Rockwell Automation Inc

NYSE:ROK

Earnings Call Transcript 2022-Q3

[Operator]

Thank you for holding and welcome to Rockwell Automation's Quarterly Conference Call. I need to remind everyone that today's conference call is being recorded. Later in the call, we will open up the lines for questions. [Operator Instructions]

At this time, I would like to turn the call over to Aijana Zellner, Head of Investor Relations. Ms. Zellner, please go ahead.

[Aijana Zellner, Head-Investor Relations]

Thanks Rex. Good morning. Thank you for joining us for Rockwell Automation’s third quarter fiscal 2022 earnings release conference call. With me today is Blake Moret, our Chairman and CEO; and Nick Gangestad, our CFO. Our results were released earlier this morning and the press release and charts have been posted to our website. Both the press release and charts include and our call today will reference non-GAAP measures. Both the press release and charts include reconciliations of these non-GAAP measures. A webcast of this call will be available on our website for replay for the next 30 days.

For your convenience, a transcript of our prepared remarks will also be available on our website at the conclusion of today's call. Before we get started, I need to remind you that our comments will include statements related to the expected future results of our Company and are, therefore, forward-looking statements. Our actual results may differ materially from our projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all our SEC filings.

So with that, I'll hand it over to Blake.

[Blake Moret, Chairman and Chief Executive Officer]

Thanks Aijana, and good morning, everyone. Thank you for joining us today. I want to also take this opportunity to congratulate Aijana on her promotion since our last earnings call. Let's turn to our third quarter results on Slide 3. We had a strong quarter with orders, shipments, margin, and profit, all at or above our expectations. We successfully navigated supply chain disruptions in a still volatile environment. And we saw the positive impact of pricing actions that demonstrate our strong position in the market.

Total orders grew over 17% versus prior year with strong demand in all three business segments. Our continued orders strength reflects the value our customers place on Rockwell's differentiated offerings and the increased need for automation solutions regardless of the current macroeconomic backdrop. Total revenue of almost $2 billion was up 6.5% year-over-year. Organic sales came in as expected and grew over 7% versus prior year. Acquisitions contributed 2.5 points of growth.

Currency translation reduced sales by over 3% driven by continued strengthening of the U.S. dollar. While we saw a gradual overall improvement in supply chain through the quarter, our sales volume and mix continue to be impacted by component shortages as we've been discussing for a while now. Our top line performance, both by segment and region was driven by specific component availability in Q3, more than the underlying demand, which remains strong.

In the Intelligent Devices business segment, organic sales were up over 2% year-over-year, but below expectations. This segment was disproportionately impacted by component availability, further exacerbated by extended China COVID shutdowns. Software & Control organic sales growth of over 13% versus prior year was above expectations. A strong performance here reflects both an improvement in the chip supply and some early benefits from the recent resiliency investments. Sales of our View operator interface panels, which we redesigned to optimize our component supply, were up almost 60% year-over-year. Our software sales grew double-digits versus prior year.

In Lifecycle Services, organic sales increased almost 9% versus the prior year, despite continued component shortages and a partial shutdown of our Shanghai facility earlier in the quarter. Within Lifecycle Services, Sensia had another quarter of strong growth with both orders and sales up over 20% year-over-year. Sales in our services business also grew double-digits driven by higher demand for asset management and cybersecurity.

Lifecycle Services’ book-to-bill was 1.27 in the quarter, reflecting continued strength in our orders. Information Solutions & Connected Services, orders and sales both grew strong double-digits in the quarter with particular strength in the MES software and industrial cybersecurity sales. Within Information Solutions, we had a number of strategic wins this quarter, thanks to our industry leading portfolio of scalable and flexible software offerings.

For instance, Eli Lilly and Company has chosen Rockwell Automation's PharmaSuite MES solution as the next-generation MES platform for their drug products. In addition to our on-prem software wins, we continue to gain traction with our recent cloud native acquisitions. One of our Plex wins this quarter was with ZEVx, an Arizona based company, focused on electrification of light and medium duty fleet vehicles worldwide.

Our smart manufacturing platform will help this customer's aggressive growth plan with advanced supplier and inventory management, improved data visibility and reporting. We're also happy to report the sale of a Plex application that will run natively on Microsoft Azure in Europe, as well as a growing list of wins in food and beverage companies. These are important deal synergies that we are starting to realize. At Fiix, we continue to see strong double-digit sales growth led by both new logo wins and expansion deals.

Our competitive maintenance management wins across many verticals, including EV and food and beverage reflect the platform's differentiated AI capabilities and ease of deployment. Connected Services’ orders and sales were also strong in the quarter, demonstrating customers increasing reliance on our deep domain expertise, cybersecurity services and 24/7 remote support, especially as many companies are struggling with labor shortages and temporary budget constraints.

In the quarter, total ARR was up almost 60%, an organic ARR grew 18%. Our strong operating performance and focus on price cost execution resulted in exceptional earnings this quarter. With adjusted EPS growing 15% versus prior year.

Let's now turn to Slide 4 to review key highlights of our Q3 end market performance. As I mentioned earlier, what we saw a gradual overall improvement in supply chain constraints this quarter, some of our businesses and industry verticals mainly discrete and the hardware intensive parts of hybrid were disproportionately impacted by the ongoing component supply issues. In our discrete industries, sales were up low single-digits. Within this industry segment, automotive sales were up 6% versus prior year.

We continue to see investments in the EV transition from both traditional brand owners and EV startups with a healthy mix of greenfield and brownfield activities. In Q3, we had a strategic greenfield win in Asia, where a Chinese automotive company, Chery Auto chose Rockwell's differentiated MES IoT and core automation offerings over their traditional European supplier to build a smart plant and increase their speed to market.

In addition to working with leading electric vehicle manufacturers, we continue to gain share in the EV battery space. With several competitive wins in the quarter, both in Asia and Europe, while most of our previous wins in this space were in battery assembly and conveyance. We're starting to expand our presence in battery cells. Rockwell's integrated logics and motion offering was selected by Doer Clean Technology Systems to provide an end to end coating process from powder handling and slurry mixing to coating and drying.

Semiconductor sales decline 2% versus prior year and were significantly impacted by COVID-related shutdowns in China. Despite the near-term supply chain challenges impacting its own ecosystem this industry continues to see strong demand with about 80 greenfield and 300 brownfield projects announced today.

In the e-commerce and warehouse automation, our sales were down over 15% in the quarter, mainly driven by electronic component shortages and tough prior year comps. While we are seeing a slowdown in investments from some e-commerce customers, we continue to work with traditional retailers and grocers who are investing in new automated infrastructure to gain share in the market.

Turning to our Hybrid Industry segment. Sales in this segment grew mid single digits led by growth in life sciences and food and beverage. Food and beverage sales were up mid single digits versus prior year, while inflation might put some pressure on new expansion investments, we continue to expect, especially strong demand in certain markets like agriculture processing, where Rockwell has high share and a differentiated technology offering.

We saw a number of CapEx wins in Latin America this quarter with one of our food and beverage wins coming from CP Kelco a Brazilian nature-based ingredients manufacturer, which chose Rockwell and our plant PlantPAx process control architecture as their automation partner for the next capacity expansion project.

Life sciences sales grew over 15% in Q3 with strong year-over-year growth in medical devices, pharma and biotech. This was another industry where our differentiated process controller along with strong network infrastructure and overall project management expertise helped us win a competitive project with Thermo Fisher in their joint venture plant in China. A combination of industry leading MES and IoT software and the multidiscipline logics platform for hybrid applications along with our increasing expertise in biotech and cell gene therapies position us well in this fast growing vertical.

Tire was up low single digits in the quarter, we continued to see increased customer demand for our software and services in this vertical. In the quarter, we had our first Plex win in tire with Prometeon Tyre Group, a global leader in tire manufacturing, headquartered in Italy. The customer chose our Plex QMS to standardize quality management across its global operations.

Moving to process. This industry segment group 12% versus prior year with oil and gas, mining and metals all growing double digits. We continue to grow our presence in process by displacing the traditional DCS players across oil and gas, mining and chemical industries. Our investments in process control technology and petrochemical expertise are paying off as demonstrated by our recent wins in North America and Europe. We also had a strategic multimillion dollar ESG win where Rockwell will be helping one of the most active operators in the Permian Basin, reduce its greenhouse gas emissions and bring all operated oil and gas assets to net zero by 2050.

Turning now to Slide 5 in our Q3 organic regional sales performance. Once again, these results were heavily impacted by our component availability. North America organic sales grew by 11% versus the prior year, Latin America sales increased by over 15%, EMEA sales were up over 3% and Asia Pacific was down almost 6%.

Let's move to Slide 6, an update to a new slide we had provided last quarter. As you can see, order cancellations remained very low and are within our historical ranges. Our strong orders and record backlog of over $5 billion, continue to support strong sales in fiscal year 2022 and beyond.

As we turn to Slide 7 let's review highlights for the full year outlook. Orders are expected to stay strong for the remainder of this fiscal year. While we continue to expect strong double digit year-over-year and sequential organic sales growth in Q4, resulting in double digit growth for the full year, we're reducing the midpoint of our organic growth range to 11%. Our revised guidance reflects ongoing supply chain volatility in this environment, especially for business operations and suppliers located in Asia. The supply of electronic components is gradually improving, but remains volatile. Acquisitions are expected to contribute 2.5 points of profitable growth, more than offsetting a 2 point headwind from currency translation.

We continue to expect double digit growth in both core automation as well as information solutions and connected services. We continue to expect another year of double digit annual recurring revenue growth. Our organic investments and acquisitions help make this revenue stream become a more meaningful contributor to our overall business resilience. Our additional investments in resiliency actions are progressing well as we develop deeper relationships with key suppliers, complete redesign projects and realize price to mitigate inflation.

We expect our margins to expand in Q4 on higher sales and continued price cost execution. With only one more quarter to go, we have narrowed our adjusted EPS guidance range with our midpoint still at $9.50. We continue to expect free cash flow conversion of 85% for the full year.

Nick will now add detail to our Q3 results and financial outlook for fiscal 2022. Nick?

[Nick Gangestad, Chief Financial Officer]

Thank you, Blake and good morning everyone. I'll start on Slide 9, third quarter key financial information. Third quarter reported sales were up 6.5% over last year with organic sales up 7.1% and acquisitions adding another 2.5 points to total growth. Foreign currency translation reduced sales by 3.1%, while the U.S. dollar has strengthened against many currencies, the strength against the euro has had the largest impact on Rockwell in the quarter.

We saw our organic sales improve through the quarter, helped by some easing of supply chain constraints following the listing of COVID restrictions in China. Segment operating margin was 20.8%, an increase of 90 basis points versus last year, mostly due to higher sales and lower incentive compensation, partially offset by higher investment spend. Last quarter, we shared our expectation that price cost would improve significantly in Q3. And that is exactly what happened. Price in the quarter more than offset our year-over-year increases in input costs. Our adjusted EPS in the quarter was $2.66, up 15% from the prior year. I’ll cover a year-over-year adjusted EPS bridge on a later slide.

The adjusted effective tax rate for the third quarter was 14.5% and in line with the prior year. This was better than our expectations due to a favorable return to provision true up. Free cash flow dollar generation was $327 million in the quarter and down compared to the prior year due to higher working capital primarily in receivables. We saw a higher percentage of our sales in June than in the prior year and our free cash flow conversion exceeded 100% in the quarter, despite our increases in working capital. One additional item not shown on the slide. We repurchased 860,000 shares in the quarter at a cost of $176 million. On June 30, $1.3 billion remained available under our repurchase authorization.

Slide 10 provides the sales and margin performance overview of our three operating segments. We had a good quarter with organic sales up in all three business segments both year-over-year and sequentially. Improving sales in our strong operating execution resulted in sequential margin growth of over 500 basis points.

Intelligent Devices organic sales were up 2.7% in Q3. This segment had the largest negative impact in the quarter from component availability and extended shutdowns in China. Compared to last year, Intelligent Devices margins declined 220 basis points to 19.7% primarily driven by higher investment spend.

Year-over-year price increases were able to neutralize the impact of higher input costs. Margin in this segment improves sequentially by 510 basis points driven by positive price costs and higher volume.

Software & Control total sales were up 19%, including 13.4% organic growth versus the prior year. Strong sales were driven by improved chip supply and benefited from resiliency actions taken earlier in the year.

Segment margins were up 620 basis points compared to last year and up 680 basis points sequentially, mostly due to higher sales. Price cost was positive year-over-year and sequentially. Lifecycle Services organic sales grew 8.7% led by strong double-digit growth in Sensia. Demand continues to remain strong across all businesses. Book-to-bill was 1.27 for Q3.

Segment margin declined 90 basis points compared to the prior year driven by supply chain constraints and higher investment spend, partially offset by higher sales and lower incentive compensation. Segment margin was up against sequentially on higher sales. With gradual improvement in the supply chain, we expect the trend of sequential margin expansion to continue in the coming quarters.

The next Slide 11 provides the adjusted EPS walk from Q3 fiscal 2021 to Q3 fiscal 2022. Starting on the left. Core performance was up about $0.15, including about $0.25 from higher sales. Price cost contributed $0.05. Strong execution led to about $0.10 of productivity. We saw some favorable corporate items about half of which were due to timing between Q3 and Q4. We also continue to invest in growth and resiliency, which offset the core growth by $0.35.

In the prior year, we made about $0.10 of non-recurring accelerated investments that mostly impacted our Software & Control business. Currency negatively impacted our earnings by about $0.10. On a year-over-year basis, incentive compensation was about a $0.20 tailwind. This brings us to our total adjusted EPS of $2.66.

Let’s move to the next Slide 12, our guidance for fiscal 2022. We are updating our sales guidance to a new range of approximately $7.7 billion to $7.9 billion in fiscal 2022, up 10.5% to 12.5% for the year. We expect organic sales growth to be in the range of 10% to 12%. And we expect about 2.5 points of growth coming from acquisitions and currency translation will be a headwind of about two points.

Our sales guidance range reflects the continued volatility we see in the supply chain. The midpoint of our guidance implies a 9% sequential increase in Q4 total sales driven by improved material flow from key suppliers including those in China, further sequential improvement from resiliency actions and higher sequential price realization. We continue to expect full year segment operating margins to be about 20% and unchanged from our prior guide. We expect our margins to continue to expand in the fourth quarter. The margin expansion will come primarily from higher sequential sales and continued positive momentum on price costs. While price costs will be negative for the full year, it is positive in the second half.

We now expect second half core conversion above 40%. We expect a full year adjusted effective tax rate to be around 16.5%. And we are narrowing our adjusted EPS guidance range to $9.30 to $9.70 with no change to our midpoint of $9.50 from prior guidance. Finally, we continue to expect full year fiscal 2022 free cash flow conversion of about 85% of adjusted income.

A few additional comments on fiscal 2022 guidance. Corporate and other expense is now projected to be around $110 million. Net interest expense for fiscal 2022 is now expected to be about $120 million. We’re assuming average diluted shares outstanding of 116.7 million shares.

Finally on capital deployment, our capital allocation priorities for this year remain the same, including our focus on de-leveraging. As I mentioned earlier, we repurchased about $176 million worth of shares in Q3 and are now projecting our full year share repurchases to be about $300 million.

Turning now to Page 13. While there is no change to the midpoint of our adjusted EPS guidance, we wanted to show some of the moving pieces within this number, starting on the left. There is a lower contribution due to the lower organic sales guidance. This is fully offset by improved productivity, favorable segment mix and lower corporate expenses.

Currency is an additional headwind of about $0.05. A more favorable tax rate adds $0.05, which brings us to our midpoints of $9.50. Although not on this page, we continue to expect our acquisitions including Plex to be about neutral this year, including incremental interest expense or a year-over-year benefit of about $0.15.

With that, I’ll turn it back over to Blake for some closing remarks before we start Q&A. Blake?

[Blake Moret, Chairman and Chief Executive Officer]

Thanks, Nick. We had a good quarter of growth, price realization, profitability, and investment for the future. We are executing well, and I’m proud of how our teams are managing supply chain complexity to serve the needs of our customers. In volatile times, a relentless focus on helping customers creates long-term differentiation and value. Aijana, we will now begin the Q&A session.

[Aijana Zellner, Head-Investor Relations]

We would like to get to as many of you as possible. So please limit yourself to one question and a quick follow-up. Thank you. Rex, let’s take our first question.

[Operator]

[Operator Instructions] Your first question comes from the line of Scott Davis. [Melius Research] Your line is open.

[Scott Davis, Melius Research]

Good morning, guys. Good morning, Aijana.

[Blake Moret, Chairman and Chief Executive Officer]

Good morning.

[Aijana Zellner, Head-Investor Relations]

Good morning.

[Scott Davis, Melius Research]

Little bit different tone this quarter than last quarter, and that’s nice to see it bounce back. But this may be a little hard to answer. But you have an order book that’s up about 17%. How much of that and you don’t have to give me an exact number, but is price because I know you had some pretty big price increases that were announced, is it order magnitude is half of that order book price? Is it – is there some way to kind of size that?

[Nick Gangestad, Chief Financial Officer]

Hey, Scott. For the full – for the third quarter, we had about 3.5% price growth for the total company. That’s about half of our total organic growth. I think that’s a pretty fair estimate to apply to our order growth as well. That 3.5% is about – of that 17% order growth, 3.5% of that is coming from price.

[Scott Davis, Melius Research]

Yes. Wow. So. Yes. Okay. Sorry, Blake.

[Blake Moret, Chairman and Chief Executive Officer]

Yes, Scott, I was just going to add. When we talk about orders, just to give some scale to the magnitude of the orders, they remain around 45% above pre pandemic levels. So in addition to the very large existing backlog, we’re continuing to add that at a rate above our expectations.

[Scott Davis, Melius Research]

No, that’s good to hear. And then you gave the example that cherry when example Blake, which I thought was interesting. Can – is a deal like that priced in U.S. dollars. Is it priced in local currency? I mean, how do you kind of compete against a suite of competitors that have such a big currency advantage if [indiscernible].

[Blake Moret, Chairman and Chief Executive Officer]

Hey Scott. Most of our transactions in a country like China are priced in the local currency and that’s generally the way we do business. When there start to be large movements in FX, like what we’re seeing there that becomes part of our pricing strategy. We have hedges in place to protect us, protect earnings in the short term. And in the longer term, then pricing becomes part of that strategy of how we’ll adjust pricing in the local currency to be offsetting what we’re seeing in terms of FX movements.

[Scott Davis, Melius Research]

Really helpful. All right, I’ll pass it on. Good luck. Thank you.

[Blake Moret, Chairman and Chief Executive Officer]

Thanks, Scott.

[Operator]

Your next question comes from the line of Josh Pokrzywinski. [Morgan Stanley] Your line is open.

[Josh Pokrzywinski, Morgan Stanley]

Hi, good morning, team.

[Blake Moret, Chairman and Chief Executive Officer]

Hi, Josh.

[Josh Pokrzywinski, Morgan Stanley]

Just Software & Control, pretty solid quarter there. I guess, that division has been a little bit less impacted by supply chain versus Intelligent Devices. But I guess if I think back to kind of other periods of macro volatility, it just seems to do this every now and then where you’ll have a pretty decently big quarter on margins and the revenue. Anything lumpy in terms of shipments or availability pull forward, like you guys had earlier in the year, anything that could sort of give us a direction on timeline would be helpful?

[Blake Moret, Chairman and Chief Executive Officer]

Sure. Well, Josh, first of all limited pull through or pull forward in that. We’re still looking at large year-over-year and sequential growth in Q4. I think you can think of this, the hardware portion of Software & Control as having less SKUs than Intelligent Devices. And the chip availability was relatively higher for Software & Control being able to ship logics, compact logics and the associated IO. So in the quarter it was less impacted. And again, with the kind of backlog that we have in the continuing orders, we can ship as much as we have components for across all of the business segments, and we expect that to be the case for quarters to come.

[Josh Pokrzywinski, Morgan Stanley]

Got it. That’s helpful. And then just quick follow-up on the orders, anything that you can kind of break down further in there, whether it’s any currency headwinds, I noticed not a cancellations, but any kind of change in that growth. So have cancellation stepped up and project size like are those getting bigger or smaller? Thanks.

[Nick Gangestad, Chief Financial Officer]

Josh, we have been seeing over time the size of our orders getting larger and that trend continues. But in terms of the specifics of your question, there’s really nothing significant to call out. Everything is tracking very similar to what we’ve seen in the past. As Blake mentioned in our prepared comments, orders are coming in even stronger than what we had anticipated for the quarter.

[Josh Pokrzywinski, Morgan Stanley]

And the FX piece is that did that move around well? [Ph]

[Nick Gangestad, Chief Financial Officer]

FX is one of the things can impacting our orders within Europe, but – and that’s included in what we’re seeing for that. So seeing the Euro devalue about 10% and that’s part of what we’re seeing in the order in the total global orders that we reported in Q3.

[Josh Pokrzywinski, Morgan Stanley]

Super helpful. Appreciate it. Best of luck.

[Operator]

Your next question comes from the line of Julian Mitchell. [Barclays] Your line is open.

[Aijana Zellner, Head-Investor Relations]

Rex, let’s move on to the next one.

[Operator]

Excellent. Your next question comes from Andy Kaplowitz. [Citigroup] Your line is open.

[Andy Kaplowitz, Citigroup]

Hey, good morning, everyone.

[Blake Moret, Chairman and Chief Executive Officer]

Good morning, Andy.

[Nick Gangestad, Chief Financial Officer]

Hey, Andy.

[Andy Kaplowitz, Citigroup]

Blake, can you elaborate on your comments regarding and improving supply chain? Did you see continued improvement in component availability throughout the quarter and through July here? And I know you mentioned chip starting to get better. Maybe give us a little more color around that. Do you have visibility toward more normalized growth, less pressure by supply chain as you go into FY 2023?

[Blake Moret, Chairman and Chief Executive Officer]

So, Andy look, we continue to see chip constraints being a factor for the near term. We did see improvement through the quarter as you’ll recall, we saw the more severe wave of COVID shutdowns in China in April and May. And we were able to largely recover from that as chips began flowing a little bit more strongly in the back half of the quarter. And we continued to see gradual improvement in Q4 and into our fiscal year 2023. But it remains a volatile situation. You can’t count the chips until they show up on your receiving doc. But we do see a gradual improvement that continues into the early part of Q4.

[Andy Kaplowitz, Citigroup]

And thanks for that Blake. And then Blake or Nick, I know you don’t want to talk too much about 2023, but when you think about incremental margin, obviously it’s picked up here in the second half, as you said, Nick. As you look at next year, maybe talk about the puts and takes you remind us about investments spend and incentive comp as we were in the second half at this point. And then, obviously growth is picking up. Usually you guys are 30% to 35%, but if growth is a bit higher, could you do higher incremental margins given the easy comps at least in the first half of the year?

[Nick Gangestad, Chief Financial Officer]

Yes. So some of the puts and takes to be thinking about that we’re thinking about for fiscal year 2023. As Blake just said, supply chain component availability that’s going to continue to be probably our most important factor in particular around growth. Some of the things that will be impacting our margin and what we’re thinking about now is aspects like price cost, where as I’ve said earlier, that was negative in the first half of the year, shifting to positive in the second half, we expect that to continue to be positive for us.

Issues like inflation, issues like FX and what that can be doing to our profit and margin. The level of investment spend another factor we’re thinking about. We also have a number of new product launches and how that will be impacting us in fiscal year 2023. So all of those things in comp, oh, the other one, we – right now, we are paying a bonus this year that is below our normal planned level. We would expect that to go back to the planned level in fiscal year 2023, all of those things in combination, we think the – our financial framework around core conversion of 30% to 35% remains a good starting point to think about 2023 and profit and margin expansion for us.

[Andy Kaplowitz, Citigroup]

Thanks for that, Nick.

[Operator]

Your next question comes from the line of Julian Mitchell. [Barclays]. Your line is open.

[Julian Mitchell, Barclays]

Thanks very much and good morning. Maybe Nick, I know there was an effort there to talk about next year’s sort of EBIT bridge moving parts. But if we just focus on Slide 4, sorry, Slide 11 and you look at those main points around price cost, investment spend, productivity and incentive comp, maybe those items in particular, when we’re thinking about the fourth quarter and the year-on-year impact, anything major to call out versus what you just saw in the third quarter? I’m assuming price cost is a bigger tailwind than that $0.05 figure. But anything perhaps to mention on investment spend or productivity or the incentive comp for Q4?

[Nick Gangestad, Chief Financial Officer]

Yes. In Q4, a couple things that are changing. I had mentioned in my prepared remarks, corporate items, while it’s a benefit for Q3. We expect some of that is timing and we’ll come back in Q4 that will flip from being a benefit to a headwind in Q4 versus what we were originally estimating price costs, as you estimated will continue to improve for us. Volume will continue to be a positive as we're expecting even higher volume growth in Q4 then in Q3. And then overall investment spend, we expect that to be pretty flat between Q3 and Q4, not really a big change happening there. And we do expect productivity to continue to be a benefit to us in Q4 as well.

[Julian Mitchell, Barclays]

That's very helpful. Thank you, Nick. And then maybe sort of a broader question, the Software & Control operating margins very volatile, particularly from the outside and maybe the inside as well. Quite hard to predict on a sort of three to six month view. It looks like for the sort of in fiscal half overall, you have a low 30s sort of Software & Control operating margin. Is that a reasonable sort of run rate looking into 2023 and the medium term, or are there any sort of exceptional mix tailwinds or something that you'd call out that are bolstering that Software & Control margin right now?

[Nick Gangestad, Chief Financial Officer]

Yes, so a few things to keep in mind when you're looking at the margins that we've been experiencing and experiencing right now. The higher margin that we had in Q3 are higher sales volume was by far the driving factor on that. In the first half of the year, it was being negatively impacted by a lower volume growth. It was also being impacted by negative price cost, which is now flipping to positive. We also, in the first half of the year, where we had the lion's share of our Plex integration expenses. And while we're still investing there, that's going to be at a lower level. So the 30 plus percent that we're experiencing, I don't see that as something being off track of what to be expecting going forward from Software & Control.

[Julian Mitchell, Barclays]

That's very helpful. Thank you.

[Operator]

Your next question comes from the line of Noah Kaye [Oppenheimer & Company]. Your line is open.

[Noah Kaye, Oppenheimer & Company]

Thanks for taking the question. Blake, obviously looks like we're going to have elevated backlogs here for a period of time, given the continuing order strength but you mentioned e-commerce as one area starting to slow down, any other pockets where you're starting to see some softening, I know, possibly in the longer cycle type parts of the business. It can all be green lights at this point. So, curious for where you think we may see some softness as we head into 2023 in the order environment and where you think you've got some cushion there in terms of the mix of products and services you're offering.

[Blake Moret, Chairman and Chief Executive Officer]

Yes. Thanks, Noah. I think e-commerce in particular has been the outlier that we've seen so far in that they've taken a pause and in some of the expansion. Within that vertical, we also talk about warehouse automation outside of e-commerce. And they're continuing to look at productivity opportunities with in some cases, reducing labor requirements, more efficient handling of product at the front end and of their process and of their stores. So that continues to be pretty strong with some nice, recent wins there. I would say in general, the closer to the consumer that you are, those would be the areas that we're probably watching the most closely. We do continue to see strong industrial production figures.

And as you know, over a long period of time, IP is what Rockwell's performance – top line performance is most correlated to. And we still see a positive IP number in our served markets, especially in the U.S. So EV continues strong. We've talked before that. It's hard to imagine that either the established brand owners or the startups are going to take a pause in trying to convert their fleet capacity to EV, they're going to have to continue because they got fear of missing out and being able to get in early to get some experience and to get some volume there.

Semiconductor, we see a lot of in-process activity, regardless of what happens from a legislative standpoint, pharmaceutical, food and beverage. It's just hard to bet, too much against these verticals but again, e-commerce, so we have seen some softening and in general, the closer to the consumer, you are, maybe recreational vehicles but that's obviously, it's not a big part of our overall auto number there.

[Noah Kaye, Oppenheimer & Company]

Yes. And maybe just to follow up on this, I don't know if the current environment affects how customers think about on-prem versus cloud native, but what are you seeing in terms of customer preferences. Does this environment create a little bit more momentum for cloud native? And are you seeing kind of relatively stronger orders trends on some of your cloud native offerings and talk about that kind of balance configurations?

[Blake Moret, Chairman and Chief Executive Officer]

Sure. No, it's a good question. I mean, some of the advantages of a cloud native deployment is that you don't have to continue to invest or to create a large IT on-prem infrastructure to either acquire the assets, the servers and such and the IT staff. You can deploy a cloud native solution much quicker and that's why offerings like Plex and Fiix have been so popular among small and medium sized businesses that just don't have that money to invest in those areas. And they want to get up and running quick, they're on a kind of a quicker time constant there. And some of the bigger companies are taking that play and looking at how they can apply that as well.

And I think that's part of the reason that we're seeing Plex win in some of the verticals that were part of the synergy that we had baked into the model where we see food and beverage, tire, these are new verticals that they just didn't have the resources to address. And we're seeing some wins there. And similarly with Fiix, some of the wins that we've seen in Asia, in India, for instance I think are part of that where customers want it now, and they don't want to have to wait to build all the infrastructure. So it's part of the reason that we have a parallel offering. We have a really strong on-prem offering with our production center based MES that continues to grow well. And then Plex and Fiix are doing what we expected them to do for us.

[Noah Kaye, Oppenheimer & Company]

Okay. Thanks for the color, Blake. Appreciate it.

[Blake Moret, Chairman and Chief Executive Officer]

Sure.

[Operator]

Your next question comes from the line of Steve Tusa [J.P. Morgan]. Your line is open.

[Steve Tusa, J.P. Morgan]

Hey, good morning.

[Blake Moret, Chairman and Chief Executive Officer]

Hey, Steve.

[Nick Gangestad, Chief Financial Officer]

Good morning, Steve.

[Steve Tusa, J.P. Morgan]

So what are you guys seeing in the process industries just as a start or orders there seem to be holding up pretty well.

[Blake Moret, Chairman and Chief Executive Officer]

Yes. Orders are going quite well in process and I would say, orders and shipments for that matter. If you notice that we gave a little bit more in the way of customer wins this quarter, that wasn't a coincidence. I have seen the number of bigger wins tick up a bit in process. And I think some of the investments that we've made over the last really five or six years beginning with MAVERICK in expertise, obviously the joint venture was Schlumberger, Sensia, Kalypso, that expertise along with the steady drumbeat of new technology introductions are helping increase the win rate. And as Nick mentioned, increasing the order size, from a macro standpoint, oil and gas spending, particularly in areas of efficiency, which is really where we're centered even more than the CapEx side of things is helpful.

But chemical had, I think, their best quarter ever for us, metals still a very big automation market, mining out there. I don't think mining has hit its full stride, but we are seeing activity particularly in battery materials. So a lot of wins in lithium over the recent past.

[Steve Tusa, J.P. Morgan]

Just to follow up on the – I guess, the S&C margin and then the cash flow. Nick, what do you think is kind of your long-term cash conversion? I mean, this year 85% is a little low relative to history. It actually, I mean, your fourth quarter looks like a pretty big step up to get to that number to begin with, but even putting that aside, maybe you could just comment on that. What – how much confidence you guys have in that fourth quarter ramp, because it's a big number, but then beyond that, what is the normal cash conversion. And does that lower cash conversion have anything to do with the growing software revenue that may be a little more lumpy versus the actual cash?

[Nick Gangestad, Chief Financial Officer]

Yes, thanks for that question, Steve. On the cash flow conversion side, 100% is our – what I consider our normal run rate. In fiscal year 2022, we are seeing noticeable increases in our working capital, some of the supply chain constraints that we're seeing. We see places where we've been building inventory. And so the biggest constraint on that's causing our free cash flow projection for the full year to be 85% is working capital.

I don't think that's a permanent thing. I think that we will start to see some normalcy. In fact, we expect our working capital to be in total dollars to be coming down in the fourth quarter. And that's why we're expecting a pretty noticeable free cash flow generation in Q4 to benefit, it'll be benefited by higher profits in Q4, but even higher conversion as we bring down some of those working capital balances. It won't get to normal in 2022, but in 2023 and 2024, we see our working capital, the types of turns we have getting back closer to our normal range, which is why I say 100% is about right.

You mentioned a little at the beginning on Software & Control margin. Is there something in particular you wanted to talk about on that, Steve?

[Steve Tusa, J.P. Morgan]

Yes. I hopped on a little late, but the margin there was obviously very strong. Is there something – what was driving that outside of maybe just the – was it just the devices within that business, the price cost there? Or is there something else going on with the more software oriented revenue streams?

[Nick Gangestad, Chief Financial Officer]

Yes. First of all, it’s not being negatively impacted by software. That’s a nice growing part of the total software. Portfolio part of that business is portfolio. The three big things that were driving up the margin this quarter, one is the higher sales. This is a business that – as our sales go up, we clearly see the margin benefit impacting that. We were also benefited by price cost, looking from negative in the first half of the year to being positive in the third quarter, it will become even more positive in the fourth quarter.

And then finally, you maybe missed me say that earlier, earlier we were investing more in our Plex integration and while we’re still investing the level of investment in Plex integration is as planned coming down. And that’s another thing that’s helping our margin go up in software and control.

[Steve Tusa, J.P. Morgan]

Got it. Great. Thanks for the color.

[Operator]

The next question comes from a line of Andrew Obin [Bank of America]. Your line is open.

[Andrew Obin, Bank of America]

Hi. Yes. Good morning.

[Blake Moret, Chairman and Chief Executive Officer]

Hey Andrew.

[Nick Gangestad, Chief Financial Officer]

Hi, Andrew.

[Aijana Zellner, Head-Investor Relations]

Good morning.

[Andrew Obin, Bank of America]

Just a question in terms of, as we think about supply chain for chips. As far as you can tell, where are we in terms of adding capacity for what you need, right? Because based on talking to chip brokers, sort of lower end stuff that industrials use are still in very short supply. And my understanding is that the big hope is capacity additions in North America. At the same time, we’re hearing that not only you guys can get chips, but guys like Lam Research can get chips to provide the equipment. So where are we in terms of the scope and timing of capacity additions in North America over the next 12 to 18 months that would be relevant for Rockwell? Thank you.

[Blake Moret, Chairman and Chief Executive Officer]

Yes, it’s a good question, Andrew. And it supports the thesis of gradually improving supply. So obviously it’s important for us to continue to deepen relationships with our existing suppliers. And the ones that are going to be most important to us, going forward are ones for whom industrial is an important part of their business models. And as we talk to them specifically about the process nodes and the increased supply, that’s going to be important to us, we see some of that capacity starting to come online at the end of this calendar year.

So TI has a couple of plants coming online, analog devices, Intel with their Tower acquisition recently and some of their new investments. So we look closely at the new capacity and while a lot of it is in the leading edge notes for handsets and communications and so on for the suppliers that are most important to us, they are making investments in the fabs that are going to produce the wafers that ultimately result in the chips that are most important to us.

So when we go through our analysis product by product and chip by chip within those products, we look at are we getting increased allocation, are redesign efforts going to have an impact such as with the view terminals that I’ve talked about for the last couple of quarters. And we have some more of those projects that are coming to fruition here in the next few months and then the capacity additions that are coming from either our existing suppliers or in some cases, new suppliers that we’re adding to the list of qualified vendors there.

[Andrew Obin, Bank of America]

Thank you. And just a follow up question also to keep on chips. There is a lot of news on incremental semiconductor capacity coming into the U.S., specifically I think Samsung has filed with the state of Texas. And the spending seems to be very, very material. I think $200 billion is what the number is used. The pushback we get on this thesis that this is important for you guys is that historically, semiconductor end market just doesn’t represent a large vertical for you. Yet the spending number seems to be very material, right, very material impact on overall CapEx in the U.S. How should we think about opportunity in semiconductors for Rockwell? And are you having conversations with the folks who are in the news that would be material to your numbers over the next year or two? Thanks.

[Blake Moret, Chairman and Chief Executive Officer]

Yes. I would characterize the opportunity as growing both in terms of the base of total announced CapEx as well as our ability to serve. So traditionally the majority of our business in semiconductors has been the facilities management control systems, the FMCS systems, which are controlling the temperature and the cleanliness and the humidity of the air in the environment, particularly in clean rooms. And we’ve always had some capability in that space, turns out that Maverick is really good at that as well.

And so we considerably increased our expertise in that area. There are drives that go into those air handling systems, and we’re beginning to win a larger proportion of the drives in addition to the software and the engineering in those FMCS systems. And those are multimillion dollar systems. We’re one few of those here recently that are noteworthy. Independent cart for material handling is also a technology that we didn’t traditionally have.

And as that technology gets qualified for clean room environments, we’re seeing increased opportunities there. Cyber security, so obviously these fabs are very concerned about being resilient in that dimension as well. And we’ve got the best offering to go in on the production floor. So we’re seeing a lot of meaningful wins in cyber security as well. So those are just a few of the areas that we’re providing value, not only for the direct fabs themselves, but also for the capital equipment suppliers, which remain good customers of ours.

[Andrew Obin, Bank of America]

And as more incremental capacity sort of shifts to North America versus what we’ve seen Asia, does it create opportunities and adjacencies longer-term that have not been present just to grow organically or through M&A?

[Blake Moret, Chairman and Chief Executive Officer]

Yes, for sure, because you’ve got ecosystems. It’s one thing to announce a fab and for Intel or TI or Micron or Samsung to build their facility, but they need a village, right? They need an ecosystem in each of these areas for the chemicals that are need, the substrates, the lead frames, all of those things. And those are all opportunities for us, particularly in the U.S., where we have overwhelmingly the strongest support and installed base.

[Andrew Obin, Bank of America]

Very much.

[Operator]

Your final question comes from the line of Rob Mason. Your line is open.

[Unidentified Analyst]

Yes. Good morning. I had a question about the order pace. And what we’ve been seeing there it sounds like, orders will still stay solid in the fourth quarter, maybe up a little bit. Previously Blake you talked about some order pull forwards – pull ahead, I’m just curious how that dynamic is continuing to play out in the order rate if you’re still seeing that if it’s backed off. You talked about larger order sizes, whether that plays into that dynamic that you spoke to.

[Blake Moret, Chairman and Chief Executive Officer]

Yes. I think there’s still – some of what we’ve talked about in the past where, because the lead times are still long, they’re longer than we or our customers would like. People are placing orders to cover that spread between now and when they actually expect to get the materials. And we see that most market with the machinery builders, they have a certain amount of machines and in the past they might have only placed orders to cover X months of those bookings that they have in their backlog and their needs for our automation equipment. And they may have doubled that at this point to be able to cover that. But that’s the machine builders. And I think while we continue to see some of that, we hope to see over the coming quarters, those lead times pull in and we’ve seen some green shoots where we’ve seen some improvements in the lead times.

In fact, we’ve won some competitive business because we could deliver faster than competitors in certain areas. And as we see those lead times reduce naturally, we’ll see the orders from some of those machine builders, for instance, reduce a bit. They also have big backlogs. And so, they’re looking to get that material. But as shown by those continued low cancellation rates and as I mentioned earlier, these customers want the equipment they need it. And I can tell you from the conversations that we continue to have with the leadership of our customers, they continue to want that material just as fast as they can.

So that would be, I’d say the most tangible element of pull forward. But we don’t see people placing orders in the last quarter, the current quarter to avoid price increases and things like that. So I would say our order development continues to be healthy.

[Unidentified Analyst]

Very good. Just one quick follow up for Nick, just around price cost. It sounds like we’ll continue to get some incremental benefit in the fourth quarter. Is there a way to think about the year-over-year benefit? Do we top out in the fourth quarter and start to moderate as we go into 2023? Or are you still expecting that year-over-year benefit to rise as you go into 2023?

[Nick Gangestad, Chief Financial Officer]

So the fourth quarter will be the highest benefit of all the quarters, Rob. Well, I’m not guiding for 2023 yet. The first half of 2023 will be getting the benefit of the fact that we don’t anticipate it to be negative as it was in the first half of 2022. So just the absence of that negative, we think creates some year-on-year benefit in the first half of fiscal year 2023. I’m not yet guiding for the full year of 2023, what we’re expecting for the net price cost.

[Unidentified Analyst]

Understood. Thank you.

[Operator]

There are no further questions at this time. Ms. Zellner, I turn the call back over to you.

[Aijana Zellner, Head-Investor Relations]

Thanks, Rex. Okay. That concludes today’s call. Thank you for joining us.

[Operator]

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