Emerson Electric Company (EMR) — Q4 2017 Earnings Call Transcript

Thank you, Keith. I'm joined today by David Farr, our Chairman and Chief Executive Officer; and Frank Dellaquila, Senior Executive Vice President and Chief Financial Officer. Today's call will summarize Emerson's fourth quarter and fiscal 2017 results. A conference call slide presentation will accompany my comments and is available on Emerson's website. A replay of this conference call and slide presentation will be available on the website for the next 90 days. I will start with the fiscal year summary, as shown on page three of the slide presentation. We had a strong second half and finish to 2017 as demand strengthened in key served markets and economic conditions improved in most world areas. Our full year results exceeded growth and EPS targets communicated at our Investor Conference, and exceeded the updated EPS guidance provided on our Q3 earnings call. Underlying sales growth was 1% in the year. Reported sales grew 5% to $15.3 billion, including the results of the Valves & Controls acquisition, which closed on April 28. Profitability in the base business, excluding Valves & Controls, was solid. EBIT margin expanded 70 basis points to 17.9%. Adjusted earnings per share increased 8% to $2.64, excluding $0.10 of Valves & Controls first year acquisition accounting charges. Finally, solid earnings in trade working capital performance resulted in strong operating cash flow generation of 8%, and free cash flow of $2.2 billion, reflecting 130% conversion of net income and a new high for Emerson's 14.5% of sales. In 2017, we completed our 61st year of consecutive dividend increases and returned $1.6 billion of cash to shareholders. We closed out the year with September trailing three months underlying orders up 11%. We're encouraged by the continued strength in orders and note that these trends are consistent with expectations communicated at the Electrical Products Group Industry Conference in May when we laid out our top line expectations for fiscal 2018. Turning to slide 4. In the fourth quarter, demand remained favorable across both platforms, and the company delivered 3% underlying growth. Reported sales grew 13% to $4.4 billion, including the results of the Valves & Controls acquisitions. Sales were negatively affected by the hurricanes that hit Texas and Florida, and we expect to recover these sales over the next 12 months. Adjusted earnings per share was up 12% at $0.83, which includes Valves & Controls operations, but excludes $0.06 of first year acquisition accounting charges. Turning to slide five. Profitability in the quarter was affected by the Valves & Controls acquisition, excluding both the first year acquisition accounting charges as well as dilution from operations. Gross margin was down 40 basis points to 43.2%. This decrease was driven by the declining ClosetMaid business, which was divested early in October, and by unfavorable mix as disruption resulting from Hurricanes Harvey and Irma. EBIT margin increased 130 basis points to 19.7%, driven by the benefit of restructuring investments and lower restructuring spend in the quarter.

Thank you very much, Tim. Welcome, everybody. And before I get into some other slides, I want to share – first of all, I want to thank all the people across Emerson after delivering a very strong year, outstanding year, strong growth at the top-line, strong order growth, as you saw in the second half of the year, very good performance relative to profitability in the margins, outstanding cash flow with our cash flow – the dividend – free cash flow to dividend ratio only being at 56%, which we, a year ago, we thought would be around 62%, so very good performance. From my perspective, the people across this company rose to the challenge that we put on their back as we went through the repositioning effort, as we moved into early parts of fiscal 2017 and I'm extremely proud of it. As I look at where we see 2018 at this point in time, I see orders continuing to be at high levels. I will share a chart with you in a few minutes, saying that the preliminary October looked at 12% underlying growth for the total corporation, with Automation at 15% and Commercial Residential at 7%. As I've also said to everybody over the last six months, as we've seen our order pace pick back up, particularly around the Automation Solutions, I want to make sure we understand the mix of this as we go through the last three months of this fiscal year, as we move into the January, February time period for a couple of reasons. One, our KOB 3, which is day-to-day MRO improvement of the facilities has been strong and continues to be the same pace. We're starting to see some of the KOB 2, which is smaller minor upgrades and our backlog is starting to build; our backlog built in the fourth quarter versus last year. We expect that to continue to happen. I want to make sure we see a steady pace as we continue to see our orders pace stay strong and also our backlog builds and we see that mix of business as we see our customer base start telling us what their capital budgets are going to be. As you know, our capital budget for next year's going to be up nearly 15%. We're talking and planning to be from about $480 million to $550 million in capital, so we are investing in the company. And if you look at the tax reform bill right now, there's a lot of focus on encouraging people to spend capital. So from my perspective right now, we're trying to be very careful relative to the pace of business, relative to our sales forecast. We have not changed the sales forecast, what I've been communicating now for several months, with the underlying growth rate of the total corporation in the 4% to 6% range; Automation Solutions in the 5% to 7% range; and Commercial Residential in the 3% to 5% range. I'll say it again, I want to see the pace of the orders over the next three to four months, I will then, at that point in time, upgrade the forecast and expectations that we see in our base business. Clearly, the momentum is on our side right now, the order pattern is consistently stayed within that band and now, as I said, we from time-to-time will go at the high end of that band which we did in September, and we are there in October. I'd expect us to see some pretty good pace along those lines. From a standpoint of the cash flow and profitability, we will continue to have very good profitability in the base business. Looking at decent conversion across this company, in the 30s on a combined basis, as we look at the two businesses, again, I will refine that as I look at the mix of business and as we go forward, that makes a big difference. Clearly right now, as the KOB 3 stays strong, KOB 2 starts coming in, profitability should be reasonable in the business. If we move towards that 7% type underlying growth rate automation or even better, then we're going to have start investing and to handle this growth in the top of business, so we'll be looking at all those trade-offs as we go forward. Right now, I feel good about where we sit at this point in time. Backlog building, orders good, world areas are all kicking in except for Latin America at this point in time. Commercial Residential is running at extremely high levels at this point in time. Order pace still is good. Clearly, we have an issue relative to North America with the three hurricanes and also the bad earthquake down in Mexico. I fundamentally believe we'll work through that and that will be a positive for us. But again, we need to see what happens here as move into that season and they start replacing some of those units. But profitability, again, at Commercial Residential is pretty good. We are upping our restructuring in the Commercial Residential next year and some capital spending as we get ready for repositioning for capital, or for capacity, and also as we look at further consolidation across the Commercial Residential under Bob Sharp and Jim Lindemann effort, and they're making great progress as you can see in the profitability and the cash flow. Cash flow, I think, will be north of $2.8 billion. We put a number out there, $2.8 billion. I fundamentally believe that we'll be north of that. I also fundamentally believe our free cash flow will be conversion of around 120% to 125%. Again, those are different numbers than we put in the press release. This is where I feel we are at this point in time. We have a lot of momentum within the process of integration of Valves & Controls. And for your information, and I'll share a chart with you in a few minutes, Valves & Controls orders for the month of October three months were all went positive. So we've been telling you that we felt they go positive, they went positive. And they went positive, as we continue to see the momentum across the organizations, as we share the synergies across our selling organization, our key accounts and we're getting into accounts that we never been in before and we're actually able to really start to really take advantage of the global network that we have in Automation Solutions, and Valves & Controls are now starting to see that momentum. We're seeing great momentum of improving their on-time delivery. We're seeing momentum relative to the asset management. You already saw some of that in the fourth quarter in the cash flow that came through. Again, I want to commend the whole organization around Automation Solutions, including a lot of help here at the corporate headquarters as they work through cash and we're starting to see that cash come through and I think we'll see that go forward throughout all 2018. Feel very good about that and from where we sit at this point in time. So, net-net, I fundamentally believe that the wind shifted. We have a couple of things we have to overcome. We'll give you a lot more details at our Investor Day in February, as we always do. But I'm giving you more insights to what we see at this point in time than we historically would in November. We clearly have a couple of things we have to overcome, one of them being when we made the restructuring in Brazil last year in the first quarter, we got a tax benefit. It was the right thing to do as we repositioned our Brazilian organization for what we saw going on in Brazil. We got a tax benefit. We have to overcome that in the full year. We will do that and, obviously, really challenges us in the first quarter. We also have lost the profitability from the business of ClosetMaid, which we did divest. And I'm glad we did divest. We've got that behind us and we, obviously, had to take a hit in the quarter as we booked that situation. So fundamentally, I feel good about where we sit. So if you look at the chart 11 here and talk about as I look at where we are relative to what – the journey that we started back in 2015, when we announced in June 30, 2015 to reposition the company, which is a healthy process. We've built a very strong company. We looked out. We said, look we need to reposition this company and focus on two fundamental platforms, which we've done. We repositioned, got that done. As we moved into 2017, we talked about growth. We talked about improved profitability. We talked about improved earnings. We talked about improved cash flow. And I fundamentally believe that we have moved through that phase in very strongly, and now we're moving into the next phase where people talk, hear me talk about getting back into a level of profitability to drive earnings per share in that $3.25 to $3.50 range as we talked about, I publicly talked about that around the 2020 range – in 2020. I've also talked about trying to get back to the cash flow levels in that $3.3 billion level, which would get us below the free cash flow to dividend ratios of the low 50% into the high-40s. Again, very important relative to where we try to go. We have a very strong company this point in time. We have a very strong organization. We continue to do bolt-on acquisitions. And clearly, we'll talk about what we see going on with Rockwell in a few minutes, but that's not what I'm talking about now. I'm talking about the core company that continues to do very well and continues to create value and grow and have a great future as we move into that next phase of accelerating growth, accelerating growth in earnings and sales and also cash flow. So if you look at 2012 – page 12, and you look at the leverage across the portfolio, if you think about the Commercial Residential Solutions business, we built this Commercial Residential business over time through strategic acquisitions, in fact, I worked on the Copeland acquisition as a very young planning expert in acquisitions back in the 1996 time period. We've gone forth and we've invested in technologies that have a lot of internal growth. We've made strategic acquisitions. We've repositioned this from a pure component type of play to more of a solutions play. And under Bob's leadership, Bob Sharp's leadership right now, he continues to make investments in that next-generation of not only technology, but the solutions on a global basis that really drive the fundamental standards we need across this world relative to energy efficiency, refrigerants, and basically stewards of this industry, and we are a major player. And we'll continue to make acquisitions relative to the technologies, relative to software as we continue to move up in this pyramid of solution. And you'll continue to see more of what we're trying to do, we actually talked about one with the board today relative to the commercial solutions area and talking about that next-generation technology around control and around communications. But very successful program of both internal development, investments, acquisitions, integration and creating us a very broad global solutions play around the Commercial Residential business and very strong Commercial Residential business today, running around $6 billion in size, with margins in and close to 24%, 24.5%, very strong business from that perspective. If you look at chart 13, Automation Solutions. As you all know, I ran this business many, many years ago. I've been involved in doing acquisitions in this business. I've been involved in creating the whole process integration, including introducing Plantweb and the first control in the field products back in the mid to late 1990s, involved in making strategic acquisitions around the Westinghouse innovation, around buying companies like Daniel, buying companies around the various technologies, and so we built a very strong business from the sensors, the instruments, from the control, all the way up to data management, with the most recent acquisitions very much in the data management area. We build a very strong portfolio of technology, product leadership, solutions capabilities on a very global basis. If you look at our marketplace today, we're fundamentally a leader in all the global marketplaces that we serve today, be it Europe, be it Asia Pacific, be it Latin America, be it the United States on a very broad automation solutions capability around the process, we've got a very strong capability, very much built on technology at the same time supplementing that with acquisitions and expectations of being able to do more in that area. The final – the Valves & Controls acquisition we just recently did was a very strategic acquisition for us relative to bringing more capabilities, relative to bring a stronger solutions package for our customer and the integration's going well. We will continue to grow this business and we'll continue to improve the profitability and the cash flow of the business. And to date, I feel very good of where we are and I fundamentally believe, as we close out the year, my hats off to Terry Buzbee, to Mike Train, and to Rob Karschnia about the tremendous progress they've made in a very short time period. But clearly, they got a lot to get done in 2018, but the wind has definitely shifted at they're back. But we really have built this strong foundation on core investments, acquisitions, going from all the way back in the 1970s, all the way up here to now to the 2017 and we'll continue to do that, so I'm very pleased with that. If you look at how we created integrated solutions, Plantweb was something that I introduced as the leader of process. Many of you might remember, we had buses down in Houston ran around with Plantweb signs on kind of funky oranges and lime greens and bringing out the technology to Plantweb the first type of control in the field, the first industrial Internet of thing within the industry. So we've been continuing to build from a foundation of products, the technologies, integrated solutions to problem-solving to now the top quartile performance. We have been – our business is all about changing and creating capabilities for our customers. And at the same time, helping our customers succeed, which allowed us to succeed, and we have continued to grow and prosper, and we've become – gone from a minor player in this industry to world's number one player in the process automation business. The time period that I've been involved with is going back into the mid-1990s to now 2018. As you can see from the participation standpoint, we have continued to grow the business. We've continue to add in both acquisitions and penetration in market. We go through periods in this business, yes it goes up, yes it goes down. We just gone through a down-cycle, it's now starting to turn around. As we look at it right now, this market is now growing. We are continuing to execute along that. We have a lot of new products, which is our core mantra within this industry. What we try to do is bring new products, new technologies out right when that market turns and the market starting to turn and we feel good about this marketplace. As we look at our automation business today as we move towards being $11 billion automation business in 2018. And so we have a lot of opportunities here. I think we have continued capabilities of outperforming the market, continue to have opportunities through acquisitions, and we'll have continued capability of creating a very broad global solutions, at the same time, investing at levels that they are very significant compared to competitors in technology and innovation and setting the industry standards that we need to set to help our customers be stronger and more competitive. If you go to chart 15, it's a chart that I actually showed back the first time in February 2016 in Austin, Texas. Showed it again last year, our fundamental discussion around be an automation business, be an automation marketplace, a very strong statement about we want to focus first going up that process, we're already in the hybrid marketplace, we're already in the discrete marketplace, but also move both up and across. The Pentair Valves & Controls clearly puts us down – coming down stronger in the process world. The Paradigm puts us stronger in the process world in the operations management and consulting world. We have made investments and we'll continue to make investments over in the hybrid market and discrete market place. This is a strategy that we've been talking about. This is not a new strategy. We've been communicating this. I've been showing this chart to the outside world now for over two years and we'll continue to show this because this is a focus for us. And with or without Rockwell, we are a very strong company and we will continue to make acquisitions within this space. We'll continue to grow in this space and be a player. Our goals and our stated goal is to be a strong global automation supplier to this industry. And we'll continue to focus on that, and we'll continue to make the necessary investments internally and through acquisitions to make that happen. It has been a stated goal ever since our whole repositioning efforts has started from that day and going forward. If you look at chart 16, the orders chart I talked about, you can see the map we laid out, the Electrical Products Group in May. We stayed pretty well within that band. And in September, we were at the high-end of it. October, I just said preliminary right now we're looking at 12% right at the tip of that. I expect us to continue to do well here in the next couple of months. But again I want to reiterate, I've been saying this now three or four months, five months, I want to see the pace of business, I want to see the mix of this business, I want to see the cut to the capital allocation coming from our customer base, that will tell me a lot about what is the momentum, what's the pace of this recovery. Is this recovery a 7%, 8% recovery, is this recovery a 8%, 9%, 10% recovery, what is this? I fundamentally believe the recovery is going to spread out over two years. I think the recovery is going to be spread out over 2018 and 2019. But then, again, I don't control the recovery, the recovery is controlled by the market and what our customers have to spend. The pace right now is very good. The order pace is very good. The comparisons will obviously get tougher, but we clearly have a lot of momentum on a global basis and it's not just one or two key markets as we started out earlier this year. Our backlog has continued to build. We're still not back to the September level as you see, excluding the Valves & Controls. But I fundamentally believe that our backlog will continue. We are actually seeing very strong, what I call, KOB 2. These are minor expansions and upgrades. And not just the KOB 3 type of projects. The order pace that we started seeing in the last couple of months, I've seen that go up. It's one of the reasons our order pace is bumped up. I want to see the mix of that; I want to see where it's going to come from. But fundamentally, I like where we are right now, though the momentum is quite strong. Our new products are coming out very nicely and we are winning in the marketplace at this point in time. If you go to chart 17, this is a chart that we're showing you the Final Control numbers, which is the – that's what we call the Fisher and all the other actuation put together, the Final Control business that Terry – that now Ram heads up, he's the Group President. You can see the recovery has really taken off in that business. We've had strong momentum. Our estimated numbers are sitting there close to 20% in October. You could see, on a pro forma basis, together the numbers are around that 10% range and you can see that Valves & Controls actually have gone positive. And we see that momentum continue to build and we like where we sit at this point in time. But the partnerships, the main valve partnerships, the broader market exposure, those are all happening. New key accounts, the areas that we thought that we could see happening are happening and I have a lot of expectations as the market recovers that we'll continue to move this forward. We will improve the profitability; we will improve the cash management. You know Emerson can deliver on cash. We set a record this year of 14.5% of cash flow to sales, and it's a very good level. I mean there's a couple of us in the industry that can do that. And – but it's a rare breed and we will have another good year in 2018. Clearly, the faster they grow the more cash we'll have to invest. But at the same time we'll also generate a little bit higher levels of profitability. So before we – I move to questions, and I know you may have one or two questions, but just before I move to questions, let me address the proposal we made to Rockwell Automation to combine our two companies. Emerson, you know, has successfully repositioned its portfolio over the last two years. I just talked about it. We've gone through phase one and phase two. We have two very strong platforms, Automation Solutions under Mike Train's leadership. The Commercial Residential Solutions under Bob Sharp's leadership. I like what I see with these two businesses. They're finding opportunities for growth, for profitability, that we had not seen before as we really focus hard on these two platforms. Both are performing extremely well right now and have very attractive growth outlooks. As you just heard, I think that the underlying growth for the next couple of years going to look pretty good, and it's a function of what we see around the world. But I still like what we see. And most importantly, we have a situation going on in Washington right now, potentially, that could really accelerate investments and capital formation which will help a company like Emerson. It was from this position of strength and our two platform focus and with confidence – strong confidence in our future that we attempted to gauge with Rockwell for the long-term global opportunities, for stronger growth and stronger profitability between our two businesses. In early August, we made a private proposal to Rockwell's board that valued the company at $200 per share in cash and stock, a significant premium to its unaffected market valuation at that point time. After that, proposal rejected, we followed up with a second proposal in early October for $215 per share in cash and stock which is a full and fair price based on public data information that we see today. The proposal will allow Rockwell and Emerson shareholders to benefit meaningfully from the superior growth in earnings, we believe, the combined company would achieve over the longer term. Rockwell is a premier high performing well-run company with strong management, strong innovation, and employee base who we believe share our values and culture of execution and exceptional profitability. Very good company, a company we've always looked up to and really appreciated what they've done in the industry. Both companies provide engineering focused solutions and are leading the way on digitalization in our respective markets. We're market leaders in the end markets we play in today. We continue to believe the combination of Emerson and Rockwell is compelling and highly strategic for the global automation markets for our customer base and for driving future technology for our customers for a long time. By leveraging the key technology platforms that are strengths of Emerson and Rockwell where these technology can mutually coexist and thrive. We would create an industry leader, better positioned in an environment where the global customer base is asking for a more integrated solution in the process world, in the hybrid world. The industrial logic behind this combination is very clear, in my mind and the board's mind. And the result would be a diversified company that's well-positioned to compete and thrive over the long-term and create value for our customers, our employees, and our shareholders. Rockwell's management has for many years described to its shareholders the importance of process automation for future growth. Emerson has the scale and the best-in-class process automation Rockwell has been trying to build for many, many years. And we provide an immediate solution for this need with our number one global installed base and global position in solutions, service, and organization. As our industry continues to consolidate to meet customer demand, we believe the opportunity to combine Emerson and Rockwell now is a timely, unique, and attractive proposition for both sets of customers, shareholders, and employees. Looking across our competitive set, no two companies are a more logical fit than Emerson and Rockwell or provide a clear path to strengthen customer relationships and generate enhanced revenue and earnings growth for many years to come. We are hopeful that Rockwell's board and management team will engage with us for the benefit of all stakeholders. But while we will be disappointed if Rockwell lets this unique opportunity go unexplored, we will remain disciplined in respect to price and we have a very viable strategic plan in place that we are highly confident as a company, as a leadership, and as a board as you've heard me discuss today and numerous times over the last 12 months. We will not extend this proposal indefinitely without a clear signal that Rockwell and its shareholders are open to a mutual beneficial transaction. We'll continue to work with our advisors, JPMorgan, Centerview, and Davis Polk to find a way forward with this opportunity. However, Emerson is a very healthy and prosperous company and we're very focused on succeeding with or without Rockwell. That is all I'll have to say about Rockwell today. As I – and I'm sure you can appreciate, will be not taking questions on any acquisition proposal. With that, I'll open the call to questions about the earnings results. A very strong close in fiscal 2017 and a look at 2018. I appreciate you understanding and honoring that because you will get – I cannot talk about it if you ask me. So thank you very much and I look forward to the Q&A section from our shareholders at this point in time. Thank you.

Hi. Good afternoon, guys.

Good afternoon, Scott.

I'm dying to ask about Rockwell, but I'm not going to because you... Just today, only today. If I got the stock right once in a while, my skin would get a little thicker, but anyways. I'm going to ask a roundabout question that isn't exactly Rockwell, but – and it's more about size of deals. And if you think in terms of, you've about bolt-on acquisitions and, even in hindsight, Pentair Valves business wasn't really all that big in the grand scheme of things. But are we to maybe take away from the Rockwell gig that you are comfortable putting together or putting out or looking at bigger stuff? And does it have to be automation? I mean, is there – would you invest in – I mean discrete automation, say. Would you invest in other kind of automation assets to get you to this maybe not the same exact place, but get you to a place that's a little bit different from where you're at right now in discrete?

Yes. I think that, from our perspective, as I communicated using that slide relative to the process automation and hybrid space, we are willing to explore significant acquisitions we've said it over the years in to expand that business presence around the hybrid space, around the discreet area. As we've gone through this whole repositioning effort, Scott, our focus is highly focused on automation as we define automation today in the Commercial Residential. At this point in time, I think we have big opportunities, both small, medium, and larger opportunities. Clearly, with this type of transaction, move like we did with Rockwell it's a very compelling strategic fit between our two companies. I fundamentally believe organization today can digest larger strategic deals, but they have to be within these two spaces. We are very focused at this point in time. We think there's unique opportunities there and we'll continue to play that. But from my standpoint, we move on after a certain point in time. We start looking at other opportunities which we have in our plate within the automation, but don't look for me and this management team and this board at this point in time to move outside these two spaces, these two platforms.

Okay, fair enough. And then just as a follow-on, I mean you talked about taking CapEx up 15% next year and oftentimes what we see is when CapEx goes up, kind of core expenses go up. I mean, do your operating expenses need to come up which is kind of a backdoor way of saying, are we going to see a full operating leverage in 2018 before – I mean, you mentioned after debt, cost back eventually, but I'm more particularly interested in that next 12 months or so?

From my perspective, where we are in this curve I'm interested in having appropriate leverage which means we've got to have a three in front of us. And the reason – yes, as you spend capital, now we've been planning and systemically stepping into the capital and I think we can manage that from the standpoint, as you know we don't really cut capital real deep nor do we go crazy on the upside, we just have a couple of larger projects that will be some big capital numbers which is, so it's not a lot of them, there's like three or four major capital spending projects, that we have a big chunk of that. So we could easily handle that and still have good leverage. The key thing for me is I've been communicating outside as I've watched the Automated Solutions orders which have continued to do well double-digit. From my standpoint as I see that mix of biz happening, we start seeing growth rates of the first five then six then seven and seven-plus or eight then that's where we're going to have start triggering the investments that we need to support our customers on a global basis. So I think in the early stages, we want to see the appropriate leverage. And then, over time, we're going to have to take some of that leverage and invest it. But as we get into 2018, my sign is I want to have the appropriate leverage and the key thing for me right now is see the whites of the eyes of the growth rate, the top line. And what that means I want to see the Automation business going to the high-end of the range we gave you. I want to see Commercial Residential business moving towards that 5% which I think they can. And then we'll start saying, okay guys, how do we invest and maybe get a little bit more growth? But that's I'm in the period right now that I want to see it. I want to, if you've ever surfed, I'm going to ride at the front of the wave for a while here as we have been riding in the last six months. I do not want to ride behind the wave which means I would not have appropriate leverage.

That's very clear. Thank you, Dave, and good luck with all the stuff.

Thank you very much, Scott. And good luck with your company, too, by the way.

Thanks. Good morning, Dave and all.

Good morning, Stevie. Are you free to talk now with your new firm, huh?

Well, well, no views or opinions just questions still.

Okay.

So, Dave, I don't want to dive into Rockwell either than that Scott said but there's a question without Rockwell. If Rockwell does not happen as you've talked about in the past, what's your ability to either partner or just organically do something that's been so difficult to build on the discrete side and the hybrid side, can you make something work internally within internal organic investment and the right partnership that actually make a dent in that market?

I think there are ways to do it outside a strategic fit like with Rockwell. There are ways to do it. There are through acquisitions and there are through joint ventures and partnerships. There are ways to do it. As we've looked at the process side as we continue to invest in the hybrid side, we know that in order for us to be successful in a good time period, we're going to have to do that. And so, that's why the focus is really picking up and we have opportunities, we talk opportunities again with the board today. And so I think that you'll see us that we'll be pushing there. It clearly is a more building approach versus a very large one strategic move at one time but there are opportunities there and we have, as you can see, the return of sales growth and the probability and cash flow is allowing us to do to be go out and find these opportunities for us for the future. So I think we're in a good position right now. And I think the opportunities are out there and people see that we are very, very focused and very true to be a global automation house. Our customers see this and our competitors see this. And so I think that we're well-positioned to do more even outside if something didn't happen to Rockwell.

And that product as well as installed base in technology?

Yes, it is. It's across the board. I mean obviously, from the standpoint of, just in the hybrid and the discrete side, we need clearly some different channels, we need some different technologies and that's why you have to do the acquisitions or ventures. But I think we have the capability to do it internally, but I think to get there faster and get there on a timely manner and do it right for our customers, we will – most likely we'll have to do the right type of acquisitions or right type of joint ventures.

Okay, great. And then you talked about this recovery potentially being more of a two-year recovery and some of the things that you're waiting to see. How much of what you're seeing is sort of MRO catch up versus new capacity, upgraded capacity in the initial discussion? And when you think about that GFI growth that you normally talk about the kind of acceleration once you hit 4% or GFI hits 4%. How should we think about it in that context because it feels like we're right in the middle or right at the beginning of all this happening? So some perspective on that one...

We are definitely beginning to see and so what we're seeing right now as we look at the order pace and our sales pace over the last six months or seven months with Automation Solutions, it's heavily what we called the KOB 3 the service MRO type of base, what our customer base have had to reinvest and to improve their efficiencies, improve their quality, to improve their obviously safety. And we're now starting to see what we called the KOB 2 side where they're doing – starting to do some minor expansions. We fundamentally believe this recovery in the initial phases will be heavy on the KOB 3 and KOB 2 throughout all of 2018. And what I'm trying to watch right now is the pace of the KOB 3 is pretty steady at this point in time, will accelerate a little bit more if there's more capital being allocated in the January, February, March budgets of our customer base. If that's the case and you're going to see more short-term investments, which will be good for us. And then we'll start to see in the KOB 2 minor expansions, which also help us late in 2018 and early in 2019. I fundamentally don't believe the bigger projects will start happening to us. We're bidding on them right now, but they will not really start happening until late 2018 early 2019. But the pace of the recovery is pretty much similar to what we see in the past, except we have a customer base that I think are being a little bit more cautious. Now with the price of commodities, all sorts of commodities firming and going in the right way, we might see some acceleration. I also see my customer base getting more healthy from a cash flow standpoint. And so those are all good signs. So I'm encouraged that we're going to see improve capital and reallocation towards the type of spending that we see in automation, which will be good for companies like us.

Okay. I'll pass it on. Thanks, Dave.

Thank you very much, Steven. Welcome back.

Thanks. Good afternoon, Dave.

Good afternoon, Chris.

Hey, I was wondering the Valves & Controls margin outlook, it looks like you had a little bit of negative EBIT in the second half of 2017 there. Do you think 5% is a good level for next year or kind of work and back to that by the second half of 2018 maybe?

No. I think we'll be better than that as we exit the year.

Yes.

We'll still be running uphill in the first half of the year. But it should be when we lapped the thing, at the end of May, we should be accretive and we should be heading towards good high-single-digits as we go into the second half of the year.

Yeah. From the standpoint of, I mean, we want to get double of that. We want a one in front of that thing soon.

Again, that's operations that's without the amortization and then the restructuring is going to be lumpy. So we're building in the certain amount of restructuring in. But depending on how things develop, we might end up doing more next year, so we don't have a really good beat on that right now.

I like the pace. I like most of these guys doing a good job. The whole organization of Valves & Controls there with Final Control's getting engaged, and so I would say we're slightly ahead of where we thought we'd be right now. And what I'm looking for without the amortization and restructuring, I want 10% and then we'll go from there to 12%, and then we'll go there – I mean, that's what I'm looking for and so for the guys like Ram and your team out there, I'm thinking 10% for the year, and I'm sort of like a target-driven type of guy if you haven't figure that out.

Okay. Sounds like that would screen well against the EPS range. And then...

If we have a continued improvement in our profitability, continued improvement in growth and with what we have with the Valves & Controls opportunities, in the Final Control area, I think we still have a good run of cash flow conversion opportunities both in 2019 and 2020. I think if we map out and we look at how do we get to $3.3 billion of operation cash flow in 2020, we have to continue and convert well north of 100% and that's going to be a lot of that is getting the cash, basically $400 million, $500 million of cash that we see in the Final Control balance sheet right now converted into cash flow. And I feel very good about it. We've done this over the years very well, and I think with a little bit of growth and improvement in profitability and investments we need to make there, I feel good about getting that $300 million to $400 million of cash flow over the next three years, and I don't think it's a one – I don't think it's a two-year thing here. I think we've got several years of run with it.

Great. Thank you.

You take care. All the best to you.

Appreciate it.

Hey, good afternoon, Dave.

Good afternoon, Rich.

So just on – from a customer standpoint, with your key customers, are you hearing from the customers that it's important to have the full suite of offerings and solutions. And is this – have seen evidence of that, because we can't see that on our end and just curious if that's partly the motivating factor. I mean, obviously, there's clear reasons why this could came together. But just curious if there's any evidence from customers that they want this?

We're seeing more and more requests on the larger projects in certain industries that they want to see an integrated solution both on DCS and on PLC and other type of control end-to-end customers, and particularly they're going into the industrial Internet of thing and they're more software, and they're more management control. So we're seeing this requests both in the power industry, in the chemical industry, in the pharmaceutical industries. We're seeing this across the various industries these days, in oil gas. And so customers are asking for this. And I think that it is an opportunity for us in the United States to put two very strong players together with a strategic fit to create a better solution for our customers, and our customers are clearly asking for this. I can find – I'm sure you can find examples of customers that are saying no, but I can find there's more customers saying yes. And so I fundamentally believe that this is the right thing to do for our customers to keep them competitive, to allow them to produce more efficiently, especially with the newer technology when they want to use less and less people out there. So the answer is, yes, we're getting asked.

Okay. And then just as we think about fiscal 2018 guidance, can you quantify the sales that were lost in the quarter and how meaningful that could be for 2018? And then just on China for Commercial Residential Solutions, it was a great year in 2017. What's your growth outlook here with the comps being pretty tough?

Okay. So, on the hurricane. So, I got all my friends out there, my auditors, my friends, and everything like that. My fundamental gut – and this is David Farr speaking from – see I only have 36 years of experience, business experience, so I'm a young kid compared to Tim. I think there is an impact around $30 million to $40 million in the quarter. It's not a huge number. And don't ask me to go audit that because I won't spend a nickel on it. This is just my intuition seeing what I saw from our customer bases and saw what went on in across the key markets. There was a lot of devastation and I want to thank my organization for rising up and helping people in their own company, but also people outside their own company, as we went through this tough time. It will spread out over the whole year because it's going to be – it's going to take time, obviously, in the residential marketplace to rebuild. It will take time in the automation space and the projects that were delayed. So I don't think you can see a meaningful bump. I just know it's there and I know, over time, we will get that back. And I think we'll get that back over the next 10 to 12 months. And so, it's a positive wind to our back that's all I can say to you there. Now let's go to China. We had it very good in China. We grew in total, I think, a little over 10% globally for the whole year, what was that – what was the number for the whole year, Tim? I know – Tim doesn't have 36 years of experience in this industry, so still looking at the book. I mean he's taking awhile. What did we grow in China?

Hold on, 15.4%.

15.4% for the whole business for everybody. So from my standpoint this year, as I look at the momentum we see in orders and Automation Solutions and opportunities still on Commercial Residential, I'm looking in the high-single-digit. It will be a lot tougher. But I will be disappointed if we don't approach the 10%. We may not get to 10%, but basically what I'm seeing the activity around Automation Solutions and orders based on what I'm hearing early stages out of the Commercial Residential, it's going to be tougher. But I still think that we're going to be looking at – I think we're going to be in that 8%, 9% 10% range, still a good year. And we do well in China, as you well know. I'll be there next week.

Okay, great. Thank you.

You take care. Great talking to you, Rich.

Good afternoon, Dave, and gang.

Good afternoon, Rob. Where you're hiding out today? You hiding here in St. Louis, or where are you hiding out?

Suitable undisclosed location like Boston. In any event, since we can't talk about Rockwell – so we can't talk about my favorite topic, Rockwell. Let's just talk about – maybe you can talk about incremental margins over the next couple of years from Automation Solutions given the fact that you have two scenarios, one which kind of a stair-step of growth and the other maybe more explosive growth which will lead to more investment and the relative mix. But how do we think about kind of incremental margins structurally in that business over the next couple of years and maybe take into account the accretion such that it is Valves & Controls?

What we've been talking to the team about internally on this, I want to get back to 19% over the next couple of years here by 2020. That means that so incrementally they're going to have to be in the 30s as we go forward here. Some of it's going to be, obviously, the improvement of Valves & Controls, some of it will be across the other businesses. But even with what I would look as a good recovery, a very solid recovery, I fundamentally believe we can get back into that 19% by 2020. Now, as you know, we peaked close to 21% in this space, clearly with Valves & Controls, it's going to take us a lot to get back over that 20%. But I fundamentally believe that we can get back to 19% within this next three-year window. And we'll get into that – into with the opportunities that I see there. I don't see why we can't do it. I mean it's – we should be able to do that.

Okay. And then, just as a follow-up on Valves & Controls. Obviously, one of the potential strategic value that could be coming out of it is, obviously, reversing some of the under-penetration you had in the Kingdom. And you did travel over to Saudi, I think, with Trump and – The President, excuse me, in May. But how do you think...

You should be more respectable there. Come on, I mean, I...

Yeah. No, no. El Presidente.

Yeah. It's hurting me, Rob. Not just – I'm the Chairman, you know, what I'm saying.

But in any event, you have been over there, but obviously we've had some pretty interesting kind of Game of Thrones headlines over there. I mean how do you think about in the context of maybe getting share back there, the outlook for the Middle East? And then, where do you see the risk on the geopolitical side as well, given the fact that you've been in the region recently?

A couple of things. One, we are making headway. We have been given approvals to be able to sell back and come off the list to sell our full product offering in the Kingdom. I will be back in the Kingdom in January. We are opening a whole new innovation center right there in support of Aramco. And – so I'll be in there meeting with the CEO of Aramco and talking to them. Our capabilities are well respected and known within the Kingdom and what we have to offer. They fundamentally understand that our processes, our disciplines around our business on Automation Solutions is different, and that we'll make sure that we follow the rules and regulations. We followed their local content and stuff like that. So I like where we sit right now with the Kingdom and the opportunities and we'll continue to invest and we'll continue to go. I mean clearly, there is some shaking out. I mean clearly they have a different political system than we do where someone says you're going to go and you're going to go and come in, it's not like an elected process. We're watching this. But I feel still very good. I'm seeing them – our business pick up in orders in the Kingdom. Across the Middle East, clearly, I think we're going to have a better year. And from my perspective, I look at, again, the combination of the potential compelling strategic fit between Rockwell and Emerson, to me it looks pretty good even in the Middle East, too. Both of us do well there and I think we have opportunities there. So I feel okay with the Middle East. I think we're going to have a decent year in the Middle East. And clearly, there's always risk relative to political and also war issues relative to the Middle East, but feeling pretty good about that. Right now, I like where we are.

Good luck with your November.

Thanks.