Emerson Electric Company

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Emerson's Investor Conference Call. During today's presentation by Emerson Management, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. 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 Dellaquilla, Senior Executive Vice President and Chief Financial Officer, Mike Train, President, and of course, Tim Reeves, Director of Investor Relations Emeritus. Emeritus, a graduate. I encourage you all to follow along in the slide presentation, which is available on our website. I'll start on slide four 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 67 cents, spot on the guidance we 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 book in the quarter after delays from the second half of the last year. Commercial and 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 five, 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 six. 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 seven. Total segment adjusted EBIT margin dropped 40 basis points to 15.4 percent, 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 eight, we will bridge first quarter EPS. Tax stock compensation and foreign exchange transactions totaled 13 cent headwind for the quarter, which was in line with guidance. Operations, share repurchases, and lower interest costs delivered 5 cents, also in line with guidance, to net 67 cents 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 the business platforms, turning to slide 10. Automation Solutions' underlying sales came in somewhat below expectations at 1% growth for the quarter. December trailing three-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. America's underlying sales were down 1% as discrete and upstream markets continued to soften. Europe's 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 and residential solutions underlying sales were down 1%. December trailing three-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 at 5% with mid-single-digit growth across China, the rest of Asia, and the Middle East. Commercial and 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 low to no growth environment in 2020. For 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 announce 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 and 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 in additional detail the outcome of the board's review announced on October 1st 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 is 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 14 cents 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 of purchases. This gets us to a full year adjusted EPS midpoint of $3.57. 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 mixed 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 81 cents, 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 guides. We expect first half restructuring spend totaling approximately $145 million across both platforms. These investments, together with easing mixed headwinds and favorable price costs, drive significant margin improvement in the second half, with Automation Solutions' adjusted EBITDA margin up approximately 150 basis points and Commercial and 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 13th. 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 core 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 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 from the first quarter press release, it's been a busy, busy first quarter executing around our two and a half year cost resetting efforts. As you know, we accelerated the fourth quarter cost resetting by about $35 million. That money, those savings are flowed into this year, built into the plan originally and from a savings dollar per 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 included corporate, where we took down the Emerson plane fleet to five 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 two and a half 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 excess facilities, and the higher cost structures will pay back more in 2021 and 2022. But we're going to continue to drive, as you can 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 in great detail yesterday with the board, well more than three and a half hours of details with the board if 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 damaging 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 13th. It's going to be, you know, not being on Valentine's Day is unusual for me, so you guys 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 in the new peak margins. We laid out very detailed with a lot of growth, you know, 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 and 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 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 possibility to drive record levels of margins by each of the major business units. While Bob and I will put more color on this next Thursday, but we're having 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 no full wealth, 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 going to have an impact in the near term, medium term, and potentially long term as we look at this. As you can see, our total orders are trending in the plus two, minus two range right now, trending right now towards zero as we look at the current month and the current quarter. It tells me that we are trending very tightly in the range that we've laid out for our 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 is down, primarily driven by Russia and Turkey. The Middle East and Africa, which we were just in, 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 quarters is I don't see the catalyst to drive the fundamental pickback up in the U.S. at this point in time. I don't see Canada, nor do I see 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 can 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 at $3.15 to $3.2 billion this Right now, as we review for the board and 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 flows, is dropping down below 50. Our share repurchase is somewhere around 1.5, assuming no significant acquisitions at this point in time. So close to 85% of our cash flow is sure to be paid 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 continue 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 an uncertainty around the cycle. Now with China's situation, we have in the process, we're in the process right now of closing two nice little bolt-on acquisitions worth about $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. Mike and I are joined, and we're going to talk to him a little bit on China, give you some insights of this. Let me give a brief overview. I'm going to turn it 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 there. 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. You know, 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 email, as they try to figure out, you know, 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 start seeing a supply chain again on February 10th, I still believe we'll have somewhere between $50 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 startup 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 and live. We also have a lot of our customers that do a lot of manufacturing and shipping out of there, and we have componentry in there, and I'm concerned about some of that work going on. My perspective is, as I look at the number of $50 to $100 million right now, Some of that will be permanently lost, depending on, you know, 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 fundamentally 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 look 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 a couple facts, and we'll go back and forth and talk a little bit later.