艾默生電氣 (EMR) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Emerson's Investor Conference Call. (Operator Instructions) This conference is being recorded today, November 7, 2017.

Emerson's commentary and responses to your questions may contain forward-looking statements, including the company's outlook for the remainder of the year. Information on factors that could cause actual results to differ materially from those discussed today is available on Emerson's most recent annual report and on Form 10-K as filed with the SEC.

I would now like to turn the conference over to your host, Tim Reeves, Director of Investor Relations at Emerson. Please go ahead, sir.

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 '17 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 3 of the slide presentation. We had a strong second half and finished 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 calls.

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 expanding 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 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 3-month 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 '18.

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. Adjusting -- 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 5. 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.

Turning now to Slide 6. In the first half of fiscal '17, underlying sales were down 1%, with strong demand in many Commercial & Residential Solutions end markets, offset by slower global automation investment.

Industrial business spending began to pick up in the second half -- in the second quarter as oil and gas prices stabilized and global economic conditions began to trend favorably. Full year 2017 underlying sales were up 1%, with reported sales up 5%.

In the fourth quarter, we saw continued strength in most world areas, with emerging markets up slightly and mature markets up mid-single digits. Growth was led by North America, including robust growth in Canada and Asia, where sales in China continued to be very strong and begun to run up against tougher prior year comparisons.

Outside of China, the rest of Asia grew low single digits in the second half, a reversal of first half performance, supported by improving demand in automation end markets. Middle East and Africa region was down in the year and in the quarter, but orders here have turned positive.

And turning now to Slide 7. Total segment margins, excluding Valves & Controls, improved 150 basis points to 21.5%, driven by the benefits of restructuring actions, lower restructuring spend and leverage on higher volume.

Corporate and other charges increased $57 million due to $56 million of Valves & Controls first year acquisition accounting charges. $44 million of this total related to inventory revaluation, which is charged to cost of goods sold, and $12 million is related to backlog amortization, which is charged to other deductions.

We increased capital spending in the quarter of 21% to $176 million, reflecting our more positive outlook on the global business environment. Trade working capital, excluding Valves & Controls, improved 90 basis points to 14.4% during the quarter, driven by execution around inventory management and accounts receivable collections.

Turning to Slide 8, Automation Solutions. September 3-month underlying orders were up 15%, supported by energy-related life sciences and chemical markets, with KOB 3 demand continuing strong through the quarter and an increasing mix of KOB 2 small and midsized projects focused on expansion, upgrades and optimization of existing facilities.

Our underlying sales grew 3% in the quarter and net sales grew 18% to $2.9 billion, including results from the Valves & Controls acquisition. Underlying sales growth of 10% in North America was supported by continued investment by Shell customers, midstream upgrade and automation investments and strong growth in Canada, reflecting a recovery in unconventional oil and gas investments.

The Control Systems and Solutions business returned to growth in the quarter, reflecting investments in small and midsized system projects. Latin America remained down and has not yet begun to recover. Middle East and Africa was down but underlying sales -- underlying orders here have turned positive.

Our funnel for tracking large projects continues to grow, and we expect to have better visibility on the timing of these projects in the first calendar quarter of 2018 as our customized -- as our customers finalize capital budget plans for the year.

Margin, excluding Valves & Controls, improved 300 basis points to 20.2%, reflecting the flow-through of benefits from restructuring actions, lower restructuring spend and leverage on higher sales. In 2018, we expect strong KOB 3 and increasing mix of KOB 2 projects to drive 5% to 7% underlying growth.

Turning now to Slide 9, Commercial & Residential solutions. September 3-month underlying orders were up 5%, led by a broad-based demand in Asia as well as continued strength in professional tools in oil and gas and construction-related markets. Sales increased 4%, with underlying sales of 3%. North America underlying sales were down 1% due to cooler summer temperatures and the impact of hurricane disruption during the quarter. Growth of 14% in Asia was led by China air conditioning and refrigeration markets. Excluding China, the rest of the region was up high single digits in the quarter.

Margin declined 110 basis points to 23.5%. Excluding the divested ClosetMaid business, margin was 24% -- 24.7% and declined 60 basis points when compared with the prior year on the same basis. The decline was driven mainly by mix as cooler weather and disruption from hurricanes slowed higher-margin compressor replacement business. In 2018, we expect continued favorable end markets to drive underlying sales growth of 3% to 5%.

Let's turn now to Slide 10 and walk through our fiscal 2018 outlook. With an improving global economic picture and momentum in our key served markets, we expect underlying sales growth of 4% to 6% next year, with Automation Solutions underlying sales of 5% to 7%, and Commercial & Residential solutions sale -- underlying sales of 3% to 5%.

Our operating cash flow target is $2.8 billion, and we expect to convert to free cash flow at over 100% of net income, in part by leveraging the working capital opportunity we see at Valves & Controls. Our adjusted EPS guidance is $2.75 to $2.95, or growth of 4% to 12%. Adjusted EPS excludes 2 items: $0.03 of Valves & Controls first year acquisition accounting charges related to inventory and backlog amortization; and $0.06 tax-related loss on the divestiture of the ClosetMaid business, which closed early in the first quarter and will drive a Q1 tax rate of approximately 40%. We expect Valves & Controls operations will be slightly accretive in 2018, including charges for intangibles amortization and anticipated restructuring spend.

And now I will turn the call over to Mr. David Farr.

Thank you very much, Tim. Welcome, everybody. And before I get into some more slides, I want to share our -- first of all, I want to thank all the people across Emerson for 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, the 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 6 months, as we've seen our order pace pick back up, and particularly around the Automation Solutions, I want to make sure we understand the mix of this as we go through the last 3 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 facilities has been strong and continues to be the same pace. We're starting to see some of the KOB 2, which is small or minor upgrades, and our backlog starting to build. Our backlog built in the fourth quarter versus last year, and 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 is going to be up nearly 15%. We're talking of planning to be from about $480 million to $550 million in capital. So we are investing in the company and -- because 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 forecasts, 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 3 to 4 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 has consistently stayed within that band and now, as I said, we -- from time to time, we'll 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 the standpoint of the cash flow and profitability, we will continue to have a very good profitability in the base business. Looking at recent -- decent conversion across this company, in the 30s on a combined basis, as we look at the 2 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 of underlying growth rate in automation or even better, then we're going to have to start investing and to handle this growth and the type of business, so we'll be looking at all those trade-offs as we go forward. Right now, I feel good about our 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 feels good. Clearly, we have an issue relative to North America with the 3 hurricanes and also the bad earthquake down in Mexico. I firmly believe we'll work through that and that will be a positive for us. But again, we need to see what happens here as we move into next season and they start replacing some of those units. But profitability, again, in Commercial & Residential looks 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 of $2.8 billion. I firmly believe that we'll be north of that. I also firmly believe our free cash flow will be conversion around 120% to 125%. Again, those are different numbers than we put in the press release. This is where I feel that 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 3-month were all -- went positive.

So we've been telling you that we felt they'd go positive, they went positive. And they went positive as we continued 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've 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 in improving their on-time delivery. We're starting to see momentum relative to 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 worked through cash, and we started seeing that cash come through and I think we'll see that go forward throughout all 2018.

We feel very good about that and from where we sit at this point in time. So net-net, I firmly 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 other things we have to overcome. One of them would be 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. It 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 book those -- book that situation.

So fundamentally, I feel good about where we sit. So if you look at the Chart 11 here and you 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 had built a very strong company. We looked out. We said, "Look, we need to reposition this company and focus on 2 fundamental platforms," which we've done. We repositioned, got that done. As we moved into 2017, we talked about growth, we talks about improved profitability, we talked about improved earnings, we had talked about improved cash flow. And I firmly believe that we have moved through that phase very strongly, and now we're moving into the next phase where people will 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've talked about. I publicly talked about that around the 2020 range in 2020. I've also talked about trying to get back the cash flow levels in that $3.3 billion level, which would get us below the free cash flow to dividend ratios of below 50% into the high 40s. Again, very important relative to where we're trying to go.

We have a very strong company at 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 right 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've 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 and had a lot of internal growth. We've made strategic acquisitions. We 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 in not only technology, but the solutions on a global basis to 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 Commercial Solutions area and talking about that next-generation technology around control and around communications. But very successful program of both internally development, investments, acquisitions, integration and creating this 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 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 '90s. Involved in making strategic acquisitions around the Westinghouse innovation, around buying companies like Daniel, buying companies around the various technologies. And so we've 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 built a very strong portfolio of technology, product leadership, solutions capabilities on a very global basis. And 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 in Latin America, be it in the United States on a very broad Automation Solutions capability around the process order, very strong capability, very much built on a 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 bringing a stronger solutions package for our customer, and the integration is 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 hat's off to Terry Buzbee, to Mike Train and to Ram Krishnan about the tremendous progress they've made in a very short time period. But clearly, they've got a lot to get done in 2018, but the wind has definitely shifted to their back. But we really have built this strong foundation on core investments, acquisitions, going from all the way back in the '70s, 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 running around with Plantweb signs on them, kind of funky oranges and lime green. And bringing out the technology of the Plantweb, the first type of controller in the field, the first industrial Internet of Thing within the industry. So we've been continuing to build from a foundation of products, to technologies, the integrated solutions, to problem solving, to now the top quartile performance. We have been -- a business that's all about changing and creating capabilities for our customers. And at the same time, helping our customers succeed, which allows us to succeed. And we have continued to grow and prosper and we've become -- gone from a minor player in this industry to the world's #1 player in the process automation business. The time period that I've been involved with this, going back into the mid-'90s to now 2018. And as you can see from the participation standpoint, we have continued to grow the business, we've continued to add in both acquisitions and penetration and market. We go through periods of this business. Yes, it goes up. Yes, it goes down. We've 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 and technologies out right when that market turns. And the market's starting to turn, and we feel good about this marketplace as we look at our automation business today, as we move towards being an $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 are very significant compared to competitors in technology and innovation and setting 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. I showed it again last year. Our fundamental discussion around being an automation business, being in an automation marketplace, a very strong statement about we want to focus first going up that process. We are already in the hybrid marketplace, we're already in 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 the discrete marketplace. 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 2 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'll 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 the stated goal ever since our whole repositioning efforts has started and from that day and going forward.

If you look at Chart 16, it's the orders chart I have talked about. You can see the map we laid out, the Electrical Products Group in May. We stayed pretty well within that band. And September, we are at the high end of it. October, I just said preliminary. We're -- right now, we're looking at a 12%. We're at the tip of that. I expect this to continue to do well here in the next couple of months. But again, I want to reiterate, I've been saying this now for 3 or 4 months, 5 months, I want to see the pace of business. I want to see the mix of this business, I want to see 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 be spread out over 2 years. I think the recovery is going to be spread out over '18 and '19. 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 1 or 2 key markets as we started out earlier this year. Our backlog has continued to build. We're still not back to the September levels you see, excluding the Valves & Controls. But I fundamentally believe that our backlog will continue. We are absolutely 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've started to see in the last couple of months, I've seen that go up. It's one of the reasons our order pace has 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. 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 as the group president. Terry Buzbee now Ram. 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 the 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'll 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 the sales, and it's a very good level. I mean, there's a couple others 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 we 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 1 or 2 questions, but just before I move to questions, let me address the proposal we made to Rockwell Automation to combine our 2 companies. Emerson you know has successfully repositioned its portfolio over the last 2 years. I just talked about it. We've gone through Phase 1 and Phase 2. We have 2 very strong portfolio -- platforms, Automation Solutions under Mike Train's leadership, the Commercial & Residential Solutions under Bob Sharp's leadership. I like what I see with these 2 businesses. They're finding opportunities for growth, for profitability that we had not seen before as we really focused hard on these 2 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 is going to look pretty good and it's a function of what we see the around 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 in capital formation, which will help a company like Emerson.

It was from this position of strength and our 2-platform focus and with confidence, strong confidence in our future, that we attempted to engage with Rockwell for the long-term global opportunities, for stronger growth and stronger profitability between our 2 businesses. In early August, we made a private proposal to Rockwell's board that valued the company to $200 per share in cash and stock, a significant premium to its unaffected market valuation at that point in 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 and 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, an 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 any really appreciate what they've done in the industry. Both companies provide engineering-focused solutions and are leading the way at digitalization in our respective markets. We're market leaders in 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 this 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 a process world and a hybrid world. The industrial logic behind this combination is very clear in my mind and the board's mind. And as a 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've provided immediate solution for this need with our #1 global installed base and global position and solution 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 2 companies are a more logical fit than Emerson and Rockwell, or provide a clearer path to strengthen customer relations -- 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 we -- while we will be disappointed if Rockwell lets this unique opportunity go unexplored, we will remain disciplined and respect the 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 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 shareholders are open to a mutual beneficial transaction.

We'll continue to work with our advisers, 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 have to say about Rockwell today.

As I am sure you can appreciate, we'll be not taking questions around 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.

(Operator Instructions) And the first question comes from Scott Davis with Melius Research.

I'm dying to ask about Rockwell, but I'm not going to because...

You can ask me and I'll give you the statement. If you wanted to ask me, I'll say...

I've got very thin skin so I -- anyway, the question I want to ask...

You started your own company. You're going to get thin-skinned?

Just today. Only today. If I got to stalk Ray once in a while, my skin would get a little thicker. But anyways...

You can't everything right, Scott. Come on.

I'm going to ask a roundabout question that isn't exactly Rockwell, but -- and it's more about size of the deal. And if you think in terms of -- I mean, if you talk 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. So 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 are right now in discrete?

Yes. I think that from our perspective, as I've communicated using the slide relative to the process automation and hybrid space, we are willing to explore significant acquisitions. We've said it all the year -- over the years and to expand that business presence around the hybrid space, around the discrete area. As we've gone through this whole repositioning effort, Scott, our focus is highly focused on automation as we define automation today and 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, a move that we did with Rockwell, it's a very compelling strategic fit between our 2 companies, I firmly believe our organization today can digest larger strategic deals and -- but they have to be within these 2 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'll 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 2 spaces or these 2 platforms.

Okay. Fair enough. And 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, core expenses go up. I mean, do your operating expenses need to come up, which is kind of a backdoor way of saying that we're going to see the full operating leverage in 2018 before -- I mean, you mentioned you have to add cost back eventually, but I'm more particularly interested in the 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 3 in front of it. And the reason, yes, if you spend capital, we've been planning it and just when I'm stepping into the capital and systematically stepping into the capital and I think we can manage that from the standpoint--we don't really cut capital real deep, nor do we go crazy in 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 3 or 4 major capital spending projects that eat up a big chunk of that. So we can easily handle that and still have good leverage. The key thing for me, as I've been communicating outside, as I watch Automation 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 5, then 6, then 7, then 7 plus or 8. Then that's where I'm going to have to start triggering the investments that we'll need to support our customers in 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 '18, my side is I want to have the appropriate leverage. And the key thing for me right now is to see the whites of the eyes of the growth rate at the top line. And with that, means, I want to see the automation business go into 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 to maybe get a little bit more growth?" But that's -- I'm in a period right now that I want to see it, I want to -- if you know how to -- if you ever surfed, I'm going to ride the front of the wave for a while here as we have been riding the last 6 months. I do not want to ride behind the wave, which means I would not have appropriate leverage.

And the next question comes from Steven Winoker with UBS.

So Dave, I don't want to dive into Rockwell either than 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 hybrid side? Can you make something work internally with internal organic investment and the right partnerships to 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 also 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 talked opportunities again with the board today. And so I think that you'll see us that we'll be pushing it 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 profitability and cash flow is allowing us to do -- to be -- go out and find these opportunities for us in 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 are very true to be a global automation house. Our customers see this and our competitors see this. And so I think that we are well positioned to do more even outside if something didn't happen with Rockwell.

And that's product as well as installed base and technology?

Yes, it is. It's across the board. I mean, obviously, from the standpoint of a -- in the hybrid and the discrete side, we need clearly some -- different channels, we need some different technologies and that's why you would 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 in a timely manner and do it right for our customers, we'll -- most likely, we'll have to do the right type of acquisitions and the right type of joint ventures.

Okay, great. And then you talked about this recovery potentially being more of a 2-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 discussions? And when you think about that GFI growth, 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 in the beginning of all of this happening, so some perspective there.

We are definitely in the beginning of this, Steve. And so what we're seeing right now, as we look at the order pace and our sales pace for the last 6 months or 7 months with Automation Solutions, it's heavily, what we call, the KOB 3, the service MRO type of pace, where our customer base have had to reinvest and to improve their efficiencies, to improve their quality, to improve their, obviously, safety. And we're now starting to see, what we call, the KOB 2 side, where they're doing -- starting to do some minor expansions. We firmly believe this recovery in the initial phases will be heavy on the KOB 3 and KOB 2 throughout all of '18. 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 it 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, then you're going to see more short-term investments, which will be good for us, and then we'll start seeing the KOB 2 minor expansions, which also will help us late in '18 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 '18, early '19. But the pace of the recovery is pretty much similar to what we've seen 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 doing -- going 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 improved capital and reallocation towards the type of spending that we see in Automation, which will be good for companies like us.

And the next question comes from Christopher Glynn with Oppenheimer.

I was wondering the Valves & Controls margin outlook, it looks like it had a little bit of negative EBIT in the second half of '17 there. Do you think 5% is a good level for next year or kind of working back to that by the second half of '18 maybe?

I think we'll be better than that as we exit the year. We'll still be running uphill in the first half of the year, but it should be when we lap the thing at the end of the 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.

Yes, we -- from the standpoint of -- I mean, we want to get double a bit. We want a 1 in front of that thing soon.

Again, it's operations. That's without the amortization and then the restructuring is going to be lumpy, so we're building a 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 what I see. These guys are doing a good job. The whole organization of Valves & Controls are up there with Final Control is getting engaged, and so I would say we're slightly ahead of where we thought we'd be right now. And I'm -- what I'm looking forward out, amortization and restructuring, I want a 10%, and then we'll go from there to 12%. And then we'll go there to 14% -- 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 figured that out.

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

That's I how I communicate over conference calls. All the people listen to the conference. I got 80,000 people listening right now to the conference call.

You're giving me stagefright. Hey, the free cash flow guidance looked, again, exceptionally strong, great conversion. As you transition out of fiscal '18, is there a challenge in the near term to holding the absolute levels of cash flow into '19?

If we have a continued improvement in our profitability, a continued improvement in growth and with what we have with the Valves & Controls opportunities and the Final Control area, I think we still have a good run of cash flow conversion opportunities both in '19 and 2020. I think -- if we map out and we look at how we get to $3.3 billion of operation cash flow in 2020, we have to continue to convert well north of 100%. And that's going to be -- a lot of that is getting the cash, the 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 3 years since I don't think it's a 1 -- I don't think it's a 2-year thing here. I think we've got several years of run with it.

And the next question comes from Rich Kwas with Wells Fargo Securities.

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 you 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 the businesses could come 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 a DCS and a PLC and other type of control. And then customers, in particular, as they're going into the industrial [another thing] into more software, there are management control. So we're seeing this request and both in the power industry, in the chemical industry, in the pharmaceutical industries. We're seeing this across the various industries these days and in oil and gas. And so customers are asking for this, and I think that it is an opportunity for us in the United States to put 2 very strong players together with a strategic fit to create a better solution for our customers. I mean, our customers are clearly asking for this. I can find -- you -- I'm sure you can find examples of customers that are saying no, but I can find you this -- more customers saying yes. And so I firmly 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 a 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 as we think about fiscal '18 guidance, what -- can you quantify the sales that were lost in the quarter and how meaningful that could be for '18? And then just on China for Commercial & Residential Solutions, it was a great year in '17. What's your growth outlook here with the comps being pretty tough?

Okay. So on the hurricanes, so I got all my friends out there, my auditors and my friends and everything like that. My fundamental gut -- and this is David Farr speaking from -- see, I only have, let me see, 36 years of experience -- of business experience, so I'm a young kid compared to Tim. I think there was 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 custom brakes 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're going to 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. Yes, we had a 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 you -- Tim doesn't have 36 years of experience in this industry, so he's still looking at the book, and he's taking a while. What did we grow...

(inaudible) 15.4%.

15% for the whole business for everybody. So I -- from my standpoint this year, as I look at the momentum we see in orders and Automation Solutions and the opportunity still in 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 the 10%, but based on what I'm seeing 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 all know. I will be there next week.

And the next question comes from Robert McCarthy with Stifel.

In any event, since we can't talk about Rockwell -- since we can't talk about my favorite topic, Rockwell, let's just talk about -- maybe you can talk about the incremental margins over the next couple of years from Automation Solutions given the fact that you kind of have 2 scenarios, 1, which is 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 margin structurally in that business over the next couple of years and maybe take into account the accretion such as it is from 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 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 will be the -- across the other businesses. But even with what I'd say -- what I would look at as a good recovery, a very solid recovery, I firmly believe we can get back into that 19% by 2020. 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 firmly believe that we can get back to 19% within this next 3-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 [perversing] some of the underpenetration you had in the kingdom. And you did travel over to Saudi with, I think, with Trump and -- or the President, excuse me, in May. But how do you think...

Yes. Let's be more respectable there. Come on (inaudible)...

Yes. No, el presidente.

(inaudible) Rob, I'm the Chairman here, so (inaudible)

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 kind of, 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?

The -- couple things. One, we are making headway. We have been given approvals to be able to sell back in -- 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 and meeting with the CEO of Aramco and talking to him. Our capabilities are well respected and known within the kingdom and what we have to offer. They fundamentally understand that our process and our disciplines around our business, Automation Solutions, is different, and it will make sure that we follow their rules and regulations, we follow 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 grow. I mean, clearly, there's 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, I mean, it looks pretty good even in the Middle East, too. Both of us do well there. 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.

And the next question comes from Joe Ritchie with Goldman Sachs.

Maybe sticking to Rob's last question on incremental margins. Dave, you talked about 30% over the next few years in Automation Solutions. I'm just trying to understand your guide here. You've got mid-single-digit type growth across your businesses, and it seems like you've got lower incrementals baked in for this year. So help me understand what's going on in both Automation Solutions and C&RS just from a margin standpoint?

I mean, I think that we have baked in the 30%. I mean, I -- the only headwinds we have at the macro level at this point in time on -- if you look at those EPS, is obviously clearly the impact of the tax rate and also the impact we have probably neutral relative to [corp.] around the final tranche of the -- of our -- we've gone to an annual stock incentive program. It's a 3-year incentive program. But the headwinds are pretty neutral there. So I think -- I mean, I think the -- right now we're giving you the -- if we approach 6%, we'll have obviously a little bit higher earnings. If we approach the lower end, we're going to have less earnings. I feel -- we'll give you more details around the pieces in February, but I feel right now we have a forecast that's very doable, one with the way the wind's going at this point in time. So there's no hidden agendas in that number at all.

Okay. And I guess, maybe just sticking that -- for that for 1 second, just price -- what's your embedded price cost for 2018?

Pretty neutral. Right now it's pretty neutral. It might be slightly negative, but it's pretty neutral at this point in time. I mean, there's lot of moving parts, but it's going to be better this year than it was last year. And so clearly, what we're having to deal with net mature inflations. We're going to have to figure out how -- some pricing, and it's going to be more rear-end loaded as we come out of this. But I think it's pretty one focus at this point in time, and I feel pretty decent about it. So get tougher in the first couple quarters and get easier, so I like where we are right now in this area, too. I think we're in a good position.

Got it. And maybe if I could follow on with one last thing. Look, the orders have been great in Automation Solutions, right? And what's interesting is if you kind of look across the rest of the space and the value chain, power and chemical CapEx has been a pretty lively discussed negative from a lot of your peers. I'm just curious what you're seeing in that end market because I think those 2 end markets still represent at least 1/4 of your Automation Solutions business so be curious to hear what you're seeing there.

We're seeing our customer base, we're winning right now in this space. We've brought some unique technologies out, and we've been able to help in this area. So we've been winning across the board. If I look at all my end markets, if I look at all the key markets I serve, from oil and gas, to power, the chemical, the pharmaceutical, the mining -- even mining is doing well for us right now because of the support that V&C got for us -- gave us. We're seeing a pretty good momentum. And we've had good spending capabilities in the power and the chemical area. People are upgrading, and they're investing in the technologies and -- for an improvement in productivity and efficiency. So we've seen a different marketplace than everybody else, and so we've been clearly gaining in this space. And as you well know, we are very focused. We have a lot of new products coming out, and I think we're winning at this point in time. So I feel -- I like the fact that we're outperforming a lot of people in that space right now. It's good news. I appreciate everyone -- I can't get to everybody, but call Tim Reeves.

And the -- that last question is from Gautam Khanna with Cowen and Company.

Yes. (inaudible)

I can hear you. (inaudible) I can hear you. Go ahead. Go ahead.

Okay, good, good. So Dave, you mentioned you've done a -- you and the rest of your team have done a heroic job of improving the balance sheet over the past couple of years, and you mentioned in your scripted remarks that you're going to remain disciplined. I was wondering if you could give us some insight in how you assess the opportunity cost of your capital, if you can give us any sort of metrics on what type of hurdle rate you have for acquisitions in terms of cash-on-cash returns, what type of weighted average cost of capital you and the board look at to measure that type of return. And then as a follow-up, if you can talk about whether there are enough independent discrete properties out there and discrete automation to allow you to kind of do this on a niche basis. Or do you have to go big? So any [sound] sense for financial framework? And then can it be done outside of a Rockwell (inaudible)?

So the first one, I'm not going to give you that much insight because that's obviously something that we, as a company, think about, and we've made very strong returns over the years. And some people say I've done some good ones and some bad ones. We've all done good ones and bad one investments. But from our standpoint, what I mean by disciplined, we will make sure that we will create value for our shareholders from the standpoint of what we see in the combination of any strategic large transactions such as a Rockwell. And we have to support that within our own board. We have to support that with our own sense of risk assessments. We've -- again, we've done certain things like -- I think Pentair Valves & Controls will be a classic example. And someone said it was a small deal but at $3.15 billion, it's not a small deal. It's a pretty big deal. And I think we stayed disciplined in what we thought we can make an adequate return on that. Clearly, it's also size -- we risk assess them on depending where they happen and the size of the company, the technologies. Clearly, a transaction like Rockwell is well within our known space. We are a major player in automation, so we feel less risk around that. That is all I can tell you, that this is something that we feel quite strongly about, but at the same time, I'm not going to kill the company I run today to make a transaction happen. Now relative to the opportunities out there, the answer is yes. There are smaller opportunities out there that we can, over time, continue to make acquisitions. If someone asked me, someone talked about that, yes, they're smaller. Yes, I can do some joint ventures. I can do some technology sharing. So there are things we can do. So we will make a decision. We're a healthy company. We will move forward and make the other investments if we're not able to make the very large strategic acquisition that we talked about. But it's -- right now there are other opportunities out there that we think, Gautam, that we -- that can make sense for us. It will take us longer to go that route, but we're a successful company. We'll continue to make those investments, but we're going to stay very focused on this automation space and the commercial, residential space.

To your point on discipline, I just want to be clear. In terms of the delta between whatever return you promised to the board and your weighted average cost of capital on a large transaction, is that -- does it have to be a much wider gap, i.e., you anticipate a much higher return to compensate for the opportunity cost of that capital? Or are you willing to go lower for something [different]?

No, I will not -- I mean, if you go lower below your cost of capital, you're obviously destroying value. And that's not something this board nor I -- we have never knowingly made deals -- now we have had acquisitions that did not pan out. Clearly, we made mistakes. But we would not normally go in there and say we're going to destroy value. That's not what I'm -- I have fiduciary responsibility as the Chairman and CEO of this company to make sure, as does this board, to make sure you make the right strategic deals, that if I can't demonstrate in a reasonable level of risk assessment with discussion amongst the board members and their advisers and I can't deliver or say we can make value, then we're not going to do that. So that's how we look at this thing. We've been involved in transactions and deals for a long, long time, and we will continue to do that way.

So I need to -- I'm going to break it off here. I want to thank everybody for joining today and then the key issue, a couple points I want to make. Emerson today has a very strong business profile, where the 2 platforms are doing well. I think the momentum is very positive on our side. I think we're -- we had a very good 2017. I look for even a better 2018 relative to our standpoint of growth and profit improvement and cash flow.

Clearly, I think that the Rockwell opportunity has tremendous strategic fit with Emerson. It clearly fits in the opportunities for our customers and for technologies and for the communities and for our employee base. It's very positive and something we're really going to work hard at. However, we do have options outside the window, so we're not going to make this forever. It's a finite situation. At some point in time, as I told my board today during a board meeting, that we will either -- we'll move forward. If we're not able to engage and do it, then we have other opportunities. We can move forward our -- and continue to invest in the company, continue to prosper as a company and continue to do well for our shareholders.

So with that, I want to, again, thank everybody for joining us. I want to thank all the employees for having a great 2017 happen and now look forward to a strong 2018. Thank you very much, everybody.

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