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Emerson Electric Co
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Good morning, and welcome to the Emerson First Quarter 2022 Earnings Conference Call. All participants are in a listen-only mode. [Operator Instructions] After today’s presentation there will be an opportunity to ask question. [Operator Instruction] Please note, this event is being recorded.
I would now like to turn the conference over to Colleen Mettler. Please go ahead.
Thank you. Good morning, and thank you for joining Emerson's First Quarter Fiscal 2022 Earnings Conference Call. Today, I am joined by President and Chief Executive Officer, Lal Karsanbhai; Chief Financial Officer, Frank Dellaquila; and Chief Operating Officer, Ram Krishnan. As always, I encourage everyone to follow along with the slide presentation, which is available on our website.
Please join me on Slide 2. This presentation may include forward-looking statements, which contain a degree of business risks and uncertainties. Please take time to read the safe harbor statement and note on the non-GAAP measures.
Turning to Slide 3. I would like to highlight a few exciting accomplishments for Emerson this quarter. First, in December, Emerson announced the acquisition of Mita-Teknik, a leader in wind power control automation. Mita-Teknik brings specific control design, expertise, complementing our existing Emerson’s Ovation and power portfolio. We are very excited to welcome the Mita-Teknik team to Emerson and its ability to expand our renewable power generation capability.
Secondly, Emerson was recently named the 2022 Industrial IoT Company of the Year award by IoT Breakthrough. Emerson was acknowledged for advanced digital technologies, software and analytics that help customers across a range of critical industries, optimize their operations and deliver on environmental sustainability goals.
Finally, last week, Emerson was recognized as a 2022 Best Place to Work for the LGBTQ+ equality, and earned a score of 100% on the Human Rights Campaign Foundation's 2022 Corporate Equality Index. Before I turn it over to Lal, I wanted to provide a brief update regarding one of our previously communicated investor events. We are now planning to host a half-day in-person investor conference in the second half of this calendar year where we will provide an overview of our business strategy, portfolio direction and long-term financial outlook. We look forward to sharing additional information as we finalize details for this event.
I'll turn the presentation over to Emerson's President and CEO, Lal Karsanbhai, for his opening remarks.
Thank you, Colleen. I'd like to begin by recognizing the exceptional work that nearly 90,000 Emerson employees did to deliver our first quarter results. I'd also like to express my gratitude to the OCE and the Board of Directors for their continued support. And last, but certainly not least, to our shareholders for your trust and investment in our company.
Saturday, February 5, marks my first year anniversary as CEO of Emerson. And although I do not intend this to be a holistic reflection of my first year, I would like to share 5 important learnings: one, build good teams and empower them to lead. We have a very strong new OCE. We hired our first Chief People Officer, our first Chief Sustainability Officer, named a new Chief Operating Officer and named our Chief Compliance Officer, to the OCE. And we have an independent chair of the Board, Jim Turley, a great partner for the shareholders and the management of this company. Number 2, diversity makes us better. It is my goal to continue to create a workplace where people feel like they belong, have a place and can be themselves. I'm very proud of the diversity targets we established to double representation of women and U.S. minorities in leadership by 2030.
Number 3, strengthening any business starts with strengthening its culture. Culture transformation is well underway at Emerson, and it includes the redesign of the Emerson management process into a new modern cohesive system.
Number 4, think boldly. Emerson is a historic company going back to 1890. But we cannot be afraid of change and must always be keenly aware of the value creation levers at our disposal.
Number 5, tomorrow starts with us. We will live our purpose. We will drive innovation that makes the world healthier, safer, smarter and more sustainable. We will create accelerated value through culture, portfolio and execution.
Allow me now to turn to the quarter. It was a very positive quarter, significant from a number of dimensions as we delivered $1.05 of adjusted EPS, an increase of 13% over 2021 Q1. Demand is accelerating in Automation Solutions and continues to be very strong in Commercial & Residential Solutions. The trailing 3-month underlying orders were up 17%, for the enterprise as a whole. Our relevance with our customers continues to be a differentiator across all of our businesses, whether it is the energy customer undergoing a critical transformation to a carbon-free or lower carbon future or new energy economy start-up customer in hydrogen of biogas. Our KOB funnel continues to be very robust, valued at approximately $6.5 billion at the end of the quarter, and KOB 3 hit 60% of total automation revenues in the quarter.
Interestingly as well, the sustainability and decarbonization element of the funnel is now valued at over $800 million, up over $100 million over this time last quarter, very positive.
Our HVAC OEM customers who rely on our compression and electronics know-how to make their systems more efficient to meet new regulatory standards. And also, the tradesmen, the utility workers, the plumbers, many of whom, as I continue to learn, have rich [indiscernible] who trust our gear to get the job done. Over the past 100 days or so, I had the opportunity along with many members of management to meet these customers, representing a broad cross-section of our markets and feel great about the role that we continue to play in making them successful.
Our execution in the quarter was excellent. We improved adjusted EBIT margin a 140 EBITDA margins -- 140 basis points to 19.6%, delivering incrementals of 32% across the enterprise. The automation business is operating at historical levels of profitability with adjusted EBITDA margins increasing 320 basis points to 21.5%. Our commercial and residential business was faced with planned but unprecedented price cost challenges, and the team performed exceptionally well. We have confidence in the price and cost management actions that are in place as we go through 2022.
We will speak about the operating challenges that continue to be prevalent and most importantly, what we are doing to address them. These include electronics, both lead time, extensions and purchase price variances and shortages, particularly that impacted automation solutions sales in the quarter, logistics and freight cost escalations and labor wage inflation and availability that are concerns, particularly in North America.
In most of these cases, we feel better today than we did 3 months ago, but they do remain challenging. And we have been aggressive and implemented further price plans to offset these additional costs.
Lastly, overall, I have and we, as management, have increased confidence in our 2022 financial plan. We have increased our underlying sales growth estimates for the year to 7% to 9%, up by 1 point and the adjusted EPS target to $4.90 to $5.05, about 10% increase over last year at the midpoint. I've often said to the management team that sometimes growth isn't a lot of fun because we are working so hard. But I'll tell you that there is no other team I'd rather do it with and this thing here at Emerson.
Let's now turn to Chart 5, please. We continue to see increasingly strong levels of demand across both platforms and all world areas. In Commercial & Residential Solutions, trailing 3-month orders were up 13%, continue an extraordinary level of demand. The European heat pump market continues to benefit from ongoing electrification trends in Europe. For our tools business, we see long-term cycle demand related to the housing market to remain strong with favorable macro trends and fundamentals, including DIY trends. At the same time, I believe commercial and industrial segments are seeing considerable strength with project starts in the U.S. and Europe.
The trailing 3-month orders for Automation Solutions were up 19% versus prior year, and there is broad strength across discrete, hybrid and process markets across all world areas. China orders were up 34% on a destination basis and continues to be an important growth region. Sustainability-related investments, as I referenced earlier, continue to be a key driver for our business, including renewable and great investments, which benefit our power and OSI businesses. We are also seeing continued recovery in our energy markets with capital spending budgets up significantly year-over-year, in part due to LNG and Middle East investments. Portions of these budgets are being dedicated to decarbonization, emissions and energy efficiency projects, which are accelerating as our customers take tangible steps in pursuit of their ESG targets.
To provide a little color on this, I'll highlight a few of our recent project wins related to this growth sector on Slide 6. First, let's start on the left of the chart. Emerson was recently awarded 2 sizable projects in the Middle East with our Measurement Solutions business to help customers reduce emissions. These solutions provide continuous monitoring systems, allowing customers to take preventive actions against emissions and releases. The main driver behind these projects was the customer's commitment to emissions reductions as part of net zero targets. Both projects were supported by environmental regulations in the Middle East to minimize emissions, protecting the environment and community.
Next, in the middle, a refining customer in Europe has chosen Emerson to implement a full-scale automation and control modernization of one of their compressor units. The upgraded system, utilizing DeltaV PK controller and control software solutions will provide greater control and load sharing of their system. This greater degree of automation, control and advanced compressor application is uniquely provided by Emerson, and will allow the customer to optimize their operations, thereby increasing their efficiency in reducing energy and load requirements.
Solutions like this can help customers use up to 30% less energy in their operations, that's a critical number. And that's a critical piece of what many customers net zero -- of the many customers' net zero journeys. And then finally, on the right, last month, Emerson announced participation in the Poseidon project in the Netherlands. Poseidon will be the world's first offshore hydrogen generation projects, basing an electrolyzer on an offshore platform, coupled with nearby offshore wind power generation. Offshore wind will power the electrolysis of the mineralized seawater to produce hydrogen, which should then be transported to shore for integration with natural gas in the national gas grid. Working as 1 of the key consortium partners with Neptune Energy, Emerson will deploy DeltaV software and systems to manage desalination, electrolysis, gas transportation and the associated infrastructure.
Learnings from this project should help provide a broader pathway to large-scale offshore green hydrogen production. So we're very excited with this partnership. These are just 3 examples of how Emerson is assisting our current and new customers on the net zero and sustainability journey.
And with that, I'll pass the call over to Frank Dellaquila, who will go through our financial results for the first quarter.
Thank you, Lal, and good morning, everyone. Appreciate you joining us. If you would please join me on Slide 7, I'll go through the quarter. As Lal mentioned, the quarter was very strong. Our business has delivered excellent financial results in the face of some significant operational challenges, and we're very grateful to the people who are working very hard to get through this time of unique challenge in operations. Our end market demand continues to be robust across most key end markets, and it drove first quarter underlying growth of 8%, which is in line with our November guidance. This growth was achieved despite the significant supply chain issues that affected the availability of certain production inputs from time to time as we went through the quarter.
In particular, electronic component availability in certain automation solutions product lines constrained sales in the quarter. Despite these challenges, adjustment segment EBITDA increased 80 basis points, driven by volume leverage, price realization and continued effective cost management. Please recall that as we explained in November, adjusted segment margins now additionally exclude intangibles amortization expense.
Adjusted EPS was $1.05, up 13% versus the prior year and exceeding the November guide of $0.98 to $1.02. Free cash flow was down 41% versus the prior year mainly due to higher inventory as a result of defensive stocking due to supply chain bottlenecks, finished goods awaiting shipment, but most importantly, higher expected sales in the second half of the year. We believe this impact on cash flow is mainly timing related and we maintain our outlook for the year. And I should point out that our first quarter cash flow last year was at a very high level versus history, just given the dynamics and the ramp-up in our commercial and residential business in last year's first quarter.
Turning to the platform results. Both businesses executed extremely well in the face of the operational challenges. Automation Solutions underlying sales were up 5%, continued recovery in the Americas and strong growth in Asia, particularly in China. All key end markets showed strength in particular, life sciences, discrete automation, chemicals and power.
KOB 3 activity continues to be strong, rising to 60% of sales in the quarter. Sales were 1 point below our guide mainly because of the availability of electronics components that affected our systems and instrumentation businesses.
Backlog increased by $500 million to $6 billion due to the strong pace of orders. We expect that our ability to convert orders and backlog to sales will improve throughout the balance of the year.
Automation Solutions adjusted EBITDA improved 320 basis points versus the prior year on the strength of leverage, price realization and cost control.
Operational performance in Commercial & Residential Solutions was also very strong.
Underlying sales increased 13%, including 5 points of price realization.
In Climate Technologies, residential demand continues to be strong in the U.S. as well as commercial and service businesses growing well.
Strength in residential construction, DIY and retail demand underpinned strong demand in home tools and home products. Backlog in the platform increased $150 million in the quarter to $1.3 billion, mainly in Climate Technologies.
Adjusted EBITDA was down 320 basis points, consistent with our expectations for the quarter due mainly to unfavorable price/cost, logistics and wage inflation, which we will talk more about. Underlying leverage and operational performance in the business was excellent.
Price cost, as we have traditionally defined it, is price less net material inflation, and that was modestly better than expected in the quarter. However, we are seeing increasing acceleration in terms of freight and wage costs due to logistics constraints and the tight labor market conditions. We are taking price actions incrementally to offset these incremental costs. We continue to expect to see tailwinds for price cost, again, as we define it in the second half.
Please turn to Page 8, and I'll take you through the EPS bridge. EPS bridge is pretty straightforward. Adjusted EPS was $1.05, up 13%. And as I said, exceeding the guidance midpoint by $0.05 despite a $0.06 headwind from tax attributable to some internal reorganizations. So as you can see, the nonoperating items wash out and the increase in adjusted EPS is on the strength of operating performance. Again, as a reminder, adjusted EPS excludes intangibles amortization, restructuring, AspenTech transaction fees, first year purchase accounting and the gain from our Vertiv subordinated interest that we recorded in the first quarter. Operations leveraged at over 30% and contributed $0.10 to EPS. Share repurchase was about $260 million, and added $0.02. We do continue to deal, as I said, with the various operational challenges and supply chain logistics and labor. Our teams are doing a great job mitigating the impact of these.
I'm going to hand the call off to Ram to provide more detail on what challenges we're facing and what we're doing about it.
Thank you, Frank. Please turn to Slide 9. Clearly, the operating environment remained a challenge in the quarter as electronic supply, labor availability and logistics constraints continue to impact our global operations. Electronic component availability drove the miss versus our Automation Solutions sales guide in the quarter and shown on this slide is what we're currently facing. Availability challenges continue to persist, but we are seeing signs of stabilization at longer lead times, which our operations teams have now calibrated to. While we still see some spot shortages, on certain electronic components, the number of decommits and pushouts from our suppliers is certainly reducing. We expect these challenges to continue into the second quarter and the rest of the year. And hence, we continue to qualify and ramp up secondary supply and proactively redesigning our products to utilize available components. Our global teams have done an outstanding job actively communicating with both suppliers and customers for improved visibility and forecasting.
On the labor front, U.S. turnover remains high but has been manageable. We did, however, see absenteeism rise in November and December due to Omicron. We saw numbers as high as 20% absenteeism in some of our plants in the Midwest. Overall, though, our plant operations have improved their ability to manage through the labor dynamics by adjusting hiring practices and entry-level wages to ensure labor availability and are certainly gearing up for a pickup in output levels as we enter the second half of the fiscal year.
Finally, as Frank mentioned, we are seeing incremental wage inflation manifest, but these are being offset with our pricing programs. Logistics continues to be constrained by the ongoing supply and demand imbalances and rolling COVID unplanned disruptions. Our teams are mitigating the impact by leveraging alternate ports and our regionalization strategy certainly continues to position us well versus our peers. Freight costs have risen to record levels across the businesses in the quarter, we are mitigating these impacts through surcharges.
Finally, our global operations teams continue to work diligently on these challenges, ensuring that our continued operational excellence remains a strong differentiator.
I will now turn the call back over to Frank.
Thank you, Ram. If you would please join me on Slide 11, and I'll go through the outlook for the rest of the year. As Lal mentioned at the top of the call, we continue to see strong demand across nearly all businesses in the world areas, and this underpins our improved outlook for the year. Within Automation Solutions, we see relevant CapEx spend rising in 2022, supported by recent LNG projects reaching final investment decision as well as strength in the Middle East. Our MRO and recurring revenue business also will benefit as budgets continue to increase.
Sustainability-related investments like the projects Lal described continue to be a key driver for our business. And although electronic component availability challenges will continue to limit top side growth potential in the near term, we are seeing stabilization of supplier lead times at longer-than-usual levels but our operations are calibrating to maximize output, as Ram described under those circumstances.
Discrete investments remain strong, and we expect a supportive automotive demand environment in the second half along with continued factory automation projects. We expect hybrid demand to remain strong at mid- to high single digits, including continued life sciences investments, and we continue to be encouraged by process automation, market demand and spend as we've discussed. This continued strength in our core markets, the wave of sustainability investments and our backlog and continued order momentum provide the underpinning for strong second half sales growth and gives us confidence in our ability to deliver the fiscal year sales guidance.
In Commercial & Residential Solutions, we expect continued solid growth and expect the impact of moderation in the residential markets throughout the balance of 2022 to be mitigated by continued strength in commercial and industrial markets. Our Pro Tools business is seeing considerable strength with project starts that drive our U.S. and Europe momentum. Overall, Commercial & Residential Solutions, we expect high single-digit to low double-digit growth in Q2 and for the full year.
Please join me on Slide 12. So in view of the strong demand backdrop and the backlog, tempered by uncertainty and limited visibility around some of the operational challenges, we are raising our underlying sales guide expectations to 7% to 9% for the year, with net sales growth of 6% to 8% currency having an impact of 1 point. The Automation Solutions guide increases to 79% and Commercial & Residential Solutions increases to 9% to 11% all on an underlying basis.
We did increase our price cost guide to favourable $175 million as our businesses implement incremental discretionary price actions to mitigate modestly higher NMI, but in response also to the higher freight costs and wage inflation. And as a reminder, both of which are not included in our typical price cost calculation. Simply said, the increase in the price cost guidance has a minimal impact to our profitability at the margin.
Restructuring actions tax, cash flow, the dividend and share repurchase are all consistent with our November guide. The GAAP EPS guide is updated for our improved sales outlook and now includes 2 items related to the AspenTech transaction. Estimated transaction fees and interest expense on $3 billion of term debt that we issued in December in anticipation of the closing. Those items reduce our GAAP EPS guide versus the November guide net of our operations improvement, and the guide is now $4.71 to $4.86. The adjusted EPS guide, which excludes those items, increases to $4.90 and to $5.05. To be clear, no estimate of the operational impact of AspenTech is included in these guidance numbers. We will address that in May after we close the transaction.
With that, I thank you for your time and attention, and I will turn the call back over to Lal for some closing comments.
Yes. Thank you. And thank you, Frank and Ram. And before opening up to Q&A, I'd like to acknowledge and you referenced it a couple of times, Frank, the AspenTech team for their strong performance in the quarter, they did report last week. The team and the business is benefiting from increased demand for their software solutions in the sustainability and electrification efforts of its traditional customer base. We are on track to close the transaction as previously communicated in the second calendar quarter of 2022.
And with that, I turn to Q&A.
[Operator Instructions] Our first question comes from Deane Dray with RBC Capital Markets. Please go ahead.
A couple of questions. The first, I would love to hear just more broadly or holistically, what kind of management processes had to change in your first year and what the impact is? And then on the business side, the question on the KOB 3 being as high as 67% when we're in a period of spiking oil prices, and I get that you're less dependent on oil per se. But when you get a spike in oil prices, doesn't that -- don't the refiners tend to hold back on maintenance. They just want to run as fast as they can as much as they can at these higher prices? And does that end up crimping some of that MRO spend? So 2 questions.
Yes, Deane. Great. So very good around the management process. We are essentially in the redesign phase as we speak. We'll speak about it holistically when we get together later in the year on our investor conference. But essentially, what we're doing, Deane, is a redesign of a process that was, for the most part, put in place in the mid-70s and we've been operating the company around that. A lot of goodness and what that's brought to us, but we believe that we have an opportunity to really challenge and create a system that can drive more innovation, collaboration and perhaps, a little more risk taking within the business itself. So we're working that. We'll talk to you about how that translates ultimately into our continued ability to execute and to meet our commitments. So we look forward to that later in the year.
Related to your KOB 3, the number is 6-0, 60%. I apologize if hadn't come across clearly earlier. It's driven predominantly by modernizations, digital, a number of the smaller sustainability type programs like flare reduction, eliminations and emission reductions fall into the category. Keep in mind also, Deane, that we had a significant amount of delayed maintenance that occurred in most of these plants through COVID, where staff left and a lot of what needed to be done just wasn't done over periods of as much as 1.5 years. So all of that is a bit of a catch up that's occurring in the plants.
In terms of KOB 1, again, the funnel is at $6.5 billion today. It's pretty -- been stable over the last 12, 18 months. We're watching that carefully as we execute the LNG wave we've completed. And there's a few things, obviously, in Qatar that will come our way. So we're watching that carefully. But there that deferred maintenance and the modernization sustainability in digital is what's driving the bulk of the KOB 3 to a large extent for us as well.
Our next question comes from Andy Kaplowitz with Citigroup. Please go ahead.
Well, last quarter, you mentioned good confidence and 30% incremental margins for the company for FY '22. Can you update us on your thoughts about incrementals in the current environment? Obviously, the incremental margin in Automation Solutions has been particularly strong. We know the savings benefits of your restructuring program have been flowing through, but the incrementals were so strong in Q1. So is there anything else going on there? And how are you thinking about automation solution incrementals for the rest of the year?
No, Deane. I think we reiterate that guide of 30% for the business for the year. They had a phenomenal execution in the quarter, it was almost dollar for dollar on the incrementals on automation. But I expect that to normalize as we go through the year, and I think that really guide us. It's the stake in the ground that we put in for our businesses, our expectation that would drive a clear amount of investment back into the business and enable a return back to the shareholders. So that's what we still expect. That's what we have in the financial plan and expect to deliver in the year.
But love nothing onetime in the quarter per se in that business, right?
No. No.
Got it. And then I think your comments were exactly in line with AspenTech management's comments that they mentioned they're seeing some acceleration of final investment decisions for LNG and Middle East oil and gas projects. But they also suggested that they were seeing their refining customers improve their spending. Maybe you could elaborate a bit on what you're seeing in your major energy markets. Are you seeing an acceleration in core North American refining and upstream markets. I think your orders at 19% would imply that, but maybe you can give us a little more color.
No, absolutely. North America is very strong for us across Automation Solutions right now and it's broad-based. It's a process. I think overall, the oil and gas segment, the outlook is very high single digits as we think about the year. And the CapEx, a lot of that CapEx that we're seeing is driven around those sustainability efforts in production and expect that to be strong. So it's consistent with what AspenTech has seen across the process industries, which has been a bit of a laggard to discrete, obviously, in hybrid that we experienced through 2021.
Our next question comes from Steve Tusa with JPMorgan. Please go ahead.
Can we just get a little bit more specific color, I don't know if you said this earlier on the call, but what you expect the price cost to be in 2Q? And then I guess just you're guiding to an expanded spread there. How much of that spread is from -- I would assume all that spread is from increased price. And ultimately, what's your price capture this year in revenue?
Yes. Steve, this is Frank. So it's -- as we've said before, it's going to improve through the year. We did raise the guide. But again, that guide also -- it does not include the impact of wage and freight. Wage and freight is a significant increase versus the visibility that we had back in November. So much of that increased price that we went out and got is in response to those 2 items.
So in terms of how the thing models out, I mean we will turn green on a traditional basis in the second quarter, and then we will continue to ramp the price actions are about 90% in place in terms of the material pass-through that we've expected right from the beginning as well as all the discretionary actions that have been implemented across commercial and residential solutions to offset the NMI, the material inflation, excuse me. So I mean, we see it pretty much as we saw it back in November. And frankly, it's kind of grossed up because we've had to go out and take incremental actions in response to what we're seeing.
So what's the total price capture for the year now for the -- in revenues percentage-wise?
Yes. I don't think we
Yes. We're not going to go exactly there. I will just tell you that our price capture is at least as good and a little bit more robust than what we talked about back in November in terms of how we model out the year.
Got it. And then just one quick one on resi. On your resi HVAC business, is there a quarter this year that you're planning to be down on that business as kind of inventory and channel fill? I mean, everything kind of whips around on a volume basis.
Down relative to where we are today, certainly in the fourth quarter.
Year-over-year. Year-over-year. Yes. down quarters.
It could be tight in the fourth quarter, Steve. It would be my take comment.
Yes, down volume in the fourth quarter, but will be -- obviously, we're getting price. So I think we'll be right around flat in the fourth quarter from a resi perspective, but down volume.
Next question comes from Andrew Obin with Bank of America. Please go ahead.
Just a question about -- on first, what have you learned since you've announced the merger with Aspen about opportunities, not only that Aspen offers but cross-selling opportunities. And a follow-up question also is on systems and software sales. Could you just give some color as to -- it seems from your disclosure revenue growth was only 1%. But can you just give us more color what happened to the assets that are going into Aspen?
Yes. No, look, we continue to be very excited about the commercial opportunities with AspenTech, as you heard from Antonio on the call as well. The commercial agreement is underway. We're working finalizing the last little elements there. The global teams have begun to collaborate. And it's very interesting and even as I made customer calls in Houston 3 weeks ago, engaged at both the Emerson and the AspenTech level in terms of defining opportunities across both businesses. So I think those will come into more clarity as we get closer to close. In terms of the software assets, Ram, if you want to comment on the performance of the assets?
Yes. I think the 2 software businesses, GSS and OSI had a very, very good first quarter from an -- orders remain very strong. OSI remains on plan. I think the other point is from a sales growth perspective, which is the number you touted in I think we were up 2% on systems and solutions. And primarily, that was driven by electronic shortages in our systems business, our DeltaV business. Orders, frankly, were strong double digits. So we are seeing good momentum from an order activity as it relates to our systems businesses, both the businesses that we're contributing as well as the ones that will remain within Emerson.
And just a follow-up on Commercial & Residential. How do you think -- what are you seeing from your customers about we've heard of the AHR Expo a lot about sort of product transition towards the year. And how disruptive do you think it's going to be sort of to the optics of shipments, right, because people may not want to have inventory in the channel, there are different regulations. What are you hearing from your customers? And what's the state of the readiness of the industry to manage this transition, given how stressed the supply chains are?
Yes. I think, Andrew, as you probably heard at the AHRI, I mean, at this point, all of our customers are telling us do not slow down. Fundamentally, they have immediate demand that we are continuing to satisfy. They're building in safety stock for what will traditionally be a big third quarter in the industry. And more importantly, they want to build up into fourth quarter in advance of the transition that's going to happen Jan 1. So at this point, I think the messaging is do not slow down, and we will continue to see good order activity from our customers over the course of the next few quarters here in preparation for that. I don't think there's going to be a significant inventory build before the transition, but I think demand will not slow down in the fourth quarter like it traditionally does.
Our next question comes from Nigel Coe with Wolfe Research. Please go ahead.
So I just want to go back to the price/cost, Steve's question. Is that 175 still being captured wholly within Com/Res? Or was it spread more across the 2 segments, I think the 100 primarily with Com/Res?
Yes. No, it's actually spread across the business. So we're seeing more of the wage and particularly the freight inflation in commercial/residential, just given the nature of the business. But we're also going out and capturing significant incremental price in automation solutions in response to the mainly, to the electronic component shortage where we are working very hard to get what we need to make product and in some cases, paying significantly more than you normally would pay. So it's pretty balanced and the actions have been significant in automation solutions as well.
And then on A/S, obviously, the margins that have been touched on already. 1Q is normally the weakest -- or rather the lowest quarter for margins. So I'm just curious, this is not a normal year or anything, but would you still expect 1Q to be the low bar for margins and the sequential improvement from there?
Then just on the guide for 7 to 9 to get to the mid- to high end of that range would require a pretty significant ramp-up in the second half of the year. I'm just curious, what does the backlog tell us about the second half? And how much comps do you have in the high end of that range?
Nigel, I think we feel pretty good. Again, everything we say is kind of tempered by the unknowns around logistics and supply chain. Having said that and seeing our operations people basically figure it out as we go through time here, we have good confidence in the upper end of the range for the year. Certainly, the pace of orders in the backlog more than supports that, and it's all about conversion. And we feel very confident in our ability to convert.
There's a big ramp in the second half of the year, no doubt, but we've known that from the beginning of the year, both in terms of volume and sales as well as in profitability because of the way the price cost comes through and the price is realized heavily in the second half of the year. So we feel pretty good about it.
Our next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.
So my apologies if I missed this earlier, but I know you spoke a little bit about KOB 1, roughly $6.5 billion. I'm curious, just more broadly, how are your conversations with customers today, just given the move that we've seen in commodity prices? I just wonder if that funnel is starting to get bigger and the near-term opportunity is more imminent?
No. Great question, Joe. And I had the opportunity to spend a few days in Houston with customers face-to-face, which is great in the Energy segment, chemical and energy, and the mood is obviously positive. But what's most interesting is how budgets are shifting into the sustainability elements in a very significant way, which is what we've seen in our own funnel, where almost $1 billion now is essentially around those types of electrification. Could be carbonization, emissions, all the sustainability buckets. So that is a significant shift in capital, and I think we'll see that increase over time as we go forward.
We see positive move on the large KOB 1s that do remain, whether they're North America-based LNG or Qatar, those are moving forward. We received a number of awards already around our instrumentation and our valve businesses and actuation businesses in Qatar over the last few months. And so we continue to see encouragement there. But I'd suggest, Joe, that the makeup of KOB 1 will start to shift more and more into that sustainability area. Ram, any comments?
No, I think well said. I mean, at this point, the number is holding flat at 6.5%, but we could tell you that the pace of FIDs or final investment decisions continue to improve just given the nature of the spend we're seeing with our customers. So we'll see that unravel over the next several quarters.
Got it. That's helpful. And then my follow-on is just on M&A. Since you clearly, obviously, announced the large acquisition at the end of last year on the software side. I'm just curious, how are you thinking about your pipeline today? There's some assets that seemingly might be coming up on the market. And I'm just curious like where is your focus today? Is there still an emphasis to diversify away from oil and gas? Just any color that you can give us today would be great.
Sure, Joe. We're very active both on the pluses and minuses. Obviously, our strategic imperatives around diversification is important to create a world-class automation business. So we're very active looking at those. And you're right, the market is active and there are interesting assets out there, and we'll participate accordingly. So we'll stay active. Our balance sheet is in very good shape. I think we have firepower if we' to choose to do other things, and we have that flexibility. So we'll keep -- we'll be smart and very attentive to the opportunities that are out. But we'll also be very intentional as to the pathways that we've defined and we'll speak more about in our Investor Day around the portfolio journey and the targeted verticals that will drive increased value creation through underlying sales growth.
Our next question comes from Markus Mittermaier with UBS. Please go ahead.
If I could come back to the budgets, please. I understand its shifting increasingly to sustainability. As you said, where would you characterize sort of the absolute level of these budgets versus, say, the last cycle peak in '18, '19 sort of -- maybe that's 1 question, trying to get to the total profit pool? And then how easy is it now to get these budgets released when you speak to your customers?
Okay. Sure. Sure, Markus. I'll be happy to give you some insights. So year-over-year from last year, budgets overall or the size of budgets there up undoubtedly on the KOB 1 side. However, if you look back through time, particularly given the significant LNG wave of investments, they're down because those are very significant capital that was put on outlay to increase capacity of LNG. So they're down on that basis overall. So for us, it's been stabilized from an Emerson Automation value over the last few months and that we'll see as things may potentially expand or particularly around sustainability, as I said earlier.
Okay. Great. And then more final question on the comments around redesign of products. I know
you obviously have to do that given the shortages of parts. But is that also an opportunity from a design to value perspective? Or is there frankly no time to kind of focus on taking cost out of all these products that you have to redesign now anyway? So is it really focused on, okay, I don't have a certain shipment and try to redesign that part? Or can you go beyond that to maybe change structurally, the bill of materials in a number of your products?
Great question, Markus. This is Ram here. So I think the short answer is we're doing both. I think the immediate need as we wrestle through component shortages is redesigning to ensure that we have component availability to meet current shipments. However, in the Automation Solutions business, particularly where we have the biggest exposure to electronics, Mark Bulanda and his team are fundamentally redesigning all of the major platforms across automation solutions into next-generation platforms that are fundamentally enhanced performance use more modernized electronic components, upgrading the chips, obviously putting more diagnostics and additional functionality into those platforms. And we're using this opportunity to invest in next-generation platforms that will address what you referenced, better cost, better performance and, frankly, give us more robustness in our supply network design in order to support these products.
Now as you know, that will take a little longer, but I think it's important to understand that we're remaining focused on both, manage the short term with immediate redesigns, but then invest in next-generation platforms going forward for the longer term.
Our next question comes from John Walsh with Credit Suisse. Please go ahead.
Great. Maybe a first question just around China. Obviously, you called out very strong growth there around sustainability, decarb, a lot of stuff happening on the ground there as it relates to potential stimulus. Just are you seeing anything change in China? And how are you thinking about it?
Look, just to give you a perspective, we have a traditionally very strong business in China, as you know, almost 10,000 employees in China and a business that continues to be incredibly robust.
On a destination basis, automation business in China in the quarter was up 17%. The orders, as I think I mentioned, were up 34% in the quarter. So we feel really good. Obviously, we continue to be active in conversations, both governmental and quasi governmental as you could say, to try to influence normalcy of relations with China, but we've continue to feel really good about our position in the marketplace, our ability to win and differentiate and really have loyalty from the customers that are based in China. And our continued acceleration in project participation and growth of our underlying business is, I think, testament to that. Ram?
And just to add, I think -- so as Lal described, I think overall, our Automation Solutions businesses remain very robust in China, and I think we expect that to continue. If there's any semblance of a slowdown in China, we've seen it in our appliance businesses, related businesses where we supply sensors. And then our air conditioning business did see a soft first quarter, flat demand, if you will. However, that's where the stimulus and the China stimulating their economy will help in the second half because we expect that to have an impact on our consumer-related businesses.
So just to summarize, China, strong automation solutions, expect that to continue, and then we'll wait to see how the stimulus drives fundamental demand in our Climate Technologies business.
Fair to say that we continue to plan very high single digits, if not low double digits for the year in China from a definition sales performance.
Great. And then maybe a similar follow-up to that. If you listen to what some of the kind of integrated energy companies are saying and where they're going to put their CapEx. I mean emissions reductions been mentioned several times. You have product that helped that. Are you actually seeing sales today that can attach that as the reason for why you're getting the sales order? Just thinking about how they have to upgrade their installed base for these -- their own sustainability goals.
Absolutely, absolutely. And it's broad-based across the energy segment from the producers in traditional upstream like Pioneer to the integrated oils flare elimination, emission reduction, decarbonization, carbon capture programs. And the example -- one of the examples that I shared with you at the offset around emissions was exactly that. So we're -- we can attribute bookings and sales. We have significant pursuits underway across our world areas with our selling organizations around those technologies that are part of our core portfolio that aid our customers in that transition. So we feel really good. Ram, if you've got something to add.
Yes. And I think to your point, in terms of the broader scope of technology, whether it's continuous emission monitoring, analytical systems that Lal showed in as an example or the relief valves or other isolation valving associated with emissions monitoring. We've got a very, very good scope of products that can help our customers, and we're certainly seeing a nice uptick on all those product lines as it relates to these type of investments for our customers.
Our next question comes from Tommy Moll with Stephens. Please go ahead.
I wanted to circle back on the strong implied exit rate for your auto cell business. I think I heard you say earlier that a lot of the visibility there is on backlog conversion. Could you give any insight as to an end market or part of the world that's particularly strong as you see that backlog start to unlock through the rest of the fiscal year?
Look, I'll give you a perspective from an industry perspective, Tommy, and just from a worldwide perspective for the quarter. The quarter performance globally was relatively strong, but the opportunity really lies in -- from a geographic perspective, in North America and Western Europe from a conversion of backlog perspective.
In terms of markets, we expect the process space to be in the high single digits to low double, ultimately, high singles on hybrid as we go through the year and low doubles on discrete as we go through the year. So the discrete strength continues, and then we'll see an acceleration as we go through the process. That's the potential that we see out there.
Geographically, I feel really good about where we are. And obviously, as we convert backlog in the developed economies of Europe and U.S., we'll see that benefit.
And as a follow-up, I wanted to ask about the funding on the Aspen deal for the $6 billion cash portion. So you've got nearly $5 billion on the balance sheet today after the recent notes financing and it looks like you monetized part of the Vertiv stake. What are the plans to fund the remainder of that $6 billion? And any chance for a sizable divestiture between now and then that would fill part of that gap?
Tommy, this is Frank. So the plan right now, leaving aside divestitures for the moment, the plan right now is we did $3 billion of term debt in December. We will probably take more cash off the balance sheet than we normally do in a given year to also partially fund and then the balance we intend to do in the commercial paper market. We've had our debt ratings now reaffirmed by Moody's. S&P had done it right from the get-go. So it will be a combination of the $3 billion term debt. Cash on the balance sheet beyond what's on the balance sheet as a function of having done the term debt and then commercial paper.
If there is a divestiture and there's no major divestiture in flight right now. But obviously, if there's any divestiture, those proceeds will go towards the cash portion of the purchase.
Last question today will come from Jeff Sprague with Vertical Research Partners. Please go ahead.
I'll make it one question because my second was about divestitures, which Frank just addressed. I will -- I'm just wondering if you could give us a little color on actually labor cost and the inflation that you're dealing with. I would assume most of the inflation is in the U.S., but I'm curious if it's spreading to other parts of the world. And can you give us any color on labor as a percent of your COGS or some other framework to think about it?
Okay. Yes. This is Ram, Jeff. First off, from an inflation perspective, you're right, U.S. inflation is probably the biggest portion of the inflation, but we have seen inflation in Mexico as well. Mexico, frankly, Jan 1, they increased minimum wage, entry-level wage by 22%. And frankly, this is 1 of 4 minimum wage increases we've seen in Mexico since 2019. So there's issues outside of the U.S. as well, but majority of the inflation is in the U.S. And in our larger compressor plant, for example, we've seen wage inflation, particularly entry-level wages go up by 20% to 25% over a couple of steps. We've had to do that to remain competitive and have the labor availability to work down our backlog. So that's the extent. Normal inflation in some of the other markets we operate, China inflation, India inflation, Europe inflation. Nothing abnormal, normal levels of inflation in those markets. So the abnormal levels we're seeing are particularly in the U.S. and some, Mexico.
And can you size labor as a percent of COGS, maybe Frank?
DL is about 9 -- high single digits...
Obviously, a little higher in Climate Tech & Commercial Residential and a little lower in Automation Solutions, but high single digits on the profit waterfall as a percent of sales.
Ladies and gentlemen, this will conclude our question-and-answer session, and this will also conclude the conference. Thank you for attending today's presentation. You may now disconnect.