Emerson Electric Co. (EMR) Q1 2020 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, thank you for standing by. Welcome to Emerson's investor conference call. [Operator Instructions]. This conference is being recorded today, February 4, 2020. I would now like to turn the conference over to our host, Pete Lilly, Director of Investor Relations at Emerson. Please go ahead.

Thank you so much, and welcome, everyone, to Emerson's First Quarter 2020 Earnings Conference Call. I'm joined today by David Farr, Chairman and Chief Executive Officer; Frank Dellaquila, Senior Executive Vice President and Chief Financial Officer; Mike Train, President; and of course, Tim Reeves, Director of Investor Relations, Emeritus.

Emeritus. I graduated.

I encourage you all to follow along in the slide presentation, which is available on our website. I'll start on Slide 4 with the results of the quarter. Underlying sales growth came in slightly below expectations, flat year-over-year, driven by softness in global discrete markets and North American upstream oil and gas activity. Despite lower sales, operations executed well to deliver adjusted EPS of $0.67, spot on the guidance we've provided in the fourth quarter call. Automation Solutions underlying was up 1%, which was somewhat below management's expectations, primarily due to the aforementioned U.S. discrete and upstream market softness. Demand in other global process and hybrid markets remained stable. Importantly, we also saw several large LNG projects booked in the quarter after delays from the second half of the year -- of the last year. Commercial & Residential Solutions was in line with expectations, down 1%, reflecting continued softness in global professional tools and cold chain markets, somewhat offset by stronger markets in Europe and Asia, Middle East, and Africa. The company initiated $97 million of restructuring actions in the quarter, well above the $70 million discussed on last quarter's call. These actions, combined with incremental actions from the second half of last year are expected to drive improved profitability in 2020. Cash flow performance was solid in the quarter with free cash flow, up significantly versus prior year, reflecting 94% conversion of net income. Turning to Slide 5. We'll review the P&L. First quarter gross margin was roughly flat at 42.4% as favorable price/cost was offset by unfavorable business and regional mix, primarily due to lower U.S. shale and highly profitable upstream and discrete markets. SG&A as a percent of sales increased 110 basis points to 27.1%. However, this includes 150 basis points of unfavorable impact from higher stock compensation due to a higher stock price. Adjusted EBIT and EBITDA margins, which exclude restructuring and related costs, declined 180 basis points and 170 basis points, respectively. Importantly, these changes include 220 basis points of combined unfavorable impact from stock compensation, pension, and FX losses. Excluding these impacts, adjusted EBIT and EBITDA margins were up 40 and 50 basis points respectively, reflecting strong read-through of prior year restructuring actions. Turning to Slide 6. From a geographic perspective, we saw mixed underlying sales results in Q1. The Americas were down below expectations due to weak U.S. upstream oil and gas and discrete end markets. The United States and Canada were down 3% and 1%, respectively; and Latin America, up 4%. Europe was down slightly with 2% growth in Western Europe offset by sluggishness in Eastern Europe. Asia, Middle East, and Africa was up 6%, led by China up 6% and strong growth in the Middle East. Turning now to Slide 7. Total segment adjusted EBIT margin dropped 40 basis points to 15.4%, reflecting the negative impacts of foreign transaction losses as well as unfavorable business and regional mix. These items totaled 80 basis points unfavorable impact. As previously mentioned, stock compensation costs increased due to a higher stock price, and pension costs increased due to lower discount rates. Corporate and other costs, excluding restructuring and related costs, was favorable. Q1 cash flow performance was solid. Operating cash flow increased by over 30% to $424 million, and free cash flow of $310 million represented 94% conversion. Turning to Slide 8. We will bridge first quarter EPS. Tax, stock compensation, pension, and foreign exchange transactions totaled $0.13 headwind for the quarter, which was in line with guidance. Operations, share repurchases and lower interest costs delivered $0.05, also in line with guidance to net $0.67 of EPS on an adjusted basis. In summary, operations and balance sheet delivered our target EPS contribution on lower-than-expected sales. We will now review business platforms, turning to Slide 10. Automation Solutions underlying sales came in somewhat below expectations at 1% growth for the quarter. December trailing 3-month underlying orders were up 2%, driven by several large LNG bookings that had been delayed from the second half of last year. Of note, backlog grew by 7% to nearly $5 billion on a sequential basis compared to last quarter. The Americas underlying sales were down 1% as discrete and upstream markets continued to soften. Europe sales were also down 1% as low-single-digit growth in Western Europe was more than offset by weakness in Eastern Europe. Asia, Middle East, and Africa grew 6% led by China and the Middle East. Our long-cycle businesses continued steady growth with both Systems and Final Control, up mid-single digits. Adjusted EBITDA margin was down 60 basis points, reflecting 50 basis points unfavorable impact of FX transaction losses as well as unfavorable mix resulting from the year-over-year decline in the more profitable North American upstream and discrete markets. Excluding these impacts, the business delivered improved adjusted segment EBITDA margins on lower-than-expected sales, reflecting the benefit of 2019 restructuring actions. In the quarter, restructuring actions totaled $83 million across the platform. These actions, together with approximately $30 million of incremental actions in the second half of 2019, are expected to support improved adjusted segment margins on flat to slightly positive underlying sales for the year. Now turning to Slide 11. Commercial & Residential Solutions underlying sales were down 1%. December trailing 3-month underlying orders were also down 1%. The Americas underlying sales were down 3% as North American residential HVAC markets remained soft, and slower industrial markets weighed on professional tools and cold chain demand. Latin America grew by 6%. Asia, Middle East, and Africa grew 5% with mid-single-digit growth across China, the rest of Asia, and the Middle East. Commercial & Residential Solutions adjusted EBITDA margin increased 90 basis points, primarily reflecting favorable price cost and the benefit of prior year restructuring actions. For the quarter, restructuring actions totaled $10 million. Combined with approximately $5 million of incremental actions from the second half of 2019, we expect improved profitability for the year on slightly negative underlying sales. Turning to Slide 13, we'll cover the updated guidance. Despite some progress toward trade resolution, we continue to expect geopolitical tensions, pending elections, and corporate focus on cost-cutting to drive a no -- a low to no growth environment in 2020. On the full year, there is no change to our expectations for underlying sales. Of note, this outlook does not include any potential impacts from the unfolding coronavirus, which will be discussed later in the call. As highlighted on the last call, Emerson has managed multiple economic slowdowns in our history. And in the current environment, we have shifted our management investment focus from a growth mindset to a cost mindset. We initiated this process last year, increasing restructuring investments $35 million in the second half of 2019. Today, we announced the next phase of that plan. For fiscal year 2020, we expect total restructuring spend to be approximately $215 million, of which $175 million will happen within the Automation Solutions platform. Commercial & Residential Solutions and Corporate will each take $35 million and $5 million of actions, respectively. Of note, during our upcoming investor conference, we expect to present an additional detail of the outcome of the Board's review announced on October 1 as well as update the longer-term guidance framework beyond 2020. We now expect adjusted EPS in the range of $3.55 to $3.80, an increase of $0.07 at the midpoint, reflecting the benefit of 2020 cost actions. We expect minimal net cash impact from restructuring actions. Operating cash flow is now expected to be $3.15 billion, and CapEx spending has increased to $650 million, leaving our free cash flow target unchanged at $2.5 billion. Please turn to Slide 14. This slide bridges our 2020 adjusted EPS guidance. The starting point for the bridge is 2019 GAAP EPS of $3.71. Walking across to the right, we have adjusted 2019 EPS of $3.69, which excludes $0.14 of favorable discrete tax items and adds back $0.12 of restructuring charges. Continuing from $3.69, we expect a total of $0.26 of headwind this year for tax, FX, stock comp and pension. Largely offsetting these headwinds, we now expect $0.15 of operational improvement on flat to slightly down sales, up from $0.08 discussed in our prior guidance, reflecting the benefit of 2020 restructuring actions. We also expect $0.09 of EPS from improved debt cost structure and a strong balance sheet with $1.5 billion of planned share repurchases. This gets us to a full year adjusted EPS midpoint of $3.67. Please turn to Slide 15. This slide lays out our second quarter 2020 guidance. The underlying sales outlook for the quarter is flat, reflecting continued headwinds in North American upstream and global discrete markets. Note that this outlook does not include any potential impact of the coronavirus. Despite continued North America mix headwinds, we expect total segment adjusted EBIT margin up 20 basis points and EBITDA margin up 60 basis points, driven by the benefit of prior year restructuring actions. We expect adjusted EPS of $0.81, which excludes $50 million of planned restructuring actions in the quarter. Please turn to Slide 16. This slide lays out the first and second half adjusted EBITDA margin progression for our business, assuming the midpoint of their respective underlying sales guidance. We expect first half restructuring spend totaling approximately $145 million across both platforms. These investments, together with easing mix headwinds and favorable price cost, drive significant margin improvement in the second half, with Automation Solutions adjusted EBITDA margin up approximately 150 basis points and Commercial & Residential Solutions up approximately 100 basis points. We plan to exit 2020 with an improved cost structure that yields stronger earnings and cash as we go forward, and we look forward to laying out our long-term plans at the investor conference on February 13. And now please turn to Slide 18. And with that, I will turn the call over to Mr. David Farr.

Thank you very much. I want to welcome all the Emerson investors this afternoon and the analysts that follow Emerson in our markets we serve as we discuss our first quarter results and what we expect for the full year. I also want to thank all the Emerson leaders around the world and for all the Emerson employees that make this -- made this quarter happen and are implementing the total aggressive cost resetting programs to make Emerson stronger, more competitive as we deal with this challenging and uncertain global industrial and commercial markets. Thank you very much for your efforts. As you can see for the first quarter press release, it's been a busy, busy first quarter executing around our 2.5-year cost resetting efforts. As you know, we accelerated the fourth quarter cost resetting by about $35 million. That money and those savings are flowed into this year, built into the plan originally and from a savings dollar for dollar, maybe a little bit more than a dollar per dollar based on the -- it was a headcount reduction program. In the first quarter, we did $97 million. Part of that includes corporate, where we took down the Emerson plane fleet to 5, and we sold the helicopter. We are expecting, for the total year, around $215 million of restructuring. And in total, you'll see next week well over $420 million, $425 million of cost reductions during this time period, over this 2.5 year time period, with savings well north of $425 million. And we're expecting incremental savings on the first quarter restructurings around $50 million. The big issue now is we're starting to attack and go after the access facilities and the higher cost structures will pay back more in '21 and '22. But we're going to continue to drive -- and you could see well into the second half this year and well into 2021. We will have over dollar for dollar savings when it's all said and done, and the execution is going pretty well at this point in time. I'm pleased with it. We reviewed with it at great detail yesterday with the Board. Well more than 3.5 hours of details with the Board as they understood what we're doing to make sure we're taking permanent cost actions, permanent cost setting and not damaging the core quality of investments, the technology and the customer service support that we have out there, not damage the long-term viability and franchise businesses that we have at Emerson. As you know, we have our annual investors conference next week in New York City on February 13. It's going to be -- not be on Valentine's Day. It's unusual for me. So you guys get -- make sure you do everything special for your spouse that evening, but we're going to be doing our call -- our investors conference in the morning. Details around the global cost resetting to drive the new peak margins, where we laid out very detailed with a lot of growth -- the very little growth environment. You'll see what we're trying to undertake and how we're trying to do it, the timing, the annual savings when they're flowing in, when we're going to reach those margins from an EBIT basis, in an EBITDA basis. At the same time, we're taking very significant actions around the corporate headquarter structure not only here in St. Louis but around the world as we look at best ways to optimize our cost structure, looking between the Automation Solutions and the Commercial & Residential. This is driven internally by the key leaders, the business leaders and the corporate leaders, but also with the support of McKinsey as we looked at how we could optimize Emerson's efficiency, effectiveness and profitability to drive record levels of margins by each of the major business units. Lal, Bob and I will put more color on this next Thursday, but we have very good progress. As you can see, in the second half of this year, Automation Solutions margins are starting to pop up. Bob took after this last year, Bob and his team, Bob Sharp, and they're already seeing improvement in the underlying profitability of the businesses. So the actions are taking hold, and they're doing a good job, and we'll talk a lot more about that as we go forward. But as the global Emerson employees know and know full well, we are fast in the execution mode right now. And we cannot depend on the fact that there's no growth out there. We are figuring out how to grow our profitability, how to grow our earnings and grow our cash flow in a no growth, low growth or maybe a negative growth environment. I'm ignoring the coronavirus right now. Both Mike Train and I will talk a little bit about this and what we see at this point in time. But it's definitely, definitely going to have an impact in the near term, medium term, and potentially, long term as we look at this. As you could see, our total orders are trending in the plus 2, minus 2 range right now, trending right now towards the 0 as we look at the current month in the current quarter. It tells me that we are trending very tightly in the range that we've laid out for underlying sales. We continue to look for those catalysts that drive up in North America and other markets of the world. But as I look at the world order pace, I look at the sales pace right now, North America is weak, weaker than we thought. Western Europe is about in line, 2% to 3%. Eastern Europe's down, primarily driven by Russia and Turkey. The Middle East and Africa, which we were just in, was -- is doing better, and several large projects are happening underway. In Asia Pacific, as of the middle of January, was trending pretty well and had pretty good growth in the first quarter, and we still look at pretty good growth for the full year there. My concern as I look at the next couple of quarters is, I don't see the catalyst that drive the fundamental pick back up in the U.S. at this point in time. I don't see Canada, nor have I seen Mexico and other parts of Latin America. What we're trying to do right now is control our destiny through our costs and cost resetting to figure out how to drive better earnings and cash flow through this cost reset. If growth comes and we get it, so be it, but we're going to have to fight, I believe, all year long for incremental pockets of growth and things are continuing to happen to us. As you could see, the global markets are not easy at this time. They're definitely not easy. I do see opportunities for growth out there. But I don't see how and when we will get to those levels at this point in time. I know people believe there will be a stronger second half. But from my standpoint, right now, I'm not betting on that. This company is betting on very low growth, moderate growth or no growth, and we're driving the actions necessary around that. Operating cash flow will be good. You saw the first quarter. We had very good operating cash flow for the first quarter. Some of that was trapped, in my opinion, working capital on the balance sheet. We also had some cash flow based on taxes. Frank had done some restructuring, Frank and his team, restructuring taxes that flowed through in that first quarter. That should continue to help us as we go into the first half of this year. Overall, I think our cash flow is going to be up nicely in the $3.15 billion to $3.2 billion. Right now, as we reviewed with the Board, and how we see this, assuming no significant acquisitions, we're going to pay back $1.2 billion in dividends. We're working on our 64th year of increased dividends. Our dividend ratio, as you look at free cash flow, is dropping down below 50. Our share repurchase somewhere around 1.5, assuming no significant acquisitions at this point in time. So close to 85% of our cash flow should be repaid back to shareholders in support of what we're trying to do with our shareholders. Again, if we have the opportunities for acquisitions, we'll take them. We're also assuming higher capital spending this year. We've raised capital spending up to that $650 million range, $650 million range, in support of the actions we're taking as we build new best cost locations around the world, as we've continued to reset our facility structure and our cost structure. Our acquisition funnel right now is pretty small. People are very nervous about selling assets at this point in time with the uncertainty around the cycle now with China situation. We have, in the process, we're in the process right now of closing 2 nice little bolt-on acquisitions worth about $120 million of sales -- or not sales, $125 million of value purchase price, both -- one in Automation Solutions, one in Commercial Residential Solutions, both in the control element part of the pyramid that we always talk about. While Mike and I are joined -- and we're going to tag team a little bit on China, give you some insights to this. Let me give a brief overview. I'm going to turn over to Mike, and we'll go back and forth here. The China situation first, I want to say something to all my employees. We have 11,000 employees here. We are in constant touch with them. We have the ability to communicate to 80,000 of our employees on an ongoing basis, every minute, every day. Our hearts are going out with all the people that are locked up in their apartments right now. Fortunately, we are all safe at this point in time. But clearly, they're in their apartments. They're working, communicating, obviously, by phone, by e-mail, as they try to figure out how do we get ready to get going as we come out of this? But our thoughts are with them at this point in time, and it's a concern that we have relative to all our employees, not only there, but also around the world. As I look at this right now, it will be a negative impact, and I'll let Mike go through some points here. But from my perspective, assuming that they do allow us to start manufacturing again, and we started, you can see in the supply chain, again, on February 10, I still believe we'll have somewhere between $50 million and $100 million of sales impact. Now folks I'm giving you my feel for knowing China and my feel for what I think is going to happen. If this extends, that number will go up, but I'm just giving you my feel. As I look at the sourcing situation we'll show you, I am concerned about the start-up of this, and Mike will give you some numbers around that. I'm concerned about the customers and how fast they'll come back up in lot. We also have a lot of our customers that do a lot of manufacturing and shipping out of there, and we have components here and there, and I'm concerned about some of that work going on. My perspective is, as I look at the number of $50 million to $100 million right now, some of that will be permanently lost, depending on Bob Sharp's business and the heating system marketplace. Once the heating system is gone, you're going to wait for the next year. I firmly believe that Automation Solutions, assuming this doesn't go too long, should make it up before the fiscal year is done or within the calendar year. But again, what I'm looking at right now is the feel that we have based on how long we're going to be shut down and our sort of estimate of how quick this thing will start up. So Mike, why don't you give them a couple of facts, and we'll go back and forth and talk a little bit more?

All right. Great. David, great to be with everybody this afternoon. Thank you very much. First of all, I also want to share my thanks to our China team, our 11,000 employees. We recently celebrated our 40th anniversary in China. Today, we have a terrific business in China, nearly $2 billion in size, and again, almost 11,000 employees. And we had a solid Q1 in both platforms in that mid-single digits that Pete talked to. Secondly, January 15, we saw the signing of the U.S.-China trade deal, which was pretty important. That Phase 1 deal is pretty important to us. I think it also -- there were announcements on both sides, which would be Phase 2 discussions commencing shortly. We're excited by that. It's going to take some time, but we're excited about that. So I wanted to highlight that. But just about that, that same time is when people were recognizing that we have this coronavirus issue. Our employees went out on January 24 for their Chinese New Year holiday. They've been out now for 11 or 12 days. And currently, under the government regulations and guidance, we intend to start -- restart our facilities next Monday, on February 10. But we need to make sure that happens. And we'll be watching that. And I think we can report on that a little bit next week...

Yes, we can.

I think some of the issues that we're going to face are going to be around as you restart these facilities. Obviously, we're going to have to manage our facilities. We have the temperature monitoring. We have travel restrictions. We're doing everything we need to manage. But our supply chain, I think, will be suffering that -- despite best efforts. It's just going to be a rocky start. The logistics, the supply chain, sub-suppliers and all those kinds of things. So...

How much do we have in our supply chain right now, both for China, Mike?

So our supply chain in China's about $750 million. $500 million stays in China, $250 million actually goes out to the global business. So have impacts in China, we'll have impacts beyond China, in terms of that. And again, as you were highlight, we have several global customers that use China to build their projects, their modules, that kind of thing. And we're going to see some impacts there that would impact business in other regions beyond China as well. So we're starting off with kind of the view of what's going to happen here. I think next week will be a big important week. We'll learn some more things as we go forward. And then maybe we could comment. Again, there's no saying what's going to happen there.

We'll do that. Thanks. Thank you, Mike. As I look at this, I referred to the Board yesterday and today, for the people -- I'm aging myself here, the Apollo space programs, in the 5 or 6 minutes, we have their reentry blackouts. We are in that reentry blackout period for China right now. We do not know what we don't know at this point in time. But clearly, the organization for China, who I know are listening on this phone or will be listening on this phone when they get -- wake up, are doing everything they possibly can to get ready right now. I just know that the supply chain, the uncertainty, logistics, all these different things, there's a lot of moving parts, the sub-supply chains, the feeders to our supply chain, there's a lot of components here. So for people not to think that it would not be a negative short term, I don't think they're thinking straight. It will be a negative. It will be a negative for the global economy. It will be, potentially, bigger, if it doesn't get started. This thing drags on long time. But right now, our feeling is right, it's not going to drag on. But we're just getting ready for it, and we're trying to get -- we're planning everything around this, so we can execute and make sure they have the resources they need to get the job done. They're all geared up to come back to work. We'll give you an update on the 14th as we look at -- on the 13th, I'm sorry, as we look at what happens at 10th, 11th and 12th because we'll get a good feel for this. My gut tells me, it will be a slow recovery, and they'll get their act together and things will happen. But again, we are in that Apollo space program reentry, 5 to 6 minutes, where no one knows what's going on. And when I talk to you on the 13th, you'll give me, "Houston, we're live." and we'll talk about that. So again, that's how we see at this point in time. I don't want to scare people. But it's the facts. We do a very major business in China. We're very strong in China. We have a good sense of China. I have -- Mike and I both managed and worked in China for many years together as a team, and we spent a lot of time there. And we're supporting our employees, we're supporting the government, we're supporting our government as we try to work through this. But that's where we sit at this point in time. And we'll keep you informed. So I want to thank all the employees. I want to thank the Board's engagement. And I also want to thank the shareholders engagements that I've been having in the last several months, and I will continue to have with our shareholders. With that, we'll open the lines and we'll take some Q&A to see if we can get some clarity around the concerns and questions people have out there. Thank you.

[Operator Instructions]. The first question comes from John Walsh with Credit Suisse.

So thank you for all that color around China. I guess, just maybe a point of clarification, you kind of detailed what you think the impact could be, but then I guess going through the prepared remarks and looking at the release, you have some comments that the guidance excludes any impact from the coronavirus?

Correct. Correct.

Just trying to -- so how do we kind of sensitize that? Is it in the plus the $0.02 minus that you call around next quarter or would it actually be greater than or lower than...?

I would say it's in the plus or minus $0.02 right now in that quarter, John, to be honest. Now, we're assuming that we're going to have starting up in the 10th, February 10, and we have a slow ramp. So I see some potential impact to the year at $50 million to $100 million, that plus or minus $0.02, I would say, covers that right now based on what we're seeing on slow start. Now if we're sitting there in New York next week and I'm saying, "Hey, this thing is really grinding and having a hard time both with our customer standpoint and also our supply chain standpoint, we'll have to reconfigure that." But right now, that's how we have this factored into play, that plus or minus $0.02. You're exactly right.

Okay. Great. And then just thinking about the margins for the quarter in Automation Solutions, you called out a couple of things in the prepared remarks. I'm just -- as I'm looking at mix for the balance of the year, thinking about North America, about discrete, about maybe some OE greater than aftermarket at some point here. How are you thinking about the cadence of seeing mix be, I guess, maybe less negative as we go through the year? Or how are you thinking about that?

So we are -- what we would like to see happen in the cadence of the year, obviously, the first quarter flow. North America was really very negative for us. The discrete business is very negative for us relative to our discrete around the world, so very high profit business, both of those. So the cadence will be expect -- I think we're going to continue to see strong KOB 3, which does help us. I think our cadence is that we see some stability within the oil and gas market space in North America, not growing, but stabilizing. So as we look at the channels, as we look at our customer base, we'll see some improvement in the flow and discrete business, which will help us a little bit on the margin pressure. And then the rest of the help is going to come from all the restructuring. But you called it right, the flow in discrete right now in North America is a very challenging issue for us. It was very difficult in the last two quarters. And as we look at this right now, our plan is we see some stability, some improvement, which will help put a little margin win to our back as we get into that second half, and that's where we see it right now. And obviously, you'll be able to tell on our order releases and our comments, basically, how we're seeing it. If you start seeing us say, "Hey, things have stabilized. Things have improved." You'll know, John, that we're seeing a little bit better improvement around that flow business, which is very important to us.

The next question is from Andrew Kaplowitz at Citi.

So, I know you don't want to give us too much color or more color around the $425 million program before the Analyst Day. But as your Board and the consultants reviewed your cost, that opportunity from, what it looks like in FY '20 for the initial $215 million? It looks like the majority is focused on AS versus C&RS or Corporate. So when all said and done, how much confidence does the program give you to get AS margin back up to the 19% margin that you've previously talked about?

Yes. So I mean, my confidence level and the Board; as I said, the Board spent 3.5 hours on these actions. We're talking about the Board confidence, my confidence is extremely high at this point in time, extremely. We are taking serious actions. Bob's business started, you well know, Bob's on his sixth quarter of negative sales. Bob started his cost out 7 quarters ago. So if you look back at his major restructuring, it actually started in late '18 throughout 2019. So what he's working on right now are actions around fixed facilities to try to take some fixed facilities offline and consolidate. So his are a little bit different. That's why you haven't seen a lot with Bob right now, his business over the next couple of years, and he'll be doing a fixed savings, and he's starting to get that. I feel very, very confident. Now I'm involved in reviewing the work with Lal and Ram, the Board and I looked at in detail, and we look at the costs, I feel very good about those savings. I feel very good about the bridge chart that we're showing you from the second half. I think the question -- the previous caller, John, asked is very relevant relative to that mix issue, which needed stability. But as I look at the actions, they're doing right now in the short term, because it's very much people oriented and then we're starting to take some of the longer-term facilities, so I feel very confident we'll start seeing that margin move up in the second half. Anything you want to add to that, Frank?

Yes. I think we've got a good plan going forward. We're looking for a significant margin improvement in the second half. And a lot of it does depend on the pace of business in the mix. The restructuring actions will kick in, and we're pretty confident in the margin development as we go through the year.

And McKinsey reported to the Board yesterday in the work that we did between the two business units and Corporate, and we have additional actions that we can deal with probably starting in another couple of years. We want some backup stuff and some other opportunity, but let's put it this way, our hands are pretty -- our plate's pretty full right now with actions we've got going on. And -- but we're going to study and lay them out and see how we can start flowing some or maybe later this year, early next year to give us some protection in case -- I'm not supposed to swear, but I'm going to swear, "Oh, [indiscernible] happened." But from my perspective, we're trying to cover that. McKinsey did a good job explaining how we're protecting what makes Emerson unique, our franchises and the corporation culture, but at the same time, look how we could be more efficient and more effective. It was a very good discussion around from the Board perspective as they pulled back the sheets.

And then you mentioned when you released December orders that they did display some signs of picking up in AS, really in LNG. You said that again today, AS backlog increased 7% sequentially. So did you see a bit of an uptick in project releases by customers? Do you think they become more cautious again as the coronavirus continues to spread? And maybe stepping back, it's been a little while since you updated us on the large project funnel, do you still have $1 billion of projects that you've been told you've won but haven't booked? And is your project funnel improving, decreasing or roughly stable?

So I mean, you've hit a nail in the head here. The issue right now, I think the North America projects we're starting to see release, I'm very worried as I'm sure my customers are worried about because a lot of that business is going to be shipped -- production will be shipped to China. And so my concern is if this coronavirus goes longer, it could delay those projects, and it could slow down some of the projects we think that should be released here in the next couple of months. So the coronavirus has an impact on many, many things relative to our business base. So therefore, that's why we are still convinced that the second half could be a challenge for us, and that's how we're banking at that 0 growth because of things like that. Now the projects we see releasing, and I still believe will release, are the Middle East and India. Those projects are separate from the work been going on in China. But I would say the Middle East, Mike, you and I were just there. China, I mean, the India projects. So I feel good about those. And I think that will help us as we fill up that pipeline for the second half of the year and then as we move into 2021. But we've got to get some settlements, some resolution on the corona. We've got to get some traveling. And if we don't, then that's going to clearly slow down some of the North America projects.

The next question is from Gautam Khanna at Cowen and Company.

Yes. I was just curious, what is your expectation this year for KOB 1 as a percentage of Automation Solutions revenue?

Okay. I'm rubbing my rally monkey's head here a little bit, Gautam. So I can see if -- okay. So I'll give you my feeling right now, okay? I think we're going to be around 25% for KOB 1. I think we will be 57% -- 57%, 58% for KOB 3, and so what's that mean for the -- 18% for KOB 2. That's where I think we're going to be right now. And I don't have any crystal ball more than you, but that's where I see -- I look at the pipelines, I look at the things we're talking about right now. We are -- we shared with the Board we're not backing off any of the KOB 3 investments. We have the organization highly motivated to try to take some market share on installed base. We're focusing other things that cut our costs around. But that area right now is ripe for us to continue to take share. And we want to build that KOB 3 up strongly because those projects will start flowing, and it'll help us offset the margin dilution from the projects.

Got it. And not to steal thunder from next week, but how far out do you anticipate providing long-term financial targets? This is a fiscal '22? Or what are you thinking? Like how long are you right now projecting?

I think we're going '23. We're going to go '23. We will bridge -- we will bridge the $450 million. And what we see -- I mean, as you know, I try to be honest and transparent, sort of like the Iowa caucus. I will try to bridge for the 2021 numbers. These guys are all -- they can't handle this -- they can't handle the truth. They could not be in any movies like me. But they -- we'll bridge that, so you can see what -- the $450 million we talked about, and then we'll talk about what we see going on going forward. You're going to see a much lower sales forecast as we manage the growth to keep it -- we're focusing on the cost and until I see some really strength in what's going to happen to underlying growth, we're going to keep that growth rate down and manage around costs. So we'll give you that bridge. But think '23, but also -- I'll tell you what I think about '21 and what we told you last year. I always try to bridge what I committed to.

The next question is from John Inch at Gordon Haskett.

Okay. So I just want to be clear. So the $215 million of restructuring, the $95 million that we did last year, Dave, you talked about reviewing this with the Board. Does this mean on the 13th when you talk about the Board's review or you present it, that there is no new restructuring on top of that? The restructuring basically is now confined to what you've articulated? Or is there more still potential?

No. What I just laid out for this year is locked and -- okay, is it going to $210 million? Is it going to be $220 million? Yes, that's what we're talking about right there at this point in time. We are and -- but we're going to show you '21 and what we're going for, as you well know, we wanted to try to get everything done within a 24-month time period best we could. So we're going to -- we did a little bit last quarter. I mean, in the fourth fiscal quarter last year. We're doing a lot right now in this period right here in '20. We're going to be doing a pretty busy '21. But when we get out of '21, I want to move back towards our stability run rate of restructuring, which typically is around $50 million. So you're going to see how we go up to over $400 million total in the cycle and how we're focusing that. But what we told you this year, that number ain't changing unless I have -- okay, I shouldn't say ain't because it could change. But if we had something happen to the world relative to a major change, and we have to refocus, something happens in China, something happens with the business, but right now, that's what we locked and loaded. And I would say that's going to keep our hands full for the year.

So what we're going to hear then on the 13th other than the traditional analyst review, the Board -- you guys have McKinsey in there. You've done this, obviously, top to bottom look through. You're going to be talking about the strategy or the payback? Or -- so if there's no more new restructuring, what should we expect? Like...

We're going to talk about macro restructuring. We're going to talk about outcome is on the review of our businesses. We're going to talk about the cash flow generation and how we're going to allocate that cash flow generation for the next couple of years, and some fundamental strategies. You're going to see a presentation on digital transformation coming out from one of Lal's key new platform leaders, which we built. Or yes, not platform, but business level units presence. And then we'll also -- we're going to give you an update on what -- on the Final Control work that Ram's doing. Ram's going to give a presentation on where he's taking this to the next level. So there's a lot -- there's going to be a lot of strategy, the company insights, what we're doing and how we're going to drive. But fundamentally, I want you to walk away with the strategies in place, and we're driving cost, and we're going to drive around that business. We're also going to give you an update after 18 months of owning the Textron Tools business. We're going to give you an update around the professional tools and how that program is going. Both B&C and the professional tool ones are going very well, and they're a key part of our repositioning effort to drive value. And Tim's down here in the room, down here he's real happy because he's going to be part of that, maybe. And we're thinking about -- there's a couple of positions open like HR and maybe plant management and we're going to put him in there and see if he's going to do anything different.

The next question is from Deepa Raghavan at Wells Securities.

Just a quick question on the -- clarification on the EPS range that you are maintaining. We understand the coronavirus impacts are not easy to assess. But how does the $3.67 guidance at midpoint feel given what we know now? It looks like there's a virus impact, your North American region is trending below your expectations. Just curious, do these newer headwinds just put the upper part of the sales range, but keep the midpoint -- sorry, upper part of the EPS guide range intact -- but sorry, risk is to the upper part of the EPS range, but keeps the midpoint impact? Or is there any risk to the midpoint also at this point in time?

No, we wouldn't put a guidance out there. I didn't think -- I mean, we can believe we can hit both ends of this, both the top and the bottom, the middle. But our feeling right now, based on the trend lines is that the midpoint is the most likely. The upper point even with the coronavirus because we're assuming that they'll get -- it will come back, and production will start coming back up. And we'll start calling back some of that -- the $50 million to $100 million of sales. So we fundamentally believe that, that range is still viable, even with everything we face around the world at this point in time. The cost actions are happening. We get a little bit more cost out. From the timing issue, it's always a lot of timing in there. It can help our margins, and obviously, help the EPS. So at this point in time, that range is very -- we're very comfortable in that range. And we feel -- I mean, my highest probability, clearly, is at that 0, but I also see -- I still see some potential on the positive side, too.

All right. Another clarification question is on China, again. Can you ring-fence what percent of your China sales or profits are in the affected areas versus your overall China exposure? I know you gave us a supply chain number, and the impact is...

No, I think we can't do that. That China sales are -- we saw across all of the markets depending on where the -- which customer is going on right now, the customers are going to be further west, east north. Now we -- there's no way we can break that down at this point in time. I mean, it's going to be a -- this one is going to be kind of fluid as we see things moving back up. And I know our sales force are going to try to figure out how they can claw some of those back. So these -- they're going to be pretty energized to figure out how to get that business back. It may come in a different location. So I -- it's -- there's nothing says at this point in time.

Your next question is from Julian Mitchell of Barclays.

Maybe a first question on Slide 13, the restructuring costs and earnings tailwinds. So you have the restructuring costs of $0.26, the benefit this year of $0.07. So that balance is sort of $0.19. Do we assume that, that's a mix of what's recognized in 2021? And also, what's kind of reinvested in 2020 and things like the service network? Just wondered how we thought about that drop through?

So now we will share with you how the savings are going to flow up in '21 and '22, and I'm not sharing that with you yet. But we'll share that out with you. So you're trying to see, I mean, say that again, Julian? Say that one more time?

Sure. So it's just that on that Slide 13, you're spending about $0.26 worth of restructuring this year, and you're recognizing $0.07 as the benefit. So I just wondered that balance of $0.19, is it all coming next year? Or a portion of that $0.19 is just -- is reinvested into the business?

No. No. No. So a big chunk of our savings will come next year of the delta, the spend from the standpoint. The area that we'll still have some delay out is going to be around the facility restructuring in the facilities because that may not start falling until early '22 or late '21. But what we see there is there's -- the reinvestments built into our core plan, we took the cost out. And we've netted that out already. There's nothing else going on here from that standpoint. Those savings will flow, and there'll be a -- there should be a significant increase in savings as we move into '21, and you'll see that and as Lal talks about his repositioning effort. And as you know, there's very little cash being impacted here because we're pretty -- we've been pretty good about managing that cash flow and trying to keep it cash neutral. So those savings and multiple, I would say, 90% of those savings will flow back into '21, and we'll still have a little tail hanging over us in '22 from this restructuring right there you're talking about.

That helps. And then my second question, just on the top line outlook in Automation Solutions. Maybe just focused on the sort of chemicals and petrochem piece of Automation Solutions. Some companies last week like AspenTech sounded pretty negative on chemical spending. Some of the customers in petrochem like Chevron or ExxonMobil are under some pressure. So I know you had good orders growth in your chemicals and petrochem piece in calendar Q4. Do you think that can continue through this year? Or it's more likely to get sort of lumpier?

Right now, we still feel pretty good about it. Now I don't think -- I think the first quarter number was a little bit stronger than I thought it would be. We had some project business come in there. But Julian, I don't -- we're not too worried about that at this point in time. Now I'd like to see another quarter of what's going on there. But that business, that petrochemical, the chemical businesses, and as we know, we serve a lot broader group of that customer base than an AspenTech will serve.

And our KOB 3, first of all.

Yes. And we've got strong KOB 3 going on right there. So I don't feel concerned about that. I'm more worried about the upstream side and the new oil and gas investments. I think what I see coming down the downstream right now, I feel better about it. And that's a very high KOB 3 marketplace. And as I said earlier, when some of the guys asked me, I firmly believe we'll continue to see some improvement in KOB 1. So I'm more optimistic about that.

The next question is from Jeff Sprague at Vertical Research.

I guess this kind of dovetails off an earlier question, but just kind of thinking about incrementals. So obviously, if we're in a no-growth environment, incrementals is kind of a non-constant, I guess, right? But are you suggesting to us though that we should assume you do some kind of normal 30% or so incremental on growth, and we can drop at the end of this 2 or 3 year period of time, $425 million of savings on top of that?

Yes. That's what we're talking about doing here. I mean, if we -- we're going to have the incremental growth in sales. We'll show that to you as we lay out our plan, and then obviously, the restructuring that we're going to flow through. And as someone -- I think Julian has asked me about the reinvestments. So we'll lay that detail. We went through that with the Board because they want -- the Board is very, very interested in making sure we don't cut key programs long term. But we're trying to structurally make some changes here so that -- that it does flow through. The key thing right now is we're banking on very little growth here for the next 12 to 18 months. That's the key issue.

Yes. And that 30% to 35%, is that kind of the ZIP code you're comfortable with for incremental?

I think we're building on 30% from that standpoint. That's what we're building it on, Jeff.

And then on the LNG stuff, so it was good to see some of the orders come through. Just wondering two things. Was the stuff that was released and hit your order book deliverable from a revenue standpoint for 2020 as it currently stood? And...

I don't think we'll see any deliveries on that. I think you could have some progress payments and some of the stuff...

Yes. Stuff that went to orders, and we'll start working on it. And what we've...

Yes. And so what we -- we probably -- we will probably have some progress payments in the latter part of 2020. It'll be more falling into '21. As you well know that where these bookings will go, you'll see more coming. It goes -- obviously, the compressors and the big LNG projects, our systems, then the control valves, then instrumentation. So we are in the early stages of this 4 way right now. So we should -- we're anticipating here in the next 2, 3, 4 months a continuation of booking some stuff. And I wouldn't see that we'll book money sales this year to be more than 2021, but I guarantee we'll have some progress payments probably in the Systems in late this year.

So if you thought of your total scope on these projects, kind of total Emerson scope like what have you booked so far? We're talking like only 10% or 20% of the project value so far?

We expect are very small.

Very small. Very small. Very small. And that's one of the concerns, I think, I can't remember which of you guys mentioned this, my concern is this whole book. Coronavirus, could that slow down the process here a little bit again, as we've got it going again with trade deal that Mike mentioned. There was the trade -- first, Phase 1, and now the coronavirus, will that slow things down again? That's always a concern of mine. That's why we need to get through this, and so we can get a little bit more visibility on what everyone's going to do. But right now, we should have a lot more bookings around those major projects.

The next question comes from Steve Tusa, JPMorgan.

This is actually Pat Baumann on for Steve Tusa. So yes, so he gave me an opportunity to harass you. Hey, on the restructuring, can you explain why you're seeing minimal net cash impacts from the actions you're taking? And then what was the comment on the cash flow based taxes you made about healthy results?

Yes. So go ahead.

This is Frank. There's a lag on the spend versus when we book the expense that's pretty significant as we get out of the gate here. And then a not insignificant portion of the restructuring is noncash. It's facilities, it's asset write-downs and things of that nature. So when we wash it all through, we think the net impact in 2020 will probably be not terribly significant, less than $50 million.

Yes. I mean, a lot of times, and the people, which was our front-load late last year, early this year, there's cash upfront, but you get -- eventually you get some of that cash back because you're not paying. So it washes out and right now -- and cash generation is pretty good. So I mean net's going to be pretty neutral. The taxes, just basically some work that Frank's been doing relative to some are international subs as we go through this process...

Yes. It's just ongoing reorganizations that we've been doing. We've had several discrete tax benefits last year. I don't expect them to be the same magnitude this year, but we will have a little bit here and there, and we had a -- we get to know the cash tax savings that actually went through into the cash flow in the first quarter.

What will be the net cash out for the $425 million you mentioned?

Oh, I don't have the number off the top of my head. It's -- Frank, do you have a number, a rough number?

I have, I would say, in the end, 80%, 85% of it is probably going to be cash...

Over time. Yes.

It's lumpy. I mean, the timing is the key.

And the key issue there is that the sooner you get some of the cash impact once done, the faster you get the cash payback, because it takes off quickly. The facility one's are the hardest part because they -- the cash goes out, and then you don't get the savings for a long time.

Okay. Maybe switching gears, just -- can you give us an update on what you're seeing in resi, a few markets in North America. What did the business do for sales in the quarter? And kind of what's your outlook there for this year?

I mean, North America is still in a tough zone right now. We're in sort of the middle of winter here, flat to slightly down. Don't -- I mean, it's hard to say how fast. I mean, the one thing I'd like is a residential marketplace truck. Construction's doing good. That's a good sign. Typically, we start seeing some payback and some improvement here as we get into that March time period. So that's not going to be -- it's not going to be much of a change until we get into a little bit warm weather. We had a good quarter in Asia and China. That was before everything happened there that bothers me. And so I'm a little bit concerned about that now as we come out of it. We hear from President Xi, he's going to try and pump up the financing and try to get some spending going to get the economy going, a strong stimulus, which could -- typically, that goes after the market, the commercial residential guys go after versus the auto solution guys done. But right now, our HVAC business in North America is weak. And we're forecasting probably our sixth down quarter in total for commercial residence, globally. And then the question is, can we see some improvement as we move into the second half of the year.

Did you see anything in the orders in January out of China that made you -- makes you concerned at all about the business there? Or is there more just like -- what do you expect?

They were -- they were pretty much what we expected. It's slightly negative. It was not that good. Again, it's a short month because it's the Chinese New Year. And so from that perspective, it's a pretty small month. But I'm really worried about what we -- we're trying to take orders over the phone right now. We're still alive, but there's not much business going on. So I'm really worried about as we get into this post February 10 as we start seeing what people do, what happens in that? And that -- so it's certainly live here after that February 10 time period comes in for the next 2 or 3 weeks to see if there's any slowdown or pick back up, we'll see.

The next question is from Joe Ritchie at Goldman Sachs.

So just focused on Automation Solutions for a second, and really first. And really just trying to think about the margin step-up expected in your fiscal second quarter. So clearly, there's definitely some headwinds out there. We talked about coronavirus. I'm just curious, like, are things expected to get better, much better, in fiscal 2Q versus fiscal 1Q from a mix standpoint? And then, secondly, clearly, you guys took a lot of restructuring actions here in the first quarter. And so do we start seeing a pretty sizable benefit from those actions in fiscal 2Q?

Yes. Okay. So did you back into Auto Sol's margins in the second quarter? Is that what you did?

Yes, I backed in as well -- I mean, you have margins up.

Yes, you could back into them. Yes. So there's two things. One, auto sales, if you think about progression, our second quarter sales typically are seasonally higher and that, obviously, in the second quarter. And we are expecting some stability around the mix of business around that flow in the discrete business. So that is not -- that's normal for us. So -- and then we've obviously started to get some savings, some of the $35 million that we spend aggressively in the fourth quarter. Most of that was around Auto Sol. And obviously, a lot of the $97 million over -- almost, I think, $85 million of it was around Auto Sol in the first quarter. And so you're seeing -- those guys are going to start seeing that benefit more and more about that as they go into that second quarter and clearly ramps up into the third and fourth quarters. But that's how we see it right now, and the savings are happening because these are really near-term cost actions that are taken.

Okay. All right. That's helpful. And then, I guess, just my one follow-up. I saw that there's no change to the buyback portion of the bridge. I guess the question I have is, like, look, your balance sheet is in great shape. You guys have the opportunity to toggle it up if you want to and be a little bit more aggressive with the buyback. I guess at this juncture, like, what's holding you back from potentially doing a little bit more?

I mean, first of all, I think if you look at our history, we buy back substantially more stock than most people. And secondly, we also continue to want to work on the acquisition front, an investment company. If we feel that we don't have the opportunities, we'll continue to take that buyback up. But right now, if I look at what we've bought back the last several years, there's been a pretty high pace, and I don't see any reason to take it any higher at this point in time. Now the Board always reviews that if we see the acquisition front state is very moderate, then we're going to have the situation coming forth that we're going to have to increase the leverage and the balance sheet. But keep in mind, I've said it again, we're already paying back shareholders 85% of our cash flow in 2020. 85%. That is a good number.

Our last question comes from Robert McCarthy at Stephens.

I guess the first question, have you had any contact with the Chinese authorities about the nature of the response, what they need to do, any kind of comfort around that? Because, obviously, it seems to be there's definitely a credibility gap that seems to be emerging over the last couple of days? And any thoughts around that just given the fact that you have substantial tendrils in China.

Our organization, we have a leadership there. The team's in constant contact with the Chinese government, and we get a -- Mike and I and the top OC get a daily report back out from what they're being told by the government, both at the national level and the local level. I mean, I disagree that the Chinese government are misleading people. I feel they've been very open to us. Now everyone wants a hard answer, but you can't get a hard answer in something that's moving like this. But as I look at the consistent information I'm getting from the government and to the regional governments to my people and my leadership team that reports into Mike, I feel very good about it. So my comfort level right now is pretty high. But key issue for me is can they get the plant there -- a lot of the people go back to work if nothing else major happens here. And then can the supply chain start mobilizing, because logistics could be a problem as things start flowing around. But it's just a matter of getting planning. And I know Mike and all the guys and gals across China are working this pretty hard right now. So I feel -- my comfort level is pretty good, assuming they can hold that tent. Or if it goes to 11% to 12%, that does a big deal. Within that, a couple of days, that's -- Rob. So I feel -- I think we're ready at this point in time. But again, it goes back to the Apollo moon shots when it comes back in the United States, we're in that blackout period right now, the reentry blackout period for about the next 5 or 6 days.

Yes. I mean, to that point, it's almost -- it seems like your guidance outlook could have two very almost binary outcomes or trajectories because, one, you could see global synchronous downturn, real problems with supply chain, demand destruction in oil impacting your projects to a material degree. But then, obviously, high visibility on you in terms of your cost actions. Conversely, if we do have a quicker than expected resolution to this, you could see a pronounced rebound in oil, which would probably be broadly stimulative of upstream projects. You could see the -- an upside to growth, overall, which -- and obviously, maybe attentively, M&A, but that obviously puts a lot more pressure on you to deliver the restructuring in what would be fundamentally a different demand environment. How do you square the circle in terms of where we could be?

Yes. I don't -- first of all, I'm not in the Pandora's box, which is your first thing, where you might as well throw in a couple of locus to tax and maybe some ships going down and claims going down at the same time there. And I'm not in that side of the equation. I think that -- and I -- there are -- I could say that there could be some positives as this thing recovers pretty quickly, I feel that. But I'm more in the status right now that this thing slowly recovers and regrowth comes back. We probably lose a couple of points of the high-single-digit growth that we were talking about for China, which takes a little bit away from us a little bit. So I'm more the glass half full than the glass empty or glass awful, we see this one.

Even if they're doing stimulus, it's going to really be more than that, make it to next year, even.

Yes. I think we get -- let's -- I know everyone's trying to guess, second guess this. I think you've got to wait -- those dates, the 10th, and they've been holding here pretty consistent. If those things hold in let's say, the 10th or 11th, going back to work and we start seeing the plants up and running, then I feel good about that. Now If the plants start starting up and they start failing, and that could be a good thing for us because it's obviously business. But I think we've got to watch that. So you've got to listen to all your -- all the people you follow and listen to them and see how things are starting. And I think that will be the key indication. Are they starting up or not starting up? Where they getting the supplies? I think you're going to hear people communicate that pretty loud and clear.

I want to thank everybody. Again, I want to thank the global organization. I want to thank the investors and the shareholders for supporting us as we go through this process. Thank you very much now. Bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.