洛克威爾自動化 (ROK) 2016 Q1 法說會逐字稿

Thank you for holding and welcome to Rockwell Automation's quarterly conference call. I need to remind everyone that today's conference call is being recorded. (Operator Instructions)

At this time, I would like to turn the call over to Patrick Goris, Vice President of Investor Relations. Mr. Goris, please go ahead.

Good morning and thank you for joining us for Rockwell Automation's first-quarter fiscal 2016 earnings release conference call. With me today are Keith Nosbusch, our Chairman and CEO; and Ted Crandall, our CFO.

Our agenda includes opening remarks by Keith on the Company's performance in the first quarter. Keith will also provide context around our outlook for fiscal 2016. Then Ted will provide more details on the results as well as our sales and adjusted earnings per share guidance. As always, we will take questions at the end of Ted's remarks. We expect the call to take about an hour today.

Our results were released this morning, and the press release and charts have been posted to our website at www.RockwellAutomation.com. Both the press release and charts include reconciliations to non-GAAP measures, and the webcast of this call is accessible at that website and will be available for replay for the next 30 days.

Before we get started, I need to remind you that our comments will include statements related to the expected future results of our Company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all of our SEC filings. With that, I will hand the call over to Keith.

Thanks, Patrick, and good morning everyone. Thank you for joining us on the call today. I will start with some key points for the quarter, so please turn to page 3 in the slide deck.

As expected, we had a weak start to the fiscal year with organic sales down a little over 3%. During the quarter, heavy industry end markets continued to soften globally, particularly oil and gas. Consumer and auto verticals were about flat.

In the US, the weakness that started at the end of fiscal 2015 persisted throughout the first quarter and was broad-based across verticals. Oil and gas again was the weakest vertical in the US, with sales down over 30% compared to last year, worse than we expected.

In China, solid growth in the consumer growth in the consumer and auto verticals was more than offset by the very weak heavy industry and tire verticals. Sales in China declined about 10% in the quarter.

I am pleased with our continued solid growth in EMEA and Latin America. Emerging EMEA and Mexico continue to be bright spots. Total emerging markets were up 3% in the quarter despite the decline in China.

Further weakening of heavy industry end markets globally impacted our process business, which was down 14% in the quarter. Process growth in EMEA and Latin America was more than offset by declines in the US and Asia. Logix sales were impacted by the significant decline in process industries including oil and gas and declined 6% in the quarter. You may recall that Logix growth was 7% in the same quarter one year ago, so certainly a tough comp. I am pleased that we were able to hold segment margin near 21% despite 9% lower sales. Ted will elaborate more on Q1 financial performance in his remarks.

Let's move on to what we expect for the balance of fiscal 2016. With respect to the macroeconomic indicators, the most recent industrial production forecasts called for lower economic growth in 2016 than previously estimated, and only modest sequential improvement later in the fiscal year. Also, since we provided guidance in November, oil and commodity prices have further deteriorated. As a result, we expect our global heavy industry end markets, particularly oil and gas, to be weaker than assumed in our November guidance.

For the US, our largest market, industrial production growth projections have now turned negative for our fiscal year. And a further strengthening of the US dollar continues to affect US-based producers and equipment builders across verticals.

In China, we expect continued weakness in the heavy industry and tire verticals that remain plagued with over-capacity and a lack of capital investments. The consumer, life sciences and auto verticals are still not large enough to offset those declines, but they continue to grow, which bodes well for the future.

In EMEA, we see continued growth led by emerging countries. Western Europe is stable and continues to improve slowly. Home and personal care is expected to be the strongest vertical in this region, oil and gas the weakest. Finally, we believe Latin America again will be our strongest region this fiscal year led by Mexico. Mexico continues to do exceptionally well across a broad range of industries including oil and gas. We expect strength in Mexico will offset weakness elsewhere in the region.

Taking all these factors into consideration, we now expect fiscal 2016 organic sales to be down 1% to 5% and no longer expect year-over-year growth later in the fiscal year. Including the effects of a larger headwind from currency, we are updating fiscal 2016 sales guidance to about $5.9 billion and EPS guidance to $5.70 to $6.20. Ted will provide more detail around sales and earnings guidance in his remarks.

Before I turn it over to Ted, I would like to again thank the many of you who attended Automation Fair in November. We had record attendance, and I am sure you were able to notice firsthand the excitement generated by our technology innovations, our expanding product portfolio including our next-generation high-performance architecture, and our broader and deeper domain expertise. The connected enterprise message and deliverables are resonating with our customers globally.

Our progress has not gone unnoticed. Control magazine, a leading process industry publication, just released its annual Readers' Choice Awards, and once again, our results were great. Of the 53 opportunities across 10 industries and six control disciplines, Rockwell Automation received 32 first place awards. The next best recipient had only 12.

We continue to be recognized as the only automation company with a scalable multi-discipline integrated control and information architecture for plant-wide optimization. This was our best performance yet in this annual survey of process automation professionals. It is a good indicator of how far we have come with our modern DCS portfolio of technology and domain expertise.

Innovation truly is the lifeblood of our sustainable competitive differentiation. And while current market conditions certainly are challenging, we will appropriately balance short-term financial performance with our long-term opportunities. We will protect key investments in innovation, domain expertise, and commercial resources. And we will continue to expand our served market and gain share.

I am very optimistic on our long-term growth prospects and would like to thank our employees, partners and suppliers for their continued dedication in serving our customers. With that, let me turn it over to Ted.

Okay, thanks Keith. Good morning, everybody. I will start on page 4, the first-quarter key financial information.

Sales in the quarter were $1.427 billion. That was 9.4% lower than Q1 last year. On an organic basis, sales declined 3.3%, and currency translation reduced sales in the quarter by 6.1%. Segment operating margin was 20.7%, and that was down 130 basis points from Q1 last year, primarily due to the lower sales volume and a negative impact from currency.

General corporate net was $18 million in Q1 compared to $23 million a year ago. Adjusted earnings per share were $1.49, down $0.15 or 9% compared to the first quarter of last year.

The adjusted effective tax rate in the quarter was 22.8% compared to 26% in Q1 last year. Congress recently enacted a retroactive extension of the R&D tax credit for 2015 and made the credit permanent going forward. Without that extension, our adjusted effective tax rate in Q1 would have been pretty close to our previous full-year tax rate guidance of 27%.

Free cash flow for Q1 was $145 million, free cash flow conversion on adjusted income was 74%, and we would think of that as a pretty typical result for Q1. Our trailing four-quarter return on invested capital was 32.6%, and there are a couple of items not shown here. Average diluted shares outstanding in the quarter were 132.6 million, down about 3% compared to last year. And during the first quarter, we repurchased 1.2 million shares at a cost of $122 million. At the end of the quarter, we had $323 million remaining under our share repurchase authorization.

The next two slides present the sales and operating margin performance of each segment. Page 5 is the architecture and software segment. Beginning on the left side of the chart, architecture and software segment sales were $643 million in Q1, down 9.2% compared to Q1 last year. The organic sales decline was 2.7%, and currency translation reduced sales by 6.5%.

Moving to the right side of the chart, on the lower sales volume, A&S margins were 27.4%, down 3.9 points from Q1 last year. Lower sales volume had a significant impact; this segment also bears the larger brunt of the negative currency conversion impact. I would note that Q1 last year was the highest quarterly margin for architecture and software. Sequentially compared to Q4, margin in this segment was about flat.

Moving to page 6, the control products and solutions segment. In the first quarter, control products and solutions sales were $784 million, down 9.6% year over year and down 3.8% on an organic basis. Currency translation reduced sales by 5.8%.

For the CP&S product businesses, the organic sales decline was about 1%. Solutions and services sales were down about 6% organically. The book to bill in Q1 for solutions and services was 1.13. CP&S continued to deliver very good operating margin at 15.3% in Q1, up 80 basis points year over year despite the decline in sales, another good productivity quarter.

Page 7 provides the geographic breakdown of our sales and shows the year-over-year organic growth results for the quarter. The overall organic sales decline in Q1 was driven primarily by the US and Asia-Pacific. The US was down 6%, which was actually a little better than we expected. We saw declines in most verticals, and oil and gas was worse than expected, as Keith mentioned. Canada was down 8%. We saw reasonable growth in the quarter in transportation and food and beverage, but not enough to make up for continued declines in heavy industry led by mining and oil and gas.

EMEA saw 6% organic growth in Q1. Results across countries were mixed, but with higher rates of growth in the emerging markets. That said, we did experience low single-digit growth in the mature countries of EMEA, and market conditions there seem to be modestly improving.

Asia-Pacific was down 11% year over year with China down about the same. We saw declines in most countries across the region. India was an exception with growth in the low double digits.

Latin America grew 8% led by Mexico. The growth in Mexico was pretty broad across verticals. Overall for emerging markets, organic growth was about 3% with Latin America and the EMEA region offsetting declines in Asia-Pacific.

And that takes us to the guidance slide. As Keith mentioned, we are making some changes to guidance. We are dropping reported sales across the range by 2%, approximately 1 point to reflect a more significant headwind from currency and an additional 1-point reduction to reflect a more cautious outlook for organic growth, particularly in the second half of the fiscal year.

The lower organic growth assumption is due to three factors. Since we last provided guidance, macro indicators related to the industrial economy globally have continued to soften. This is especially true of industrial production growth rates and projections. Generally, PMI is weaker, and particularly in the US, PMI was solidly below 50 for November and December.

In addition, oil prices have continued to decline. We now expect our oil and gas business will decline at a higher rate for the full year and likely weighted more toward our US business. In the key emerging markets, particularly China and Brazil, we're not seeing any evidence of, or catalyst for, meaningful improvement in the near term.

Our previous guidance called for reported sales of approximately $6 billion at the midpoint. Our revised guidance has reported sales a little under $5.9 billion. Prior guidance called for an organic growth sales decline of 4% at the low end to flat at the high end. The new range is a decline of 5% to a decline of 1%.

Our previous margin guidance was about 21%. The new guidance is about 20.5%. That reflects the additional currency impact that is converting at a higher than normal rate -- we talked about that last quarter. And we now see more risk to our product business growth rates and to our business in the US both on average higher-margin parts of our business. We previously expected margin conversion on the year-over-year sales decline of about 30%. Based on the changes I just mentioned, we now expect that to be about 35%.

Previously, we expected a full-year adjusted tax rate of 27%. We now expect that to be 25%, reflecting the benefit of the R&D tax credit that I mentioned.

We are revising adjusted EPS guidance from the previous range of $5.90 to $6.40 to a new range of $5.70 to $6.20. You can think of the change in EPS guidance as about a $0.14 improvement due to the tax rate, about a $0.16 decline due to the additional currency headwind, and about an $0.18 decline that is a combination of lower organic sales and a lower margin expectation.

We continue to expect to convert about 100% of net income to free cash flow. A couple of other items, we now expect general corporate net expense to be approximately $75 million for the full year. And we expect average diluted shares outstanding to be closer to 131 million for the full year. And with that, I will turn it over to Patrick for Q&A.

Before we start the Q&A, I just want to say that we would like to get to as many of you as possible, so please limit yourself to one question and a quick follow-up. Thank you. Operator, let's take our first question.

(Operator Instructions) Your first question comes from Scott Davis from Barclays.

I probably asked this question on three of the last four calls, but do you have a sense, in China, of what the overall market growth is, and whether you are outperforming that or not? Down 11% seems like a pretty big number. And I know the industrial economy over there is not so great, but that seems like a little outsized versus what some of your peers are putting up.

We do not have great market data for China. But I would say that, at this point, we do not believe we are underperforming the underlying market.

We just believe that some of the impacts, particularly in the heavy industries, continue to reduce capital spending in many of those areas. Obviously, metals, cement, mining -- all of those are very challenging at this point in time.

We have seen growth in many of our OEM sectors, other than tire. Tire has been a major downturn this last quarter and last -- probably almost up to a year now. But the other OEM sectors are able to grow, and we are seeing growth in mainly the consumer and automotive OEMs. Unfortunately, those are still the smaller pieces of our business.

I think challenging, in the broadest sense, but we continue to see new opportunities and continue to believe that China will be a very important growth market for us in the future. I was just there a little over a week ago, and I am very encouraged with the outlook that the country has with what they are doing to drive towards their strategy of China Manufacturing 2025. That's their 10-year vision, but behind that is a 30-year vision as to where they are going to improve the competitiveness of their manufacturing sector, now that their costs are increasing. And we believe the connected enterprise is absolutely the way that they will be able to start the journey to that 2025 vision that they have for their manufacturing sectors.

We are encouraged in the long term, and I think right now, we are just seeing a period of time where they are rebalancing some of their spending, some of their investments. As we know from the previous five-year plan, that they are trying to drive towards a more consumption economy. And I think that, once again, plays very strongly into the sectors that I said were performing better for us this past quarter.

That makes sense. So, it's a mix issue.

Keith, I'm just curious on your view on this economy, and you've seen cycles, you came into -- you did an excellent job 2001, 2002. You were known as the cost-cutting guy back in that time period, and did a great job of getting asset base down to a realistic size and such.

What do you see -- I mean, you could make an argument that this earnings -- this guidance cut is going to be the first of many, or you can make an argument that you're being realistic to a modest industrial recession. What do you see -- I'm curious in your opinion on what you see on the endgame of -- if this gets substantially worse, and are you concerned about the weakness in the industrial economy moving into the more consumer-based stuff, which, of course, is where you guys had a lot of exposure? It's a bit of an open-ended question, but --

Very open-ended, but let me try to comment a little bit. My first comment would be I am not an economist, so I think I can predict the economy about as good as we can forecast our future performance, given our short-cycle business, which is really the point I wanted to make.

We believe that, given everything we've seen, that while the industrial economy is struggling, the consumer is still spending. And I just saw a report that consumer confidence has gone up again.

We're not seeing this as a consumer-led recession at this point in time. We do believe that the industrial economy with the latest industrial production measures, particularly in the US, is definitely weakened since our last quarter. That was what was behind our change in our guidance.

But right now, the expectation is that we will not see a recession. Obviously, you know that our visibility is limited in two-thirds of our business; but when we look at the macroeconomic indicators, it is not pointing to that at this point in time.

So, that's how we've structured our business going forward. And certainly, given what happened over the last quarter from the outlook standpoint, we are definitely looking at -- what do we need to be ready for, in case this view changes over the remainder of our fiscal year.

Okay. Good answer. Thanks, guys, and good luck.

Your next question comes from Steve Tusa from JPMorgan.

Keith, a ton of debate right now on auto. I know you guys have tremendous insight and a pipe into what's going on there. It seemed like -- you said consumer and auto was stable. Can you maybe disaggregate that, and tell us what auto was, and walk through what you are seeing by region, and then what your customers are telling you about their future needs on capacity?

Well, with auto, if we want to walk through the regions, the US auto continues to be solid. We think the programs that we've seen in the pipeline -- there has been no change to those programs over the last quarter. And we see that as one of the stronger verticals as we go throughout the remainder the year.

If we go to Asia, in particular China, while the China sales have been slowing, and in some cases slightly negative depending upon the auto company, we're still seeing investment in China automotive. We see, once again, the need to continue to automate to take costs out of their operations, and auto is one of the places that we will see that. And we're also seeing a lot of interest in what we can do with respect to our operational intelligence software to help them improve the asset utilization and efficiencies and effectiveness of their manufacturing plant floor. There, we think, it's great.

As you know, Mexico has seen a lot of investment in automotive. I would say the difficult areas for automotive -- Brazil is struggling now, given the economy. And we're not seeing significant investments in Western Europe at this point in time either. So, that's how I would characterize the automotive market on a global basis.

Canada, a little more investment, quite frankly, and I think a lot of that is the change of the dollar and the currency has improved Canada's competitiveness in automotive, and there's a little more activity there than previously.

Okay. And then lastly, I guess just on the competitive dynamics out there, anything you are seeing from your European competitors that's at all -- any pockets of greater competitive behavior and a more aggressive push for installed base where that type of business comes into play? I know your business is pretty insulated when it comes to the upgrading of installed base and things like that, but anything you're seeing out there from your European guys that concerns you competitively?

I don't think that concerns us. I think, in certain countries, in certain areas, I think a little more competitiveness, given particularly the drop in the heavy industries.

We're seeing a few projects that are now being released or being processed -- that there's a little more competitiveness on those projects and on that activity than we've seen. In particular when oil and gas was booming, it was a very heavy capital expenditure pocket. And now that we're seeing that reduced, some of the competitiveness has moved into other spaces, where historically they probably would not have participated.

Great, thanks a lot.

Thank you, Steve.

Your next question comes from John Inch from Deutsche Bank.

I want to also pick up on the auto thematic. It's obviously -- there's this widespread, fast-money view that anything auto is about to fall off a cliff. Could you just remind us, Keith and Ted, how big is auto for you? And what does your penetration opportunity look like over the next couple of years for the powertrain side, particularly in Asia and North America?

At the end of the day, I realize you can't forecast this precisely, but it's obvious there is going to be a little bit of an auto correction. I think even Parker yesterday talked about in-plant CapEx slowing a little bit.

But do you think, based on, as you've been building this pipeline up with powertrain, that there's enough to offset that? And maybe you could just frame what you think a scenario might look like. So, start with -- remind us what your exposure is, and then just talk to the scenario if, in fact, auto softens, which probably is likely to occur.

Our exposure currently is around 10%. And that's been the number that we've had for probably the last couple of years now, as we've grown in some of these other verticals; so, 10%.

We believe that when you look at the price of gas, you're seeing continued growth in auto spending, in particular in the vehicles that they make a lot of money in. That bodes well for continued investment and continued modernization of their platform. So, we aren't anticipating a significant change in the automotive outlook, particularly in the US.

With respect to penetration, we believe, as we've talked a couple of times, our best opportunities for increased penetration is in powertrain. And we think that's an area where there will be continued investment because of the need to continue to achieve the fuel guidelines that are being mandated now over the next -- the coming five plus years. Most of the investment and improvements are going to have to come in engines and transmissions. We see a healthy pipeline of powertrain, and we believe that has the opportunity to add $20 million to $30 million of incremental revenue to our automotive business going forward.

But in fairness, you are actually a little more profitable than 10%, right, Keith? You're probably not 20%, but you are more profitable. Auto is going to be a richer mix business. Is that not a fair statement?

That is a fair statement. And I would lump all of the consumer in that, consumer and auto, simply because they are more A&S-centric businesses. They have a much higher control concentration and architecture concentration than they do -- than the heavy industries because the heavy industries have a lot of solutions built by Rockwell. And they have a lot of intelligent motor control, which is the heavy asset -- critical assets are a bigger part of the expenditure in those industries.

It's a mix more than anything else. And our software and our automation is the predominant purchase of the consumer, including automotive companies. So, yes, but it's because of the way automation and the intensiveness of automation in those industries.

Okay, so, that's a good segue into my second question or follow-up. And the follow up is basically -- I think, from a high level, if you look at Rockwell, A&S margins, which were obviously very high before, right, are coming under some pressure. This is against a backdrop where -- Keith, you just mentioned the word mix. We're obviously against a backdrop with very tough markets globally, where pricing is increasingly becoming a factor.

Now, I know that Rockwell -- in the past, you don't really compete on price. It's not the nature of discrete automation. But could you talk to the mix context for A&S? Because you may not be seeing price, but maybe you are seeing people swap into lower-priced or -margin solutions?

The question is obviously, just from a high level, what are the risks that A&S margins go from where it was to materially lower in the coming quarters, even if your sales are still relatively resilient?

To your point, I think it is all about mix in our A&S segment. Our highest-margin business is the controller and software business. We talked about the controller decline.

But we still have very solid margins in our motion business, our safety business, our sensor business. And so, I think the overall impact to A&S margins will not be substantial as we go forward. And I think that is not a critical issue.

I think the bigger issue for A&S is going to be volume and then the exchange rates. Those are the two more compelling concerns that we would have at this time, as opposed to overall mix in the segment.

Certainly, with the high margins throughout that segment, volume declines are very impactful. And you saw some degree this quarter; the volume -- the impact of FX changes that come about as well, particularly in some of the currencies that are, I will say, different than just a traditional euro/US dollar or Canadian/US dollar, which is the ones that we have a greater concentration in.

Hey, John. The one mix impact we may see in A&S this year that's a little negative is, with process now being down more than we expected, and oil and gas down more than we expected, and probably consumer and auto a little bit better, particularly consumer, we think we're going to see a less rich mix of ControlLogix made up for with a little more CompactLogix and motion control, particularly on the consumer side. That will create a little bit of mix headwind. But compared to the volume issues in A&S and the currency, that's not a big number.

There's no cliff function that you're anticipating?

No.

Got it. Thank you very much. Appreciate it.

Your next question comes from Shannon O'Callaghan from UBS.

On CP&S, it seems like that should just be under all kinds of pressure, which apparently it is, with all of the oil and gas in that segment, but the solutions book to bill was 1.13 and you've got up margins, even on the down revenues.

Can you just give us a little better sense on the outlook for that piece of the business because the book to bill looks good, but I imagine it shouldn't be too encouraging given what's really going on in that segment. And can you continue to drive up margins on down revenues?

Yes. Let me start with book to bill. The 1.13 is about what we were expecting.

I think you've got to recognize it's 1.13 on a lower sales number, obviously. But we would expect to be above 1 in the first quarter of the year, and we got that. That's keeping us reasonably on track now as we enter the next two quarters.

On the margin side, we had great margin performance in CP&S all through last year. We talked a lot about productivity last year, and that was disproportionately on the CP&S side. And we're continuing to see some of that year-over-year benefit in Q1.

I think the other thing that influenced this is -- I mentioned that architecture and software is the segment that bears the largest burden of the currency conversion problem that we've got. And CP&S doesn't really face a lot of that because of their more balanced supply chain, particularly because of the solutions and services business where we have the people resources deployed all over the world. So, we get a better match across the currencies.

I would add -- and the answer to your question of being able to continue to do this is no. There's only so far we can take this. And our key now is to get back to growth in our solutions and services business.

Obviously, as we have talked before, we have done a lot of work in improving the competitiveness and the cost structure of our engineering resources. To Ted's point, we've globalized that; we've created a much more standard approach to the application and the engineering tools that we use. And we focus very much on the applications that are most important to us, and where we're most competitive and have the ability to serve the market best.

So, we've tried to be able to take a much better approach to that overall business, and I think you're seeing the results of that. It started last year, and it's continuing into this year. But at the end of the day, we do need to make sure we're driving growth for the long-term success and the long-term protection of what we've done over the last couple of years.

Shannon, the other thing I would add is -- in the quarter, we were up about 80 basis points. You asked about -- can we continue to deliver improvement? Keith's answer was no, but I want to make sure I don't leave the wrong impression. For the full year, at the current sales levels, we don't see margin deterioration in CP&S either.

Okay. That's helpful.

On this broad-based US weakness, how broad based is it? We know oil and gas is down; I think you said over 30%. Can you give a little color on the ranking of the other verticals, and is everything feeling bad -- it sounds like auto is still okay in the US. Maybe just a little bit of color by vertical, specific to the US?

Yes. I think, while it's a small vertical, it's a somewhat meaningful one in the US, and that would be -- pulp and paper is probably the best vertical for us in this quarter. I think we've had some success in the chemical arena, but that is still a small percentage for us.

At about the average, as we mentioned, was auto, and food and beverage, and certainly home and personal care. And then at the negative side would be the metals, water/wastewater, and a little bit in some of the heavy industry -- not heavy industry, but the life sciences sector this quarter.

But obviously the biggest negative was oil and gas, and that's what triggered the vast majority of the decline from a vertical standpoint. The others compared to that were all much better performing across the board, but obviously the reduction in IP has impacted more than just oil and gas.

Okay, great, thanks, guys.

Your next question comes from Richard Eastman from Robert Baird.

Yes. Keith or Ted, could you just -- given last year's performance on the oil and gas side, could you just size that business in dollars at this point?

Well, so, roughly $700 million a year. That's pretty close.

Okay. That's fine.

And then the expectation for this year, on the back of this first quarter, but what is the expectation for this year in terms of that base in oil and gas? Is it down 20%?

Yes, so, originally in November, we were thinking down 10%. We're now thinking it will be down closer to 20%.

Okay. In the guide when you drop the organic growth by essentially 1 point or 2, it looks like about half of that is FX. But the balance of that equates to maybe $70 million, $75 million. Is that largely the oil and gas outlook that you are adjusting that?

Yes. Just to correct a little bit, we dropped top-line sales by 2%, 1 point for currency and 1 point organic. Most of the organic -- there are some puts and takes across verticals. But I would say you could think of most of that organic decline as related to oil and gas.

Okay. Fair enough.

And just last, Ted, typically in the fiscal second quarter, expenses step up. Comp -- I think you give your annual comp expense increase there, also some of your investments. Should we expect that same dynamic on the expense line here for this fiscal year?

Yes. Every year we do, across the globe, our merit increases in January. There's a step up -- ballpark think of it as about $0.05. There's a step up in costs from Q1 to Q2 sequentially.

Okay. All right. Very good. Thank you.

Your next question comes from the line of Nigel Coe from Morgan Stanley.

I just wanted to dig into the organic cadence to the year. You're looking for a midpoint base case of down 3%. You did down 3.3% in 1Q.

You've said, I think -- Ted, you mentioned, or maybe it was Keith -- second half of the year, you're no longer expecting growth. But if we assume the easy comps get you to maybe a flattish result in the second half of the year, it implies 2Q might be worse than 1Q. Is that how you are thinking about it?

Yes, Nigel, it is. You know we don't give quarterly guidance, but we think Q2 is probably similar or maybe a little worse than Q1, and things get a little bit better in the second half.

Okay. And Siemens called out some channel de-stock in China, which I'm assuming, given the down 11% in China, you are seeing as well. Are you seeing -- you mentioned in November you're not seeing channel de-stock, but are you starting to see that now in the US?

No. We don't -- I would say two things. In China, (technical difficulty) but on the other hand, our Chinese distributors don't carry all that much inventory. So, we don't think the results we are seeing in China are about de-stocking. In North America, we have very good visibility of our distributor inventories, and they've remained pretty stable.

I would only add, in China, we have a different -- around the world, we have a different channel model than our competitors. There's different dynamics going on there that may be part of the reason for that difference in the way we see our channel performance versus the way some others might.

Sure, yes, I understand. And then just quickly on the products, it seems that the CPS products business has performed better than the A&S products. And that fits in with my channel de-stock questions. I'm just curious -- is that true and would you expect that to continue?

I think there's just some normal variability quarter to quarter around the performance of A&S versus CP&S. I don't think there will be, for the full year, a significant difference at this point.

And I'm not sure I understand the part of it related to channel de-stock.

I would just expect channel de-stock to impact A&S more than CPS, given CPS is a bit longer cycle in nature. But I can follow up offline. Thanks, guys.

On the product side, if there was channel stocking or de-stocking, it would pretty much affect the A&S and CP&S product businesses about equally.

I see. Okay. Thanks, guys.

Your next question comes from the line of Rick Kwas from Wells Fargo.

This is Ron Jewsikow on for Rich Kwas. Just wanted some clarification -- has there been any change to the $20 million restructuring target for oil and gas?

I would say there's no change to having $20 million available for restructuring. We always have about $10 million in what we would think of as pay-as-you-go.

Last quarter, we talked about having an additional $10 million, in case we needed some restructuring. I don't think we ever talked about that as specific to oil and gas.

Okay, sorry. And then, on the MRO front or mix front related to new projects, are you seeing anything incremental there?

I didn't catch the first part of the question.

Are you seeing anything mix related on MRO or anything else that could be driving -- keeping margins higher than expected, at least on our end?

I think, generally, but particularly on the additional 1 point of organic growth that we are dropping out -- so, that extra $60 million -- we think that is weighted toward our US business and weighted more toward our product businesses. So, in the US is our largest installed base; it's where we have the most MRO business. So, there is some unfavorable margin impact, in a relative sense, of having that coming out of the US and coming out of product business.

And that's correlated with the significant reduction in IP in the US that recently came out. That slowdown will impact the MRO business, as Ted outlined.

And that's reflected in our guidance change.

Okay. That's very helpful. Thanks for taking my questions.

Your next question comes from Jeremie Capron of CLSA.

I want to stay on the discussion around cost, and could you tell us a little bit more about where you're taking cost actions? I see you have lowered the corporate expense guide for the year by about $5 million. But more generally speaking, I know you've talked about being positioned or being more -- having more flexibility on the cost side of the equation this time around relative to the previous cycle. So, tell us about where you're taking cost actions and how you see costs unfold through the year.

Jeremie, I think you will remember, in Q4 we took about -- I think it was $12 million of restructuring charges so that we could start to get ahead of getting costs out, recognizing that fiscal 2016 was likely to be a more difficult year. At the current time, and including the revised guidance, we're implementing what I would call sensible expense controls that are consistent with the revised guidance, and given a slow and uncertain economic environment. But we are not calling this the beginning of a recession.

We expect business levels to remain reasonably stable from this point out into the balance of the year. And consequently, we are not planning additional major restructuring actions at this time. If things get worse, we may have to go there. But we think our cost base is reasonably well structured at the current guidance sales levels.

Okay. Thanks for that.

In Mexico, I know we have talked about it for several quarters now, but you're talking about broad-based strength, including oil and gas. What visibility do you have in Mexico? Are we talking about strength for the next year or so? Or is that a much nearer-term strength that you are expecting there?

Our visibility in Mexico, given that a portion of this is our solutions and services business, we think our outlook at this point is for the remainder of the fiscal year, and feel that the economy there at this point continues to grow. And more importantly, our ability to support our customers and the demands continue to improve as well.

In particular, our channel partners are very strong, and it's probably the strongest distributor network that we have in an emerging market. So, we feel very good about the capabilities there.

Thanks very much.

You're welcome. Thank you.

Your next question comes from Steven Winoker from Bernstein.

Ted, sorry, and to push a little bit on this, but you say you're not calling for a recession right now. I guess with -- and your second quarter of organic decline, and forecasting what now is at least the next one, two or three -- so, now we are looking at a good year of declines, what do you need to see inside the business to call it a recession?

And does that really matter anyway, in terms of what you call it relative to expense decline? Is it more just that you say -- look, we have R&D programs where we want to have them, we think we can -- we're willing to hold out for a year because we're going to have another share gain opportunity on the back of this, like we did before? How should we think about it from an investor standpoint, relative to the negative growth that we are looking at?

I think you captured a lot of what I would have said in my answer to where you started. I think basically what I'm trying to say is -- given an expectation that sales are going to be 1 point lower now than we previously thought, and given that we had already implemented restructuring actions in Q4, we will take some steps now to sensibly control expense.

And I expect our full-year spending now is going to be a little bit lower than we previously talked about. But we don't see the need, based on that 1 point reduction in organic growth, to take major restructuring actions.

And I think the point you also made in your comment, or question I should say, is relevant as well, and that is -- we do see the opportunities to come out of this stronger. And certainly as an intellectual capital business, it is about people, and we think we have some great investment opportunities that we discussed during the investor day at Automation Fair. And we think those are important to continue to keep that investment level, given that we feel we're in a stable economic environment, to Ted's point.

So, we do want to keep that in place. And our goal is to come out stronger and gain share, just like we did in the previous recoveries. And so, I would say that's the other piece of the equation, and that's the balance that we constantly evaluate and make trade-offs and ultimate decisions on.

Given the uncertainty right now, it would not be prudent not to have contingency plans, and we will go there if we need to. But we don't think that's necessary at this time.

And, Keith, just on this whole question of growth, we often talk about the secular versus cyclical dynamics. And it's really hard sometimes on the outside to figure out whether those secular growth dynamics are buffering what would otherwise be a much worse cycle on the growth. Are you seeing evidence that says -- hey, our secular growth dynamics are still in place; we still feel confident about these?

Absolutely. We see that based upon the conversations we have with customers. There is no question. And these are global discussions. Everybody understands -- customers understand that they need to continue to drive productivity and sustainability and their competitiveness.

(technical difficulty) just on my recent trips to Europe and to Asia. So, I think the secular story is absolutely in play. If anything, I believe it's stronger today than a couple of years ago when we started on this journey.

So, it's real. In this area, it moves a little bit around that trend, based upon the current economic environment. But I think the underlying secular trend here is in play -- will continue to become even more important as time unfolds.

So, that's why we have such a positive outlook for the long term. And that's part of the reasons why we need to keep investing during this period, because we do see the demand for what we're doing as something that is not going to disappear from a cyclical standpoint.

And just one clarification quickly on the quarter -- last guidance I think you guys had talked about down mid-single digit expectation for the quarter. Even thought it was down 3%, it was better. What again was better than what you had previously thought might happen?

So, I would say, one of the places we were better than we thought was the US. And in the US, it was primarily around our product business. Some of that was about backlog reduction at the end of the quarter. The underlying orders were down about what we expected in the US, but shipments were a bit better.

Thanks.

Thank you.

Operator, we will take one more question, please.

Your next question comes from Andrew Obin of Bank of America.

Just a follow-up question on the FX impact that you were talking about CP&S being -- having a global supply chain. As I look at my notes, Monterrey is the biggest manufacturing facility you have in the world, I think, by far. My notes say something like 20% of your manufacturing capacity globally is there.

Mexican peso is down 20%, I think, in the past year. How does it impact your profitability? How do you book the transaction effect in your P&L from that facility?

Andrew, I may have to defer this one to some time you can spend on the phone with Patrick. Basically I would say, we hedge our peso exposure. That helps offset some of the decline in the Mexican peso.

Also, part of our manufacturing activity in Mexico is US dollar-based. So we don't really have an exposure on it.

Got you. We can take it offline.

And in Europe, can you just provide more color -- what are you seeing in Northern Europe versus Southern Europe? Any particular trends that you are seeing, because you highlight it as a better market for you?

The biggest increase last quarter was in emerging Europe. And that would be the Middle East and Eastern Europe. But within Western Europe, the strength came more from Italy and the Southern Europe, Italy and France as opposed to the Northern.

Northern had been where the strength was previously. We are now seeing it move a little bit to some of the other countries in the south that were not as fortunate earlier in the period. That's how Europe played out.

Terrific, thank you very much.

Okay, that concludes today's call. Thank you all for joining us.

That concludes today's conference call. At this time, you may disconnect. Thank you.