Good day, ladies and gentlemen. Thank you for standing by. Welcome to this special Emerson conference call. During today's presentation by Emerson management, all parties will be in listen-only mode. Following the presentation, the conference will be open to questions. This conference is being recorded today, August 27, 2020. Emerson's commentary and response to your questions may contain forward-looking statements, including the company's outlook for the remainder of the year. Information on factors that could cause actual results to vary materially from those discussed today is available at Emerson's most recent annual report on Form 10-K as filed with the SEC. I would now like to turn the conference over to David Farr, Chairman and CEO. Please go ahead.
Thank you very much. I want to welcome everybody here this morning. I appreciate your time. We're sitting right now live in my conference room, myself and Mark Bulanda here to my left. Kitty-corner to me is Bob Yeager, who runs our PWS business. Jim Nyquist is across from me, who runs all of PSS, headquartered in Austin. Lal Karsanbhai, who runs all of the automation solutions business. Then we have Collin Mettler , who's in charge of investor relations, but also for many years worked at the power business, so he knows quite a bit about this acquisition, and then myself. I want to welcome all the investors, the sell-side analysts, and also want to welcome the Emerson and the OSI employees I'm sure are also looking and listening to this conference call today.
For your information, and just to clarify things, there were two OSI companies being auctioned off at the same time. We had OSIsoft, who I know very well. Pat Kennedy, a longtime friend. Jim and I knew Pat for at least 25 years.
Yep.
Very close friend, associate, iconic person in the process business. We get obviously involved in that process at that point in time. They were bought out, or in the process of being bought out by AVEVA. Then OSI Inc, which we refer to internally as OSI Power. The reason we did that is we had two acquisitions underway, and I had to clarify for the management team and also for the board as we talked about OSI Power and OSIsoft. There were two companies out there, and the marketplace talked about them, but they got them intertwined from time to time. As you look at chart three, you think about our acquisition strategy. This is extremely strategic. A company that we've known for many, many years, headquartered up in Minneapolis, where we have also a lot of sensor capability in Minneapolis.
We're a very large employer in the Minneapolis region. As you look at this pyramid, as you can see, we've been making strategic acquisitions in our data management services, software-based companies now for the last several years. We've done 14. inmation was just recently a joint venture investment we're making in Germany, a very nice acquisition, helpful from the data management standpoint. We look forward to doing more with that company. We look at our makeup, we've done a lot of acquisitions of software, and yet we continue to do little bolt-ons in the sensors and devices area. Clearly it brings a lot of power to us, and you're going to see as we go through this presentation, where we have a lot of synergy, both within the power side of the business, but also in the process side of the business.
A lot of technology that we're going to be able to share back and forth. We're extremely excited about this. We're really excited about Bahman and his team and Al. They built a great company in Minneapolis, and we're looking forward to working with them. This business will report into Jim. Jim Nyquist, as we look across the whole PSS business, obviously has a very close connection to what Bob runs on the power side, and you'll see that very quickly. There's going to be a lot of sharing of technology across Emerson. A very unique software acquisition, and we're very excited about it. With that, I want to turn it over to Lal and Jim to talk, and Bob and Mark to talk a bit about the slides. What we'll do is we'll interject amongst all of us.
We'll come in and play and talk about it, and we'll do the same thing in the Q&A area too, so you can get a perspective from each of us. Mark, so go ahead.
Great. Slide four. Good morning, everyone. We're really excited to have OSI join Emerson and in our power markets. We have had a strength and built a strength in the generation side with the acquisition of Westinghouse back in the 1990s and have really built up that business, and it's our Power and Water Solutions business and very much focused on the power generation side, in steam and gas turbine, as well as an acquisition we did earlier this year with American Governor on the hydro side, renewable energy. What we're adding into the equation is OSI, who is in the control space and for transmission and distribution, which is a very important area, and we view being able to connect across from generation all the way to distribution. We will cover that entire spectrum in the market.
OSI really helps manage the energy flow on the distribution side with the ADMS product line that they have. It is a world-class product line there, as well as EMS. With the advent of renewable energy and microgrids coming into the power equation, ADMS is becoming more and more adopted to control the two-way flow of electricity, as well as restore any kind of outages that occur out in the market, as we all want to have our power working all the time. OSI has really created a world-class platform that is in this space and allows us also to expand into other spaces. If you look on slide five to depict where we are in the technology stack of devices, controls, and data management, you can see where Emerson's current capabilities are in generation.
Listed in green, primarily across the software and control space. What is really exciting about this, it also gives us a runway into some future opportunities. Lal and Jim will talk about our market expansion with OSI itself of $2.7 billion growing very nicely. We have opportunities to add down the road another $5 billion market space over the coming years. Slide six is OSI, the company.
I'll take it from here, Mark. Thank you. I would like to second David's words and congratulate Bahman Hoveida and Ron Ingram for really establishing a phenomenal company here, and Al Ellison for running it for a number of years now. For that team, this is a unique asset and a unique opportunity for us from a market expansion and technology perspective. Chart six is the profile of the company, based just outside of Minneapolis in Medina, founded in 1992. We add about 1,000 employees to the already 2,000 employees that we have in the Minneapolis area across Emerson. It's a very important regional area for us, as David referred to, sensor manufacturing. The key industry here is power transmission and distribution.
There are applications on the natural gas grid side and distribution, and water distribution as well, as many principles that can be applied to electricity can be leveraged into other medium here. It's predominantly a U.S. company today, with 85% of their sales in North America, in U.S. and Canada. With tremendous opportunity to be globalized around the world as well. I'll turn it to page seven. This is a compelling chart. One of the key reasons, as Mark highlighted earlier, that the asset was of interest to us. On the left-hand side of the chart was our current power generation market, approximately $2.7 billion in size, with the DCS, the distributed control system, representing the bulk of that market opportunity. The acquisition of PWS, the Westinghouse business in 1998, Bob?
That's correct.
1998. At the time, David was running automation, the process. It was a 13% market participation company. We drove that to about a quarter of the global market in power generation and controls, and about 50% in the U.S., in North America. Tremendous work there. On the right-hand side of the chart is the market expansion opportunity here. Mark already talked about the advent of renewables and the implications to the grid of renewables entering the grid. The overall market essentially doubles. The sandbox doubles as we look at control elements now in both transmission and distribution. The traditional, what we call EMS, energy management systems, and then the more advanced and faster-growing, driven by the renewable into the grid, advanced distribution management systems, the ADMS, and we'll refer to that a number of times. Jim, would you like to talk a little bit about ADMS?
Yeah. One of the things that's happening in the distribution, of course, is the two-way flow of power now. A lot of the software out there that's controlling a distribution system simply can't handle that. As those renewables come on, more and more distributed energy resources comes on, having the software that can manage that is so critically important. These guys really have developed a very, I'd say, modern, modular package, scalable, that they can drive into that space. You see on the right-hand side there, the adoption. This is a new, I'd say, emerging area because there's a real discontinuity in the market here. Only about 35% of the market today has ADMS. They have more of a traditional distribution management system. Now about 35% penetration today.
A large market here for us to go back in there, modernize those software systems, replace what's out there today with something now that can handle the renewable portfolios.
One of the things I would like to bring in here, Bob, in the world of renewables today, the U.S. manufacturers of power are starting to struggle with the renewables.
A classic example is California.
Correct. Yeah.
Their grid is going down. Today, as a percentage of renewables, power generation is once again where it is and where it's got to go to, and that's where the ADMS really comes into play. All the major utility companies really need to move to ADMS to be able to manage those renewables. Why don't you give some insight to that?
Yeah. The traditional utilities are getting into commercial microgrids, right? Wind and solar and that generation, it can be disruptive on the grid.
Yeah.
It could create, as you mentioned in California, it can create frequency issues and spinning reserve issues.
Today, what does the U.S. grid have in renewables? 10%, 12%?
About 10%, 12%. Right. Yeah.
The target is in some places like California, it's 100%.
Well, California is saying they want to go to 100% renewables.
Most people are looking at 25%-30%.
Yeah, something like that.
By law.
Yeah. When the renewables generation is coming onto the grid, it's creating this instability, right?
Right.
It can be, as we're saying in California, it can be forced outages because there's no generation, there's no spinning reserve. Also what's happening, it's frequency. This is why ADMS and Monarch, their platform, is so important to us because they do volt/VAR control and frequency regulation across the grid. Together with our software, Mark mentioned that we have about 50% of the U.S. generating capacity and about 1.3 million MW around the world. If you bring in the T&D together with our code, we have about 25 million-30 million lines of code in generation.
Yeah.
They have about 15 million-20 million lines of code in transmission and distribution, and we believe this can be the next generation for the total power system, certainly in the United States and globally.
There's a huge growth opportunity here, both here in the U.S. and around the world, and we know it's happening live, basically being driven by the renewable drive by the government, the local government.
Correct.
Jim, back to you or Lal.
Yeah. Just to close out chart seven, David, we feel very strongly that we can take what OSI has on a global participation basis today at 5% and double that plus.
That's where you look forward and grow the company.
I still have a target out there for Bob. What's the target for you to get by what's that number? Not 24%. 24% is nonsense.
Yeah. You went north of 30.
I went north of 30.
North of 30.
Before I die.
Yeah.
Okay.
Understood. You're going to do it, too.
Yeah.
Very exciting.
Yeah.
Yes.
Okay, well, let's turn to page eight. I'm going to ask Bob to help me cover this. This is a compelling chart from us, for us, and it points to the electrical generation distribution landscape across North America. We've bifurcated here the market into three buckets here.
The large utilities, these are large integrated utilities, companies like Duke.
Duke, NextEra, Southern Company.
Exactly.
Southern Company.
There are a group of large and mid-size utilities, that is about 50 companies we segmented there, and then the smaller mid-size munis and co-ops down at the bottom. We have taken the terawatts produced, generated by each of these companies, and put them in the appropriate buckets. The first message here is that Emerson has a significant presence in terms of terawatts controlled, particularly at the top of the pyramid.
Yes.
Among the top 20.
Total U.S., about 450,000 out of 1 million MW in the U.S.
Okay. 17 out of the 20 companies.
Correct
we control on the generation. OSI, on the other hand, is very strong down at the bottom of the pyramid.
They've been able to grow and gain relevance working with the smaller utilities, the munis, the co-ops, et cetera.
Mm-hmm. Correct.
The opportunity, clearly, for us, is to bring OSI into the large-scale utilities up at the top, and for us to come down into the smaller side on the generation side. There's synergies on both ends here, Bob.
Hundred %, Lal. If you think about large generators in the U.S.-
you look at the top 70, we have great presence there. We have great relationships there. A lot of those utilities have standardized on our control system, Ovation. We have a great relationship there. Like you said, Lal, on the 2,900 below, so I like that.
Right.
What's very exciting is when we join our business development and sales teams together around the world.
we'll go and be able to address these key accounts and really meet their needs, from generation through transmission, distribution, all the way to the munis. It's a very powerful combination, not only from a technology perspective, which we just love. I mentioned they have 20 million lines of code that will work right into our 30 million lines of code, so we're going to have 50 million lines of code, right, to cover that, but great support for our customers.
One of the issues, before I go back to Lal, is the things I think that we're starting to see as we've got to know about OSI power, and maybe even improving the technology movement within the generation world, between the distribution side and the generation side. We can bring, offer more service and capabilities to the power generation companies, which they've never had available until before, given the makeup of these two businesses together. Anything you want to comment on?
Yeah. Creating this common platform. Another thing that we're really excited about is we have a digital twin. We've added five to six million lines of code, and they have a digital twin. A historian. I call it CHRONUS. We see two immediate needs, not only the monarch platform and Ovation coming together and meeting our key customers' needs, but the historian will be something that we can drop right in. All we need is some connectors, which is not hard to do, develop that code. That can become the Ovation default historian. It already is the monarch default historian, and it's great, this commonality and do data exchange between transmission, distribution, and generation. That's step one. Digital twin, we're really excited about because we have well over 100, maybe 200 digital twins around the world now.
It's a breakthrough technology because it uses the same engineering tools for the digital twin as it does the generation side. If we can combine their digital twin and ours, we can create this unified virtual system from end to end across the entire power system. If you think about outage management, we could go to large utilities and say, "Look, here are all your generating assets." We have this virtual version of this. Here's what your transmission looks like, right? You can do what if scenarios if you lose generation, if you lose different grid. You can reconfigure the grid. You can reconfigure the whole power system virtually.
This is the way of the future.
This is the way of the future.
The other thing I'd mention, too, Bob, in addition to that, the historian, back on the historian topic, taking that and dropping that into Ovation, we can also play the same game on the process side with our DeltaV, with our process customers, too, because that same thing, a few new connectors and things, we really can look right into that area.
This is a cloud-native historian.
Yep.
It is a cloud-native historian, so it's very advanced in terms of technology.
Advanced historian, yeah. It's a great fit. Low hanging fruit for us to go and reach technological synergy.
That is a very straightforward integration.
Probably have our own opportunity to go after some new competitors in this space.
Oh, yeah.
We might. Yeah.
Possibly.
Possibly. Okay.
On slide, if we turn to slide nine, we've hit a lot of these points on the page, but just to cover them, what we did. In the upper part, it does expand our software portfolio, and we'll show you what the breadth and depth of that is in the next couple of slides. OSI itself has 50% recurring revenue and has 100% customer retention rate. We see that as very exciting to add into our portfolio as we expand our presence in the power market. We've already talked about the modular technology. We have the ability to take that to other areas of Emerson, into other end markets, and to other geographies. A large part of our synergy plan. We talked to you about the extension into transmission and distribution.
We've been working on different angles to move into that space for some time now, and it's great to be able to bring OSI into Emerson. I've already mentioned it doubles the served market and then also gives an entrée to another $5 billion of expansion. The mega trends, clearly environmental sustainability, adoption of renewable energy across the grid, across the world, will be with us for some time to come and will really drive the adoption of ADMS. We've had OSI, hats off to the entire team through 2020. They marketed their company, they battled COVID, and they grew 20%. Phenomenal job. Their historical growth rate is around 15% consistently in the last five years. It is margin accretive immediately at mid-30s EBITDA with 25% free cash flow margins. Extremely strong backlog running into 2021 and beyond with some significant large customer contracts that are multiple years.
We have a really good background, excuse me, backlog to grow into.
Can I interrupt you here?
Of course.
A couple comments here. One, we fundamentally believe this business will grow 10%, 15% for the next several years.
Yes.
What we see right now, they have a huge backlog.
Project backlog.
What do you guys see right now, Jim and Bob, for the backlog and also for the funnel?
The backlog right now is about $300 million.
Okay.
We think we'll generate another $100 million in backlog in 2021. Going into 2022, we should get close to $400 million backlog.
Okay. On the funnel side, they've got about a $1.3 billion funnel worldwide, projects they're pursuing right now and bidding all the way from early qualification to bidding and closing. A lot of that's international, Dave.
Yeah.
One of the things they've, as you see, 85% in North America, but a lot of the opportunity we see right now, and they see, is to go internationally here. That's something I think from our international infrastructure, we can take them to a lot of countries.
Much stronger than they have.
Much stronger than they have.
Yeah.
We can take them into some of the world areas and be really successful in converting that funnel.
A lot of the large utilities are globally. We have 1.3 million MW, again, around the world. We have great presence globally in power generation. We can go into those key accounts now.
Good. Go back to you, Mark. Sorry, guys.
In terms of the transaction summary, it was a competitive process that was run. The cash price is $1.6 billion, as we indicated in the press release, with 23.5 x next 12 months EBITDA. It is EPS accretive immediately, excluding amortization and other acquisition accounting charges. We believe this will close very early in our fiscal 2021. You can think about October. Our pro forma net debt leverage ratio would be 1.6 x. All well within our balance sheet capacity. We really look forward to working on the integration plan with OSI and look forward to getting past the customary regulatory approvals to get it part of Emerson as soon as possible.
One of the things that we had done, if you had paid attention back in the April/May time period, February, April, May time, March time period, Frank Dellaquila went out and borrowed some money at very low interest rates to get our balance sheet strong, one, for the COVID crisis, but also we knew in this process, we were working forward to try to land one of these acquisitions. We had already funded this at very low cost of funds, and our balance sheet has the flexibility to do this acquisition at this point in time. We also have the flexibility to do more acquisitions in the next 12 months as we get forward here and continue to integrate. Something we're ready for. We're ready for this, and our balance sheet's in great shape to handle this one right now.
Okay.
Why don't we step back a little bit and look at the overall software portfolio, David, and Mark and I will go through the next few charts. Page 10. Back in February in New York, we segmented the software business within automation, and this is an Emerson perspective here on page 10. We talked about a $500 million software business. The total software business at the top of this pyramid, which is we're calling standalone software, is sized at $1.1 billion today. That is $750 million approximately pro forma with OSI power in it, and about $350 million of associated services.
Engineering services.
Engineering services for implementing and then application of the software. That's the top of the pyramid. In addition to that, there is embedded control software and software-enabled devices, which are a variety, and you can see a few of the brand names that we use across the corporation there, from DeltaV to PACSystems in commercial residential.
Ovation.
Ovation, of course.
Yes.
$1.3 billion there. In total, the software innovation is approximately $2.4 billion of revenue as we look across the Emerson portfolios.
We'll start tracking and monitoring this information and report to the shareholders so they can see it, because we've been making this investment for quite some time. It's not a one-time push. We've been doing this on for the last couple of years. Obviously, we have not disclosed it until February, now I think it's very important for us to continue to disclose it, in particular, given the fact that we're making a significant investment, the largest investment in software that we've ever done, with the OSI acquisition here. We have a great background and a lot of software-enabled products across this company and a very strong, powerful situation as we built it in the last couple of years.
If you turn to slide 11, we just give you some examples. We've talked about a few of these already, the OSI ADMS, Bob talked about the digital twin, clearly software at the highest level. The control level of Ovation control system, where again, PWS under Emerson has moved from 25% market share to around 50% in North America and controlling half of our power in the country. This also applies to commercial residential solutions with the supermarket control system, which we've actually had for over 15 years in the marketplace, and we continue to add capabilities. On the commercial and residential side with the recent acquisition of Verdant for hospitality, energy efficiency thermostat systems that cut across the whole hotel, for instance. At the device layer, obviously we've debated how to include the devices, when to include them.
We've taken a very cautious approach in what we include in ensuring that the embedded software-enabled devices that we include really need the software side of the equation for them to exist. We wouldn't have cargo tracking if we didn't have the corresponding software. That is what really creates the value. We're taking a pretty strict definition there, to make sure that software is the primary driver of everything on this page and everything on the prior page that Lal went through with you. Okay. Then slide 12, just to wrap it up and then move into Q&A. Really, as we look at the spaces that we can continue to look at in the software area, we do like our devices.
Rest assured, we will continue to look for the right devices to help us create a stronger solution for our customer, and create value for our shareholders. We are also looking at adjacencies within the software space, for both platforms and for Emerson in total. There's some exciting opportunities. As you all know, these are very high growth areas, high margin areas, expensive to get into, but well worth getting into these areas, to create a broader solution in the marketplace and continue to strengthen Emerson for the long term.
With that, we'll move to Q&A. We'll open the phone line up to take on questions. Again, what I'll do is, you can either ask specific an individual or just ask a question, and we'll probably pass it around the room based on so you get the various inputs from the various leaders here in the room. With that, the line's open.
Our first question is from Steve Tusa from JP Morgan. Go ahead.
Good morning, this is Steve Tusa.
Hey, good morning, guys.
Good morning.
When you think about the technology here, I think you touched on it a bit, but do we think about this as kind of longer term, the growth is in T&D, or is there an opportunity to take the platform or the embedded technology and leverage it, kind of across other process disciplines or discrete disciplines as more of kind of an end market neutral type of technology?
Steve, I'll give you my inputs first, then I'll turn it over to the experts, Jim and Bob here. From my perspective, when we went into this process and started looking at OSI, I call OSI Power, that we saw a lot of unique technologies, a lot of integration opportunities. We see a lot of opportunity to take this outside, what I call the core power and water distribution side into the generic power or process side. We're very excited about it. Clearly, we'll take our time, and we'll let Lal and Jim go through this.
There's some unique opportunity here for us to take this a lot broader and to move it way outside the band that it is today, and it's the reason why I wanted to report it into Jim Nyquist versus a Bob Yeager, because Bob is very much focused on power to water, and Jim would take it to a broader perspective. Jim, Lal, Jim, why don't you give your two cents here?
Yeah. David, that's exactly right. What we actually found when we began our engagement with the management team in Medina, Steve, was that they had already started to pursue opportunities in a broader segment of the marketplace beyond power.
Right.
They saw it very important from their perspective to diversify their business into natural gas distribution networks, into water and wastewater controls. There's absolute application. Jim, you've seen the funnel, and there's a significant amount of process.
There is. There's some process opportunities. I think you may recall we bought a company, ESI, a few years ago that really does pipeline optimization and scheduling applications. When you take that kind of capability that sits in that pipeline area and combine it with the SCADA and the distribution capabilities here, it's a natural fit. We see those kinds of synergy opportunities on an industry basis. We also see, again, we talked about the historian. The historian is because we scale that very horizontally across all industries, that's another easy piece. We begin to develop that list of areas we think there's a great opportunity to take either technology or applications and then move them into some of the other industries.
Yeah. I think, Steve-
What's so special about that technology? Is there something that they've worked on that's kind of something that's unique to these guys outside of the end market?
Okay, let me start with the Monarch platform itself. We believe it's technically superior to the competition right now, because if you think about the T&D space, the competitors right now, when they do a new transmission or distribution system, they have to write a lot of custom code. They kind of, a lot of times, go with a one-off system. The unique thing about Monarch and what Baumann has done over the last, say, 10 years is create a very standard platform, a lot like Ovation. You'll see the same software in a nuclear plant that you will in a hydro plant, you have a coal plant or a combined cycle plant. You see Monarch with this configurable software.
Modular
modular software.
Configurable, yeah.
No custom code required. It's a very, very unique feature, and that's why they're so profitable. Okay. If you look at their EBITDA, and you and Mark's gone through that's why they're profitable, because they don't have to write a lot of custom code for this platform. If you think about changing the dynamics, they've done it in the T&D side already. Think about pipelines. Think about water distribution, right? If you have a configurable software product that can do that across all those, and it's just the apps that are different, see enormous advantage, from just delivering projects and cost reductions and profitability. We merge the platforms together, and create at least in power, the next generation power management system that's configurable.
I think they have the core software, as you say, modular, and then the opportunity for us to put more applications on top of that core system in the other industries.
That's why it's so unique, Steve, is because of their approach and the fact that we can use our core software today and embed it right into their modules and sell it on. It's a lot easier to take a cost if it was very specifically written for one industry. This is not written for specific one industry.
Right.
I think we can take it into other industries and, more importantly, we can take it around the world, which they do not have the strength that we have around the world. There's a lot of growth opportunity here in a very profitable business, and it'll allow us to change some of our investment profiles within the company today too, not just in power.
Great. Okay. Thanks a lot.
All the best, Steve. Take care.
Our next question is from Andrew Obin from Bank of America. Go ahead.
Hi, guys. Can you hear me?
Good afternoon.
Yeah, I can hear you, Andrew. That's okay.
Yeah. Good morning. Just as I think about this deal, it seems a very nice tuck-in that fits in, but how should we think about two things? First, M&A, how much spent on software versus hardware going forward? The second, just in terms of capital allocation, M&A versus buybacks. How do you think about the two of these balances?
Yeah. I think that from our perspective, I would say that we're trying to target more of a 50/50 software versus unique software, sensors or hardware, Andrew. I think that's very important. There's not a lot of software assets out there that are very specific to this industry, but we're continuing to look at those. We're looking at a 50/50. If you looked at the number of deals the last couple of years, you look at the number of software control and the number of sensors, we were basically 50/50 in number of deals. Dollar-wise, it was more probably deals with sensors because of the V&C acquisition. For capital allocation standpoint, we'll still target next year 1+ billion type of transactions for acquisitions. We'll be looking next year, most likely, around the $500 million share repurchase number.
We'll take it down a tad because of this acquisition, as we talked about in February, but we're still going to do share repurchase. If we don't do the deals, we'll do more share repurchase. We want to get our ratios back down a little bit. I think we're going to be at 1.6, 1.6.
1.6, 1.7 EBITDA to debt. What we want to do is get that down a tad. That's how we look at it right now, and we're out there working software deals, as fast as we can from that perspective.
Thanks a lot.
Andrew, your son can ask the question.
Yeah, I know. I'm getting incoming messages from that. Yeah. I know.
Okay. Well, if he has a good question he wants to know, is dad a good guy or not? Let me know. I'll talk to him about it, okay?
He has a toy dinosaur called David Farr, so you should know.
You're calling me a dinosaur? Oh, God, Obin.
No, no. It's a predator.
My favorite dinosaur was the Tyrannosaurus rex. You can imagine, I used to eat shit.
It is a T. Well, I think that's the reference we were going for, Dave.
T-rex. Okay, next one.
Our next question is from Andy Kaplowitz from Citigroup. Go ahead.
Close enough. Good morning, guys.
Good afternoon, Andy. Good morning.
Hey, Dave. Look, utility customers, at times, I think you know this, tend to be a little slow at adopting new technology, but it doesn't seem like OSI has had any issues with its growth. Could you give us more color into that 5% market penetration that you talked about with OSI? How likely do you think it will be, for instance, for utility customers to adopt ADMS and an accelerated pace, as you mentioned? Do they have to adopt as they move more to renewable base? How much does Emerson Global Power Gen platform help awareness to that penetration?
I will let Bob answer the question in detail because he'll get into the micro. Top line, Andrew, they really have no choice.
Yeah.
The major utility companies are going to have to go this route. They built this structure off of the old GEs or the Siemens or the ABBs, and it's just not flexible enough to deal with this movement to renewables, and it's balanced back and forth. On the short term, why our power business North America is doing so well right now is because the power grid is struggling, or the power generation is struggling. Renewables in our service business right now is growing more than double-digit, basically, in North America because of this. They really have no choice. Let Bob.
We mentioned it's highly under-penetrated at 35%, right?
Yeah.
We know about the microgrids, the commercial microgrids, and the integration of renewables is not going to change.
Yeah.
As this continues, and this trend will continue, it creates these instabilities. It creates instabilities on the grid with volt/VAR, creates frequency issues. At the distribution level, this is definitely software that's needed. As more and more microgrids come on and the renewables come on, it's going to create more of these issues, and they're going to definitely have a widely adopted distribution.
I mean, the hydrocarbon plants right now are running very inefficiently. They're breaking down, and that's why our service is doing so well. As the states and the countries have set renewable goals, I mean, for instance, Europe has set renewable goals. U.S. state that's set renewable rules. In the state of Missouri right now, the number is 30%. They're sitting probably at 10. They have no choice. They're going to have to move this way in order to manage this. That or they're going to have a very unstable grid like you see in California right now, and that's not going to work for the consumers at all. I think this is a very powerful message. We know right now, a Southern Company, not mentioning the name of the company, but a Southern Company type company is looking right now to go this way.
They're going to go out and go towards ADMS versus the old style.
Yeah. If you look at just CapEx, capital spending, traditional generation versus Transmission and Distribution, it's like 10 x the amount of capital spending over the next 5 - 10 years.
In T&D. When you look at what we see, they're going to see 10 x more in this space.
Right. It's for two reasons. One, for the grid stability issues and just for the support of renewables.
Yeah. Correct.
If I could just add one thing. We're buying the leading technology in ADMS, in our opinion, and OSI's technology, coupled with Emerson's financial backing and breadth and depth in the power industry, provides a lot of credibility for these larger North American power utilities to adopt OSI's technology as part of Emerson, as opposed to an independent company. It is a very strong value proposition that we can now give to the power industry.
Very helpful, guys. Just as a quick follow-up there, you mentioned the 5% that they have as a percentage of the T&D automation market. What's the competitive landscape like then? Is it as simple as this renewable ramps up and it's part of the Emerson platform, you get that above-market growth that gets you much higher penetration? Like, who are you taking share from?
Andrew, Andy, let's let Lal mention it first, and then Bob can comment there too, because we compete against them. We know who the common-
Mm-hmm. Sure.
the guys in the old technology and the ADMS technology. Who are the top players in the older technology?
We've got General Electric out there. We've got ABB Hitachi with the older technology established. The ADMS technologies, that shift is occurring at about a 9% market clip.
Yeah.
You noted OSI is growing at a 15% market clip on that, and it's displacing some of those traditional GEs, ABBs that are out there in the grid. Bob?
Right. Again, it's a standard approach, right? What most customers do not want is a one-off. They don't want someone to come in and put a system in and then write a lot of custom code, and they're off on their own. They like to be able to upgrade over time, and they like to take advantage of new features of the software. That is the key difference between the monarch platform and the competition. That is really what the differentiation is there. ABB, the grid system is now part of Hitachi. There's a lot of dynamics going on there. We believe that from a product technology perspective, OSI is a level above the competitors. When people are looking to get this new system, they want a standard platform.
Yeah. I think that the key issue, Andy, is that with our reach across the world in the power generation, we have a very strong presence. They know who we are from the top, from me on down. We have the capability to really take them into customers they've never been in before, both in the power side, but going back to another question we had, into the process world too, where there's this type of distribution going on in the T&D industries that we see. A lot of unique leverage both in the core but outside the core.
Thanks, guys. Congrats on the deal.
Thank you.
Thanks.
Our next question is from Joe Ritchie from Goldman Sachs. Go ahead.
Thanks. Good morning, guys. Interesting deal. Congrats.
Morning, Joe. How are you doing, Joe? Thanks.
Hey, can you guys dig in a little bit into the revenue model? You guys mentioned 50+% recurring revenue, also kind of referenced the backlog that was almost 2x the size of trailing 12 months revenue. How does the revenue model actually work, and is it right to think of your backlog as kind of being like a two-year backlog?
No. Jim, why don't you explain it?
Not two years.
It's not two years. What happens, and I'll let Jim talk about it. They just won a huge Hydro-Québec project on the T&D side. We won the system side, the generation side. Siemens has been taken out there. We're putting Ovation in, and they won the T&D side. These type of backlogs will go five, 10 type of years. Why don't you give him how the model works relatively? He's trying to understand this from the standpoint of all of a sudden, we're going to see $500 million of sales in the next two years. Why don't you talk about how that works?
It does spread out. It really is a combination of licensing and all the software engineering services that go along with it. I think if you want to split those up, you could say it's probably about 40% license, 40% engineering services, and then about a 20% ongoing maintenance and recurring revenue specifically on that side. That's the way it works. I would say, yeah, that backlog is going to run out over, some of that backlog is going to run out over four or five years, like a Hydro-Québec.
Yeah.
There's a little bit of quick turn business here, the subscription or the ongoing recurring revenue. You've got the longer-term licensing, which will run out over multiple years as they ship it out.
What we'll have to do, Joe, is when we bring it in, I haven't talked to Frank Dellaquila about this, we have a very disciplined approach to backlog. When we report backlog to you guys, it doesn't go 10 years or five years. We're, I think, what, 18 months?
Correct.
18 months. When you report back those, Bob's got contract to run out five or six years too. How long does your hydro contract run?
The maintenance goes for 15 years.
Yeah.
The base contract will be done by 2023.
Yeah. We'll bring that into our backlog calculation. What we want to let you know is they have a very healthy business model right now running out for many, many years. We're going to quickly work on the big project, in particular outside the U.S., to see if we can land those projects, given our organization, to help them land them very quickly. Very healthy background right now, backlog and helpful from that standpoint. Does that help, Joe?
Yeah, super helpful. I guess just the follow-on, as you're thinking about the international opportunities and still a small portion of the business today, is it predominantly Europe? How much of it is being driven by, obviously, renewable standards and the Euro Green Deal, maybe accelerating some of those standards. I'm just curious how you kind of plan to go after the international opportunity.
The $1.5 billion funnel, about $400 million is in Europe, about $400 million in the U.S., the rest is split between Middle East and Asia.
Yeah.
So Europe-
Europe's big.
is approaching the U.S. pursued list. Yes.
Yes. To your point, Europe's going to be very shaky.
Which is why we love this, because we were counting on North America, where we have a lot of presence there, and we talked about the key accounts and the collaboration in the key accounts. Equally exciting, maybe more exciting, is the international expansion.
Today, Bob, if you break down PWS in between the three buckets I look at, the Americas, Europe, to help Joe out here, and Asia Pacific. How do you break down roughly today?
we're about half U.S.
Okay.
North America.
Yeah, North America, about 50%, and then about 35% Asia.
Asia.
Right. We're split between Europe.
15, okay. That's how we break down PWS. I would say that Europe's going to be probably bigger in this case here because we're extremely strong. We have the largest power generation player in China.
Exactly. We have over 1,000 systems in China.
I think you're going to see this, over many years, go to 50/50, and 50 inside the U.S., outside everywhere.
Yep. Mm-hmm.
We can drive that given our organization. As you know, we have a very powerful organization outside. Automation Solutions today is what is your breakout sound today between Americas and-
In the Americas today, we're about 45%, David.
Yeah, 45/55.
Right around that way.
We have a large organization. We can help pull this thing around the world.
Interesting. Great. Appreciate all the color, guys.
Take care, Joe. Thanks.
Our next question is from Julian Mitchell from Barclays. Go ahead.
Hello, Julian.
Hi, good morning.
How you doing?
Good, thank you. Congratulations on this news. Maybe a first question.
I guess non-European companies can buy our software companies. I'm just paraphrasing.
No, I said congratulations. No, it's good to see the-
I know that.
skies getting evened up.
I saw a note come out on OSIsoft, and you said, "U.S. companies are dead. They're not doing anything." To paraphrase people.
I suppose for now at the end of the title, but that's. No, you're right. This evens out the playing field.
You know, Julian, you got to take cheap shots from the CEO once in a while. You give them back to me, as you well know.
Maybe, Dave, one question around the integration of the business? As you know, it can be difficult for industrial companies sometimes to integrate software pure plays. That's a common issue across the world. Maybe help us understand how this will be integrated, what happens to the management, the existing management of OSI power?
Okay. I'll let Lal go first with it, and then Jim. Go ahead.
Yeah. Thanks, Julian. We do have a $1.1 billion software business within the corporation already that we're managing and working through. The cultures in those businesses, the times and the management processes we use are different.
Yeah.
We integrate them into the overall financial systems, et cetera. We're excited about the management team. It's a very solid management team. We're buying a great group of employees. I'll let Jim add a little more color on how the actual integration is going to go in the first three months to year.
Just for our interest, when we bought Westinghouse, at that time, it was called Westinghouse Power, and we bought it, and we changed the name to PWS because I didn't want to pay Westinghouse any more fees after a while. We left it alone. It reported up into, at that point in time, I think it was you, Jim.
Yep.
I think when I bought it, you were still running the systems business. We will keep it isolated, and we'll try to leverage it because we understand, to what your point, Julian, we could destroy it, and that's not what we want to do. Software is way too important into the next generation of growth. We'll keep it isolated as best we can and use the resources. They have great team today already, and they're young from that standpoint.
Yeah.
Jim.
I'll just add a couple of things, Julian, that, yeah, some of the software acquisitions we've made are product line extension or a gap filler in a particular business, so we integrate that pretty quickly. I think one of the examples, we bought a company a few years ago for the life sciences.
Yeah.
MES layer. It's called Syncade now. That's very tightly integrated in and a part of that group or that business. This one we see really more like what we did with Power and Water, as Dave said. It'll be a standalone business, new business unit. We'll create a new business unit for T&D here. This will be the cornerstone of that, and it will be really pretty much standalone. We'll run it as its own independent business. It's a standalone today. Then we'll look at where those synergy opportunities are, work very closely with Bob. Then, we have some other shared areas that we share across functional areas, across our systems businesses, and we'll look at how we can leverage those as well for some efficiencies. This will really continue to be pretty much a standalone new business unit.
We have an integration plan now that first thing will be
Go out and work with their accounts and their customers on how can we leverage the strength of Emerson to help them close some of those deals. The second priority will be where do we find these technology and industry synergies that we already talked about?
Very helpful. Thank you. Maybe just a more prosaic financial question, secondly. Maybe help us understand what kind of cash-on-cash returns, maybe by year five, you'll get from the deal, and whether that type of return is consistent with what we should expect from future Emerson software acquisitions.
I'm not going to put a cash-on-cash return out there, but it's going to be a very good cash-on-cash return, and it will be consistent. I think some of the smaller deals, we get better cash-on-cash deals because they're less competitive from the standpoint of the opportunity here. This is accretive from a return standpoint and margin standpoint, and the returns are very good. From our software acquisitions, we've done very well over the years. Obviously, the smaller ones, we get better returns, but that's how we see it, Julian.
Great. Thank you.
Thank you.
Our next question is from Josh Pokrzywinski from Morgan Stanley. Go ahead.
I guess close enough. I think that's me. Hey, Dave. How you doing?
You want to try that again, Joe?
We'll go with Josh Pokrzywinski. I didn't know if Joe at Goldman was-
No, but he doesn't have that. Yeah, he's inherited you, and you just send all the bills to Joe Ritchie at Goldman, okay?
Will do.
Hey, Joe. Hey, Josh.
We've covered a lot of ground. Good detail out there. Looks like a good pickup for you guys. I guess, in terms of the selling process, you have a few electrical guys that weren't on the list of major competitors for this business. I think of somebody like an Eaton that I think has some grid automation and self-healing capability. I guess, as you go to market with OSI or as OSI goes to market, is there some natural attachment point between hardware and software that needs to occur? Or is there a channel by which, hey, if you're selling some of the electrical gear, it's an easier add-on.
No.
I guess just-
No
help me out with how that interface works.
No.
That's the beauty of OSI. They're not tied to any specific hardware architecture. As a result, they're able to go across all the competitors' installed base.
Correct.
As we said earlier, with this highly configurable code that doesn't give one-off and a lot of custom code, that's really where a lot of their growth has come from competitive displacement.
Correct.
You combine that with this very fast-growing ADMS market, and we just really see it taking off.
I mean, there's a lot of smaller competitors out there, but the big competitors in this space are the big global companies. We all know who they are. We talked about them. They're the major players.
It's a lot like our control system when you acquired us in 1998.
Yeah.
We didn't have the hardware. We didn't have the turbines. We didn't build the turbines. That was all divested. As a result, we weren't tied to a specific major equipment or hardware.
It makes it a lot easier for us to sell.
As Mark highlighted on chart five, there are an interesting set of potential future opportunities at the device layer around intelligent sensors.
Yep. Intelligent.
That, I think is something we're going to continue to work and think about.
Okay.
Got it. That's helpful. I guess the other element related to kind of the purchase cycle is, are customers really looking to interface as they're adding renewables to the grid, i.e., do they need to be buying stuff to want to buy this? At any point along the way, will they just pull the trigger on ADMS?
It's not tied to the original. This is for optimization. To look at the generation loads, to look what I talked about, volt/VAR control, frequency regulation. They can add that in if it's not part of the greenfield project, but later on.
Later on.
To optimize the whole distribution system.
Today, how much money is being spent this year in the U.S. utility industry? What's the number? How many?
Oh, For the total T&D architecture, Duke, for example, is spending $10 billion over the next five years.
I think the top 10 are around $90 billion.
$90 billion.
They're spending a lot of money on this area right now because the big problem before they really expand the renewables is they got to figure out how to.
Bring stability.
really bring stability to the network. Unlike California, who doesn't think about things like that until the last second. You've got to bring that into. All the big major utility companies that supply the rest of the country are thinking about how they do that, and that's why they're going to invest it. They'll do it. They'll go out and make those movements, and it'll be made over five or eight years. It won't be a one big bang because they'll try to figure out how to manage that grid. Once they go forward, they move. They don't stop.
They're going to live with their custom software so long that the pain gets so much, they really got to move to a new architecture here.
That's how it goes, Josh. Thanks.
Got it. Appreciate it. Thank you guys.
Take care, Josh. Send your bill to Ritchie.
Our next question is from Christopher Glynn from Oppenheimer. Go ahead.
Thank you. Good morning. My name is Chris.
Good morning, Chris. How you doing?
Good, thanks, Dave. How are you?
I'm doing fantastic. I'm sitting, I look out my window, it's a nice kind of warm, humid day. Great day for air conditioners to break down. If you guys have an air conditioner breakdown, call us. We'll fix it, replace it. What can I do for you?
Beautiful day here today in Boston. I got it off for the first time all summer.
Yeah.
You talked about the 10%-15% growth outlook. It seems like that's the industry growth, but you've got a nice slide aid on cross-selling opportunities and talk about the impact of Emerson's financial backing helping them. I'm kind of wondering what are the prospects you could really grow much faster than that growth target, because that almost sounds like the market rate, but you've got some real levers.
Yeah, the market's growing less than 10%. The market's more like 8% or 9%.
9%.
9%. I would say, to be honest, Chris, the key issue for us from our perspective is if we can land some of the international programs which we have underway, if we can go out and land one or two of the big North America, the top 20 customers in North America, then we really do have a chance to grow this business faster than we just talked about there. We've got to land those. We've got to bring them on board. I think that the growth opportunities are enormous out there for us, as we get to working together on this. I think that from my perspective right now, our plan assumes X% of share gains around the world. We're looking at, say, just pick the midpoint, 12.5 versus the market of eight or nine.
We have that built in, but our hope is to obviously beat that going forward. This is so profitable that we can generate a lot more cash and returns for our shareholders.
One of their limiting factors have been just reach and their infrastructure around the world to be able to do that. I think when we bring ours in, both from a sales infrastructure, country infrastructure, engineering, service infrastructure, I think we can really create some real synergy there.
Yeah. Anything else, Chris?
What's that?
Go out. Another question?
Yeah, I was just going to say, what direction do you see the sales synergies developing faster? Synergies to Emerson's platform would probably be displacement versus Emerson pulling OSI would be pulling adoption probably.
Yeah. I think our biggest opportunity is really to help them with our international organization. We're going to work very closely with Baumann and Al on this from that standpoint. We're going to try mobilize their teams and our teams together on international projects that we see, in particular around Europe, which are on the table right now. I think the next thing is that we'll be able to go out. There will be RFQs coming in the U.S., in the top 50 utility companies. There are RFQs coming right now around this change to ADMS. I guarantee you, we will be right there as one company, and OSI will now have the backing, obviously, of Emerson. Same thing that Bob saw when he was a young engineering guy at Westinghouse. The backing of Emerson made a big difference relative to getting these customers.
We've quadrupled our business since becoming part of Emerson.
I think that's where we go. Then the technology stuff will take some time. You're exactly right. I think there's some things we can do pretty quickly, and we're pretty excited about this. I'll wrap it up here with you, Chris. We're extremely excited about it. A unique opportunity, a unique software company that really fits very core to what we offer today, both on the true process side, the power side, the water side, and I think we see some unique opportunities out to create some new business models to grow and to change the profile of some of our businesses inside Automation Solutions. With that, I'm going to wrap it up. I want to thank everybody. If you have any questions, call Pete.
Pete's quite knowledgeable about this space, obviously being involved in the due diligence, but also coming out on the power side of the process world. Thank you very much, and I appreciate your time today. Bye.
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