Rockwell Automation's (ROK) CEO, Keith Nosbusch on Q1 2016 Results - Earnings Call Transcript

| About: Rockwell Automation, (ROK)

Rockwell Automation (NYSE:ROK)

Q1 2016 Earnings Conference Call

January 27, 2016 8:30 am ET

Executives

Keith Nosbusch - Chairman, Chief Executive Officer

Ted Crandall - Senior Vice President, Chief Financial Officer

Patrick Goris - Vice President, Investor Relations

Analysts

Scott Davis - Barclays

Steve Tusa - JP Morgan

John Inch - Deutsche Bank

Shannon O’Callaghan - UBS

Richard Eastman - Robert W. Baird

Nigel Coe - Morgan Stanley

Ronnie Upskill - Wells Fargo

Jeremie Capron - CLSA

Steven Winoker - Sanford Bernstein

Andrew Obin - Bank of America

Operator

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. Later in the call, we will open up the lines for questions. If you have a question at that time, please press star, one.

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

Patrick Goris

Good morning and thank you for joining us for Rockwell Automation’s first quarter fiscal ’16 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 ’16. Then Ted will provide more details on the results, as well as our sales and adjusted earnings per share guidance. As always, we’ll 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’ll hand the call over to Keith.

Keith Nosbusch

Thanks Patrick, and good morning everyone. Thank you for joining us on the call today. I’ll 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 U.S., 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 U.S. with sales down over 30% compared to last year, worse than we expected. In China, solid 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 continued 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 U.S. and Asia. Logic sales were impacted by the significant decline in process industries, including oil and gas, and declined 6% in the quarter. You may recall that logic’s 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 call 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 U.S., our largest market, industrial projection growth projections have now turned negative for our fiscal year, and a further strengthening of the U.S. dollar continues to affect U.S.-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’m 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, and our progress has not gone unnoticed. Control Magazine, a leading process industry publication, just released its annual Reader’s 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-disciplined, integrated control and information architecture for plant-wide optimization. This was our best performance yet in this annual survey of process automation professionals, and 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.

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.

Ted Crandall

Okay, thanks Keith. Good morning everybody. I’ll start on Page 4 with our first quarter key financial information. Sales in the quarter were $1.427 million, and 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 and primarily due to the lower sales volume and the 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 solution 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 a 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 U.S. and Asia Pacific. The U.S. 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 the 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.

That takes us to the guidance slide. As Keith mentioned, we’re making some changes to guidance. We’re dropping reported sales across the range by 2%, approximately one point to reflect a more significant headwind from currency and an additional one 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 U.S. 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 U.S. 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 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’s 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 U.S. both on average higher margin parts of our business.

We previously expected margin conversion on a 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’re 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 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.

With that, I’ll turn it over to Patrick for Q&A.

Patrick Goris

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.

Question-and-Answer Session

Operator

[Operator instructions]

Your first question comes from Scott Davis from Barclays. Please proceed.

Scott Davis

Good morning guys.

Keith Nosbusch

Good morning, Scott.

Scott Davis

I’ve 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’re outperforming that or not? I mean, down 11 seems like a pretty big number, and I know the industrial economy over there isn’t so great, but that seems like a little outsized versus what some of your peers are putting up.

Keith Nosbusch

Well, we do not have great market data for China, but I would say that at this point, we do not believe we’re 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, and 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’re seeing growth in mainly the consumer and automotive OEMs. Unfortunately, those are still the smaller pieces of our business, so 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’m very encouraged with the outlook that the country has with what they’re 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’re going to improve the competitiveness of their manufacturing sector now that their costs are increasing. We believe the connected enterprise is absolutely the way that they will be able to start the journey for that 2025 vision that they have for their manufacturing sector.

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

Scott Davis

That makes sense, so it’s a mix issue. Keith, I’m just curious on your view on this economy. You’ve seen cycles. You did a--you did an excellent job in 2001, 2002. You were known at 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 guidance cut is going to be the first of many, or you could make an argument that you’re being realistic to a modest industrial recession. What do you see--I’m just 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. So it’s a bit of an open-ended question, but--.

Keith Nosbusch

Yeah, very open-ended, but let me try to comment a little bit. My first comment would be, I’m 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. I just saw a report that consumer confidence has gone up again, so 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 U.S, is definitely weakened since our last quarter, and 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’s not point to that at this point in time, so that’s how we structured our business going forward. 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.

Scott Davis

Okay, good answer. Thanks guys and good luck.

Keith Nosbusch

Thank you.

Operator

Your next question comes from Steve Tusa from JP Morgan. Please proceed.

Steve Tusa

Hey guys, good morning.

Keith Nosbusch

Morning Steve.

Steve Tusa

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 seems like. You said consumer and auto was stable. Can you maybe disaggregate that and tell us what auto was, and just walk through what you’re seeing by region, and then what your customers are telling you about their future needs on capacity?

Keith Nosbusch

Mm-hmm. Well, with auto, if we want to walk through the regions, the U.S. 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 of 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’ll see that. 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. So 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. There’s a little more activity there than previously.

Steve Tusa

Okay, and then lastly I guess, just on the competitive dynamics out there, anything you’re seeing from your European competitors that’s at all--you know, 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 that you’re seeing out there from European guys that concerns you competitively?

Keith Nosbusch

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 industry, we’re seeing a few projects that are now being released or being processed, that there is 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 capital expenditure pocket, and now that we’re seeing that reduced, some of the competitiveness has moved into other spaces where historically they probably wouldn’t have participated.

Steve Tusa

Great. Thanks a lot.

Keith Nosbusch

Thank you, Steve.

Operator

Your next question comes from John Inch from Deutsche Bank. Please proceed.

John Inch

Hey, thanks. Good morning everyone.

Keith Nosbusch

Morning John.

John Inch

Morning. Hey, I want to also pick up on the auto somatic. 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 power train side, particularly in Asia and then North America? I mean, at the end of the day I realize you can’t forecast this precisely, but it’s obvious there’s going to be a little bit of an auto correct. 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 power train, that there’s enough to kind of offset that? Maybe you could just sort of frame what you think a scenario might look like.

So just remind us what your exposure is, and then just talk to kind of the scenario if in fact auto softens, which probably is likely to occur.

Keith Nosbusch

Well, 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 the vehicles that they make a lot of money in. So that bodes well for continued investment and continued modernization of their platforms, so we aren’t anticipating a significant change in the automotive outlook, particularly in the U.S.

With respect to penetration, we believe, as we’ve talked a couple of times, our best opportunities for increased penetration is in power train, 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 coming five-plus years. So most of the investment and improvements are going to have come in engines and transmissions, so we see a healthy pipeline of power train, and we believe that has the opportunity to add $20 million to $30 million of incremental revenue to our automotive business going forward.

John Inch

But in fairness, you are actually a little more profitable than 10%, right Keith? You’re probably not 20, but you’re more profitable. Auto is one of your richer mix businesses, is that not a fair statement?

Keith Nosbusch

That is a fair statement, and I would lump all of the consumer in that, consumer in auto simply because they’re more A&S-centric businesses. They have a much higher control concentration and architecture concentration 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. So 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.

John Inch

Okay, so that’s a good segue into my second question or follow-up. The follow-up is basically if you--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’re 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?

Keith Nosbusch

Well, 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, and 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. 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 impact of FX changes that come about as well, particularly in some of the currencies that are, I’ll say, different than just a traditional euro-U.S. dollar or Canadian-U.S. dollar, which is the ones that we have a greater concentration in.

Ted Crandall

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 control logics made up for with a little more compact logics 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.

John Inch

Right, there’s no cliff function that you’re anticipating.

Ted Crandall

No.

John Inch

Got it. Thank you very much. Appreciate it.

Keith Nosbusch

Thank you, John.

Operator

Your next question comes from Shannon O’Callaghan from UBS. Please proceed.

Shannon O’Callaghan

Morning guys.

Keith Nosbusch

Good morning Shannon.

Shannon O’Callaghan

On CP&S, it seems like that should just be under all kinds of pressure, which apparently it is with all the oil and gas that’s in that segment, 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. Can you continue to drive up margins on down revenues?

Ted Crandall

Yes, so 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, so 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 kind of 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 influences 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 currencies.

Keith Nosbusch

I would add in answer to your question of being able to continue to do this, is no. There is only so far we can take this, and our key now is get back to growth in our solutions and services business. Obviously as we have talked before, we had done a lot of work in improving the competitiveness and the cost structure of our engineering resources, and 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’ve used, and we’ve focused 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.

Ted Crandall

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.

Shannon O’Callaghan

Okay, that’s helpful. Then just on this broad-based U.S. weakness, how broad-based is it? We know oil and gas is down, I think you said over 30%. Can you just kind of 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 U.S. Maybe just a little bit of color by vertical specific to the U.S.

Keith Nosbusch

Yes, I think while it’s a small vertical, it’s a somewhat meaningful one in the U.S., 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, 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.

Shannon O’Callaghan

Okay, great. Thanks guys.

Keith Nosbusch

Thank you, Shannon.

Operator

Your next question comes from Richard Eastman from Robert Baird. Please proceed.

Richard Eastman

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

Ted Crandall

So roughly $700 million a year, that’s pretty close.

Richard Eastman

Yes okay, that’s fine. 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, or--?

Ted Crandall

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

Richard Eastman

Okay. In the guide when you dropped the organic growth by essentially a point or two, it looks like about half of that is FX; but the balance of that equates to maybe 70, $75 million. Is that largely the oil and gas outlook that you’re adjusting that?

Ted Crandall

Yes, so just to correct a little bit, we dropped top line sales by 2%, one point for currency and one point organic. Most of the organic--I mean, 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.

Richard Eastman

Okay, fair enough. Then just last, Ted, typically in the fiscal second quarter, expenses step up. 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?

Ted Crandall

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

Richard Eastman

Okay, all right. Very good. Okay, thank you.

Operator

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

Nigel Coe

Thanks. Good morning. I just wanted to dig into the organic cadence to the year. You’re looking for a midpoint base case of down 3, and you did down 3.3 in 1Q. You’ve said--I think Ted, you mentioned, or maybe it was Keith, that second half of the year you’re no longer expecting growth, but if we assume that easy comps get you to maybe a fattish result in the second half of the year, it implies that 2Q might be worse than 1Q. Is that how you’re thinking about it?

Ted Crandall

Yes, Nigel, it is, and then 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.

Nigel Coe

Okay. Siemens called out some channel de-stock in China, which I’m assuming given that down 11 in China, you’re 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 U.S.?

Ted Crandall

No, we don’t have the same--I would say two things. In China [audio interference] but on the other hand our Chinese distributors don’t carry all that much inventory, so we don’t think the results we’re 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.

Keith Nosbusch

I would only add, in China we have a different--well, around the world we have a different channel model than our competitor, so there is 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.

Nigel Coe

Sure, I understand. Then just quickly on the products, it seems that the CPS products business has performed better than the A&S product, and that sort of fits in with my channel de-stock question, so I’m just curious - is that true, and would you expect that to continue?

Ted Crandall

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.

Nigel Coe

Just that I would 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.

Ted Crandall

Yeah, just 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.

Nigel Coe

I see. Okay, thanks guys.

Operator

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

Ronnie Upskill

Hi, this is Ronnie Upskill [ph] on for Rich Kwas. Just wanted some clarification. Has there been any change to the $20 million restructuring target for oil and gas?

Ted Crandall

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, and 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.

Ronnie Upskill

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

Keith Nosbusch

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

Ronnie Upskill

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

Ted Crandall

I think on the--generally, but particularly on the additional one point of organic growth that we’re dropping out, that extra $60 million, we think that is weighted toward our U.S. business and weighted more toward our product businesses. So in the U.S. is our largest installed base, that’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 U.S. and coming out of product business.

Keith Nosbusch

And that’s correlated with the significant reduction in IP in the U.S. that recently came out, so that slowdown will impact the MRO business, as Ted outlined.

Ted Crandall

And that’s reflected in our guidance change.

Ronnie Upskill

Okay, that’s very helpful. Thanks for taking my questions.

Keith Nosbusch

Thank you.

Operator

Your next question comes from Jeremie Capron, CLSA. Please proceed.

Jeremie Capron

Thanks. Good morning, gentlemen.

Keith Nosbusch

Good morning Jeremie.

Jeremie Capron

I want to stay on the discussion around cost. Could you tell us a little bit more about where you’re taking cost actions? I see you’ve 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 talking cost actions and how you see cost unfold through the year.

Ted Crandall

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 cost out, recognizing that fiscal ’16 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’re 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.

Jeremie Capron

Okay, thanks for that. Mexico, I know we’ve talked about it for several quarters now, but you’re talking about broad-based strength, including oil and gas. What sort of visibility do you have in Mexico? Are we talking about strength for the next year or so, or is that much more near term strength that you are expecting there?

Keith Nosbusch

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. It’s probably the strongest distributor network that we have in an emerging market, so we feel very good about the capabilities there.

Jeremie Capron

Thanks very much.

Keith Nosbusch

You’re welcome, thank you.

Operator

Your next question comes from Steven Winoker from Bernstein. Please proceed.

Steven Winoker

Thanks, and good morning guys.

Keith Nosbusch

Morning.

Steven Winoker

Hey Ted, sorry to push a little bit on this, but you say you’re not calling for a recession right now. I guess with your second quarter of organic decline and forecasting what now is at least the next, maybe one, two or three, so now we’re 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 declines? Is it more just that you say, look - we have R&D programs where we want to have them, 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’re looking at?

Ted Crandall

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, look - given an expectation that sales are going to be one 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 one point reduction in organic growth, to take major restructuring actions.

Keith Nosbusch

I think the point you also made in your question 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. 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.

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.

Ted Crandall

Given the uncertainty right now, it wouldn’t be prudent not to have contingency plans, but we’ll go there if we need to but we don’t think that’s necessary at this time.

Steven Winoker

Keith, just on this whole question of growth, we often talk about the secular versus cyclical dynamics. 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?

Keith Nosbusch

Absolutely. We see that based upon the conversations we have with customers. There is no question, and these are global discussions, customers understand that they need to continue to drive productivity and sustainability and their competitiveness [audio interference] 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. It 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 reason 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.

Steven Winoker

Okay, and just one clarification quickly on the quarter. Last guidance, I think you guys had talked about kind of down mid-single digit expectations for the quarter. Even though it was down 3, it was better. What again was better than what you had previously thought might happen?

Ted Crandall

So I would say one of the places we were better than we thought was the U.S., and in the U.S. 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 U.S. but shipments were a bit better.

Steven Winoker

Okay, thanks.

Patrick Goris

Operator, we’ll take one more question, please.

Operator

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

Andrew Obin

Hey guys, good morning.

Keith Nosbusch

Good morning, Andrew.

Andrew Obin

Just a follow-up question on the FX impact, and you were sort of talking about CP&S having a global supply chain. As I look at my notes, Monterey 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. The 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?

Ted Crandall

Andrew, I may have to defer this one to some time you can spend on the phone with Patrick, but basically I would say we hedge our peso exposure, so that helps offset some of the decline in the Mexican peso. Also, part of our manufacturing activity in Mexico is U.S. dollar-based, so we don’t really have an exposure on it.

Andrew Obin

Got you, okay. We can take it offline. In Europe, can you just provide more color, what you’re seeing in Europe, northern Europe versus southern Europe? Any particular trends that you’re seeing, because you highlighted it’s a better market for you.

Keith Nosbusch

Yes, 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’re 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. So that’s how Europe played out.

Andrew Obin

Terrific, thank you very much.

Keith Nosbusch

Thank you.

Patrick Goris

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

Operator

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

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