Emerson Electric Company (EMR) — Q1 2020 Earnings Call Transcript

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. 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 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 of 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, were 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 the 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 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. 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 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 to be 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, will 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 move 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 Emerson investors and the analysts following us as we discuss our first quarter results and our expectations for the full year. I also want to thank all Emerson leaders and employees worldwide for their contributions to this quarter and for implementing our aggressive cost resetting programs to strengthen Emerson and enhance our competitiveness in challenging and uncertain global markets. As indicated in the first quarter press release, we have been busy executing our 2.5-year cost resetting efforts. We accelerated our fourth quarter cost resetting by approximately $35 million. These savings have been incorporated into our plans for this year, and we've achieved $97 million in reductions in the first quarter, which includes corporate actions such as reducing our Emerson plane fleet to five and selling the helicopter. We anticipate a total restructuring cost of around $215 million for the year, and we expect to see over $420 million in cost reductions over the 2.5-year period, with savings significantly exceeding that amount. We also expect an additional $50 million in savings from first quarter restructurings. Our current focus is on addressing excess facilities and high-cost structures that will yield returns in 2021 and 2022. We are on track to achieve dollar for dollar savings, and execution is progressing well. We discussed this in detail with the Board recently, ensuring that our permanent cost actions do not compromise the quality of our investments, technology, and customer service, or the long-term viability of our franchise businesses. We will hold our annual investors conference next week in New York City on February 13. We will provide detailed information about the global cost resetting efforts aimed at achieving new peak margins in a low growth environment. We will outline our strategy, timing, and projected annual savings. Simultaneously, we are taking substantial actions to optimize our corporate headquarters structure both in St. Louis and globally, with a focus on Automation Solutions and Commercial & Residential sectors, supported by McKinsey's insights on enhancing Emerson's efficiency and profitability. Lal, Bob, and I will share more details during the conference, and we are pleased with the progress we are making. We are starting to see improved margins in Automation Solutions, thanks to Bob and his team's efforts. We are currently in execution mode and recognizing that we cannot rely solely on the absence of growth. We are actively looking for ways to enhance profitability, earnings, and cash flow in a challenging environment. The current global order trends show that North America is weaker than we anticipated, while Western Europe is performing in line with expectations, and Eastern Europe is declining, particularly due to challenges in Russia and Turkey. The Middle East and Africa are performing better with several large projects underway. In Asia Pacific, we saw solid growth in the first quarter and expect strong performance for the entire year. However, I do not see clear catalysts for growth in the U.S. or other parts of Latin America at this moment. Our strategy is to control our costs and reset them to improve earnings and cash flow. While growth is desired, we anticipate a challenging year ahead. The global market conditions are tough, and although I see growth opportunities, I'm uncertain about the timelines. Operating cash flow is expected to be positive, with the first quarter showing solid performance despite some working capital constraints. Our overall cash flow is projected to improve to the range of $3.15 billion to $3.2 billion. As discussed with the Board, we plan to distribute $1.2 billion in dividends as we mark our 64th consecutive year of increasing dividends, with our dividend payout ratio dropping below 50%. We expect approximately $1.5 billion in share repurchases, assuming no major acquisitions occur. This means about 85% of our cash flow will be returned to shareholders. While we remain open to acquisitions, we are also planning to increase capital spending to around $650 million as we establish new cost-competitive locations worldwide and continue to reset our facility and cost structures. Our acquisition prospects are limited, as many sellers are hesitant due to market uncertainty. However, we are working on closing two promising acquisitions totaling about $120 million, one in Automation Solutions and the other in Commercial Residential Solutions, both focusing on control elements. I also want to acknowledge our commitment to our employees in China, where we have 11,000 staff members. We are in constant contact with them and can communicate with our larger workforce. Our thoughts are with those who are currently confined to their homes. Our teams are preparing for the eventual return to operations, and we are concerned about the ongoing situation. Based on my experience with these circumstances, I expect a sales impact ranging from $50 million to $100 million. If the situation continues to extend, this range may increase. Additionally, many of our clients rely on manufacturing and shipping from China, which raises our concerns about ramping operations back to normal levels. I estimate that a portion of the sales impact will likely be permanently lost, particularly affecting the heating system marketplace. I believe, however, that we can recover losses in Automation Solutions if the situation is resolved quickly, but I will monitor how the extended shutdown affects productivity. Mike, would you like to add any insights?

Alright. 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. We had a solid Q1 in both platforms, as Pete mentioned, in the mid-single digits. Secondly, January 15, we saw the signing of the U.S.-China trade deal, which was pretty important. That Phase 1 deal is significant for us. I believe there are also announcements on both sides, which would be Phase 2 discussions commencing shortly. We're excited about that. It's going to take some time, but we're pleased. However, right at that same time, people began to realize that we had this coronavirus issue. Our employees took the Chinese New Year holiday on January 24 and have been off for approximately 11 or 12 days. Based on government regulations and guidance, we plan to restart our facilities next Monday, February 10. We need to ensure that can happen and will be monitoring the situation closely. There are issues we will have to face regarding the restart of these facilities. For example, we must implement temperature monitoring and have restricted travel. We'll do everything needed to manage this. However, I believe our supply chain will struggle, despite these best efforts. It is going to be a rocky start due to challenges with logistics, supply chains, sub-suppliers, and all those associated elements. So how prepared are we for this situation, David?

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

Our supply chain in China is about $750 million—$500 million stays in China, and $250 million goes to the global business. Therefore, impacts in China could further impact our operations globally due to interconnectedness. We're going to start off with a view of what will happen here. I believe next week will be an important week for us, when we will gain more information as we go forward, and at that point, we may have updates to provide. Again, there’s a significant uncertainly surrounding these events.

Thank you, Mike. As I considered this situation, I likened it to the reentry blackouts during the Apollo space programs. We are in that reentry blackout period for China right now. We do not yet know everything that we will face. The team in China, who I anticipate are listening to this call or will catch up later, are doing everything possible to prepare for this. I am concerned about the supply chain disruptions, logistical hurdles, and the various components involved in our operations. To believe we won't feel some negative effects in the short term would be unrealistic; it will be a negative for the global economy. Should this situation drag out, it could have even greater consequences. Right now, our inclination is that it will not linger. However, we remain prepared for the worst, and we're rallying to ensure they have the resources necessary to overcome this challenge. Our teams are ready to come back to work. We will provide updates as they emerge in the next few days.

David, I’d like to delve a bit deeper into the numbers to give our teams and stakeholders some clarity as we go forward. While our employees in China are working remotely and face considerable challenges, we’re doing what we can to ensure their safety and wellbeing. However, I do want to emphasize that ongoing monitoring means we can respond to employee well-being and address business needs responsibly. As I look at the broader impacts of the coronavirus, I strongly believe that we’ll be able to recover, particularly for Automation Solutions, assuming we maintain composure during this process.

Our orders are broadly in the stated range, as I have mentioned. While some variability exists month-to-month, I feel we maintain a normal cadence, as expected. Yet, my oversight leads me to believe we may have additional challenges with the coronavirus ongoing, which may affect some orders. We remain focused on maximizing operations throughout this period. I’ll keep a close watch on our supply chain and endeavor to ensure timelines remain accurate.

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 on the 10th of February, 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 a 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, a 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 to see some stability and 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. Obviously, you'll be able to tell from our order releases and comments 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 better improvement around that flow business, which is very important to us.

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, 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 measures 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 offline capacity and consolidate. So his are a little different; that's why you haven't seen much from Bob right now; his business over the next couple of years, and he'll be doing fixed savings. I feel very, very confident. Now I am involved in reviewing the work with Lal and Ram; the Board and I look at these costs in detail, and I feel very good about those savings. I feel very good about the bridge chart we're showing you from the second half. I think the previous caller, John, asked is very relevant relative to the mix issue, which needed stability. But as I look at the actions, they are doing well right now in the short term, as it is very much people-oriented, and we're starting to take some of the longer-term facilities offline. So I feel very confident we’ll start seeing that margin move up in the second half.

Yes. I think we've got a good plan going forward. We're looking for a significant margin improvement in the second half. A lot of it depends on the pace of business and the mix. The restructuring actions will come into play, and we're pretty confident in the margin development as we progress through the year.

And McKinsey reported to the Board yesterday in the work that we did between the two business units and Corporate, we have additional actions we can deal with probably starting in another couple of years. We want some backup stuff and some other opportunities, but let's put it this way, our hands are pretty full right now with actions we've got ongoing. But we're going to examine and lay them out and see how we can begin executing some of those perhaps later this year or early next year, to provide protection in case something unexpected occurs. From my perspective, we are doing what we can to ensure we are safeguarding what makes Emerson unique, as well as keeping our corporate culture intact, but at this time, we are also analyzing how we can improve our effectiveness and efficiency. The discussion we had with the Board was very productive.

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? 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, you've hit the nail on the head here. The issue right now, I think the North America projects are starting to see release; I’m very worried as my customers are worried because much of the business is produced—and production is shipped to China. My concern is if this coronavirus goes on longer, it will delay those projects and could slow down some of the initiatives that we anticipated would release in the upcoming months. Thus, the coronavirus has a significant effect on various aspects of our business base. Therefore, we remain convinced that the second half could be a challenge for us, and that's how we are anticipating very low growth considering events like this. As for the projects we see releasing, I still believe some, particularly the Middle East and India, will proceed. Those projects are separate from what’s going on in China, and I feel good about them. I think that will assist us as we fill up that pipeline for the second half of the year and as we move into 2021. But we must achieve some settlements and resolutions regarding the coronavirus and ensure smooth travel as we go. Without them, some North America projects will clearly be slowed down.

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. 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 it—I look at the pipelines, I look at the things we're discussing right now. We are—we shared with the Board—we’re not backing off on any of the KOB 3 investments. We have the organization highly motivated to try to take some market share on the installed base. We're focusing on other areas to cut our costs around. But that area right now is ripe for us to continue taking share. We want to build that KOB 3 up strongly because those projects will start flowing, assisting us in countering 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 for fiscal '22? Or what are you thinking? Like how long are you projecting right now?

I think we're going out to '23. We will bridge the $450 million. And as you know, I try to be honest and transparent, sort of like the Iowa caucus. I will attempt to bridge for the 2021 numbers. But we will provide you with the bridge so you can see what the $450 million we talked about and then what we see going on going forward. You will notice a much lower sales forecast as we manage growth to keep it in check. We're focusing on cost until we see robust underlying growth; we'll keep that growth rate low and manage around costs. So we'll provide that information, but we anticipate '23 as a timeline.

Okay. So I just want to be clear. So the $215 million of restructuring, the $95 million that we executed last year, David, you talked about reviewing this with the Board. Does this mean that on the 13th when we discuss the Board's review or presentation, there is no new restructuring on top of that? The restructuring will essentially be confined to what you've articulated? Or is there still potential for more?

No. What I just outlined for this year is confirmed. Are we looking at $210 million or $220 million? Yes, that's what we're currently addressing. However, we will also show you our goals for 2021; as you know, we aim to complete everything within a 24-month timeframe as much as possible. We made some progress in the last quarter of last year and are handling a lot at this time in 2020. It’s going to be a busy year in 2021. But once we move past 2021, I intend to return to our stable restructuring run rate, which is typically around $50 million. You will see that we aim to exceed $400 million in total across this cycle and our concentrated efforts in that direction. What we've communicated for this year is that this number is mostly fixed unless a significant global event occurs that requires us to recalibrate, such as a major change in China or the business environment. For now, that plan is set, and I believe it will keep us busy for the year.

So we can anticipate on the 13th, beyond the traditional analyst review, the Board—you have McKinsey involved, you've undertaken this top to bottom review. You will be outlining overall strategy or the returns? If there are no new restructurings, what should we expect?

We're going to discuss macro restructuring. We'll outline the outcomes of the review of our businesses. We'll talk about our cash flow generation and how we will allocate that in the next couple of years, along with some foundational strategies. Expect to see a presentation on digital transformation coming out from one of Lal's key platform leaders. Or yes, not platform, but the business unit presence we’ve built. Additionally, we’ll update you on the Final Control operations led by Ram. You're going to see a lot of strategy insight into what we are doing and how we're intending to drive our goals. However, I want you to grasp that we have established strategies in place, and we will effectively manage costs while promoting our business. We will also provide an update after 18 months of owning the Textron Tools business regarding professional tools and how that program is progressing. Both B&C and the professional tool ones are performing quite well, and they're integral to our repositioning efforts to drive value.

Just a quick question on the clarification of 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 adjust the upper part of the sales range but keep the midpoint intact? Or is there any risk to the midpoint also at this point in time?

No, we wouldn't set out guidelines out there that we don't believe we can achieve on both the top and bottom of the scale. However, our trend lines indicate that the midpoint is the most likely outcome. The upper point remains feasible concerning the coronavirus because we anticipate that production will ramp back, and we expect to recover some of the lost $50 million to $100 million of sales. Thus we fundamentally believe that this range remains viable, regardless of all that we face globally at this time. The cost actions are taking effect, and timing factors can help our margins and, indeed, the EPS. So at this point, we are comfortable in that range. My highest probability clearly rests at that midpoint, but I also see some potential benefit on the upside.

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

No, I think we can't clarify that. China sales fluctuate across all the markets depending on where operations are being undertaken in regions. Thus, we cannot break that down presently. Over time, this will evolve, and I know our sales force is energized to find out how to reclaim that business back. These individuals will pursue ways to recover their losses and will likely redirect operations to a different location as needed.

Maybe a first question on Slide 13, the restructuring costs and earnings tailwinds. You have the restructuring costs of $0.26, with a benefit this year of $0.07. So that balance is sort of $0.19. Do we assume 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 will flow in '21 and '22, and I'm not sharing that with you yet. But we'll share that with you.

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. I just wondered if that balance of $0.19 is all coming next year, or is a portion of it just reinvested into the business?

No, no, no. A big chunk of the savings will come next year from the delta I'm referring to. The segment that may have some delay to flow involves the facility restructuring aspects because that may not begin to bear fruit until early '22 or late '21. What we see there is the reinvestments are integrated into our core plan; we have accounted for the costs. We have netted that already. There are no additional actions occurring from that standpoint. Those savings will be flowing, and I would say that 90% of those savings will materialize heading into '21, and we'll yet have a bit of carryover into '22 from the restructuring processes you are mentioning.

That helps. And then my second question, just on the top line outlook in Automation Solutions. Maybe just focused on the 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. 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 somewhat 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'm not overly worried about that right now. Now I'd like to see another quarter of performance with that. But that business, that petrochemical and chemical, as we know, we serve a much broader swath 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. 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. That’s a very high KOB 3 marketplace. And as I said earlier, when some of the guys asked, I firmly believe that we will continue to see some improvement in KOB 1. So I'm generally more optimistic about that.

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 aiming to do here. I mean, if we are expecting incremental growth in sales, we will share that with you as we lay out our plan. And obviously, the restructuring that we're pushing will also flow through as someone—I think Julian asked me about the reinvestments. So we'll present that detail. We went through that with the Board because they want to ensure we are not cutting key long-term programs. However, we are trying to structurally make some changes, which will help that flow through. The key thing right now is we're relying on very little growth here for the next 12 to 18 months. That's the central point.

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

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

I mean, if we're going to take those costs out at that scale, you've got to assume some stabilizing effect on the revenue side.

Yes. That's the key point; we need to reign in the fixed costs to accommodate revenues. And, of course, we're banking on marginal improvements depending on demand behavior.

This is actually Pat Baumann on for Steve Tusa. So yes, he gave me an opportunity to ask about 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 between the spend and when we book the expense that’s pretty significant as we get out of the gate here. And then a portion of the restructuring is non-cash; it involves facilities and asset write-downs, things of that nature. So when we wash it through, we think the net impact in 2020 will probably not be very significant, less than $50 million.

Yes, I mean a lot of times from that front-load late last year, early this year, there's cash upfront, but eventually you get cash back because you're not paying. So it balances out, and right now cash generation remains strong. Overall, the net will be pretty neutral. The taxes are essentially some work Frank's done related to our international subsidiaries through these processes.

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

I would estimate that 80% to 85% of it will probably be cash.

Over time. Yes. And the key issue is the sooner you mitigate some cash impact once done, the quicker you obtain your cash payback, because it happens fast. The facility challenges are tougher because the cash leaves and does not generate savings for a long time.

Okay. Maybe switching gears, just—can you give us an update on what you're seeing in residential 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 remains in a tough zone right now. We're caught in the middle of winter here, flat to slightly down. I don't see how fast the impacts will be; however, the one encouraging indicator is that residential construction is doing well; that’s a good sign. Typically, we can see some payback and improvement here as we transition into the March period. The last quarter was strong in Asia and China, albeit pre-existing the circumstances there. I'm a bit apprehensive about that as we come through it now. Our reports indicate that President Xi will perhaps stimulate financing and spending to boost the economy, typically beneficial to the residential and commercial markets.

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 performed pretty much as we expected, which is slightly negative. The month tends to be comparatively small as it's the Chinese New Year. From that perspective, it's a short month. However, I remain concerned about our practices as we attempt to take orders over the phone now. We're still operational, but business volume is sparse. I’m particularly anxious to see what unfolds post-February 10 as we commence observations about behaviors and measures taken to restore activity in the weeks thereafter.

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

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

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

Yes, you can back into them. Yes. So there are two factors. First of all, auto sales—typically, our second quarter sales are higher seasonally, as you know, and that influences volume in the second quarter. We do expect stability with the mix of business in that segment. In addition, we have initiated savings, some from the $35 million spent aggressively in the fourth quarter; most of that was around Auto Sol. There's been solid execution from the $97 million we've undertaken—most of it, I think, $85 million of it was allocated to Auto Sol in the first quarter. They will reap those benefits incrementally as they go into the second quarter and naturally ramp up into the third and fourth quarters.

Okay. All right. That’s helpful. And then, I guess, just my one follow-up. I saw there's no change to the buyback portion of the bridge. I guess the question 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?

First of all, if you look at our history, we have bought back substantially more stock than most people. Secondly, we also continue to pursue acquisitions. If we feel we don't have ample opportunities, we'll escalate the buyback. But right now, I've seen our historical rates, and we've maintained high buyback numbers, thus I don’t see any reason to escalate it at this time. The Board reviews this frequently, and if acquisition activity remains moderate, then we will need to consider increasing leverage and balance sheet. However, I will reiterate that we are committing 85% of our cash flow back to shareholders in this year's budget. That is a substantial figure.

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 days. Any thoughts around that just given the fact that you have substantial operations in China?

Our organization, we have a leadership team on the ground there; the team is in constant touch with the Chinese government, and we are getting a daily report from them regarding what they are being communicated from the government, both at the national level and the local level. I do not share the sentiment that the Chinese government is misleading people; I feel they have been very open with us. Now, everyone seeks hard answers, but you cannot exact hard specifics from something dynamic like this. However, from the consistent information I’m receiving from the government and the local leadership team reporting to Mike, my comfort level is quite high. The key issue for me is whether they can ensure those in the plants return to work when things normalize, and that the supply chain can mobilize as the channels open up, because logistics could hinder that.

Yes. I mean, to that point, 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 affecting your projects materially. But then, of course, 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 oil rebound, which would likely be broadly stimulative of upstream projects. You could find an upside to growth overall, which—and additionally, maybe attentively considering M&A, but that would likely put a lot more pressure on you to deliver the restructuring in what would inherently be a different demand environment. How do you square that circle in terms of where we could be?

Yes. I don't—we're not in a situation extreme enough, which is your first point; I might as well throw in a couple of locusts and sinking ships going down at the same time here. However, I think that—and I could say that there could be some positives if this thing resolves quickly, I feel that. But I’m more in a state of viewing this situation where I think it recovers slowly and regrowth returns gradually. We probably lose a couple of points from the high single-digit growth that we previously anticipated for China, which removes some growth potential for us. I develop a more glass-half-full perspective rather than the opposite.

Even in the scenario where there is stimulus, it may not come to fruition until next year, even then.

Yes, let's—those dates, the 10th, and they've been holding here pretty consistently. If those hold, then I feel good about that. Now if the plants are starting up, and they start failing, that might help us because of the business. But we’re waiting, and we’ve got to listen to what people say about the 10th and later to see if we can start gaining traction. So again, I want to thank all the employees. I also want to express gratitude for the engagement from the Board and shareholders I have interacted with over the last several months, and I will remain committed to continuing that engagement. We will now open the lines for Q&A in order to address any concerns or questions people may have out there. Thank you.