9 | | | 598.1 | | | 592.9 | |
Dilutive shares | 3.7 | | | 3.7 | | | 3.4 | |
Diluted shares outstanding | 606.6 | | | 601.8 | | | 596.3 | |
(4) ACQUISITIONS AND DIVESTITURES
Aspen Technology
On May 16, 2022, the Company completed the transactions contemplated by its definitive agreement with Aspen Technology, Inc. ("Heritage AspenTech") to contribute two of Emerson's stand-alone industrial software businesses, Open Systems International, Inc. and the Geological Simulation Software business (collectively, the “Emerson Industrial Software Business”), along with approximately $6.0 billion in cash to Heritage AspenTech stockholders, to create "New AspenTech", a diversified, high-performance industrial software leader with greater scale, capabilities and technologies (hereinafter referred to as "AspenTech"). Upon closing of the transaction, Emerson beneficially owned 55 percent of the outstanding shares of AspenTech common stock (on a fully diluted basis) and former Heritage AspenTech stockholders owned the remaining outstanding shares of AspenTech common stock. AspenTech and its subsidiaries now operate under Heritage AspenTech’s previous name “Aspen Technology, Inc.” and AspenTech common stock is traded on NASDAQ under AspenTech’s previous stock ticker symbol “AZPN.”
The business combination has been accounted for using the acquisition method of accounting with Emerson considered the accounting acquirer of Heritage AspenTech. The net assets of Heritage AspenTech were recorded at their estimated fair value and the Emerson Industrial Software Business continues at its historical basis. The Company recorded a noncontrolling interest of $5.9 billion for the 45 percent ownership interest of former Heritage AspenTech stockholders in AspenTech. The noncontrolling interest associated with the Heritage AspenTech acquired net assets was recorded at fair value determined using the closing market price per share of Heritage AspenTech as of May 16, 2022, while the portion attributable to the Emerson Industrial Software business was recorded at its historical carrying amount. The impact of recognizing the noncontrolling interest in the Emerson Industrial Software Business resulted in a decrease to additional paid-in-capital of $550.
The following table summarizes the components of the purchase consideration reflected in the acquisition accounting using Heritage AspenTech's shares outstanding and closing market price per share as of May 16, 2022 (in millions except share and per share data):
| | | | | | | | |
Heritage AspenTech shares outstanding | | 66,662,482 | |
Heritage AspenTech share price | | $ | 166.30 | |
Purchase price | | $ | 11,086 | |
Value of stock-based compensation awards attributable to pre-combination service | | 102 | |
Total purchase consideration | | $ | 11,188 | |
The total purchase consideration for Heritage AspenTech was preliminarily allocated to assets and liabilities as follows. Valuations of acquired assets and liabilities are in-process and subject to refinement.
| | | | | | | | |
Cash and equivalents | | $ | 274 | |
Receivables | | 61 | |
Other current assets | | 262 | |
Property, plant equipment | | 4 | |
Goodwill ($34 expected to be tax-deductible) | | 7,225 | |
Other intangible assets | | 4,390 | |
Other assets | | 511 | |
Total assets | | 12,727 | |
| | |
Short-term borrowings | | 27 | |
Accounts payable | | 8 | |
Accrued expenses | | 113 | |
Long-term debt | | 255 | |
Deferred taxes and other liabilities | | 1,136 | |
Total purchase consideration | | $ | 11,188 | |
Emerson's cash contribution of approximately $6.0 billion was paid out at approximately $87.69 per share (on a fully diluted basis) to holders of issued and outstanding shares of Heritage AspenTech common stock as of the closing of the transactions, with $168 of cash remaining on AspenTech's balance sheet as of the closing which is not included in the allocation of purchase consideration above.
The estimated intangible assets attributable to the transaction are comprised of the following (in millions):
| | | | | | | | | | | | | | |
| | Amount | | Estimated Useful Life (Years) |
Developed technology | | $ | 1,350 | | | 10 |
Customer relationships | | 2,300 | | | 15 |
Trade names | | 430 | | | Indefinite-lived |
Backlog | | 310 | | | 3 |
Total | | $ | 4,390 | | | |
Results of operations for 2022 attributable to the Heritage AspenTech acquisition include sales of $356 while the impact to GAAP net earnings was not material.
Pro Forma Financial Information
The following unaudited proforma consolidated condensed financial results of operations are presented as if the acquisition of Heritage AspenTech occurred on October 1, 2020. The pro forma information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved had the acquisition occurred as of that time ($ in millions, except per share amounts).
| | | | | | | | | | | | | | | | | | | | |
| | | 2021 | | | | 2022 | |
Net Sales | | | $ | 18,966 | | | | 20,042 | |
Net earnings common stockholders | | | $ | 2,106 | | | | 3,262 | |
Diluted earnings per share | | | $ | 3.50 | | | | 5.46 | |
The pro forma results for 2021 include $159 of transaction costs which were assumed to be incurred in the first fiscal quarter of 2021. Of these transaction costs, $91 were included in the Company's reported results for 2022, but have been excluded from the fiscal 2022 pro forma results above. In addition, Heritage AspenTech incurred $68 of transaction costs prior to the completion of the acquisition that were not included in Emerson's reported results. The pro forma results for 2021 include estimated interest expense of $147, respectively, related to the issuance of $3.0 billion of term debt and increased commercial paper borrowings to fund the acquisition, while results for 2022 include additional interest expense of $56 to reflect the increased borrowings as if they were outstanding for the entire fiscal year.
Other Transactions
On July 27, 2022, AspenTech entered into an agreement to acquire Micromine, a global leader in design and operational solutions for the mining industry, for AU $900 (approximately $623 USD based on exchange rates when the transaction was announced). The transaction is expected to close by the end of calendar 2022, subject to various regulatory approvals.
On May 31, 2022 the Company completed the divestiture of its Therm-O-Disc sensing and protection technologies business, which was reported in the Climate Technologies segment, to an affiliate of One Rock Capital Partners, LLC. The Company recognized a pretax gain of $486 ($429 after-tax, $0.72 per share).
On May 4, 2022, Emerson announced its intention to exit business operations in Russia and divest Metran, its Russia-based manufacturing subsidiary, and on September 27, 2022, announced an agreement to sell the business to the local management group. Emerson's historical net sales in Russia were principally in the Automation Solutions segment and in total, represented approximately 1.5 percent of consolidated annual sales. The Company recognized a pretax loss of $181 ($190 after-tax, in total $0.32 per share) related to its exit of business operations in Russia. This charge, which included a loss of $36 in operations and $145 reported in Other deductions ($10 of
which is reported in restructuring costs), is primarily non-cash. The transaction will be subject to regulatory and government approvals, and other customary closing conditions. Emerson will work closely with the local Russia management group to help ensure a smooth transition for employees through the sale process.
In 2022, the Company acquired three other businesses, two in the Automation Solutions segment and one in the AspenTech segment, for $130, net of cash acquired. The three businesses had combined annual sales of approximately $40.
On October 1, 2020, the Company completed the acquisition of Open Systems International, Inc. (OSI), a leading operations technology software provider in the global power industry, for approximately $1.6 billion, net of cash acquired. This business, which had net sales of $191 in fiscal 2021 and is reported in the AspenTech segment, expands the Company's offerings in the power industry to include the digitization and modernization of the electric grid. The Company recognized goodwill of $967 (none of which is expected to be tax deductible), identifiable intangible assets of $783, primarily intellectual property and customer relationships with a weighted-average useful life of approximately 11 years, and deferred tax liabilities of $193. Results of operations for the year ended September 30, 2021 included first year pretax acquisition accounting charges related to backlog amortization and deferred revenue of $30 and $14, respectively, and fees of $6.
As previously disclosed, the Company sold its network power systems business (rebranded as Vertiv, now a publicly traded company, symbol VRT) in 2017 and retained a subordinated interest contingent upon the equity holders first receiving a threshold cash return on their initial investment. In the first quarter of fiscal 2022, the equity holders' cumulative cash return exceeded the threshold and as a result, the Company received a distribution of $438 in November 2021 (in total, a pretax gain of $453 was recognized in the first quarter, $358 after-tax, $0.60 per share). Based on the terms of the agreement and the current calculation, the Company could receive additional distributions of approximately $75 which are expected to be received over the next two-to-three years. However, the distributions are contingent on the timing and price at which Vertiv shares are sold by the equity holders and therefore, there can be no assurance as to the amount or timing of the remaining distributions to the Company.
In 2020, the Company acquired three businesses, two in the Automation Solutions segment and one in the Climate Technologies segment, for $126, net of cash acquired. These three businesses had combined annual sales of approximately $50.
(5) OTHER DEDUCTIONS, NET
| | | | | | | | | | | | | | | | | |
Other deductions, net are summarized below: | | | | | |
| 2020 | | | 2021 | | | 2022 | |
Amortization of intangibles (intellectual property and customer relationships) | $ | 239 | | | 300 | | | 357 | |
Restructuring costs | 284 | | | 150 | | | 86 | |
Acquisition/divestiture costs | — | | | — | | | 110 | |
Foreign currency transaction (gains) losses | 21 | | | 4 | | | 7 | |
Investment-related gains & gains from sales of capital assets | — | | | (69) | | | (30) | |
Russia business exit | — | | | — | | | 135 | |
Other | (12) | | | (67) | | | (64) | |
Total | $ | 532 | | | 318 | | | 601 | |
In fiscal 2022, intangibles amortization included $97 related to the Heritage AspenTech acquisition, while the prior year included backlog amortization related to the OSI acquisition of $30. Foreign currency transaction losses included a $50 mark-to-market loss in fiscal 2022 related to foreign currency forward contracts entered into by AspenTech to mitigate the impact of foreign currency exchange associated with the Micromine purchase price. Other is composed of several items, including pension expense, litigation costs, provision for bad debt and other items, none of which is individually significant.
(6) RESTRUCTURING COSTS
Each year the Company incurs costs to size its businesses to levels appropriate for current economic conditions and to continually improve its cost structure and operational efficiency, deploy assets globally, and remain competitive on a worldwide basis. Costs result from numerous individual actions implemented across the Company's various operating units on an ongoing basis and can include costs for moving facilities to best-cost locations, restarting plants after relocation or geographic expansion to better serve local markets, reducing forcecount or the number of facilities, exiting certain product lines, and other costs resulting from asset deployment decisions (such as contract termination costs, asset write-downs and vacant facility costs).
Restructuring expenses were $86, $150 and $284 for 2022, 2021 and 2020, respectively. The Company expects fiscal year 2023 restructuring expense to be approximately $100.
Restructuring costs by business segment follows:
| | | | | | | | | | | | | | | | | |
| 2020 | | | 2021 | | | 2022 | |
Automation Solutions | $ | 225 | | | 121 | | | 52 | |
| | | | | |
AspenTech | 7 | | | 2 | | | — | |
| | | | | |
Climate Technologies | 23 | | | 15 | | | 10 | |
Tools & Home Products | 21 | | | 7 | | | 11 | |
Commercial & Residential Solutions | 44 | | | 22 | | | 21 | |
| | | | | |
Corporate | 8 | | | 5 | | | 13 | |
| | | | | |
Total | $ | 284 | | | 150 | | | 86 | |
Actions taken in 2022 included workforce reductions of approximately 2,200 positions and the exit of eight production facilities worldwide. Costs incurred in 2021 and 2020 primarily relate to the Company's initiatives to improve operating margins that began in the third quarter of fiscal 2019 and were expanded in the third quarter of fiscal 2020 in response to the effects of COVID-19 on demand for the Company's products. Expenses incurred in 2021 and 2020 included actions to exit eight and six facilities, and eliminate approximately 3,600 and 5,400 positions, respectively.
The change in the liability for restructuring costs during the years ended September 30 follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2021 | | | Expense | | Utilized/Paid | | 2022 | |
Severance and benefits | $ | 172 | | | | 46 | | | | | 79 | | | | 139 | |
Other | 4 | | | | 40 | | | | | 38 | | | | 6 | |
Total | $ | 176 | | | | 86 | | | | | 117 | | | | 145 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| 2020 | | | Expense | | Utilized/Paid | | 2021 | |
Severance and benefits | $ | 176 | | | | 112 | | | | | 116 | | | | 172 | |
Other | 5 | | | | 38 | | | | | 39 | | | | 4 | |
Total | $ | 181 | | | | 150 | | | | | 155 | | | | 176 | |
The tables above do not include $43 and $38 of costs related to restructuring actions incurred for the year ended September 30, 2022 and 2021, respectively, that are required to be reported in cost of sales and selling, general and administrative expenses.
(7) LEASES
The components of lease expense for the years ended September 30 were as follows:
| | | | | | | | | | | |
| 2021 | | | 2022 | |
Operating lease expense | $ | 195 | | | 185 | |
Variable lease expense | $ | 17 | | | 20 | |
Short-term lease expense and sublease income were immaterial for the years ended September 30, 2022 and September 30, 2021. Cash paid for operating leases is classified within operating cash flows and was $188 and $192 for the years ended September 30, 2022 and 2021, respectively. Operating lease right-of-use asset additions was $97 and $194 for the years ended September 30, 2022 and 2021, respectively.
The following table summarizes the balances of the Company's operating lease right-of-use assets and operating lease liabilities as of September 30, 2021 and 2022, the vast majority of which relates to offices and manufacturing facilities:
| | | | | | | | | | | | | | | | | |
| | 2021 | | | | 2022 | |
Right-of-use assets (Other assets) | | $ | 558 | | | | 489 | |
Current lease liabilities (Accrued expenses) | | $ | 155 | | | | 144 | |
Noncurrent lease liabilities (Other liabilities) | | $ | 413 | | | | 348 | |
The weighted-average remaining lease term for operating leases was 5.7 years and 5.8 years, and the weighted-average discount rate was 3.0 percent and 2.6 percent as of September 30, 2022 and September 30, 2021, respectively.
Future maturities of operating lease liabilities as of September 30, 2022 are summarized below:
| | | | | | | | | | | | | | | | | |
| | | | | 2022 | |
2023 | | | | | $ | 152 | |
2024 | | | | | 115 | |
2025 | | | | | 80 | |
2026 | | | | | 51 | |
2027 | | | | | 37 | |
Thereafter | | | | | 104 | |
Total lease payments | | | | | 539 | |
Less: Interest | | | | | 47 | |
Total lease liabilities | | | | | $ | 492 | |
Lease commitments that have not yet commenced were immaterial as of September 30, 2022.
(8) GOODWILL AND OTHER INTANGIBLES
The change in the carrying value of goodwill by business segment follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Automation Solutions | | AspenTech | | Climate Technologies | | Tools & Home Products | | Commercial & Residential Solutions | | |
| | | | | | Total |
Balance, September 30, 2020 | $ | 5,506 | | | 77 | | | 730 | | | 421 | | | 1,151 | | | 6,734 | |
Acquisitions | — | | | 967 | | | 23 | | | — | | | 23 | | | 990 | |
| | | | | | | | | | | |
Foreign currency translation and other | 2 | | | — | | | — | | | (3) | | | (3) | | | (1) | |
Balance, September 30, 2021 | 5,508 | | | 1,044 | | | 753 | | | 418 | | | 1,171 | | | 7,723 | |
Acquisitions | 40 | | | 7,289 | | | — | | | — | | | — | | | 7,329 | |
| | | | | | | | | | | |
Foreign currency translation and other | (292) | | | (7) | | | (38) | | | (53) | | | (91) | | | (390) | |
Balance, September 30, 2022 | $ | 5,256 | | | 8,326 | | | 715 | | | 365 | | | 1,080 | | | 14,662 | |
| | | | | | | | | | | |
The gross carrying amount and accumulated amortization of identifiable intangible assets by major class follow:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Customer Relationships | | Intellectual Property | | Capitalized Software | | Total |
| 2021 | | | 2022 | | | 2021 | | | 2022 | | | 2021 | | | 2022 | | | 2021 | | | 2022 | |
Gross carrying amount | $ | 2,391 | | | 4,563 | | | 2,062 | | | 4,121 | | | 1,458 | | | 1,457 | | | 5,911 | | | 10,141 | |
Less: Accumulated amortization | 896 | | | 1,056 | | | 923 | | | 1,123 | | | 1,215 | | | 1,238 | | | 3,034 | | | 3,417 | |
Net carrying amount | $ | 1,495 | | | 3,507 | | | 1,139 | | | 2,998 | | | 243 | | | 219 | | | 2,877 | | | 6,724 | |
Intangible asset amortization expense for the major classes included above for 2022, 2021 and 2020 was $563, $470 and $369, respectively. Based on intangible asset balances as of September 30, 2022, amortization expense is expected to approximate $778 in 2023, $745 in 2024, $672 in 2025, $565 in 2026 and $546 in 2027. The increase in goodwill and intangible assets in fiscal 2022 and 2021 reflect the Heritage AspenTech and OSI acquisitions, respectively.
(9) FINANCIAL INSTRUMENTS
Following is a discussion regarding the Company’s use of financial instruments:
Hedging Activities
As of September 30, 2022, the notional amount of foreign currency hedge positions was approximately $2.7 billion, and commodity hedge contracts totaled approximately $138 (primarily 38 million pounds of copper and aluminum). All derivatives receiving hedge accounting are cash flow hedges. The majority of hedging gains and losses deferred as of September 30, 2022 are expected to be recognized over the next 12 months as the underlying forecasted transactions occur. Gains and losses on foreign currency derivatives reported in Other deductions, net reflect hedges of balance sheet exposures that do not receive hedge accounting.
Net Investment Hedge
In fiscal 2019, the Company issued euro-denominated debt of €1.5 billion. The euro notes reduce foreign currency risk associated with the Company's international subsidiaries that use the euro as their functional currency and have been designated as a hedge of a portion of the investment in these operations. Foreign currency gains or losses associated with the euro-denominated debt are deferred in accumulated other comprehensive income (loss) and will remain until the hedged investment is sold or substantially liquidated.
The following gains and losses are included in earnings and other comprehensive income (OCI):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Gain (Loss) to Earnings | | Gain (Loss) to OCI |
| | | 2020 | | | 2021 | | | 2022 | | | 2020 | | | 2021 | | | 2022 | |
| Location | | | | | | | | | | | | |
Commodity | Cost of sales | | $ | (8) | | | 33 | | | 12 | | | 10 | | | 29 | | | (20) | |
Foreign currency | Sales | | (5) | | | 3 | | | (2) | | | 4 | | | 3 | | | (9) | |
Foreign currency | Cost of sales | | 4 | | | 8 | | | 31 | | | (25) | | | 34 | | | 53 | |
Foreign currency | Other deductions, net | | (40) | | | 53 | | | 48 | | | | | | | |
| | | | | | | | | | | | | |
Net Investment Hedge | | | | | | | | | | | | |
Euro denominated debt | | | | | | | | | (123) | | | 21 | | | 266 | |
Total | | | $ | (49) | | | 97 | | | 89 | | | (134) | | | 87 | | | 290 | |
Regardless of whether derivatives and non-derivative financial instruments receive hedge accounting, the Company expects hedging gains or losses to be offset by losses or gains on the related underlying exposures. The amounts ultimately recognized will differ from those presented above for open positions, which remain subject to ongoing market price fluctuations until settlement. Derivatives receiving hedge accounting are highly effective and no amounts were excluded from the assessment of hedge effectiveness.
Fair Value Measurement
Valuations for all derivatives and the Company's long-term debt fall within Level 2 of the GAAP valuation hierarchy. The fair value of long-term debt was $7.6 billion and $6.8 billion, respectively, as of September 30, 2022 and 2021, which was lower than the carrying value by $1,207 and exceeded the carrying value by $485, respectively. The fair values of commodity and foreign currency contracts were reported in Other current assets and Accrued expenses as summarized below:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2021 | | 2022 |
| | Assets | | Liabilities | | Assets | | Liabilities |
Commodity | | | $ | 12 | | | 6 | | | — | | | 25 | |
Foreign currency | | | $ | 36 | | | 6 | | | 51 | | | 80 | |
(10) SHORT-TERM BORROWINGS AND LINES OF CREDIT
Short-term borrowings and current maturities of long-term debt are as follows:
| | | | | | | | | | | | | | |
| | 2021 | | | 2022 | |
Current maturities of long-term debt | | $ | 538 | | | 516 | |
Commercial paper and other short-term borrowings | | 334 | | | 1,599 | |
Total | | $ | 872 | | | 2,115 | |
| | | | |
Interest rate for weighted-average short-term borrowings at year end | | 0.1% | | 2.8% |
In May 2018, the Company entered into a $3.5 billion five-year revolving backup credit facility with various banks, which replaced the April 2014 $3.5 billion facility. The credit facility is maintained to support general corporate purposes, including commercial paper borrowings. The Company has not incurred any borrowings under this or previous facilities. The credit facility contains no financial covenants and is not subject to termination based on a change of credit rating or material adverse changes. The facility is unsecured and may be accessed under various interest rate alternatives at the Company’s option. Fees to maintain the facility are immaterial.
(11) LONG-TERM DEBT
The details of long-term debt follow:
| | | | | | | | | | | |
| 2021 | | | 2022 | |
2.625% notes due December 2021 | $ | 500 | | | — | |
2.625% notes due February 2023 | 500 | | | 500 | |
0.375% euro notes due May 2024 | 579 | | | 490 | |
3.15% notes due June 2025 | 500 | | | 500 | |
1.25% euro notes due October 2025 | 579 | | | 490 | |
0.875% notes due October 2026 | 750 | | | 750 | |
1.8% notes due October 2027 | 500 | | | 500 | |
2.0% notes due December 2028 | — | | | 1,000 | |
2.0% euro notes due October 2029 | 579 | | | 490 | |
1.95% notes due October 2030 | 500 | | | 500 | |
2.20% notes due December 2031 | — | | | 1,000 | |
6.0% notes due August 2032 | 250 | | | 250 | |
6.125% notes due April 2039 | 250 | | | 250 | |
5.25% notes due November 2039 | 300 | | | 300 | |
2.75% notes due October 2050 | 500 | | | 500 | |
2.80% notes due December 2051 | — | | | 1,000 | |
Other | 44 | | | 255 | |
Long-term debt | 6,331 | | | 8,775 | |
Less: Current maturities | 538 | | | 516 | |
Total, net | $ | 5,793 | | | 8,259 | |
As of September 30, 2022, other includes $240 in outstanding borrowings by AspenTech under a revolving term loan credit facility that matures on December 23, 2024. The interest rate is variable and was 4.31% as of September 30, 2022.
Long-term debt maturing during each of the four years after 2023 is $738, $527, $484 and $745, respectively. Total interest paid on long-term debt was approximately $199, $156 and $163 in 2022, 2021 and 2020, respectively. During the year, the Company repaid $500 of 2.625% notes that matured in December 2021. In 2021, the Company repaid $300 of 4.25% notes that matured in November 2020. In December 2021, the Company issued $1,000 of 2.0% notes due December 2028, $1,000 of 2.20% notes due December 2031 and $1,000 of 2.80% notes due December 2051.
The Company maintains a universal shelf registration statement on file with the SEC under which it can issue debt securities, preferred stock, common stock, warrants, share purchase contracts or share purchase units without a predetermined limit. Securities can be sold in one or more separate offerings with the size, price and terms to be determined at the time of sale.
(12) PENSION AND POSTRETIREMENT PLANS
Retirement plans expense includes the following components:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Plans | | Non-U.S. Plans |
| 2020 | | | 2021 | | | 2022 | | | 2020 | | | 2021 | | | 2022 | |
Defined benefit plans: | | | | | | | | | | | |
Service cost (benefits earned during the period) | $ | 57 | | | 54 | | | 49 | | | 30 | | | 29 | | | 25 | |
Interest cost | 125 | | | 94 | | | 99 | | | 30 | | | 32 | | | 33 | |
Expected return on plan assets | (268) | | | (264) | | | (253) | | | (72) | | | (74) | | | (56) | |
Net amortization and other | 148 | | | 143 | | | 102 | | | 17 | | | 14 | | | 3 | |
Net periodic pension expense | 62 | | | 27 | | | (3) | | | 5 | | | 1 | | | 5 | |
Defined contribution plans | 112 | | | 114 | | | 124 | | | 56 | | | 52 | | | 52 | |
Total retirement plans expense | $ | 174 | | | 141 | | | 121 | | | 61 | | | 53 | | | 57 | |
Net periodic pension expense decreased in 2022 primarily due to lower amortization of deferred losses. For defined contribution plans, the Company makes cash contributions based on plan requirements, which are expensed as incurred.
The Company's principal U.S. defined benefit plan is closed to employees hired after January 1, 2016 while shorter-tenured employees ceased accruing benefits effective October 1, 2016.
Details of the changes in the actuarial present value of the projected benefit obligation and the fair value of plan assets for defined benefit pension plans follow:
| | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Plans | | Non-U.S. Plans |
| 2021 | | | 2022 | | | 2021 | | | 2022 | |
Projected benefit obligation, beginning | $ | 4,525 | | | 4,338 | | | 1,633 | | | 1,562 | |
Service cost | 54 | | | 49 | | | 29 | | | 25 | |
Interest cost | 94 | | | 99 | | | 32 | | | 33 | |
Actuarial gain | (13) | | | (1,170) | | | (101) | | | (404) | |
Benefits paid | (218) | | | (204) | | | (39) | | | (40) | |
Settlements | (105) | | | — | | | (35) | | | (29) | |
| | | | | | | |
Foreign currency translation and other | 1 | | | — | | | 43 | | | (182) | |
Projected benefit obligation, ending | $ | 4,338 | | | 3,112 | | | 1,562 | | | 965 | |
| | | | | | | |
Fair value of plan assets, beginning | $ | 4,383 | | | 4,844 | | | 1,367 | | | 1,474 | |
Actual return on plan assets | 771 | | | (1,030) | | | 100 | | | (337) | |
Employer contributions | 12 | | | 15 | | | 29 | | | 28 | |
Benefits paid | (218) | | | (204) | | | (39) | | | (40) | |
Settlements | (105) | | | — | | | (35) | | | (29) | |
| | | | | | | |
Foreign currency translation and other | 1 | | | — | | | 52 | | | (188) | |
Fair value of plan assets, ending | $ | 4,844 | | | 3,625 | | | 1,474 | | | 908 | |
| | | | | | | |
Net amount recognized in the balance sheet | $ | 506 | | | 513 | | | (88) | | | (57) | |
| | | | | | | |
Location of net amount recognized in the balance sheet: | | | | | | | |
Noncurrent asset | $ | 732 | | | 676 | | | 283 | | | 205 | |
Current liability | (13) | | | (14) | | | (16) | | | (17) | |
Noncurrent liability | (213) | | | (149) | | | (355) | | | (245) | |
| | | | | | | |
Net amount recognized in the balance sheet | $ | 506 | | | 513 | | | (88) | | | (57) | |
| | | | | | | |
Pretax accumulated other comprehensive loss | $ | (274) | | | (284) | | | (182) | | | (136) | |
Actuarial gains in 2022 were largely due to an increase in the discount rates used to estimate the benefit obligations for the U.S. and non-U.S. plans, which were 5.64% and 4.9% at September 30, 2022 compared to 2.92% and 2.2% at September 30, 2021, respectively. Actuarial gains in 2021 were largely due to an increase in the discount rates used to estimate the benefit obligations for the U.S. and non-U.S. plans, which was 2.92% and 2.2% at September 30, 2021 compared to 2.81% and 1.9% at September 30, 2020, respectively. As of September 30, 2022, U.S. pension plans were overfunded by $513 in total, including unfunded plans totaling $162. The non-U.S. plans were underfunded by $57, including unfunded plans totaling $236.
As of the September 30, 2022 and 2021 measurement dates, the plans' total accumulated benefit obligation was $3,910 and $5,634, respectively. The total projected benefit obligation, accumulated benefit obligation and fair value of plan assets for individual plans with projected benefit obligations in excess of plan assets were $527, $444 and $102, respectively, for 2022, and $1,142, $1,016 and $544, respectively, for 2021. The total projected benefit obligation, accumulated benefit obligation and fair value of plan assets for individual plans with accumulated benefit obligations in excess of plan assets were $477, $421 and $63, respectively, for 2022, and $711, $626 and $123, respectively, for 2021.
Future benefit payments by U.S. plans are estimated to be $215 in 2023, $220 in 2024, $225 in 2025, $229 in 2026, $232 in 2027 and $1,174 in total over the five years 2028 through 2032. Based on foreign currency exchange rates as of September 30, 2022, future benefit payments by non-U.S. plans are estimated to be $60 in 2023, $58 in 2024, $59 in 2025, $62 in 2026, $65 in 2027 and $366 in total over the five years 2028 through 2032. The Company expects to contribute approximately $40 to its retirement plans in 2023.
The weighted-average assumptions used in the valuation of pension benefits follow:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Plans | | Non-U.S. Plans |
| 2020 | | | 2021 | | | 2022 | | | 2020 | | | 2021 | | | 2022 | |
Net pension expense | | | | | | | | | | | |
| | | | | | | | | | | |
Discount rate used to determine service cost | 3.40 | % | | 3.16 | % | | 3.16 | % | | 1.9 | % | | 1.9 | % | | 2.2 | % |
Discount rate used to determine interest cost | 2.87 | % | | 2.10 | % | | 2.31 | % | | 1.9 | % | | 1.9 | % | | 2.2 | % |
Expected return on plan assets | 6.75 | % | | 6.50 | % | | 6.00 | % | | 5.8 | % | | 5.6 | % | | 4.4 | % |
Rate of compensation increase | 3.25 | % | | 3.25 | % | | 4.00 | % | | 3.7 | % | | 3.6 | % | | 3.7 | % |
| | | | | | | | | | | |
Benefit obligations | | | | | | | | | | | |
Discount rate | 2.81 | % | | 2.92 | % | | 5.64 | % | | 1.9 | % | | 2.2 | % | | 4.9 | % |
Rate of compensation increase | 3.25 | % | | 3.25 | % | | 4.00 | % | | 3.6 | % | | 3.7 | % | | 4.0 | % |
The discount rate for the U.S. retirement plans was 5.64 percent as of September 30, 2022. An actuarially developed, company-specific yield curve is used to determine the discount rate. To determine the service and interest cost components of pension expense for its U.S. retirement plans, the Company applies the specific spot rates along the yield curve, rather than the single weighted-average rate, to the projected cash flows to provide more precise measurement of these costs. The expected return on plan assets assumption is determined by reviewing the investment returns of the plans for the past 10 years plus longer-term historical returns of an asset mix approximating the Company's asset allocation targets, and periodically comparing these returns to expectations of investment advisors and actuaries to determine whether long-term future returns are expected to differ significantly from the past.
The Company's asset allocations at September 30, 2022 and 2021, and weighted-average target allocations follow:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. Plans | | Non-U.S. Plans |
| 2021 | | | 2022 | | | Target | | 2021 | | | 2022 | | | Target |
Equity securities | 39 | % | | 39 | % | | 35-45% | | 35 | % | | 11 | % | | 10-20% |
Debt securities | 55 | | | 54 | | | 50-60 | | 55 | | | 73 | | | 70-80 |
Other | 6 | | | 7 | | | 0-10 | | 10 | | | 16 | | | 10-20 |
Total | 100 | % | | 100 | % | | 100% | | 100 | % | | 100 | % | | 100% |
The primary objective for the investment of pension assets is to secure participant retirement benefits by earning a reasonable rate of return. Plan assets are invested consistent with the provisions of the prudence and diversification rules of ERISA and with a long-term investment horizon. The Company continuously monitors the value of assets by class and routinely rebalances to remain within target allocations. The equity strategy is to minimize concentrations of risk by investing primarily in a mix of companies that are diversified across geographies, market capitalization, style, sectors and industries worldwide. The approach for bonds emphasizes investment-grade corporate and government debt with maturities matching a portion of the longer duration pension liabilities. The bonds strategy also includes a high-yield element which is generally shorter in duration. For diversification, a small portion of U.S. plan assets is allocated to private equity partnerships and real asset fund investments, providing opportunities for above market returns. Leveraging techniques are not used and the use of derivatives in any fund is limited and inconsequential.
The fair values of defined benefit pension assets as of September 30, organized by asset class and by the fair value hierarchy of ASC 820, Fair Value Measurement, follow. Investments valued based on the net asset value (NAV) of fund units held, as derived from the fair value of the underlying assets, are excluded from the fair value hierarchy.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Level 1 | | Level 2 | | Level 3 | | Measured at NAV | | Total | | % |
2022 | | | | | | | | | | | |
U.S. equities | $ | 405 | | | 6 | | | — | | | 633 | | | 1,044 | | | 23 | % |
International equities | 225 | | | 10 | | | — | | | 123 | | | 358 | | | 8 | % |
Emerging market equities | — | | | 1 | | | — | | | 124 | | | 125 | | | 3 | % |
Corporate bonds | — | | | 1,143 | | | — | | | 859 | | | 2,002 | | | 44 | % |
Government bonds | — | | | 468 | | | — | | | 152 | | | 620 | | | 14 | % |
| | | | | | | | | | | |
Other | (9) | | | 7 | | | 130 | | | 256 | | | 384 | | | 8 | % |
Total | $ | 621 | | | 1,635 | | | 130 | | | 2,147 | | | 4,533 | | | 100 | % |
| | | | | | | | | | | |
2021 | | | | | | | | | | | |
U.S. equities | $ | 591 | | | 9 | | | — | | | 670 | | | 1,270 | | | 20 | % |
International equities | 356 | | | 17 | | | — | | | 563 | | | 936 | | | 15 | % |
Emerging market equities | — | | | 1 | | | — | | | 212 | | | 213 | | | 3 | % |
Corporate bonds | — | | | 1,516 | | | — | | | 565 | | | 2,081 | | | 33 | % |
Government bonds | — | | | 642 | | | — | | | 730 | | | 1,372 | | | 22 | % |
| | | | | | | | | | | |
Other | 46 | | | 8 | | | 135 | | | 257 | | | 446 | | | 7 | % |
Total | $ | 993 | | | 2,193 | | | 135 | | | 2,997 | | | 6,318 | | | 100 | % |
Asset Classes
U.S. equities reflect companies domiciled in the U.S., including multinational companies. International equities are comprised of companies domiciled in developed nations outside the U.S. Emerging market equities are comprised of companies domiciled in portions of Asia, Eastern Europe and Latin America. Corporate bonds represent investment-grade debt of issuers primarily from the U.S. Government bonds include investment-grade instruments issued by federal, state and local governments, primarily in the U.S. Other includes cash, interests in mixed asset funds investing in commodities, natural resources, agriculture, real estate and infrastructure funds, life insurance contracts (U.S.), and shares in certain general investment funds of financial institutions or insurance arrangements (non-U.S.) that typically ensure no market losses or provide for a small minimum return guarantee.
Fair Value Hierarchy Categories
Valuations of Level 1 assets for all classes are based on quoted closing market prices from the principal exchanges where the individual securities are traded. Cash is valued at cost, which approximates fair value. Debt securities categorized as Level 2 assets are generally valued based on independent broker/dealer bids or by comparison to other debt securities having similar durations, yields and credit ratings. Valuation techniques and inputs for these assets include discounted cash flow analysis, earnings multiple approaches, recent transactions, transfer restrictions, prevailing discount rates, volatilities, credit ratings and other factors. In the Other class, interests in mixed asset funds are Level 2, and U.S. life insurance contracts and non-U.S. general fund investments and insurance arrangements are Level 3. Investments measured at NAV are primarily nonexchange-traded commingled or collective funds where the underlying securities have observable prices available from active markets and typically provide liquidity daily or within a few days. The NAV category also includes fund investments in private equities, real estate and infrastructure where the fair value of the underlying assets is determined by the investment manager. Total unfunded commitments for the private equity funds were approximately $190 at September 30, 2022. These investments cannot be redeemed, but instead the funds will make distributions through liquidation of the underlying assets, which is expected to occur over approximately the next 10 years. The real estate and infrastructure funds typically offer quarterly redemption.
Postretirement Plans
The Company also sponsors unfunded postretirement benefit plans (primarily health care) for certain U.S. retirees and their dependents. The Company’s principal U.S. postretirement plan has been frozen to new employees since 1993. The postretirement benefit liability for all plans was $83 and $119 as of September 30, 2022 and 2021, respectively, and included deferred actuarial gains in accumulated other comprehensive income of $112 and $98, respectively. Service and interest costs are negligible and more than offset by the amortization of deferred actuarial gains, which resulted in net postretirement income of $12 for 2022 and $15 for 2021 and $12 for 2020. Benefits paid
were $10 and $9 for 2022 and 2021, respectively, and the Company estimates that future health care benefit payments will be approximately $10 per year for 2023 through 2027, and $33 in total over the five years 2028 through 2032.
(13) CONTINGENT LIABILITIES AND COMMITMENTS
The Company is a party to a number of pending legal proceedings and claims, including those involving general and product liability (including asbestos) and other matters, several of which claim substantial amounts of damages. The Company accrues for such liabilities when it is probable that future costs (including legal fees and expenses) will be incurred and such costs can be reasonably estimated. Accruals are based on developments to date; management's estimates of the outcomes of these matters; and the Company's experience in contesting, litigating and settling similar matters. The Company engages an outside expert to develop an actuarial estimate of its expected costs to resolve all pending and future asbestos claims, including defense costs, as well as its related insurance receivables. The reserve for asbestos litigation, which is recorded on an undiscounted basis, is based on projected claims through 2065. See Note 19 for additional information about the Company's asbestos liabilities and related insurance receivables.
Although it is not possible to predict the ultimate outcome of these matters, the Company historically has been largely successful in defending itself against claims and suits that have been brought against it, and will continue to defend itself vigorously in all such matters. While the Company believes a material adverse impact is unlikely, given the inherent uncertainty of litigation, a remote possibility exists that a future development could have a material adverse impact on the Company. The Company enters into certain indemnification agreements in the ordinary course of business in which the indemnified party is held harmless and is reimbursed for losses incurred from claims by third parties, usually up to a prespecified limit. In connection with divestitures of certain assets or businesses, the Company often provides indemnities to the buyer with respect to certain matters including, for example, environmental or unidentified tax liabilities related to periods prior to the disposition. Because of the uncertain nature of the indemnities, the maximum liability cannot be quantified. As such, contingent liabilities are recorded when they are both probable and reasonably estimable. Historically, payments under indemnity arrangements have been inconsequential.
At September 30, 2022, there were no known contingent liabilities (including guarantees, pending litigation, taxes and other claims) that management believes will be material in relation to the Company's financial statements, nor were there any material commitments outside the normal course of business.
(14) INCOME TAXES
Pretax earnings consist of the following:
| | | | | | | | | | | | | | | | | |
| 2020 | | | 2021 | | | 2022 | |
United States | $ | 1,360 | | | 1,491 | | | 2,684 | |
Non-U.S. | 975 | | | 1,421 | | | 1,401 | |
Total pretax earnings | $ | 2,335 | | | 2,912 | | | 4,085 | |
The principal components of income tax expense follow:
| | | | | | | | | | | | | | | | | |
| 2020 | | | 2021 | | | 2022 | |
Current: | | | | | |
U.S. federal | $ | 123 | | | 152 | | | 511 | |
State and local | 15 | | | 26 | | | 60 | |
Non-U.S. | 288 | | | 355 | | | 400 | |
| | | | | |
Deferred: | | | | | |
U.S. federal | (44) | | | 81 | | | (101) | |
State and local | 1 | | | (2) | | | (13) | |
Non-U.S. | (38) | | | (27) | | | (2) | |
Income tax expense | $ | 345 | | | 585 | | | 855 | |
Reconciliations of the U.S. federal statutory income tax rate to the Company's effective tax rate follow.
| | | | | | | | | | | | | | | | | |
| 2020 | | | 2021 | | | 2022 | |
U.S. federal statutory rate | 21.0 | % | | 21.0 | % | | 21.0 | % |
State and local taxes, net of U.S. federal tax benefit | 0.6 | | | 0.7 | | | 0.8 | |
Non-U.S. rate differential | 1.7 | | | 2.0 | | | 1.6 | |
Non-U.S. tax holidays | (1.1) | | | (0.8) | | | (0.9) | |
Research and development credits | (1.8) | | | (0.6) | | | (0.3) | |
| | | | | |
Foreign derived intangible income | (1.2) | | | (1.4) | | | (1.4) | |
Gain on divestiture | — | | | — | | | (1.1) | |
Russia business exit | — | | | — | | | 1.2 | |
Subsidiary restructuring | (4.4) | | | (0.5) | | | (0.3) | |
| | | | | |
Other | — | | | (0.3) | | | 0.3 | |
Effective income tax rate | 14.8 | % | | 20.1 | % | | 20.9 | % |
The tax rates for 2022, 2021 and 2020 include benefits from restructuring subsidiaries of $11, $13 and $103, respectively. The impact on the 2022 tax rate from the gain on divestiture of the Therm-O-Disc business and the Russia business exit in 2022 essentially offset. The lower rate in 2020 included the impact of a research and development tax credit study.
The Company has elected to recognize the tax on global intangible low-taxed income earned by certain of its non-U.S. subsidiaries as a period expense when it is incurred.
On March 27, 2020, the CARES Act was enacted in response to the COVID-19 pandemic, and among other things, provides tax relief to businesses. Tax provisions of the CARES Act include the deferral of certain payroll taxes, relief for retaining employees, and other provisions. The Company deferred $73 of certain payroll taxes through the end of calendar year 2020, of which approximately $37 was paid in December 2021 with the remaining amount due in December 2022.
Non-U.S. tax holidays reduce tax rates in certain jurisdictions. Approximately half of the tax holidays expired by September 2022, with the remaining expiring over the next 8 years.
Following are changes in unrecognized tax benefits before considering recoverability of any cross-jurisdictional tax credits (U.S. federal, state and non-U.S.) and temporary differences. The amount of unrecognized tax benefits is not expected to change significantly in the next 12 months.
| | | | | | | | | | | |
| 2021 | | | 2022 | |
Unrecognized tax benefits, beginning | $ | 195 | | | 219 | |
Additions for current year tax positions | 27 | | | 25 | |
Additions for prior year tax positions | 17 | | | 9 | |
Reductions for prior year tax positions | (6) | | | (65) | |
Acquisitions and divestitures | 1 | | | 1 | |
Reductions for settlements with tax authorities | (5) | | | — | |
Reductions for expiration of statutes of limitations | (10) | | | (11) | |
Unrecognized tax benefits, ending | $ | 219 | | | 178 | |
If none of the unrecognized tax benefits shown is ultimately paid, the tax provision and the calculation of the effective tax rate would be favorably impacted by $151, which is net of cross-jurisdictional tax credits and temporary differences. The Company accrues interest and penalties related to income taxes in income tax expense. Total expense (income) recognized was $(6), $(4) and $1 in 2022, 2021 and 2020, respectively. As of September 30, 2022 and 2021, total accrued interest and penalties were $24 and $24, respectively.
The U.S. is the major jurisdiction for which the Company files income tax returns. Examinations for U.S. federal are complete through 2017, except for 2014. The status of state and non-U.S. tax examinations varies due to the numerous legal entities and jurisdictions in which the Company operates.
The principal items that gave rise to deferred income tax assets and liabilities follow:
| | | | | | | | | | | |
| 2021 | | | 2022 | |
Deferred tax assets: | | | |
Net operating losses, capital losses and tax credits | $ | 316 | | | 212 | |
Accrued liabilities | 216 | | | 217 | |
Postretirement and postemployment benefits | 29 | | | 21 | |
Employee compensation and benefits | 149 | | | 125 | |
| | | |
Other | 128 | | | 135 | |
Total | $ | 838 | | | 710 | |
| | | |
Valuation allowances | $ | (236) | | | (174) | |
| | | |
Deferred tax liabilities: | | | |
Intangibles | $ | (787) | | | (1,633) | |
Pensions | (107) | | | (119) | |
Property, plant and equipment | (212) | | | (208) | |
Undistributed non-U.S. earnings | (38) | | | (37) | |
Other | (54) | | | (160) | |
Total | $ | (1,198) | | | (2,157) | |
| | | |
Net deferred income tax liability | $ | (596) | | | (1,621) | |
Total income taxes paid were approximately $720, $680 and $400 in 2022, 2021 and 2020, respectively. Approximately two-thirds of the $212 of net operating losses can be carried forward indefinitely, while most of the remainder expire over the next 10 years.
(15) STOCK-BASED COMPENSATION
The Company's stock-based compensation plans include performance shares, restricted stock, restricted stock units, and stock options. Although the Company has discretion, shares distributed under these plans are issued from treasury stock.
In fiscal 2022, the Company changed the terms of its annual performance share awards that were issued in the first quarter. The new terms meet the criteria for equity classification in accordance with ASC 718, Compensation - Stock Compensation, and therefore expense will be recognized on a fixed basis over the three-year performance period. The terms of the performance share awards issued in fiscal 2020 and 2021 are unchanged and therefore continue to be accounted for as liability awards and marked-to-market each period based on changes in the stock price.
AspenTech also has stock-based compensation plans that are settled in its own stock. These plans consist of restricted stock units and stock options.
Total compensation expense and income tax benefits for Emerson and AspenTech stock options and incentive shares follows.
| | | | | | | | | | | | | | | | | |
| 2020 | | | 2021 | | | 2022 |
Performance shares | $ | 98 | | | 203 | | | 89 | |
Restricted stock and restricted stock units | 11 | | | 21 | | | 23 | |
Stock options | 1 | | | — | | | — | |
AspenTech stock-based compensation plans | — | | | — | | | 32 | |
Total stock compensation expense | $ | 110 | | | 224 | | | 144 | |
| | | | | |
Income tax benefits recognized | $ | 18 | | | 27 | | | 19 | |
As of September 30, 2022, total unrecognized compensation expense related to unvested shares awarded under Emerson plans was $153, which is expected to be recognized over a weighted-average period of 1.3 years, while the total future unrecognized compensation cost related to AspenTech stock options and RSUs was $41 and $97, respectively, which is expected to be recorded over a weighted average period of 2.1 years and 1.8 years, respectively.
Emerson Performance Shares, Restricted Stock and Restricted Stock Units
The Company's incentive shares plans include performance shares awards which distribute the value of common stock to key management employees at the conclusion of a three-year period subject to certain operating performance conditions and other terms and restrictions. The form of distribution is primarily shares of common stock, with a portion in cash in the first quarter following the end of the applicable three-year performance period. Dividend equivalents are only paid on earned awards after the performance period has concluded. Compensation expense for performance shares is recognized over the service period based on the number of shares ultimately expected to be earned.
Information related to performance share payouts for the years ended September 30, 2021 and 2022 follows (shares in thousands):