Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Emerson's fourth quarter and full investor conference call. During today's presentation by Emerson management, all parties will be in listen-only mode. Following the presentation, the conference will be open for questions. If you require operator assistance, please press star then zero.
This conference is being recorded today, November 3rd, 2020. 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, Pete Lilly, Director of Investor Relations at Emerson. Please go ahead.
Thank you. Welcome everyone to Emerson's fourth quarter and full-year 2020 earnings conference call. I hope everyone is staying safe and healthy. Today, I am joined by David Farr, Chairman and Chief Executive Officer; Frank Dellaquila, Senior Executive Vice President and Chief Financial Officer; Lal Karsanbhai, Executive President of Emerson Automation Solutions; and welcoming Jamie Froedge, our new Executive President of Emerson Commercial & Residential Solutions.
As usual, I encourage everyone to follow along in the slide presentation, which is available on our website. Starting with the cover slide. Despite the overarching challenges of COVID-19, Emerson has continued to invest in key technologies and solutions for future growth and value creation. We are excited to welcome OSI Inc. to the Emerson family, a leading provider of software-based technology for advanced grid management.
Additionally, we also welcome Progea Group to Emerson, a leader in software-based HMI, SCADA, and analytics solutions. We will also review other important strategic 2020 acquisitions later in the call. Now, please turn to slide three. Similar to last quarter, I'd like to briefly highlight the Emerson Corporate Social Responsibility Report, which is available on our website, emerson.com.
This document reviews, in detail, many of Emerson's aspirations and accomplishments within the environmental, social, and governance realms. Many of these important topics remain at the forefront of the national and international conversation. As problem solvers at our core, Emerson strives to advance the discussion, share our own progress and strategies, and also be a valued resource for our customers as they embark on their own individual sustainability journeys.
Emerson takes very seriously our role as a critical enabler and partner for digital monitoring, measurement, control, optimization, and efficiency management across our broad customer base. Fundamentally, we believe that this role and responsibility aligns very well with the broader purpose and goals of the sustainability movement. I encourage everyone to read the CSR report if you have not yet had a chance to do so. Please turn with me to slide four. We will review some highlights of the quarter and the fiscal year.
First, Emerson remains steadfast in our commitment to health and safety for our employees, customers, and communities. Business continuity, serving our customers in critical industries, disciplined cost control, and positioning to outperform as we emerge from COVID-19 remain our key thematic priorities. Next, we continue to work hard to ensure that our localized supply chains and operations remain stable, safe, and productive.
Turning to performance, Emerson executed well in a challenging but stabilizing demand environment. The organization was able to deliver adjusted earnings per share of $1.10 in the quarter and $3.46 for the full year. A strong finish driven by our ongoing aggressive cost reset actions, which totaled $73 million of restructuring actions in the quarter and over $300 million for the full year.
Cash flow in the quarter was very strong, representing 128% conversion of net earnings and 6% growth year-over-year. It is important to highlight that the balance and market diversity and stability of our two-platform business portfolio was critical to enabling the strong operational and cash flow outcome. Savings for the year on both restructuring and COVID-related cost actions totaled approximately $370 million, and we were able to manage decremental margins to 21% at Adjusted EBITDA.
Despite all the uncertainty and demand challenges, sales and orders finished squarely in line with guidance given in August. Commercial & Residential Solutions orders turned sharply in the quarter, ending up 6% on a trailing three-month basis. We now expect this business platform will turn positive to sales growth earlier than previously expected.
Overall, as we look towards 2021, management has adopted a conservative view given the uncertainty in the marketplace, but continues to expect sales to turn positive in Q3. Now please turn to slide six, which summarizes results of the year. Both net and underlying sales growth finished towards the higher end of their guidance ranges at down 9% and 8% respectively. Commercial & Residential Solutions came in slightly ahead of expectations at down 7% underlying.
Adjusted EPS of $3.46 was above the guidance range of $3.20-$3.35, and restructuring actions finished slightly above guidance of $300 million. Despite lower sales, both platforms executed well on profitability through the COVID-19 related cost control measures, in addition to the ongoing aggressive restructuring and reset actions. Finally, cash flow performance for the year was strong, with both operating and free cash flow finishing above guidance.
Turning to slide seven, we will briefly bridge full year adjusted earnings per share. Starting with Adjusted EPS in 2019 of $3.69, we subtract $0.13 for foreign exchange, pension, and other items. Tax, share repurchase, and interest added $0.17, which partially offset operational headwinds totaling $0.27. The operational headwinds from COVID-19 were broadly mitigated by restructuring and cost containment efforts. This left Adjusted EPS for the year at $3.46.
Turning to slide eight, we will review the results of the quarter. GAAP EPS of $1.20 was up 3%, while Adjusted EPS of $1.10 was down 4%. Total net sales were down 8%, with underlying sales finishing down 9%. Importantly, both underlying sales and orders for the consolidated company showed improvement from last quarter. Automation Solutions underlying sales were down 11%, and trailing three-month underlying orders were down 19%.
Commercial & Residential Solutions underlying sales were down 3%, while trailing three-month orders were up 6%. Cash flow performance was strong in the quarter, with operating cash flow of $1.23 billion and free cash flow of $1.02 billion. Full year operating cash flow and free cash flow of $3.08 billion and $2.55 billion were up 3% and 6% over prior year respectively.
Lastly, the company continued and built upon its aggressive cost reset plan, initiating a total of $73 million of restructuring actions in the quarter. Turning to slide nine, we will bridge Adjusted EPS. Beginning with fourth quarter of 2019, Adjusted EPS of $1.14, you can see that non-operational items of foreign exchange effects, pension, tax, and other items detracted a total of $0.07. This was somewhat offset by $0.03 from share repurchase and interest.
Most importantly, operational deleverage was fully mitigated via cost control actions. Overall, we finished the quarter at $1.10, $0.15 above consensus estimates. Moving to slide 10, we will review the P&L in the quarter. Starting with gross margin, we saw a reduction of 150 basis points to 41.3% as deleverage and unfavorable mix were partially offset by favorable price cost.
Importantly, SG&A as a percent of sales declined by 150 basis points as aggressive cost control actions took effect. Adjusted EBIT and Adjusted EBITDA margins, which exclude restructuring and related costs, increased 80 basis points and 140 basis points respectively, also reflecting the cost containment actions flowing through. Lastly, our effective tax rate dropped this quarter, driven by foreign subsidiary reorganization efforts.
Of note, the Adjusted EPS decline of approximately 4% was ahead of overall revenue decline of approximately 8%. Turning to slide 11, we will look at underlying sales by geography. For the quarter, the Americas continued to show the steepest declines, down 13%, with the North American market also down 13%. Here we saw strength in residential, life sciences, medical, and food and beverage markets, more than offset by weakness in most other end markets.
Europe was down 5%, and Asia, Middle East, and Africa was down slightly, driven by growth in Southeast Asia. For the year, the Americas finished down 11%, with the other two world areas each down a more modest 4%. Please join me on slide 12, and we will discuss total business segment performance. Total segment Adjusted EBIT margin decreased 30 basis points to 19.9%, reflecting aggressive cost control measures and strong operational execution as sales declined.
Total segment Adjusted EBITDA deleverage was limited to 21% in the quarter. Meanwhile, adjusted pre-tax earnings increased 70 basis points to 18.4%. As previously highlighted, Q4 cash flow performance was strong given the challenging environment. Operating cash flow of $1.23 billion and free cash flow of $1.02 billion both increased year-over-year by 2%. Free cash flow represented 140% conversion of net earnings. Turning to slide 14, we will review the business platforms.
Automation Solutions underlying sales finished down 11% for the quarter, as broad-based declines in most end markets were slightly offset by life sciences, medical, and food and beverage markets. North America again saw the steepest declines, down by over 20%. Mean while, Asia, Middle East, and Africa was slightly positive, driven by India and Southeast Asia. Trailing three-month underlying orders were down 19%, again reflecting stagnant but stabilizing demand trends.
Restructuring actions totaled $52 million across the platform, which brought the total to $244 million for the full year. The platform delivered on profitability in a very challenging demand environment. Adjusted EBIT and Adjusted EBITDA margins were limited to down 80 basis points and down 20 basis points respectively, reflecting the aggressive cost actions taking effect. Segmental margins were held to 26% at Adjusted EBITDA. Lastly, the platform converted approximately $400 million of backlog, leaving an ending balance of $4.7 billion.
Turning to slide 15. Commercial & Residential Solutions underlying sales were down 3% in the quarter. The Americas and Europe each had modest declines of 1%, while Asia, Middle East, and Africa was more challenged at down 13%. As previously mentioned, trailing three-month orders turned sharply in the quarter, finishing up 6%, driven by residential and big box retail market demand.
For the quarter, restructuring actions totaled $21 million, which brought the total figure to $52 million for the year. Adjusted EBIT and Adjusted EBITDA margins were up 50 basis points and up 120 basis points respectively, reflecting continued effective focus on profitability. Please turn to slide 17 and we will introduce the first quarter guidance.
We expect that underlying sales will be in the -7% to -6% underlying range, as residential, life sciences, medical, and food and beverage market growth is more than offset by challenging but stabilizing other process, discrete, and commercial markets. GAAP EPS and Adjusted EPS are expected to be $0.52 and $0.67 respectively, ±$0.02. We expect Adjusted EBIT margin to be 15.5%-16%, with Adjusted EBITDA margin in the range of 21.2%-21.8%. Slide 18 introduces our full year 2021 guidance framework.
First, management has a conservative outlook for the macroeconomic environment in 2021, given the ongoing COVID-19 uncertainty. We assume that demand will continue to be challenging, but stabilizing and gradually improving as companies, communities, and governments continue to learn and operate and live with the virus as the year progresses.
We also assume that there will be steady progress with regard to vaccine development and distribution during the fiscal year. Lastly, we assume there are no major operational or supply chain disruptions, and that oil prices remain in the $35 - $50 range. With those assumptions in mind, we expect a flat underlying sales year with a range of -1% to +2%.
Automation Solutions is expected to be in the range of -4% to -1%, while Commercial & Residential Solutions is expected to grow between 4% and 7%. Expected total restructuring in 2021 now totals over $200 million, with approximately $160 million coming from Automation Solutions, $30 million coming from Commercial & Residential Solutions, and the balance coming from corporate.
We expect operating cash flow to come in at approximately $3.1 billion, capital spending of $600 million, resulting in free cash flow target of approximately $2.5 billion. Emerson intends to resume share repurchases in fiscal year 2021 in the amount of $500 million-$1 billion, while concurrently maintaining optionality for further acquisitions should the opportunity arise. This allocation excludes the funding of the previously announced acquisition of Open Systems International, which closed on October 1, 2020.
Aditionally, we remain fully committed to our dividend program and plan to increase our dividend per share for a 65th consecutive year. Within this framework, as management forecasted in April 2020, we expect overall revenue to return to growth in the third quarter of 2021. Commercial & Residential Solutions is expected to return to growth earlier than originally expected, while Automation Solutions is expected to return to growth later in the year.
GAAP EPS is expected to be $3.11, ± $0.05, while Adjusted EPS is expected to be $3.45, ± $0.05. Lastly, we do expect to encounter some profitability headwinds in the year. These include the return of some COVID-related costs as business conditions slowly normalize, stock price changes, and amortization costs from the OSI acquisition.
Also of note, we expect price costs to be less positive in 2021 and pension costs to be a tailwind for the year. Now, please turn to slide 19, and we will review the updated reset restructuring and COVID-related savings summary. Due to the delayed recovery in many automation markets, we are increasing restructuring spend within Automation Solutions in 2021, resulting in a total company restructuring spend of over $200 million, up from the $125 million shown last quarter.
This increase in restructuring spend yields higher incremental savings in 2021 of approximately $245 million. We still expect that approximately $70 million of the $150 million COVID-related savings from 2020 will come back in 2021 as business conditions start to normalize in the back half. Total long-term annualized savings of the overall reset restructuring program are now expected to exceed $650 million. Please turn to slide 21, and I will now hand the call over to Mr. David Farr.
Thank you very much. Thank you very much, Pete and Jamie. Welcome to the group here. Thanks, David, Frank, and obviously, Lal. Chart 21 is clearly the underlying orders forecast. I'll talk about that in a second. First, I do want to welcome everybody from the investor world, the shareholder world, our employees. Thanks for joining us today, and thank you for your continued support and engagement over this quarter and the total fiscal year. As we all know, it's been a truly unusual fiscal year for this company, but I think this team has risen to the challenge.
I want to make a special call-out to the global Emerson employees, the leadership team, and our new members from acquisitions this year to thank them for their commitment to safety, our customers, our fellow employees, and shareholders and community as we return to work starting in March and throughout the year as we continue to reengage and be successful as a company.
I want to appreciate everything you've done. I want to thank you for the job you did, and thank you for everything you did over the last eight months as we got back into our offices, as we got back in the manufacturing plants, and we opened and produced product for our customers. I want to thank all of you very, very much. I know that this was not easy to do, but you all did it. You rose to the challenge. You delivered for our customers, our shareholders, the communities, and the fellow employees.
As we know, 2020 was an exceptional year in sales, profit margins, earnings, and cash flow. Our free cash flow to earnings, our conversion was close to 140% this year. It's our 64th year dividend increase. Our dividend free cash flow came in at 47.5%. As many of you know, we did not cut our dividend when we did the major repositioning back in 2016. We've worked our way back into under 50% in free cash flow to dividend ratio.
We returned over $2.1 billion to our shareholders this year in 2020. We kept our dividend going like many companies did not do. We returned capital to our shareholders through share repurchase. Given what I see right now in underlying margin improvement, strong cash flow generation, growth returning in the Commercial & Residential Solutions business, and I think that a business and Automation Solutions that will return in the second half of the year, we are going to increase our capital allocation back to the shareholders to get to $2 billion this year, as Pete talked about.
This is something we feel strongly about, confidence in the company, how we position the company from a cost standpoint, the new products, the investments we've made in acquisitions. Clearly, w e've got a very uncertain political environment right now, the investments we've made, we have a lot of confidence in that we'll be able to grow and outperform this marketplace and do well. At the same time, make an investment internally while returning more cash back to our shareholders.
I think that's very important to show that confidence to our shareholders that we will get our way through this. As you know, we sat here in April, gave a forecast for quarters, for the year, and the first half of 2020 and 2021. Very few companies did that. We delivered. We actually beat them as we went into that quarter. We are two quarters ahead in Commercial Residential Solutions return to growth.
Tremendous performance by the Commercial and Residential Solutions group and the market's coming back. Great to see. They're leveraging, their margins are really doing well based on all the restructuring that went on from 2019 throughout 2020, and they're ready to grow and expand those margins. We also believe that Auto Solutions, the cycle that we laid out back in August, we're probably one and a half quarters behind that cycle.
Still some tough things ahead of us, but we feel quite strongly that business will return to growth in the second half of the year. Lal and his team have confidence in delivering improved profitability and improved cash flow in 2021, have made the decision to increase the restructuring in the first half of this year and mostly for the second half of the year. Most importantly, in the first half of the year to drive higher margins, even though sales are going to continue to be down the first half of the year.
That is not easy to do when you look at all the things they've been doing over the last 12 - 18 months. I feel quite strongly that they will deliver. The company's stronger, the balance sheet's stronger. I believe the underlying growth momentum will return. Our aggressive cost actions, our self-help.
We're on track to deliver the peak margin plan we laid out in February of 2020, despite sales being approximately $2 billion lower than we said back then before the pandemic, before obviously the recession we've had to go through. The hard work on cost actions, the hard work in restructuring, the hard work in new product investments, and the things we had to do to make this company stronger for our shareholders and for our customers, we have done. We have confidence in 2021.
Yes, we still have problems ahead of us. Yes, we have an election going on today. Who knows what's going to happen? Yes, COVID virus is still out there, but we have confidence we'll have a vaccine. We have confidence that we'll move back into a more normal business environment as we go into the middle of 2021.
We feel good that we can return more cash to our shareholders as we go into 2021. Again, before I go to the charts, I want to make a very special call-out to our Emerson employees around the world. The Emerson leadership team, the corporate employees, the employees that stood by me and the OCE live in St. Louis, not live from Saturday Night Live, but live in St. Louis to get through this COVID pandemic environment, live together. I want to thank them for making that happen.
Clearly, we got some challenges, but clearly, I feel the company today is in much stronger position than it was back in April when we talked, and I feel very good about what was going to happen as we go into the 2021 time period. As we laid out in chart 21, chart you saw in 21, a lot of people said, how are you going to get back to the top of that line as we were coming down? Well, we did. Upper right-hand corner.
Obviously, Commercial & Residential Solutions came back strong. Lal's business is going sideways right now as we continue to wait for America, KOB-3 and some KOB-2. He'll be talking about that. We've laid out some dots here as we go forward into this quarter and how we think orders will trend in the first quarter, how orders will trend in the second quarter.
This is the trend line we see we have to be on as a total company. How the various pieces move around, that will change depending on what happens each month. This is the trend line we have to be on to return to total growth for the total company by the second half of 2021.
Again, as we sit here today, as we talked about in April of 2020, in the midst of COVID, the forecast we laid out is pretty well in line, except we're a little bit ahead for Commercial & Residential Solutions and Lal's a little bit behind just from a recovery standpoint. He didn't go any deeper than we thought, he has not recovered yet, primarily because of KOB-3 and the turnaround business in North America. We're seeing other parts of the world doing pretty well for Lal.
If you go forward to chart 22, here's the forecast we laid out right now. On the first quarter, after delivering down 8.6 underlying growth in the fourth quarter this year, we're looking to be down somewhere in the 6%-7%. I hope it'll be closer to 6%. As we look at October, I hope Jamie will comment on how he saw October, and I hope Lal will comment on how they saw October.
I think that we'll be down somewhere in the 6%-7%. We'll get a little bit better as we move into the second quarter, we'll get better and go positive as we go in the third and fourth quarter. This is the same lines that we drew out last year in April. The only difference is right now, we clearly have the uncertainty of the election.
We clearly have the uncertainty of how the COVID will continue to move and impact the rest of the world. We feel confident that we can control some of our own destiny for underlying growth and also improvement in profitability and cash flow as we go into 2021. As I look at the Automation Solutions business, and I'm going to turn it over to Lal right now to talk about what he sees. It's very important to see that I think the momentum will start shifting for you, Lal as we go through this quarter.
I want to take the hats off to you and your whole team in the restructuring. Many people on this phone don't know how hard it is to restructure and do what you're doing. My hat's off to what you got done. I know how proud you guys are of the team, but this is not easy work. It's your mic.
Thank you. Thank you, David, for those words. Very meaningful for all of us in the business. It was an extraordinary year, as you described, and I'm so grateful and humbled by all the efforts and the results that this team delivered. Very proud, as you said. A few words, if I may, on 2020.
The second half of 2020 was weaker than we expected when we first talked, David, back in April, as we reset the plan. We did not see that acceleration in orders in the second half, in the latter half of the year as we expected into Q4. However, the team did a tremendous job, and I'll call out five fronts here. The first being identifying and executing the restructuring programs. Secondly, converting $400 million of backlog in the second half of the year, meeting that commitment that we had made.
Thirdly, growing our life science and medical segment by over $100 million in sales value through the year. That's through participation gains in therapeutics and vaccine development, as well as medical PPE manufacturing. Fourthly, staying committed to the Digital Transformation journey across our business. Lastly, working very diligently on the diversification and software elements of our business, including through acquisition and internal development.
Just tremendous work across the business to deliver a 26% quarterly Adjusted EBIT leverage and 23% annual Adjusted EBIT leverage on almost a billion and a half down sales. Great work on the year. Turning to 2021, we do expect two additional challenging quarters in the first half prior to turning positive in the second half of the year as we laid out the plan here. We are watching three key leading indicators in the business.
First, the discrete industry orders and the inventory levels in the distribution channels. To David's earlier point, we are seeing some early encouraging signs through September, October, particularly in Europe and China, driven by automotive. That's encouraging to see as we've gone through the first month of this fiscal.
Number two, the manpower presence in customer sites. If you recall, we had talked about back in August that at a 40% level of manpower presence, that's moved now into the mid-70s through October. That's very encouraging as it will be a sign of moving from an environment of break fix into further KOB-2 and KOB-3 activity. Lastly, and perhaps most importantly, the ultimate bellwether in this business is the rate of our short cycle KOB-3 business in North America.
Again, as Pete pointed out, it's stable today. We need to see an acceleration in the core market spending as we go through the quarter and into the second half of the year. Let's turn then to page 24. I want to highlight three specific segments that performed extremely well over the calendar year 2020. There are over $650 million of sales represented on this chart across the platform.
Life sciences, on the left, grew 15% in 2020. We have the leading DCF position in the life science industry with DeltaV, a position that has been invested in over time through both organic investment and acquisitions. We have over 3,000 DeltaV systems installed in the industry, including 1,200 across the top 20 pharmaceutical companies. The growth has been predominantly in two areas, driven by COVID.
The first has been therapeutics, the second has been vaccine development and production, where we are engaged in over 20 of the 160 vaccine efforts underway around the world. In the middle part of the chart is our medical business, which grew 40% in 2020, driven by two predominant applications. Mask manufacturing, where we use ultrasonic welding machines instead of, for example, glue to assemble masks.
Secondly, valves and regulators for ventilators and oxygen therapy devices for patient treatment. Lastly, but very important, is our clean fuels and renewable businesses. We have a well-positioned portfolio that grew 10% this year to really capitalize on this macro trend. There are two key areas here. Number one, enabling our core process customers to reach carbon neutrality, and predominantly in the power and oil and gas industries.
Secondly, we have the technology and application know-how for biofuels, biomethane applications, as well as the growing field of clean hydrogen aimed at fuel cells for the long-haul mobility segment. Very encouraging, and we have a significant role to play here, particularly in that hydrogen value chain from production to distribution and utilization.
We turn to page 25, and I wanted to highlight four very significant investments that we made through the year. We continue to be inquisitive and really think about expanding our served markets, diversifying our industry, and increasing our software portfolio. In 2020, we completed three acquisitions and made a fourth equity investment. The four investments, American Governor, OSI, and Progea, as well as Enmation, support our strategy to drive end market diversification and strengthen the portfolio, as I described.
Our power industry diversification is driven by growth in renewables, hydro turbine controls, and grid control and optimization. We bought an HMI company in Progea that complements the PLC assets that we had acquired from General Electric. It really focuses on the hybrid and discrete segments.
Lastly, Enmation is a German-based, next generation, cloud native and OT data lake, which is a critical element for the continued success of our digital transformation business. Lastly, I wanted to provide you with an update on our project funnel. The funnel today is valued at $6.4 billion. That's down from the $7 billion when we last reviewed the funnel in April of 2020. David, we did not look at this since that period of time as we went through the last six months.
We have booked approximately $150 million out of the funnel since April to bring the total bookings from the funnel to $400 million for 2020. The significant bookings in Saudi Arabia as well as in the Arctic LNG. As a matter of fact, I would like to highlight the LNG wave. We've spoken at length with the investment community about the eight jobs that have been committed to this wave.
We have won 54% of the available automation dollars to- date, and there are an additional $600 million to be bid over the next year or so. A tremendous job across all the automation businesses, but I'll take my hat off particularly to the final control business that has participated in every single one of the eight jobs to- date. So great job there.
There's been about $800 million of value that's been removed from the funnel. The single biggest cancellation was about $200 million. That's a Saudi crude to chemical job that was just moved out. We've had about $700 million of projects that have shifted from 2021 into 2022 and beyond. That's occurred. The last thing I'll say is $500 million of project additions into the funnel. These are particularly, on average, smaller projects and concentrated in gas globalization in the power generation segment.
Good. Before we turn over to Jamie, I just want to thank Lal and the team for a couple things here. One, major effort under restructuring cost reductions to drive their margins back up to peak margin improvement, and to drive higher margins in 2021 they're going to have, even though sales are still going to struggle for them in the first half of the year.
I also want to say that they made sure they made the right investments. As we did site reviews, as we did talks and had Webexes or face-to-face meetings, we made sure we talked about the new products, the next generation technologies. We wanted to make sure that we continue to make the right investments, that got the right monies where they need to be to make sure we did not jeopardize the future franchises within this company.
At the same time, we made some very unique, as you saw, acquisitions that strengthen our hand in many core places that we think that will have long-term growth and long-term sustainability from the standpoint of value creation for Emerson and diversification for Emerson. Lal and your team, phenomenal job. Jamie, your first call. I hate to say, Bob Sharp set it up for you. Now you got a growth, and you just got to keep the plants open and start growing. You got a growing tire in your hands. Here it is. Let me talk about it.
Yeah. I was in Asia working with Lal as we were working through the depth of the COVID impact, and it's great to come back here and see that the team put a tremendous number of investments in place, both in terms of improving our operational capabilities and transforming our structures and our business so that we can have improved profitability as we grow going forward. They also invested in the technology.
As we go through these charts, I think you'll see a combination of those two things. Looking at chart 27, we saw a return to growth in underlying sales in the fourth quarter of 2020 across many of our product lines, driven by strength in the North America residential markets. We also experienced sequential improvement across our businesses as the quarter unfolded.
Trailing three-month orders in September were 6.4% and will improve to be double-digit as we finalize the October numbers. Residential markets globally typically represent between 40%-50% of our mix in a given quarter. North America is by far the largest portion of that. Inventory restocking across residential segments is providing additional order sales growth opportunities beyond the demand being driven by home sales and home improvement.
I think we're very well- positioned for 5%-6% underlying sales growth in the first quarter. Second quarter outlook and growth percentage is slightly lower than Q1, as we believe the inventory rebuild restocking activities will start to level out a little bit. The North America AC strength we think could continue potentially into fiscal third quarter, given seasonal trends.
We see growth occurring in the Europe heating and AC technologies group businesses throughout the year, overall growth for the broader European portfolio returning in the second quarter. Asia is on track right now to return to growth late Q1 or early Q2. Looking on to Chart 28. Home sales, home improvement, inventory restocking, and our operational capabilities enabled strong Q4 North America residential AC growth.
Our strong partnerships with customers' ability to execute have allowed us to capitalize on these growth opportunities. Q1 2021 North America AC will be up 20%+ with greater than 50% growth in the residential space alone. We've also been investing heavily during the downturn in technology and recently won an AHR Expo Innovation Award.
The K7 compressor that you see on the chart will help prepare the industry to meet the new DOE efficiency standards, which go into effect January 2023. This product line will support multiple refrigerant types, including lower GWP refrigerants such as R32 and R454B. This product line will serve residential and commercial markets.
On the right side of the chart, you can see the Sensi platform. Our Sensi thermostat sensing and analytics platform continues to outperform and has been recognized in the industry. Additionally, we have lots of exciting features on the way over the next couple of years, so we're very excited about how that space is unfolding. Moving on to Chart 29.
Not only have market conditions created growth opportunity in our wet dry vac and InSinkErator businesses, but the investments in improved performance as well as new features, functions, and product lines position us well in these spaces. Q4 combined sales for these businesses were up 10%, and as you can see on the chart, we expect an even stronger Q1 performance.
Additionally, our main wet dry vac competitor, Shop-Vac, has created a unique opportunity for us in the market to take our leadership to the next level. We are working very closely with our channel in that space, and we're putting in the appropriate investments to help serve the industry needs and accelerate growth.
Looking at the bottom half of the chart, although the commercial industrial spaces haven't returned to year-over-year quarterly growth, sequential improvement matched with our investments in new technology provide momentum into the second half of the year. On the chart, you can see multiple examples of products that we launched in fiscal 2020. The team really stayed focused on innovation and launching new products.
Flex shaft and pipe inspection enhancements in technology will increase our customers' productivity and provide features such as the combined cleaning camera visibility and the ability to see the pipe pitch during inspection. In our next gen battery tools category that you can see on the right side of the chart, our RIDGID product shown increases cycles to a level 2x the normal time needed for service and provides cycles greater than the tool normally requires, making it essentially service-free.
The insulated tool shown can help protect a worker from accidentally cutting a live line up to 1,000 V. A very unique and new feature for a battery hydraulic tool in this industry. The remote cable cutter product shown, which was awarded the Showstopper Award by the National Electrical Contractors Association, allows the user to manage the job with a remote control, keeping them safely away from the cutting procedure.
In partnering with users of our products, it has really helped us unlock innovative ways to improve their work experience, allowing them to be safer and more productive. On Chart 30, you can see our focus on product lines that help drive decarbonization served us very well in 2020 with strong year-over-year sales growth in European heat pumps and renewable natural gas compression orders.
Multi-year growth in these spaces is expected to continue, driven by market trends and in many cases, accelerating subsidy and decarbonization targeted policies. Just to wrap up, I'd say that, given the current market conditions, we do see a solid first half fueled by residential markets, second half growth driven by improving non-residential markets as those residential markets kind of ease into more sustainable growth rates.
I want to say just as Dave and Lal said, how so proud I am of the team, their focus on safety, our people safety, our customer safety, operational excellence, and margin improvement. I'm really proud of them because they did all those things while maintaining the same intense focus on innovation as they had in all those areas so that we can return to growth with enhanced products to serve our customers' needs. With that, I'll hand it back to David, to you and Pete.
Thank you very much, Jamie. Again, I want to thank the Commercial & Residential Solutions organization for the work you got done. Bob in 2018 and 2019, and the first half of 2020 really got into the restructuring. They kept the investments going. We knew that we'd return to growth, and they are that. They returned to growth with a major new innovation, major new product portfolio, second to none, and I think it's pretty exciting.
The markets are returning. The key issue for them right now is they have several plants within their structure running full out. In the midst of increased COVID, t hat's not easy to do. They have plants they have to keep running and producing at record levels. We have a major competitor that disappeared out of the marketplace. He will return, but we don't know exactly when.
In the same time, they'll have other industries across their business that will start growing in the second half of 2020. The team got ready for this, they executed, and I give them high marks. Before I go to Q&A, I just want to make a couple of comments here. First of all, 2020 was my 20th year as CEO, a year that I'll never forget.
We started out with activism. We launched a massive restructuring effort across the company to drive increasing margins in a tough year. We just happened to have this thing called COVID-19 pandemic with a resulting recession around the world. The Emerson team rose to this challenge and we drove, I think, less down sales than people thought. Our earnings minimization of decreasing was less than people thought, and we drove increased cash flow. A very strong 2020.
Some people say, w hat are you going to do for us in 2021? We had a heck of a 2020. We've got a little bit tougher base to come off of, but we're going to make 2021 a better year. As I move into my final year as the Emerson CEO, I think our plans to drive top-line growth, improve margins and earnings and cash flow as we get into the second half of the year are very strong and very positive, and we'll be ready to hand this over to the next CEO and his leadership team, and I want to thank everyone for that support.
We got a tough 2021 ahead of us, but I think we have a lot of confidence that we can deliver improved sales, earnings, and cash flow and turn that over to that next leadership team, as Mr. Knight did back to me in early 2020. With that, we'll open the mic for Q&A. Let us have it.
We will now begin the question and answer session. To ask a question you may press star one on your touchphone keypad. If you are using a speaker phone, please pick up your head set before pressing the keys. If at anytime your question has been addressed and you would like to withdraw your question, please press star then two. Our first question comes from Jeff Sprague from Vertical Research. Please go ahead.
Hello, everyone. How are you doing?
Good afternoon, Jeff. How are you doing, my friend?
Hey, doing well, Dave. Congrats to Jamie. Glad to have had the chance to meet you a few years back in Austin. Good luck in the new position there.
Thanks, Jeff. Look forward to seeing you again soon.
Yeah, absolutely. Well, Dave, you've been signaling your impending retirement for a while, but you made some pretty explicit comments just there. I guess some of us have nothing better to do than speculating whether you're going to stay around longer and all that sort of thing. Really my first question is, though, how does this play out? What's kind of the timing of naming your successor, and how long a transition period might there be?
From the standpoint, that's obviously a board decision. I'm just one member of the board as chairman of the board. As I basically communicate, I would say that we will name my successor sometime in late 2021, the second half of 2021. In my opinion, there will be very little transition. It's up to the next CEO that, does he even need J. Farr, the old man around? We can hear. Okay. Someone came in and said they can't hear us, but I think they can hear us. Yeah, I thought so.
I think that what will happen is what Mr. Knight did to me is I got announced, he threw the keys in my chest and said, it's all yours, I'm out of here. I'll probably throw a couple of bats at them and a couple of rally monkeys and say, I'm out of here. Give me a call if you need me. I think that Emerson management team is strong. They don't need old farts like me around. Maybe I know how to fight COVID, maybe I know how to fight recessions, but my door is always open. The house is always open for people to ask me questions.
It'll be quick, bam. I'm not a big believer in transition. The guys will be ready. They don't need Dave. That's where it is right now. I would say I'm in charge still, and I will most likely name it with the board sometime in late 2021. That's how it looks right now, Jeff.
Yeah. Thanks for that color. We'll definitely miss you when that day comes. I had a question for Lal, too, as just a follow-up, and I'll pass the baton.
That's assuming I don't die in between now and then, okay, Jeff? Okay?
Yeah. No, please don't. Stay safe.
Thank you.
Lal, on the KOB -3, everything you said was pretty crystal clear. I'm just wondering, though, in terms of dialogue with customers or other indicators that you look at, do you actually have some visibility on when this may begin to turn? Can you just level set us, too, so we have the base correct? What was KOB -3 as a percent of the total mix for 2020?
Hi, Jeff. Thank you. KOB-3, right now we're still crunching the numbers, will be close to flat from 2019. That was 57% of sales in 2019. That's what we expect right now. The reason for that, I actually expected it to come up. The reason they haven't is that we had a significant drop-off in the latter half of the year, particularly in that short cycle business, the instrumentation into discrete side, and consequently impacted KOB-3.
It sits right at flattish to 2019. That's the way to think through it right now, Jeff. In terms of indicators, there are a couple others. The shutdown turnaround activity is a very relevant indicator to us of KOB-3 activity on sites. We talked about at the prior earnings call of what occurred in the spring and the summer shutdowns. They obviously didn't occur.
We have seen reschedule of activity into the fall, and we're actively working those now. I will tell you that they tend to be more systems-driven upgrades than valves and instrumentation right now. Whether it's cybersecurity upgrades or various other things, that's what they're really focused on.
We haven't seen a tremendous uplift yet in what would drive core device valve instrument uplift in new orders. That's another one to watch carefully. Last, Jeff, I will mention, it is important, what I stressed, in terms of getting the customer back on site, and we're watching those numbers very carefully, and that will be a telltale sign to activity. Ultimately, as you and I talked, Jeff, in the past, it's got to be demand-driven. We've got to see that underlying demand in the end products come back for us to see an acceleration. David?
Thanks. We were talking about it internally. The people dialing can hear us, but the people on the Webex couldn't hear us.
Correct. They can't.
They can't hear us. I think it was Jeff, because when I told him I was retiring and stepping down next year, they all cut off and just died.
You blew up the website, yeah.
I blew up the website. They said, oh my God. A celebration. People are saying, like, God, we finally got rid of this guy after 40 years.
Right?
Well, best of luck. I'll pass it on to somebody else.
Okay. Thank you very much, Jeff.
Yeah. Take care.
I hope to see you soon.
See you soon.
Good.
Our next speaker is Josh Pokrzywinski, and it is from Morgan Stanley. Please go ahead.
Hey, Josh. How you doing, my friend?
Hey, good afternoon, guys. Not so bad, Dave. How are you?
I'm fantastic. Pretty cool, nice sunny day here in St. Louis. It's going to be a low 70s, and if we weren't talking to investors, might be out playing golf today. I know Frank would, for sure. Frank Dellaquila will. For sure. Go ahead.
Not too late.
Good.
A couple of questions for me. I guess first, just looking at the Auto Sol orders, and how they've been trending the last few months, not just what we've seen here more recently in September. Trying to square that away with the outlook for fiscal 2021. I guess, part of that mix is also considering that you guys said you did a better job of working down some of the backlog.
Carrying a little less backlog into the year, if I understand it right. Seems like orders are still a little mushy, and the underlying sales outlook doesn't quite jive with it. What am I missing in that, and what should we watch for that order cadence to really need to pick up to support it?
Okay.
I see the chart in there, obviously, but any milestones that you would really need to hit on orders?
I'll give you my two cents, and then I'll give the expert, Lal. My two cents is what we're still watching for is North America, USA, KOB-3. We're seeing some early life in that and some plant turnaround right now, but we're not expecting anything of substance to return to that until we get into the new calendar new year.
We're going sideways, and then what we expect is going to happen is those investments will start unfolding in the USA. We'll start seeing some additional investments in aftermarket and some KOB-2 coming in and allowing us to have a little bit of growth in the second half of the year. We're watching, and we'll continue to communicate to you all about this KOB-3 when we start seeing it happen.
The problem will be if we get into February, March, April, and we don't see any turnaround in KOB-3, i f something happens, that will be a problem for Lal and his business. That's why he has chosen to do additional restructuring in the first half of the year and the first quarter in particular, to try to give him some protection as we wait for this thing to turn. That's the way we look at it right now.
We've been here before. It is probably a little bit, as we say, on the come for the second half of the year. I feel confident the customers will start spending as we see that capital coming in. Lal, why don't you go ahead and give what you feel? You're the expert.
No, I think you're an expert. You said it well, David. We've been running between $38 and $40 million a day-
Correct.
... in bookings. Through October, that has not changed. We actually expected to see a drop-off in October. We did not see it. It stayed very stable at $39 million a day in October.
That's good.
Which is good. David, you're absolutely right. We've got to watch that KOB-3 environment. Europe, North America predominantly, and Asia. Very telling as to the pace of business as we see those early short cycle orders come in. I will also say that there are elements where we can control our own destiny. We've set very aggressive new product sales goals. Our competitive displacement activities that we worked in the power industry are now working in the chemical segment. Really going after the life cycle and the medical opportunities that are out there in our business.
Josh, what we'll do, as you know, we are a company that puts out orders and dialogue. What we'll commit to do, Lal and I will commit to the shareholders right now, and obviously the sell side analysts here, is we'll continue to put out any dialogue we see on the day-to-day, the daily order number that he just put out there, $39 million a day right now. Also most importantly, the North America KOB-3. That's what you got to watch. That's what we're watching.
The fact that the plants now are getting a 70% population, that's a good sign. That means they're getting ready, and they'll start spending money. They have to spend money, or those plants will have safety or quality issues. That's not a good thing for the facilities we operate in. That's what we're watching, Josh.
It is perhaps anecdotal.
Got it. That's helpful.
Sorry, Josh. Perhaps anecdotal, but I'll throw it out. Customers are actually inviting us into sites now.
Oh, good.
I've got customer visits lined up in Houston in a couple of weeks. That's encouraging, again, as we see activity pick up.
Maybe we'll get some investors to drive to St. Louis. Okay, next. Go ahead, Josh.
Yeah. Just a quick follow-up. I heard both Lal and Jamie mention restocking in some of their comments. Any sense on what that might be embedded in the guide over the next, presumably not more than the next one or two quarters, but whatever timeframe you want to say that that's baked into numbers, how much of that is restock? Thanks.
Yeah, I'll let Jamie answer that. The restocking mostly will be in Jamie's side of the business. Lal, he's watching restocking on the hybrid and the discrete side, the early stages of that, because inventories have been taken way down. Jamie has the biggest restocking going on because his customer base liquidated inventory when we went into COVID. Demand came up and now he's behind the curve. Why don't you do your-
Yeah, that's right, Dave. I hate to give you a little bit of a vague answer, but it's a little hard to tell right now because the levels were taken down so low, historic levels. Big box retailers, the CEOs in those spaces have been very public about their comments about what happened there. They took them down to almost nothing. Our AC industry did the same thing.
What you have is, there's a lot of noise in the system right now as people are chasing to restock inventories. There's real demand by home improvement, and home sales, and we don't know how long that cycle's going to last. If you ask the AC folks, I think right now, how much of this is going to be restocking versus real demand, it's too early to tell.
Yeah.
The cycle could run into the third quarter if you have a hot summer. By the time you catch up to the demand we're seeing right now and you get caught up, all of a sudden you hit peak season.
Yeah.
It could keep running. We're seeing similar things. How long does Shop-Vac have challenges-
Right.
... supplying the industry? Okay. We're not sure yet. There's a lot of unknowns, and I think we'll have more clarity as we get into the first part of the calendar quarter, first quarter of calendar year. It'll get a little more clear to us.
Josh, what we're looking at right now from this is Dave's expertise from being 40 years in this company and 20 years as CEO, is we're adding capacity in Jamie's business right now. I think we have a unique window here to pick up some share. Jamie and his team The innovation that Jamie inherited from Bob and those guys is phenomenal, and I think that we have a unique opportunity here.
We're adding capacity at this point in time. At the same time, we're running at peak levels, we're adding capacity. Right now, Lal's business is we're more interested in getting some of the capacity moved around into better cost structure, and he's got to get that done because he doesn't want to be in the position that Jamie is right now, where he's trying to do some massive restructuring with capacity moving around.
We're betting on things will get better in Jamie's business, and that the restocking will go and the pace of online business will continue to go, assuming nothing happens relative to the election or something crazy happens with the COVID. We're adding capacity in Jamie's business right now because we think we'll be better as we get into the second half of this year.
The only other comment I would add is that as you look at our first half outlook for sales, especially first quarter, we are being prudent right now-
Yeah.
... as we assess those orders. I'm not giving the exact numbers, but just know that as we see the orders unfolding, they're good. Like I said, October is a double-digit orders number. Again, we know some of that's restocking, and so we're being prudent in what we put into the sales forecast at this time.
We'll keep you informed as we go forward. That's our vehicle to let you guys know if we think things are better or worse. Okay?
Got it. Thanks, team. All the best.
Thanks, Josh. Hope to see you soon. Come out of the bunker.
Our next question comes from Gautam Khanna at Cowen. Please go ahead.
Hey, Gautam.
Yes, thanks. Hey, how's it going?
Where you hanging out today?
Lovely Jackson, Wyoming, actually.
Oh, I mean, you said that last time. If I was your boss, you wouldn't have a job. I'll be very honest right now. You know that, don't you?
Yeah, please let's keep that on the down low.
Yeah. We're on a global webcast right now. We're going to keep this on the down low.
Yeah.
How do you spell your last name, Gautam? Promise we won't tell.
Yeah. I'll make sure we edit the transcript.
It's good to hear your voice, my friend. It's always good to hear your voice.
Yeah. Likewise. Thank you. Hey, my question is more on how you look at the business, the oil and gas exposure. Time and again, we hear from investors that this is not just a cyclical challenge, it's more secular as the world moves to alternative fuel sources and the like, and how Emerson is going to react and position to be ahead of that trend and maybe help in that trend with your customers. If you could just talk a little bit about your perspectives on what might be a structural change and how the company's going to emerge on the other side of it?
Yeah. It definitely is a structural change, Gautam Khanna. If you look at this year's sales as a percent of our total sales, we're going to be down to 23%-24% as a total company. As we continue to invest in other technologies, as we make acquisitions, we are still a major supplier, a very important supplier, and especially in KOB-3, which if you look in the oil and gas industry, our KOB-3 is probably closer to 70%. It's primarily an aftermarket business.
What we'll do, and we'll talk more about this in February, but we're continuing to make investments in the next generation renewables, be it hydrogen, be it hydro, be it the investment we made in OSI Inc. We continue to make investments around other uses of powered energy to replace oil and gas. We'll continue to do that.
It's not something you can say, okay, we're going to sell that segment off, because a lot of the technologies we use from a DeltaV or sensors or pressure or whatever we're doing are very similar to what we use in other industries. I think what you're going to see, we'll continue to serve this industry.
At the same time, we continue to invest in other technologies. As we talked to the board today about the innovation we're doing in the medical field and also we're doing in the sensing field and in the renewable fields, we'll continue to do that. That percentage will continue to move downwards. We're not going to walk away from it. We can have a spike as they make investments come back in it.
We fundamentally believe as we show the board the pieces of the pie of where Emerson's going, it will continue to be smaller and smaller. We'll continue to grow, and we continue to make those investments to allow us to have a more balanced portfolio. I think people are way overestimating how much oil and gas we have in this company and are way overestimating the impact as we make this transition.
We've been making this transition for some time now, over the last several years, and we'll continue to make it. At the same time, we'll continue to make those investments. I feel very good under where we are right now. We're working very, very hard with our customers from a renewable standpoint, and we'll share that with you in February so people can have that.
I think people have to understand, we as a board, we as a management team, understand we have a very strong presence in oil and gas. We'll continue to invest to try to diversify, but we're not going to walk away from that cash cow that we have from the standpoint of that business segment today. I think that from the standpoint of what I see also is the good news happening is the consolidations of this industry.
That's going to be good for the short term, and that will help us as people consolidate. In the meantime, we'll continue to invest to diversify. We'll continue to be a player, but it'll be less and less of a player. I think people overestimate the impact of that because most of that business right now in oil and gas is around KOB-3 aftermarket.
By the way, if you go look at any forecast for the next 20, 30, 40 years, oil and gas is still the primary source of energy, and it's still growing. It doesn't mean you're going to make more double down on it. It's still growing and investments will come back. Got to have it, unless you don't want to have lights. Unless you want to be like California.
All right. Thank you very much. Appreciate it, guys.
Okay. Okay, got them. All the best to you.
Our next question comes from Steve Tusa from JP Morgan. Please go ahead.
Good afternoon, guys.
Good afternoon, Steve. How are you doing?
I know Jackson, Wyoming sounds nice.
I know your pay grade. You could not afford Jackson, Wyoming.
Yeah. Certainly not as good as your pay grade, that's for sure, Dave.
Wait a second. You think I'm in Jackson, Wyoming right now, Jose? I'm sitting here in St. Louis in my little conference room right now. I mean, fortunately, my kids are out of college. I don't have that college expense anymore, which you got looking forward to.
Yep. I got a dog, too-
I got two.
... so just got to buckle down. Buckle down.
That's going to do for you, my friend.
Speaking of dogs jumping over targets or whatever you used to say, I kind of calculate a bit more tailwinds just mechanically. You do have a bit of a tailwind, whether it's restructuring and some of these other things, buyback. On kind of flat revenues, a flat EPS number, I know you got a little bit of tax headwind, some of these temporary costs on the back.
Is there anything in the mix that we should be aware of? I mean, KOB-3 is already kind of down. CRNS is a higher margin platform that should outperform. Is there anything in the mix or anything like that? You've given us price cost. Anything in the mix that's negative that would be kind of holding you guys back from converting whatever little kind of revenue you get on top of some of these tailwinds?
No. Okay, Steve. I mean, what we try to put forth for our shareholders, we had a very, very strong second half of the year. You know that. I mean, our earnings per share, our margins, our cash flow is much better. One of the things we're all worried about is my concerns about what happens with election, in particular North America, what happens to the global. The COVID-19 comes back in our plants and things don't have investments happening.
You're right. I would say that we put forth what I would call a conservative forecast in a somewhat uncertain world. The only bad mix we have coming at us right now that I can tell you about is I know that Lal, in the first half this year, his most profitable business being instrumentation and flow, without the return to KOB-3, he'll struggle.
That's a 60%+ GP margin business. All his cost reductions are very helpful, but 60% plus GP margin business when it has a struggling in the short term. You're right. He's taken additional actions. I think that if we get any volume, our leverage, our upside is there. I want to make sure that we laid out a foundation forecast for that little I have two dogs right now. Both of them can jump a little bit higher than Zorro can do because they're younger. One's two and a half, and one's eight one and a half. They can jump a little higher. They can jump higher than dad can jump now.
I think the key issue for us is the only tail headwind we see is the mix on KOB-3 North America. If we start seeing that turnaround, especially around instrumentation and flow, Lal's business will do pretty well. As it is right now, he's targeting internally a 20% deleverage in 2021 as he's got this forecast.
The only thing we're watching very carefully and we'll be conservative about is, does this North America not turn around in KOB-3? If it doesn't, he's going to have a really tough I don't care what he does. That instrumentation and flow business will deleverage pretty hard because he's got it down to the bare minimums at this point in time. That's the only thing we're really cautious about, Steve. You're right.
Yeah. I guess what I kind of like, maybe this is just too stupid of a way to look at it.
I never call you stupid, Steve.
Your underlying is down. You have your toughest comp in the first quarter, yet your Adjusted EPS is going to be flat, you're calling for the year to be flat. It just is kind of like if you're starting the first quarter at kind of flat EPS and that's your toughest revenue comp, I kind of struggle with why you're going to be flat for the rest of the year on an EPS basis.
I just want to make sure that I'm not trying to be too crazy here. There's so much uncertainty around it and the timing. I think as Josh said earlier talking about the signs. Our biggest uncertainty right now is the U.S.A. KOB-3. I did not want to put a forecast out there that really gave us a lot of leverage around KOB-3 in the U.S.A. until we started seeing the whites of those eyes. That's why we're being a little bit cautious, Steve.
T hen one-
Go ahead.
Then, sorry, one for Jamie. Congrats, first of all. Second of all, why not more of a catch up on North American resi HVAC? I mean, is that just all coming now? Is there a particular, now that we've seen all the resi guys report, the numbers are obviously very strong. In fact, Carrier up ridiculously. Lennox, who you may not serve as much, not up as much. Is there a particular customer out there that you guys serve that may have kind of missed out a bit on this season and is now kind of restocking for next?
It's just a little bit strange to me that you guys, as a component supplier, would be having this big channel fill in kind of the first quarter of this year as opposed to a catch-up in the third, or maybe a catch-up in the second going into the third of next year or whatever it is, the next spring. Maybe you could just talk about resi HVAC, what you saw there.
Yeah. Look, the AC orders have been strong going back into June, especially July, August, September. This isn't a brand new thing, okay? As you know, there's a timing differential between our order rates, our sales rates, and when these guys, our customers are reporting out, and they have a different mix than we do. Actually, Steve, it's quite the contrary to your question.
We believe, based upon what our customers are sharing with us and what we've been asked to do to help the industry out, that we're doing very well during this recovery. Now, there are uncertainties with everyone's operations, but overall, I think we've done a nice job, maybe better than their competitors on the operations side, and we're being asked to fill some holes. If anything, it's kind of the opposite of what I think the question maybe implies. We've seen strong orders now three, four months. We see strong orders going into the next few months and sales following right along. We've not lost track with any major customers.
I think it's just a function of trying to keep up with them right now, and we always will lag them a little bit.
Yeah.
We'll always lag them a little bit. Our underlying growth rates are the same as their growth rates are from the standpoint of components. We're not seeing any problems there.
Yeah, I mean-
Dave, just one last quick one. Who did you mention? You mentioned some competitor that's exited the market. Was that on the HVAC side? Is that Bristol, or are you talking about somebody on the automation side, somebody exited or something, or somebody's not there?
No, I said Shop-Vac.
Who is it?
Shop-Vac. Shop-Vac went bankrupt, and Shop-Vac is the number two player.
Oh Shop-Vac. All right. I'll have to add that to my watch list. Okay. All right. Awesome. Thanks, guys.
Well, it's a private company. You can't add it to your watch list.
Yeah.
It's a major supplier in the industry, and they had half the industry. We had the other half. It's going to come back, but I think that we have a window here to pick up some of that business over the next, I would say, the next six months before they get their act back together. They literally shut down their plants in Asia, Vietnam, and the U.S. right now, and they've been shut down for probably 30 days. That's a unique opportunity for us right now.
All right. Go get them.
You nailed the head there, Steve. I want to be very careful with the uncertainty out there and as we see things getting better. If Lal's business picks back up North America, we will leverage. That's the whole game here. That's what we want to play this year.
All right. Thanks, man.
Thank you. Okay. See you, Steve.
Our next question comes from Andrew Obin from Bank of America. Please go ahead.
Yes, good afternoon.
Good afternoon, Mr. Obin. How you doing? Are you in New York, New Jersey?
I am in New York. Yes, I am in New York.
I hope you don't go to Jackson Hole. I know you're not that type of guy.
I'm not.
You're more a down-to-earth guy, like the Emerson guys here in St. Louis.
That's right. Question on oil and gas. You did talk about structural change in oil and gas, but the question I have, as your customers sort of think about, we've seen headlines, for example, Exxon is reducing CapEx to protect its dividends. Clearly, they're thinking about the world differently. What does it mean for what they're going to spend money on going forward? Does it change the mix dramatically? In particular, does it change the conversation? You have this, if I have it right, top quartile initiative. How does it change their thinking about efficiency and, as I said, just going back, what do they spend on going forward if there's no more growth long term?
I'll take a shot. I mean, Lal will too. I think it is going to change the mix. You're not going to see a lot of new energy resources go into play. What they're going to figure out how to do is get more out of it. More efficiency, more productivity, safety. I mean, all those different things which will be good for us. It's a good thing other than the fact that there won't be any new fields for many years for us to deal with from an installed base.
The KOB-3 will become more and more significant for us, and the upgrades they're going to have to spend around that to be from a productivity, a quality, and safety issue, which are all good things for us because that's not a jump ball type of big project. You're going to be mining your install base, and we have the strongest by far of the global service support organization around the world for all the oil and gas industry.
As you know, we have made huge investments in that over the last couple of years, and that will really pay dividends for us as they start changing that mix. That's why I think what's going to happen is. We'll see that industry continue to shrink relative to investments, but our profitability should be pretty good once they start spending that money. That's the way I see it. Lal, what are you hearing from your guys in the field right now?
Yeah. I think that's right, David. Just three things to add there, Andrew. The first is I still believe, and we still are executing around the investments for the globalization of natural gas.
Correct.
Methane will continue to be a viable energy source in industry and in power generation, combined cycle, and we're seeing those investments continue, be it at Exxon, Shell, anyone around the world. That's important to note that it's not purely an oil and gas across the board.
The second is the technology investments that drive reliability, safety, smart operations will continue to be very viable. A lot of those fall within our digital transformation business, and we continue to see those go forward. Lastly, Andrew, we talked about a little bit earlier is the applicability of our technology for the decarbonization efforts.
Correct.
For the sustainability efforts that these customers are driving in a very broad set of applications, which we'll flesh out in more detail for you in February and highlight. That's an opportunity for us to change our mix within the customer spend.
Yes. All the big oil and gas customers right now are engaging pretty heavy with Stuart Harris and Lal's business profile on digitalization and how they're going to try to reduce their carbon use. That's a benefit to us because it's a sensor business, it's more of a technology business, and that's our strength.
As that shift happens, we'll still have pretty good sales, and we'll definitely have better profitability over the long term. It is a shift that we're all going through, but I think it's going to benefit us as a company, given our presence and our digitalization position and everything we've been doing relative to that over the last 20 years. I like the hand we have right now.
Got you. Just a follow-up question on Commercial & Residential Solutions. Asia and Middle East and Africa down just a little bit surprising given the pace of recovery in China. Is it China? Is it something else? Maybe more color on what's happening specifically. What are you seeing in China specifically? Thank you.
Go ahead, Jamie.
Well, look, October there were some positive signs in Asia. I think it's too soon to say that we've turned a corner at this point. I still think it's a quarter, maybe a quarter and a half away. What you see there is we participate in industries like the hospitality as far as servicing hotels and restaurants and food service, food retail, and those industries are industries that are still pretty heavily impacted in China and across large parts of Asia.
Although we've got some growth that's come back, like we serve some of the appliances in China out of our Therm-O-Disc business has been very good. There's pockets where we're strong. We've seen some good strength in the residential side. Some of the cold chain and especially around food service, food retail, hospitality is still a tough market. However, again, October results were promising. We had positive results in Asia and China.
Good.
We'll see if that's sustainable or if it's just a blip on the radar here, but too early to tell, but some positive signs.
Andrew, as you know, our thrust in Asia and the Middle East was all around commercial, not residential.
Right.
Those are the markets that have been hurt pretty hard relative to the end markets of this COVID situation. We continue to develop the new products and new technologies around that. They'll come back, until we start seeing movement of people, I think you're going to have a struggle there. I think it will start bouncing back as we go forward this year.
Obviously, it's been down tough for us, so you get an easier comp. More importantly to me is what I'm watching people spend the money on. Lal bounced back pretty nicely in China and Southeast Asia. Jamie ran that. He probably stuffed the channel before he came back to make a good year. Susan Hughes, who follows him, will have a hard time with that if she ever gets over there.
Got a work permit.
She got a work permit?
Yes.
T hat's fantastic. I think I'm more optimistic about 2021 in Asia for Jamie than I was last year.
Yep.
I see signs picking back up.
Yeah, it should be a good year. What we're out looking for the full year is extraordinarily positive. It's just the growth really starts to accelerate kind of more in the second half.
It's been disappointing. I would say the second half of 2020 was disappointing-
Yeah.
.. for us. It didn't come back like Lal did.
Thank you.
Take care, Andrew. Hope to see you soon, my friend.
Our next question comes from Andy Kaplowitz for Citigroup. Please go ahead.
It was somewhat close. How you doing, guys?
Well, how you doing, Andy?
I'm doing fine.
Your last name starts with K. I don't want to pick on it because she could cut me off the phone right now, but Andy K.
She can cut me off, too. Just call me Andrew K., and we're good.
Once you start putting your name as Andrew K., we all know who that is. That's a famous actor, and so you know.
Between your name, Karsanbhai and Froedge, we should have a little spell that last name party.
Hey, whatever works. It's all about branding. You guys know that.
It's all about branding, that's for sure. Well, what can I do for you, Andy, Kaplowitz, whatever it was, last name?
Dave. You've talked about $650 million of annualized cost savings. That's a big program. I think it might be the biggest you've done in your tenure. P ut it in perspective for us. You did talk about reaching your margin targets still that I think you set for FY 2023, despite $2 billion less of sales. I think you already answered Steve's questions regarding conservatism around decrementals and incrementals. If Lal's business does turn, does he get to see better than historical incrementals, especially if KOB-3 is coming back faster than KOB-1?
I'll answer that question right away. It's better or he won't be around by the time I step down. That was an easy answer to that one. To be honest, he wants it, too. His organization, they've gone through pain to step up. He's doing the first half. He wants to get back to peak margins. He wants to do that, and his whole organization is very much focused on it, but at the same time, not cutting.
The answer is yes, he'll get very good leverage as he comes back in the peak margin plan. We presented to the board. We haven't talked to you this time, but we'll update you. I updated the planning conference group last week. We had our planning conference where we had 700 people, 600 of them on the Webex, and 100 in our conference room live face-to-face.
I think the key issue for the restructuring number, it is the largest number. Now, the next largest would've been back, I would say, in the year that we broke the back in 2002, 2003, 2004, that time period there, 2005, as we reposition the whole company, as we globalize the company. That would be the next largest. We had a very strong margin run off of that as we go back. You look at those historical charts we put out there.
I think the most important thing we're doing here, we're also going back to the questions people have been asking. We're resetting the industries we're going after, where we're putting the resources, where we're putting our facilities, what type of plants we want to have, and from the perspective of what we're trying to get done with this repositioning. It's not all about margins.
It's about how we reset the businesses for the next generation. A lot of that work that both Jamie and the Commercial & Residential Solutions side's been doing, the work that Lal's been doing is say, okay, where does the business go? It's not where it's been, but where does it go?
That's why what he's looking at a lot of his restructuring and the old line type of technologies, the old line customer base that's moving, where do I want that to be? That's why it's such a massive number. I think that what we're trying to do is reset like we did back in 2002, 2003, and 2004, and then had a hell of a run all the way through 2008 as we set some peak margins. I think that that's what these guys are trying to do right now.
It's heavy lifting, but it's resetting the company structure for a different Emerson, for different industries, different customer base, and different services as the company continues to transform. That's not easy to do because you got to go debate with everybody and say, why are we doing it this way? I think that Lal and Jamie are set up when they finish this to be a good run. Jamie, you want to say?
Yeah. David, thank you. No, you said it well. We didn't want to waste the opportunity. It's not purely about taking cost out. It's about thinking about how we can do business differently.
Correct.
We're resetting the platform and how we interface with our customers and how we interface internally as an organization through this process. That's really what this is. A heavy element of that is also realigning our best cost structure-
Correct.
... into Eastern Europe, Mexico, and Asia. A very important part of this journey as well. Both components are very well thought out. Our entire plan runs across 17 different individual tracks of execution that we manage month-to-month, and it's been done very well with the leadership of Ram and others across the organization.
Yeah. We're trying to totally reset what Automation Solutions is. There's not as much of that with Jamie. There's a little bit of that, but it's been far more with Lal's business because we know Lal's business, as we've been talking about, there will be different customer base, different customer needs as he thinks forward 10, 15, 20 years from now. That's what this is, a reset.
Yeah. On the comm res side, it's different SG&A profile. As David said, we did take out around 11% of SG&A headcount over the last few years because the business wasn't growing in 2019 either. There'll be a little that comes back. There's still a lot of work that we're doing that we're able to get done on the facility side.
Yeah.
Our footprint, and to Lal's point, where the footprint is and how efficient that footprint is to serve our markets, how regionalized we are, we'll be able to do six, seven years worth of work in two or three years. Like Lal said, we didn't want to waste the opportunity, and it's going to pay huge dividends for our business going forward.
That's why I keep telling everyone out there thank you very much, because that's not easy to do in the middle of a freaking COVID recession pandemic.
Very helpful. Just talking about free cash flow, it probably doesn't get talked about enough, but obviously strong conversion in Q4. Can you talk about how you're thinking about sort of the puts and takes of working capital as you go into 2021? Obviously, you mentioned a little bit more CapEx. Good conversion kind of continue.
2021's going to be a fun one. We've set ourself up for a very challenging 2021 because we know obviously we really performed well in the second half of the year in operating cash flow and free cash flow. We almost set a new record as free cash flow as a percent of sales at 15.1%. I think all-time record's probably around 15.5%, 15.6%.
The big issue for us, Andrew, it's got to be around we need earnings. We need earnings because what's going to happen as the year progresses, our balance sheets, other than a little bit of extra inventory that we brought in to make sure we protected our customers from a channel standpoint and a supply chain standpoint, we're in pretty good shape on the balance sheet.
What's going to happen is that balance sheet's actually going to get bigger from a working capital standpoint because we're going to be growing in the second half of the year. The way for us to get back to the very challenging operating cash flow and free cash flow number next year, which will still be very good, is we've got to get higher earnings, b ecause as Frank and I have been communicating to all the lead people out there, earnings is going to drive cash flow this year, not the liquidation of balance sheets. In fact, the balance sheet's going to go the opposite way. We thought last year was a lot of fun.
This one's a higher degree of difficulty for the operating people because they're going to try to figure out how not to put a lot of working capital on, but they're going to have to put some on because our receivables are growing. Our inventory will be growing a little bit. At the same time, how do I get more earnings?
We want to keep a three or three-one in front of the operating earnings, our cash flow next year. We've got to really work hard on the earnings side, and it's not going to be the working capital side. Everyone's been communicating. Frank's been beating everyone up on that one from the standpoint of CFO. We can see that.
Great. It sounds almost as much fun as trying to pronounce my name. Thanks, Dave. Appreciate it.
It's always fun to run Emerson. It's just a joy. That's why we're calling you Andy K.
There you go.
Sounds like maybe a cereal or something like that.
Appreciate it.
See you later, Andy. Special K. Oh, there's Special K.
Our next question comes from Julian Mitchell from Barclays. Please go ahead.
Oh, Dave, you laughed at that one. You got Julian right. Way to go. Okay, Julian, how are you doing, my friend?
Very good, thank you. I'll keep it quite brief. Maybe just two quick ones. One would be for Jamie, and welcome again to this forum. What are your thoughts around-
Forum.
Yes, I think a virtual forum, perhaps. How's the operating leverage in the business this year? You've got that mid-single digit plus sales growth. What kind of incremental margin should we expect? Any big variation through the year? The second question would just be for Lal, around China. How did that business finish up fiscal 2020, in Auto Sol? What's the expectation for China in fiscal 2021 in your business, please?
Okay, Jamie?
Yeah, it'll be somewhat just north of 30%. Exactly what number it will be, it'll depend a little bit on the mix and other factors, but it'll be in that range. We feel very positive about it. We've not lost any momentum on the cost actions that we're taking, and those are going to continue throughout the year. We feel pretty good about that. I don't look at the year right now and say, well, this quarter we're fine, this quarter we're not. Pricing MI was very good for us last year. It's good for us in the first quarter. It gets a little tougher as the year develops, but we knew that, we've known that, and that's normal for our cycle, and so we've got plans around it.
I don't see anything extraordinary at this moment. We got profitable businesses growing right now. We got other profitable, very profitable businesses, have similar profit profiles that start to grow in the second half.
Yeah.
Right now, that's the way the plan looks.
Yeah.
Yeah, Julian, hi. On China, first, obviously we had a very significant downturn in the second quarter, fiscal quarter of the year. The market recovered very aggressively in the second half, and we ended up flat for the year in China, destination sales for 2020. It was a flat, but as Jamie will tell you, having been there, it felt like a +10 or more-
Yeah.
... because of the tremendous second half of work and what our teams had to encounter on that $1+ billion business. Looking at 2021, I'll give you a range of +1 to +4, somewhere in there is where I'm landing right now. I think there's some positives in chemical, life science, automotive, as I said earlier, and that's offset by some challenges around power generation and refining. The +1, +4 is where we're working it right now. I think it'll be low single digits. It may turn better as we go through the year.
Great. Thank you.
All the best, Julian. Hope to see you soon. One more question here.
Our next question comes from Joe Ritchie from Goldman Sachs.
Okay.
Good afternoon, everybody.
Hey, Joe. How you doing?
Doing pretty good, Dave. I'll just keep it to one question since we're bumping up against on time here. If I look at your portfolio, you guys referenced, especially within Automation Solutions, some good growth on the hybrid and discrete side. Just talk to us a little bit about how you feel about the portfolio there and whether you need to add on via M&A, just given some of the growth that you're seeing, especially, whether it's on medical or life sciences. Do you have the right portfolio in place today to go after the opportunity?
From our perspective, as we went through, Lal and his team this year from the strategy standpoint, we are acquirers in this space. We would like to add more, again, help us diversify into the hybrid space. We've been doing some software acquisitions, not many hardware at this point in time. We have the primary software.
We would like to continue to acquire this space, to help us diversify and also drive a little bit faster growth. It's a tough market right now to do it, but we're out looking pretty hard and we're trying to shake it out, and I know Lal has his wishlist working with Mark Bulanda and the team there. We are an acquirer in this space right now, and we will continue to push that pretty hard for that perspective. I know Lal is very interested in it and has a very strong preference to that from that standpoint. Is there anything else you want to add?
No, you mentioned it earlier, David. I think that's all said, but there's also internal development ongoing-
Yeah.
... in this space, including single-use devices for pharmaceutical bioproduction. That's very relevant as well.
Yeah.
It's a combination too, but absolutely inquisitive in that segment.
Yeah.
We'll continue to look at that.
A lot of investment in that area right now, trying to make that more relevant and more significant for all of us. With that, I want to thank everybody for joining today. It was an amazing year. It's quite an unusual year as we wrap up 2021 and our 2020s move into 2021. I want to again thank everybody out there for attending today and talk. I apologize, we lost our webcast, Webex, I guess, webcast for everybody-
For a few minutes, but the recording will be available.
The recording will be available. Unfortunately, that tells you that Mr. Farr is stepping down or something like that, so you can't go back and change that. I want to appreciate everybody for joining, and I want to thank everybody for this year, and we're looking forward to have a very good 2021 in an uncertain time.
We feel good about going into '21 based on what we got done in self-help in 2020. Got a strong team at the top here. We got Jamie here, Lal here, Frank, and everybody else working around here. We're looking forward to have a great year and making another record year for us in 2021. Thank you, everybody, and look forward to seeing everybody soon.
This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.