Emerson Electric's (EMR) CEO David Farr on Q1 2016 Results - Earnings Call Transcript

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Emerson Electric Co. (NYSE:EMR)

Q1 2016 Earnings Conference Call

February 2, 2016 2:00 p.m. ET

Executives

David Farr - Chairman and Chief Executive Officer

Frank Dellaquila - Executive Vice President and Chief Financial Officer

Craig Rossman - Director, Investor Relations

Analysts

Johnny Wright - Nomura

Josh Pokrzywinski - Buckingham Research

Andrew Kaplowitz - Citigroup

Joe Ritchie - Goldman Sachs

Mike Wood - Macquarie Securities Group

Julian Mitchell - Credit Suisse

Steven Winoker - Bernstein

Eli Lustgarten - Longbow Research

John Inch - Deutsche Bank

Robert McCarthy - Stifel Nicolaus

Scott Davis - Barclays Capital

Shannon O'Callaghan - UBS

Rich Kwas - Wells Fargo Securities

Deane Dray - RBC Capital Markets

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Emerson's Investor Conference Call. During today's presentation by Emerson management, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. This conference is being recorded today, February 2, 2016.

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

I would now like to turn the conference over to our host, Craig Rossman, Director of Investor Relations at Emerson. Please go ahead.

Craig Rossman

Thank you, Alisha. I'm joined today by Dave Farr, Chairman and Chief Executive Officer of Emerson; and Frank Dellaquila, Executive VP and Chief Financial Officer. Today's call will summarize Emerson's first quarter 2016 results. A conference call slide presentation will accompany my comments and is available on Emerson's Web site. A replay of this conference call and slide presentation will be available on the Web site for the next 90 days.

I will start with the first quarter summary as shown on page two of the slide presentation. Net sales in the quarter decreased 16% to $4.7 billion with underlying sales down 9%. Our results reflected a continuation of the difficult economic conditions that were experienced during most of fiscal 2015. We continue to find ourselves in the midst of a global industrial recession, and recent economic data suggests that capital spending by industrial businesses weakened during the course of the fourth calendar quarter.

In the energy sector, lower but equally as important uncertain oil prices continued to impact both operational and capital spending by our end customers. Reported earnings per share in the first quarter decreased 29% to $0.53. Adjusted earnings per share, which exclude $24 million in separation costs, were better than our previous expectation of $0.50. These separation costs relate to our portfolio repositioning actions, specifically the planned spinoff of Network Power and the potential divestitures of the Motors and Drives and Power Generation businesses.

Overall, the first quarter results were slightly better than our expectations, and the company remains well positioned for a challenging 2016. Turning to Slide 3. Gross profit margin in the quarter decreased 70 basis points to 40.1%, primarily due to volume deleverage and unfavorable mix. EBIT reflects the impacts of unfavorable currency transactions of $27 million and portfolio repositioning separation cost of $24 million. Additionally, the aggressive restructuring actions initiated in 2015 are beginning to have a positive impact on profitability.

During the quarter, approximately 12 million shares were repurchased for $554 million. The company still plans fiscal year share repurchase to reach approximately 1.2 billion. Turning to Slide 4. Underlying sales were down in all regions except Europe, where our euro based businesses are becoming more globally competitive.

Turning to Slide 5. Business segment margin declined 170 basis points to 13.3%, primarily due to volume deleverage and unfavorable mix, partially offset by the savings from restructuring actions. Operating cash flow was down 15%, reflects the impact of lower earnings. Similar to many industrial manufacturers, capital spending was reduced due to lower global demand. Capital spending was down 30%.

Turning to Slide 6. Process management underlying sales declined 11% in the quarter. Energy sector spending remained at challenging levels as lower and increasingly uncertain oil prices further pressured spending, particularly in upstream markets. Upstream projects underway will continue to completion but new projects are facing potentially further delays. Downstream markets remained favorable in the U.S., Europe, and Middle East, mainly on small to medium size projects in the chemical and power markets. We will continue to shift our resources to capitalize on more favorable business activity levels in downstream and life sciences markets.

Turning to Slide 7. Industrial automation first quarter underlying sales declined 15%, reflecting continued weakness from a global industrial recession and reduced levels of spending in upstream oil and gas customers. These conditions are expected to continue into the second quarter with improvement expected in the second half of the fiscal year. Turing to Slide 8. Network Power underlying sales declined 1% in the quarter as global demand for data center and telecommunications infrastructure spending was mixed. From a regional perspective, Asia had growth in Australia, India, and South East Asia, while Latin America reflected favorable data center activity levels, particularly in Mexico.

Segment margins increased 90 basis points to 8%, benefitting from restructuring actions. Recent order trends have reflected improving conditions in both data center and telecommunications investment. Turing to Slide 9. Climate technologies underlying sales declined 10% as global air conditioning sales decreased driven by higher U.S. residential demand in the prior year resulting from regulatory changes. Global refrigeration markets grew modestly, as growth in the United States and Asia was partially offset by softness in Europe. Demand in the air conditioning and refrigeration markets remains favorable, supporting our outlook for modest levels of growth in 2016.

Turning to Slide 10. Underlying sales in the commercial and residential solutions segment were down 2%. Favorable activity levels in U.S. construction markets resulted in growth in both the wet/dry vacuums and food waste disposing businesses. Segment margins improved 20 basis points to 21.7% from the favorable impact of the divestiture of the InterMetro business. The favorable trends in U.S. residential and commercial construction continue to support our outlook for modest levels of growth in the segment.

Turning to Slide 11. As we have indicated, we expect difficult market conditions to persist throughout the fiscal year, but we do still see a bottom forming in both sales and earnings by the middle of 2016. We will continue to execute on our operational plans while diligently working to complete the important portfolio repositioning actions that were announced last June. Taking into account our first quarter results and recent order trends, we are reaffirming our fiscal year 2016 guidance.

Underlying sales are expected to be down approximately 2% to 5%, excluding negative currency translation and a deduction from completed divestitures of approximately 2% each. We continue to expect adjusted earnings per share of $3.05 to $3.25, excluding estimated separation costs of approximately $250 million to $350 million, which are approximately $50 million lower than our previous expectations. For the second quarter, underlying sales are expected to be down approximately 4% to 6%, excluding negative currency translation and a deduction from completed divestitures of approximately 2% each. Adjusted earnings per share of $0.60 to $0.65 are expected excluding estimated separation costs of approximately $75 million or approximately $0.11 per share. Our long-standing commitment to return cash flow to our shareholders will be supported by an expected increase in 2016 operating cash flow to approximately $3 billion.

And with that, I will now turn it over to Mr. David Farr.

David Farr

Thank you very much, Craig. Thank you very much for joining us today. I appreciate that. We are looking forward to seeing our investors and analysts in Austin next week, and we will talk a little bit more about that in a second, but looking forward to really seeing everyone down there and sharing our plans and ideas to the group. I also want to thank everybody across Emerson relative to the execution in the first quarter. Clearly, this is only the first quarter, and we have a very detailed undertaking ahead of us relative to sequentially improving our sales, our profitability, our earnings and cash flow for the remaining part of this year.

As I look at the plans, we started back from restructuring back in February and I look at announcement of repositioning that we announced in June, we continue to make very good progress. But it is clearly all about executing around those plans that we put in place and making sure we get it done from the standpoint of driving costs, standpoint of repositioning this company, and looking forward to how, as we go through a very challenging global economy, very challenging industrial recession that we see today and coming out of this a stronger company and one that can continue to add assets once we reposition to a new Emerson platform.

Looking forward to giving you insights of how we see the 2016 unfolding from an economic standpoint, how we see the numbers happening from the cost of the repositioning, how we see the issues that we may see from a risk standpoint and what we are going to have to do about those that we see additional risk. Those are all things that we will be talking about. I will defer those until we get together next week. Also looking forward to having Bob Sharp and also Steve Sonnenberg talk about the two key business segments, business platforms that we are moving into. The commercial residential solutions and that also the automation solutions, those two individuals will give you insights to what we see the strength of these platforms, what we can do with those platforms and where we are going to invest going forward.

Clearly, we have a challenging oil and gas and industrial marketplace right now but it's nothing new, we have been there before, we know what to do to deal with this issue. That’s why we started the aggressive restructuring last year. As we talk amongst the business leaders, the OC and the board, if the market continues to get challenging, we will continue to do additional restructuring. We will continue to make sure that the cost structure of this company stays competitive and that we can deliver the highest level of profitability that our shareholders expect from us.

That is what we are all about, right now. Executing around that and getting things forward. As I look at our current marketplace, the last 30 days have been what I would call the most unusual in my time at Emerson. I have never seen a marketplace go so volatile from the standpoint of the end markets, the stock markets, the interest rates, I guess the attitudes. It's just a very amazing marketplace right now and one that clearly global CEOs like myself have to deal with and be prepared for whatever comes at us. But we are now basically in our fourth quarter of the recession. I see, as we will talk about next week, I see at least one more quarter, maybe another quarter. But sequentially our game plan is to improve the business, cycle this business back up and start improving the profitability and that’s what we are all about here.

So with that I will open the floor. I am glad to have the first quarter behind us. I want to again thank the organization. They did a great job executing on the plans we put out there. We are making great progress and clearly it's only one quarter, we know that. And our game plan is sequentially improve sales, the profitability, earnings and the cash flow to our shareholders and establish the premium valuation that this company deserves. With that, I will open the floor.

Question-and-Answer Session

Operator

[Operator Instructions] We will go first to Johnny Wright of Nomura.

Johnny Wright

Good morning, guys.

David Farr

Good morning, John -- because I didn’t have anything because of the board meeting just ended, so I had to give something to my body here. Be an on the [nerve] [ph] CEO.

Johnny Wright

Sure. Back in August, I think on the earnings call, Dave, you talked about process order stabilizing but if oil moved below kind of $30 or better off, looking at words to that effect. So here we are, oil is around $30. I'm just wondering how you see that playing out for process if oil stays at these levels both this year and then into FY '17?

David Farr

Let me see. Chevron reported a loss. BP reported a loss. So I would say the market is stressed. So from my perspective right now, I would say the capital market in oil and gas is going to be lower. Our expectation for our process business will be lower, and we will have to do additional restructuring. We are looking at a situation, in my opinion in the oil and gas marketplaces, that will not recover until well past middle of '17, maybe late '17. Fortunately, we have 75% of the business that doesn’t serve oil and gas marketplace. So even though we will talk about this next week, oil and gas spending is down, it is not going to zero. It will be a tougher marketplace and we will have to work harder at it. And clearly there is a lot of uncertainty around this, but the game is we are going to have to figure out how to get the sales, how to get the business, and get our cost down. And it will clearly be a tougher year in '16 than we thought. That’s the game. Pretty straight forward.

Johnny Wright

Okay. Great. And then I guess in the quarter, I guess January you guys announced a big project with Tahrir Petrochem, I think $150 million. I am just interested to see you guys taking a preferred equity investment in that customer. I am just wondering is that reflective of the competitive environment where alongside price you are now kind of having to think of other ways to win business? Or how do you think about that and how should we think about it going forward on other kind of big, large projects?

David Farr

We have done some of the things in the past. This is unique. This is very strategic for the country of Egypt, and we felt that as with other people, we are not the only one that did this. We are probably the only one who has gone public with it, but I think that you will see this happening from time to time. It's a huge opportunity for us, and it really is all about forming a relationship because I think once this project is done and is successful, there will be future projects and it will happen. But it's not for every customer. It's not for every marketplace. But this one, we worked on it long time, and I have met with the CEO, and we had long conversations, and I feel that this makes a lot of sense for us relative to strategic relationship going forward. So I don’t think -- it is just our commitment to making sure that these guys are successful, and we are going to have a lot of business with them for many years to come.

Operator

We will go next to Josh Pokrzywinski from Buckingham Research.

Josh Pokrzywinski

Dave, just looking at the order trends here and process in December. Obviously, the month to month can be volatile with different project activity and what stays and goes rather comp [walks] [ph]. But maybe just comment on how that month looked and any kind of body language you've gotten just with the last $10 move? Obviously, projects don't go forward on a day, a week, or even a month of oil prices, but maybe what the psychology has been with this last move down?

David Farr

I think to be honest, I think the psychology is very nervous and tense within the big oil and gas investors at this point in time. I think that we see, from our perspective what we are looking at is that we will talk to you next week. We will try to encompass what we think the downside will be relative to oil and gas in the process businesses. But I would say December quarter for orders for process were not that bad. We pretty well had that factored in what's going on. I would say that my concern is the psyche of a Chevron or psyche of Exxon Mobil, psyche of these Shells and the BPs and things like that are going to kind of freeze up some of that spending level. They can't go to zero, but I think it's going to make it tougher. So my gut tells me that it is going to be more challenging in the near term and [old] [ph] process, order pace will be a drag in this, and the other businesses will start pulling back up. So that’s where we are at this point in time.

We will give you an update on what I think the process segment is going to do. In fact it will be more negative based on – because the the first question, I did say that when the price of oil got down to that level, it will be an impact. And I think right now our underlying sales will be more negative in the process than we thought originally and hence we are going to have to cut more costs there. But the psyche is not good in that space right now. Fortunately, there is more investments going on in the parts of the marketplace, and it's a big part of the marketplace, but the oil and gas investment area is not very good right now, and I think it's going to hurt us from the second half of this year.

Josh Pokrzywinski

And obviously you'll touch more on this next week, but I think maybe looking into last quarter, the expectation on being able to hold the line on price somewhat and being able to hold the line on margins this year. Assuming all that plays out what we're seeing today, I would imagine those two items are also part of that discussion that maybe goes out of the window as well?

David Farr

It's not gone out the window. From the standpoint of -- the pricing right now -- let me make a forecast for, we look at ranges. We have ranges you know. There is a reason why we go 2 to 5 or other ranges in the underlying sales, we look at also pricing environment changing too. The pricing environment today is still within the range that we laid out when we put our plan together back in August and September and just talked to you all in November. The net material inflation has continued to drop down, so we are going to give you a forecast. We are going to give you a range of what it looks like right now. But it's well within our range. I would say the one negative will be, underlying sales of process will be more negative and the profitability will still be very good. And we are going to have to take some additional restructuring both for the '16 and '17 in that space, because the recovery will be longer.

And we are going to see what our customer base does right now. As you said, man, they don’t move that fast but I know the psyche is not good. You just have to look at the reports that came out in the last three days or four days relative to two major oil and gas providers.

Operator

We will go next to Andrew Kaplowitz from Citigroup.

Andrew Kaplowitz

Dave, on last quarter's call you talked about the expectation that we might see one more quarter where inventory in the channel could be worked down and then by 2Q destocking could be high. It could be behind Emerson. Did you see -- I assume you saw continued destocking in the quarter, do you think inventories in the channel are low enough where the destocking for the whole company should end as we go through fiscal 2Q and in the second half of '16?

David Farr

I would say what my knowledge is right now, inventory levels within the channel including ourselves, our levels that, they are pretty good levels, low. And so the pace of business right now and the run rate where I see, I would say the inventory levels are pretty good for us. I don't see much of a downward draft on that now. I think it's pretty well over with, probably very minor downward draft. I think it's pretty well there, around the world. I've been in Asia, have been around the world and I don't see the inventory being a big issue for us right now. So that's a good thing.

Andrew Kaplowitz

Got it. And then just asking about China. You talked about China in '16 maybe being down mid-single digits on your last call, and maybe down 15% in 1Q, but you actually did down '13. So do you think China has stabilized a little bit for you in terms of the decline and are you still expecting mid-single digits for '16 to hold down in single digits?

David Farr

Well, first of all, I called down '13, I would say that's a pretty good forecast call right there without knowing what was going to happen. So I know if I could do that maybe I should go into the investment mode but, just joking clearly. I think that China in my opinion today, the forecast when we put that out there, I still think it's going to be that mid-single plus digit. I think it's going to be in that 5%, 6%, 7% range negative. I don't see it changing. I would say my China organization is more optimistic than that. They are less negative. But I think that looking at what I see going on in China and the marketplaces around the world, I think that that's going to be a tough one for them to do though they are working through the inventory that was built up in the first part of 2015. But my gut tells me that I would not be surprised if we don't finish at minus 7% or 8% in China when it's all said and done.

Andrew Kaplowitz

It's helpful, Dave. Thanks.

David Farr

Write that down and you can see how good a forecaster I was.

Andrew Kaplowitz

We'll hold you to that.

David Farr

I know you will, you guys always do.

Operator

We will go next to Joe Ritchie of Goldman Sachs.

Joe Ritchie

And, Dave, we'll welcome you over as an analyst any time you want to come to the dark side.

David Farr

I didn’t say an analyst, I said investor.

Joe Ritchie

Oh, investor, got it.

David Farr

You know I am not that good of an analyst. You know that. I would fail. I would be fired within one week. As an investor that’s a whole different story.

Joe Ritchie

All right. Well, just keep your day job. So maybe focusing a little bit on your commentary about the last 30 days never being so volatile and just taking a look at the order trends. It's interesting as you look at the trends you think about the last 30 days, it's interesting that you haven't really updated your guidance for the underlying growth rate for the year. I recognize that comps are going to get easier as we get through the year but why not maybe be a little bit more, I guess, conservative with the underlying order trends or with the underlying organic growth trends for 2016?

David Farr

Because I think that when we put our plan together we had certain assumptions relative to the volatility of the marketplace and what the market is going to look like. And as I look at all analysis and I look at the upsides, the downsides, I think right now we are still well within that boundary. And to come out and to widen that boundary right now is not what I find acceptable. I think our organization at this point in time, we are well within that even with the 30-day risk. I mean the risk in the 30 days is more around one piece of the company and the standpoint, I mean, Europe's not that case it's primarily around the oil and gas, the price of oil and gas investments. So it's not the whole economy but it's definitely -- I mean we encompass what we thought could possible happen to us. Now, it could get worse and I will talk a little bit about that in Austin but right now I think we are well with inside the boundaries of what we put out there.

Joe Ritchie

All right. Okay. Fair enough and maybe talking about--

David Farr

By the way it helped that. We got ahead a little bit in the first quarter so it did help a little bit there that we made progress better than I thought. So, clearly it helped me a little bit. But it's obviously our easiest quarter. I mean I am not a fool, I know that.

Joe Ritchie

Sure. No, that makes sense. Maybe talking about the cost actions then for a second, I just want to make sure I've got my numbers straight. You spent a little over $220 million in restructuring in 2015. I think it was another $13 million in 1Q. Can you talk a little bit about the benefits that came through this quarter? Clearly they are helping the margins a little bit and maybe your expectations on cadence as we progress through the year?

David Farr

Yes. I think that what we see right now, around $80 million improvement came through in the first quarter. There will be -- from the standpoint of restructuring, there is still a big number in the second quarter. My gut tells me that we will probably be on restructuring around $20 million in the second quarter. And then we are going to be increasing this. The question is, can I get it done in the third or fourth quarter. Is it going to be more in the early part of next year? But, clearly, I think you are going to be looking at the 20 page for each quarter now as we start pushing in anticipation of concerns that we may have in the marketplace out there.

Savings wise, you are going to be building from this 80, incrementally be coming up towards I would say the 90 level by the time we get into that fourth quarter. And that’s basically how we see that happening per quarter.

Operator

We will go next to Mike Wood of Macquarie Securities Group.

Mike Wood

Good job executing in a very tough back drop. I'd like to follow-up on an earlier question on the price. Have you actually began to see the increased price competition in process and has that been rational? Just given the fact there's very little project activity out there, I'm just curious how you actually measure that price change.

David Farr

Well, we measure the price change, obviously on the contracts we also measure the price change that we have to give on short-term actions from the standpoint of a day-to-day business. So it's very measurable because we can see the average pricing within the structure of the business. But you are right. There has not been a lot of big bid around what I would say the oil and gas or the other big projects. So the pricing has been rationale. The other issue is right now, like our European competitors, we are also major player in the process [world] [ph] of Europe. And so we get the benefit of that too. So what I see going to happen is we are going to be seeing sales shift to our European operation because we have been working for this last 12 months. You know the dollar really started appreciating last year, well over a year ago. So we have been working to get our rebalanced cost structure which we will continue to do. So our USP in the organization right now is seeing the benefit of the lower cost structure, so they are winning in, I would say, you are going to see other regions of the world. So we are pushing around the world just like our European competitors do. And that’s one of the benefits we do have relative to having a broad manufacturing spaces on all these businesses.

So I feel reasonably comfortable right now on the forecast we are going to give you for price. I mean we track this extremely hard. I don’t know how long you have been following us but first when I met in the early 2002-2003 timeframe, I can't remember exactly when that was, we got side swiped on how fast this things move. But now we have created a lot tougher tracking process and so I can tell what's going on across this company. And it's going to be a little more negative this year than last year but well within what I thought we are going to see and well within the net mature inflation level. And people are acting rationale. It's going to be an interesting year to see. A lot of people are trying to improve the profitability on down volume. And dropping price in a down volume to try to prove your profitability does not work. Economic 101. It does not work.

Mike Wood

Understood. And given the recent volatility you mentioned in crude, how does that impact the downstream businesses and MRO and your investments that you are making.

David Farr

Two things. I am concerned that’s why I think we are talking about we need to get our action together and think about, if it takes longer to recover as we go into late '16, early '17 in the process side. Because I personally think what will happen is, there will be a freeze. A little bit right now relative to a lot of our customers, as they say, okay, we are reallocating capital. We are cutting capital again 10%, what that number is going to be we will see the next 30 to 60 days. And that will create a pressure on, I know, our base relative to smaller projects and the MRO projects. So the initial reaction is, I think we are going to see a slow down and then hopefully as we get into the year, we will start seeing that capital freed back up. It can't to go zero. It's not going to go to zero but they are clearly going to reallocate and they are doing that really fast right now from our customer base. So my concern right now is, we are looking at downward pressure relative to our total sales in underlying process. We need to take capacity offline. So from my perspective right now, initial phases for the last 12 months is very much focused on people, on restructuring the overall overhead cost.

And now where I want to look at -- if we are going to look at a long recovery here in this particular part of the process world, we are going to look at taking fixed assets offline. And so now that’s Frank and Ed Purvis and the business leaders at their upcoming reviews which start, I think, a week or two from now, look at what extra capacity that we may need to take off permanently if we are looking at a different environment and where should that capacity be and not be. So I think that will lead to higher level restructuring later this year to early '17.

Operator

We will go next to Julian Mitchell of Credit Suisse.

Julian Mitchell

You mentioned earlier that your though process would lag a recovery in some of the other businesses. But I guess if we look at industrial automation, it does seem if it's got pretty bad. So maybe just comment on how you say IA playing out. And related to that, any color you can give on orders in January?

David Farr

I don’t have orders for January yet. This is February 2, so I don’t have that yet. It's a little bit quick for me and the company. But relative to IA, I think IA got hit harder, sooner relative to the space they are in. And so there might be a little downside risk in IA but not that much. I think these guys are sitting really down, pretty far right now. I mean things can always go down further but my gut tells me they are pretty close to that cycle right now. The process guys because of the type of business they have, they are still coming off some of the wins and things they won last couple of years. So I think that they will continue to Slide a little bit here. And that’s my biggest concern right now. If I look at the '16 forecast, I always have little IA concern but my biggest concern would be the process guys at this point in time.

Julian Mitchell

Thanks. And then Network Power, orders look a little less bad than a few months ago. Margins are up. You have a big project in Europe you are working on. But outside and beyond that, do you think that you have succeeded now in sort of stabilizing the earnings in Network Power and the rest of the year we should see that stable margin play out?

David Farr

Yes. Yes. I think if you look at the underlying order pace of our Network Power business, is actually noses up. And as of right now even, I was talking to Scott Barbour today and his team is doing a great job out there. The nose is up, continues to move the right way. Profitability continues to move the right way. These guys took some serious actions, hard actions the last 12 or 18 months and right now I feel good about, it's a broad base and I feel good that these guys are heading the right way. As of right today that’s what I feel. So I feel good about that. I think they had a very good first quarter. I mean it's a long way to go but they have been noses up right now. That’s a good place to be in any business as you know.

Operator

We will go next to Steven Winoker of Bernstein.

Steven Winoker

Dave, given all the commentary and sort of how obviously the volatility is right now, what's going on with the process, the capital deployment process or should I say the sale process for industrial automation, some of those assets and the separation activities for Network Power. Is that delayed in anyway?

David Farr

The Network Power asset, there is no delay going on. We have the fuel path looking at strategic buyers within that business. We also have the fuel path of moving right down towards the spend. So that half is well underway. On the industrial asset, automation assets, I would say that based on what we see right now, we are probably two to three months behind where I want to be relative to the discussions with strategic buyers. So I would say Network Power heading okay. Industrial automation, given the tactical customer base, a lot of my potential customers or buyers are clearly are seeing some tough times too. So I would say that one is a little bit delayed by couple of months. But that as of right now today as I report to the board.

Steven Winoker

Okay, Dave. And then also the combination of process and industrial, in other words the future structure of the business, the future Emerson here. Are you taking actions already to combine overhead or other elements of these two businesses yet or is it just standalone, frankly, until you got that other process down and then you will go down this one.

David Farr

We are -- I would be very careful here -- relative to this business we are taking some actions early on the combination. Not totally across the board but in certain select areas in preparation of it. So that will be, by time we get into the middle of this year, those actions will underneath way. On the commercial residential solutions business, we are embarking upon it as we speak. And so both are well on their way. I made a commitment to the board, I made a commitment to the individuals and I think I probably told you guys that by the end of the second, halfway the third quarter, we are going to have these things structured properly. Now it doesn’t mean are things done but that’s what the game plan is at this point in time.

Operator

We will go to Eli Lustgarten of Longbow Securities.

Eli Lustgarten

One quick question on the process side. You talk about the upstream projects, some on completion new projects. What portion of the business at this point still relates to the upstream projects that are being completed and how much does that disappear. In what sense does that go to as you look through the year? Does that basically go to a very minor part or how do we handle that?

David Farr

I don’t have those exact numbers. I can't give that. I can't break it out that way. I know what our oil and gas percentage will be this year in upstream. I mean I know it's still going to be a significant percentage of or total business and it will be next year too because it's not going to zero. People just don’t stop it. We will give you our best feel or it on next week. I have some ideas where we think the segment is going to go. But they don’t move that fast. So it's really hard to say because what we talk about, what you think about are not necessarily how everyone looks at this business in a day to day standpoint. So I can't give you that information to be honest. And its [indiscernible]

Eli Lustgarten

I am just trying to sense, is that the part that’s disappearing. Are you trying to say are we closer to bottom of that impacting or sort of indicating that by middle of the year?

David Farr

No. I don’t think it is. We will talk next week.

Eli Lustgarten

And you talk about having to do more restructuring in process because of market that's quite easily understood. But can you talk about whether you're starting to look at industrial automation in the same way? I mean it's a very weak market. Conditions or so that there's more of, or a second level of restructuring there to try to hold profitability better because that profitability could be under a lot of pressure if the demand stays in the current way.

David Farr

Well, we have laid out the restructuring that we have intended to do this year relative to the industrial automation business and that’s well on our way. I am also in the process of selling that business. So from my perspective, I mean I believe that there is more additional restructuring most likely [indiscernible] from the potential buyer of the company. I have a business plan laid out which is being worked out right now. I don’t see anything at this point in time. If we make the decision we are not going to sell this industrial automation asset then this [owner] [ph] right now, we are down the path, then if we are going to sell that asset.

Operator

We will go next to John Inch of Deutsche Bank.

John Inch

So last quarter you called out, in general, incremental concerns possibly about Middle East. Has your thought process changed because there's obviously been some conjecture around possible efforts to curtail production and you called it volatile. I'm just curious, has anything changed in the last few months with respect to your perspective on Middle East?

David Farr

No. My perspective on the Middle East hasn’t changed. I think that the risk I see today in the world for spending, and your talk about say the oil and gas, the type of spending that goes on and just the process of spending. North America, China and Latin America. Those are three concern areas I have relative to the spending around that industry. I was just coming back from the Middle East. I mean the national oil companies have to spent a certain level of money and they have been cutting back and I think we probably have that build in. So I feel okay there right now, as of right now. And I see some major crisis going to erupt in the Middle East, you know things falling up and stuff like that. But right now, I feel reasonably good about that. But concerns are North America investments and the concerns we are going to have on companies that may not make it or be consolidated. And then China, clearly concerns. My forecast of China is worse than probably most people would say out there. So I am a little concerned about that one.

John Inch

No, that makes sense. Dave, a year ago at the analyst meeting you made comments that you thought Canada's petroleum industry was probably going to be better than people expected because there were a lot of obviously reasons for it. Efforts to support domestic businesses, that sort of thing. Do you think that's changed? The dollar has collapsed a lot and I guess debatably it makes that country a little more export competitive or what not. I'm just wondering if you think because it's such an important trading partner with the United States, if you think the outlook for Canada is kind of where you thought it was before? It's sort of a similar question on the Middle East, only for Canada.

David Farr

I would say it's worse. One, they have a new type of government there that doesn’t necessarily care for this industry. And secondly the price where it is right now, it's not good. So I would say, from our perspective what we have been doing is we have been restructuring and downsizing in Canada. I mean it's an important market but strategically it is going to be a tough market for the next two years.

John Inch

Just lastly, Dave. You obviously touch an awful lot of the verticals, right, lots offer different things. So kind of ex-petroleum, do you think that, I mean are you guys tracking maybe some end markets or verticals or other things within Emerson that actually could be contributively positive or surprise kind of to the upside, let's call it in the next, I don’t know, 6-12 months?

David Farr

Yes. I am going to give -- we are going to give you a different view of the verticals and the growth rate next week. And I think the answer is yes. I think there are some verticals that are going to do better than people think. And that’s where -- you know we started talking about this last summer. We have been reallocating our resources, really pushing hard to reallocate our resources. We had a very very good run in oil and gas upstream and we gained a lot of growth, gained a lot of market share. And now what we are doing is refocusing those resources and so we will talk a little bit about that next week because what you just said is exactly right. And there are markets out there and the whole organization in process management is focused on how they can go after those markets and re-energize their workforce to go after that.

Operator

We will go next to Robert McCarthy of Stifel.

Robert McCarthy

Maybe we can just go back to, I think kind of a question I asked on the last call. But just given what you see in process and obviously your commentary throughout the last 30 days, I think implicit in your guidance for fiscal '16 was some firming of order trends in terms of kind of the March-April timeframe. I'm not trying to put words in your mouth, but I think it was to that effect. And then you know...

David Farr

I mean exactly what I said -- you are not putting -- and I will tell you again today that I will show you a chart next year that I am saying we will, I'd say right now the call April 1, our orders go positive. It's total [positive] [ph]. I said that last time on the call, I am still saying that. Now for whatever, you know what but I am making that call and I will stand by that call.

Robert McCarthy

All right. And you don't want to move the call to April 2, maybe but...?

David Farr

Well, because it's April fool's day, so I can get that.

Robert McCarthy

Okay

David Farr

I made that call back then, I am standing by that call.

Robert McCarthy

Okay, fair enough. I guess the only other question I have is, you did mention, and this dovetails with the question I just asked, but I think you did mention like we've come through four quarters of what looks like an industrial recession. You think there's about one to two left. Are you seeing anything in the GFI or just the order patterns or trajectory, absent process management vertical where it's obviously dynamic and tied to the commodity price, where you can kind of point to an upward trajectory or reason for recovery there in terms of the macro?

David Farr

Yes. The answer is yes. And the call is April 1. And I am talking about the April orders, you know that. And then we are right now, Frank and I will sit here, we will tell you we believe that our underlying sales will go positive in the third quarter. Based on the -- I felt that all along, and Frank has crossed his fingers over there, he is a great CFO, he really stays right behind us. He is right behind be with a gun to my back. But, no, I still believe that. And the key issue, now keep in mind, if you are paying attention, we said that first quarter underlying sales will be down, probably 9% to 10%. We finished a little bit under 9%. Last time I talked on the phone I said underlying sales will be down 5% to 7% in the second quarter. I am now, Frank and I believe that our underlying sales will be down 4% to 6% in the second quarter. So the key issue for is, as we map out and we get together, we will give you the insight on orders when we are together next week. We are trying to get orders, somebody asked me a question about January, we will try to get those so we can at least have a sense on where to go the next week. [indiscernible] would stop going to play basketball so much and watching Lebron James. Maybe we could get them but. So I think right now I am standing behind that. I mean the chart is going to say, April, orders to above positive and third quarter sales will have a plus in underlying sales. And we will not be standing there talking to me.

Robert McCarthy

Well, we've got our line in the sand. I'll see you next week.

David Farr

I like to draw lines. You know me.

Operator

We will go next to Scott Davis of Barclays.

Scott Davis

I'm trying to reconcile, I think like everybody else, I mean you're bearish but you're still calling things getting better in April. And I think the angle I want to take is that, and there's a good and bad here, and the good is that you mentioned the comment fixed assets off line and we've been writing and we think the entire industry needs to do this. But you guys are the only ones that are really doing it. So how do we get out of this mess if you're one of the only companies that's willing to admit that it's a, for lack of a better word, a bit of a site-show out there. How do we get out of this mess to where even if your orders turn, call it slightly positive, I mean it's probably more flattish than positive to be more realistic, but how do we get out of this. I think...?

David Farr

It will be above the line. I have actually got my nose above the water, it [counts] [ph] Scott.

Scott Davis

Well, what's it going to take to get us out of this mess is my question really, Dave. Because again unless everybody capitulates, which we saw in 2002, we saw it in 2009. Doesn't it just start to bleed into different components of the economy and different businesses that you sell into that aren't being impacted right now start to see impact as we get later on in the, call it cycle?

David Farr

You know, I can't speak to other people. I mean they've got to be looking at the same issues from the standpoint of too much cost, too much capital, fix that investments invested. They've got to be looking at that and so eventually they are going to have to say look, we've got to take action. A good leader -- if they don't take action I think there will be some other people coming and working on that issue. But from our standpoint I feel quite strongly as you know. We're trying to deal with this issue. We make calls. I make calls, as you know my for a long time. I make a call. Sometimes I call right, sometimes I call wrong. But you have to make calls and say we've got too much capacity, things are going to be down longer, you've got to deal with it.

And we started seeing this happen last year and I think other people are now maybe just starting to see it and starting to deal with it. But if you don't have the capability of dealing with it sometimes you just sit there and tread water and watch your profitability get hit. I think there are several companies out there in my opinion in the industry right now that are doing a good job in dealing with this issue. There are several companies that are not and you know that. You can see it. And I don't have that magic call. I can tell you what we could do. And so I know right now that certain things are going the right way. I have a feel for what things are but I do know that given right now, given where the price of oil & gas is and potentially where it could go, we fundamentally will have a capacity issue on that industry which we didn't have say 12 months ago. And so we have got to think about how we deal with that issue and as you know it also takes time. But that's on the table right now and no one wants to deal with that because that’s really a hard thing to deal with. But you got to deal with it period.

Scott Davis

Yes. Understood, and I'm encouraged by your comment on price being relatively rational. It was in the last cycle as well but there's always little tidbits out there. Caterpillar has been talking about the alternator contract they have with you guys and trying to drive price down. You view that as more of a one-off or do you have multiple situations going on like that but you've been able to hold on price because the competing bids haven't been any better?

David Farr

From the standpoint I think most people are being rational on this thing. Our contract, capital as a contract, and the contract is set and they have the right to go do what they want to do, but the contract is set. And so from the standpoint of the overall industry I would say the biggest issue right now is because volumes are dropping for people and they have excess capacity, trying to fill plan up with a lower price is not a very smart thing to do because it doesn't work for you. That's why I think it's been more rational here. And so far we mapped it out and Frank and Ed Purvis and all the business leaders laid out a plan what they thought last summer, early fall. We will look at it again right now on the pricing and it's pretty well in line and I feel good about it. But like I said, 10 years ago, or was it 12 years ago, I got really side swiped and so that's why we spend more time on it than probably the average company.

Operator

We will go next to Shannon O'Callaghan of UBS.

Shannon O'Callaghan

Hey, Dave, just within the process spending that you are seeing, I mean we went through this period which seems like in a lot of cases we are still in where seemingly everything was getting cut upstream, mid-stream, downstream, maintenance spending. The spending that you are seeing happening, whether it's some of the downstream stuff or the chemical, what are the projects exactly? What are people willing to spend on right now?

David Farr

On the big projects, say upstream is that it's a project to certain in time that they see that spending -- I will make a number up, a billion dollars more to get cash flow. The customer is going to move forward with that because if you are stuck 75% of your projects and you stop it, you got a problem. Because the project won't be that good but the time you come back to it in five years or whatever it is. So most people you see and those monies will get spent. Now every time they go through a process they are having to cut capital within that industry, that will fine tune that. But most people are taking advantage of the environment right now to go out and improve, I would say the efficiency of the facility. So spending on small capital projects, upgrades will help to get more out of the facility, higher quality, higher yields. So that’s what they are spending right now to get more of each facility. So I see them still spending money. It's just an interesting process. They are going through the process of being very selective. When things were going their way they threw a lot of money at everything. So the money is still being spent but it's definitely being a lot more selective and it's going to be much more on how can I prove the investments we have made over the last ten years. Get me more money out of that given the fact that my oil prices or down or my inputs are down, what can I do. So they are being a lot more selective along on those lines. Which is a good business for us but clearly you don’t have the big projects which give you a lot of top line growth for the big bank. But there is money being spent out there.

Shannon O'Callaghan

Okay. And then on Network Power, nice margin result there in the quarter. It's been a while since Network Power margin has beat my expectations. Is that a function of having kind of cleared any major part of the restructuring or just a lag of getting this stuff to kind of show up in what you're shipping in terms of the numbers, or is there a reason why it sort of finally came through now?

David Farr

I think that across Network Power, from the standpoint of actions they started undertaking last summer and started flowing through. And they exist in that, we have been working them. It's really starting to come through in the final P&L. So it started actually around the last month or last year or the fiscal year September and it's [preceding] [ph] each month. So our expectation is that this will continue to take hold based on what we see happening in that market. So we should see a sequential type of margin improvement in that business. Which would be good because Scott and his team have really attacked this. They are getting out of certain business, they are investing in other businesses. I think they have done a great job in evaluating where they want to be and the cost structure they have. And now they are executing around that flexibility. And my hats off to that team in a very dynamic marketplace. So I think they are heading the right way and I feel good about that. They did a great job executing the first quarter.

Operator

We will go next to Rich Kwas of Wells Fargo.

Rich Kwas

So, Dave, just broadly speaking, given what's going on in oil & gas here in North America, are you seeing any signs in your other businesses of meaningful contagion in CRNS or climate. Anything that you would point out here? You talked about the last 30 days being volatile. Just any thoughts there because obviously there's a lot more concern in the market in the last 60 days or so?

David Farr

Yes. I would say we have not seen it yet, Rich, from the order pattern that we saw in December. I don’t know, even the forecast for January, I didn’t see anything. It could take a little while but we don’t see it yet. I think the marketplace has definitely been very volatile. I think the marketplace is starting to see numbers that we have been seeing. Now we have been -- if you look at the fourth calendar quarter, the third calendar quarter, they were pretty tough quarters for companies like Emerson. And so the market is now digesting that news as they saw it come out in the earnings report and the comments people are making right now. Let's say a little bit more negative about 2016. So I would say that we have been trying to get ahead of that and at this point in time I feel that we have got that size. I don’t see the knock on effect of what we saw the volatility both from the marketplace and then also the commodity place in January. We will have to watch it very carefully, unfold. And if I look at the construction, residential construction, the residential spending, the consumer spending in the areas that we are, they are still holding up pretty well right now. So we will see. I mean 30 days is pretty short. You guys give us a few more days here.

Rich Kwas

Understood.

David Farr

I know you are very quick compared to me but.

Rich Kwas

On process in terms of M&A, you talked about deploying some capital there for this year. With what's happened here, incrementally more interested or less interested? How should we gauge that over the course of '16 in terms of the opportunities you're seeing right now?

David Farr

I am interested. Higher interest. You can never call what time to buy and from my perspective right now, I think that there unique assets out there that I would like to buy. And our cash, you know Frank is over here working on how we are going to get cash back in the United States with the spin, the divestitures. And we are going to talk a little bit about that next week so from my standpoint, I will look at this as a buying opportunity. And I talked with my board today and the board is right there. They are on me, on is to make sure we execute and we execute as hard as possible around this repositioning, the restructuring. And then spend that money to make Emerson a better company long term and we have got opportunity here and let's think how hard we play with it. So that’s what we are all about.

Rich Kwas

Okay, thanks. By the way I thought Rossman was up for the [cavs] [ph] coaching job. I guess that didn't play out.

David Farr

He just missed it. They called me at it. They called me and I said, he was questionable with his leadership capability and I also felt that he would have a hard time coaching a guy that’s seven foot tall.

Operator

And we will go next to Deane Dray of RBC.

Deane Dray

Just thought it was interesting how in a period of significant volatility we have all been questioning you about what you're seeing here, but you're also giving quarterly guidance. That's not really what -- Emerson didn't used to be in the quarterly guidance business but where is the additional confidence, where's the additional visibility? I mean it's certainly welcome, but it's a change.

David Farr

The change, I may go back, you know me I have around few years. It's all about right now that we are on a detailed plan that we started executing last June and I want to make sure you guys understand where we are relative to that transition. And I want to make sure you guys get clarity around what I see sequentially happening each quarter. And the management team has been working, is very aggressive right now. We have been discussing with the board and I think it's very important for you all to understand what I see happening each quarter. We see happening each quarter and that clarity. Now once we come back to normalcy in the marketplace, we may go right back to -- necessarily I don’t believe in quarterly guidance but just go right back to old way. But right now I think we are in through this transition period. I think it's very very important for you to understand what's on our mind and where we see standing [indiscernible] how we are positioning each quarter. And so we are going to actually give you clarity on things next week on the second quarter which you probably would never get from us. I think it's important that we stay joined in the hip here. Some of you are right there with me, some of you don’t necessarily agree with us. It's all about execution. Can we execute and I am telling you what the roadmap looks like, what the band looks like each quarter and I will get through this quarter and I will tell you the third quarter.

Deane Dray

Yes. It's a great perspective and it is a change and in a period of this uncertainty to have your line of sight on this is appreciated. And then just have a niche follow up on commercial and resi. It was interesting for professional tools, you wanted to blame that also on upstream spending and I just never thought professional tools was as tied to that, but maybe I'm wrong.

David Farr

Now you are talking to one of the former presidents of Ridge Tool.

Deane Dray

I know.

David Farr

And the former president of Ridge Tool that went through a last recession, a really tough recession we had. We have a significant part of that business that sell specialty tools and equipment to the oil and gas producers and users, upstream and downstream. And if this whole industry stops spending and the first things is that it just drives right up, around the world. And that is a big chunk of our business there and it's significant enough from the standpoint it's big and it's also profitable. And all I can tell you is I thought I was going to be fired at the division president in my first 12 months when I came in here and oil and gas hit me back in the early 1990-1991. It's tough. That’s what it is. It's not made up, trust me it's there.

Deane Dray

Understood. See you next week.

David Farr

Look forward to guys. I have to get going. I apologize. I know we have a lot of questions. We have got to cut some people off. I don’t have any idea who I cut off. I didn’t look at the list. I was no selective here. I want to appreciate everybody for calling and I appreciate the questions. And I am going to try to be open and honest as possible in this situation, give you an idea of where we are trying to go. But clearly, I am giving the clarity that I see what my management team right now and it's our call and that’s what we are going to do up here for this year to make sure we are all on the same journey together as we come out of 2016. Thank you very much. Bye.

Operator

And this concludes our conference for today. We thank you for your participation.

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