Emerson Electric Company

Good morning and welcome to the Emerson First Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Colleen Nettler. 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 Karnabai, Chief Financial Officer Frank Delaquilla, 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 two. This presentation may include forward-looking statements which contain a degree of business risk and uncertainty. Please take time to read the Safe Harbor Statement and note on the non-GAAP measures. Turning to slide three, I would like to highlight a few exciting accomplishments for Emerson this quarter. First, in December, Emerson announced the acquisition of META Technique, a leader in wind power control automation. META Technique brings specific control design expertise complementing our existing Emerson Ovation and Power portfolio. We are very excited to welcome the META Technique team to Emerson and its ability to expand our renewable power generation capabilities. 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 Plus 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 Karzanbai 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 5th 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 five 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 in Jim Turley, a great partner for the shareholders and the management of this company. Number two, 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 am very proud of the diversity targets we established to double representation of women and U.S. minorities in leadership by 2030. Number three, strengthening any business starts with strengthening its culture. Culture transformation is well underway at Emerson, and it includes a redesign of the Emerson management process into a new, modern, cohesive system. Number four, think boldly. Emerson is a storied 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 five, 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 is 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 and residential solutions. The trailing three-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 a new energy economy startup customer in hydrogen or 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 tattoos and 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 margins, 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 solution 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 three 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 a 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's no other team I'd rather do it with than this team here at Emerson. Let's now turn to chart five, please. We continue to see increasingly strong levels of demand across both platforms and all world areas. In commercial and residential solutions, trailing three-month orders were up 13 percent, continuing 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 US and Europe. The trailing three-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 grid 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 six. Excuse me. First, let's start on the left of the chart. Emerson was recently awarded two 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. You upgraded systems utilizing Delta V 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 and reducing energy and load requirements. Solutions like this can help customers use up to 30% less energy in their operations. That's a very critical number. And that's a critical piece of what 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 project, basing an electrolyzer on an offshore platform with nearby offshore wind power generation. Offshore wind will power the electrolysis of demineralized seawater to produce hydrogen, which will then be transported to shore for integration with natural gas in the national gas grid. Working as one of the key consortium partners with Neptune Energy, Emerson will deploy Delta-B 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. We're very excited with this partnership. These are just three examples of how Emerson is assisting our current and new customers on their net zero and sustainability journey. And with that, I'll pass the call over to Frank Dellaquilla, who will go through our financial results for the first quarter.

Thank you, Lyle, and good morning, everyone. Appreciate you joining us. If you would please join me on slide seven, I'll go through the quarter. As Lyle mentioned, the quarter was very strong. Our businesses 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 and 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, adjusted 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 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. KOB3 activity continues to be strong, rising to 60% of sales in the quarter. Sales were one 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 and residential solutions was also very strong. Underlying sales increased 13%, including five 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 whole 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 costs, 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 5 cents despite a 6-cent headwind from tax attributable to some internal reorganizations. So as you can see, the non-operating 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, Aspen Tech transaction fees, first-year purchase accounting, and the gain from our averted subordinated interest that we recorded in the first quarter. Operations leveraged at over 30% and contributed 10 cents to EPS. Share repurchase was about $260 million and added 2 cents. 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 nine. 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 push-outs from our suppliers are 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 redesign 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 us turnover remains high, but it's 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're 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 team 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, Rob. If you would, please join me on slide 11, and I'll go through the outlook for the rest of the year. As Lyle 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 Lau described, continue to be a key driver for our business. And although electronic component availability challenges will continue to limit topside 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 Ron 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 guide. In commercial and 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 and 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%. The Automation Solutions Guide increases to 7% to 9%, and Commercial and Residential Solutions increases to 9% to 11%, all on an underlying basis. We did increase our price-cost guide to favorable $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 two items related to the Aspen Tech transactions. 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 471 to 486. The adjusted EPS guide, which excludes those items, increases to $4.90 to $5.05. To be clear, no estimate of the operational impact of Aspen Tech 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.

Yeah, 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 times, Frank, the Aspen Tech 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 a traditional customer base. We are on track to close the transaction as previously communicated in the second calendar quarter of 2022. With that, turn to Q&A.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Dean Dre with RBC Capital Markets. Please go ahead.

Thank you. Good morning, everyone.

Hi, Dean. Good morning.

Good morning, Dean. Hey, a couple of questions. The first, well, 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 KOB3 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, 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 span. So two questions, thanks.

Yeah, thanks, Dean. So very quick 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, Dean, 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 in 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 I look forward to that later in the year. Related to your COB3, the number is 60, 60%. I apologize if I didn't come across clearly in the 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, Dean, that we had a significant amount of delayed maintenance that occurred in most of these plants through COVID where staffs left and a lot of what needed to be done just wasn't done over periods of as much as a year and a half. So all of that is a bit of a catch-up that's occurring in the plants. In terms of K.O.B.1, again, the funnel is at $6.5 billion today. It's pretty much been stable over the last 12, 18 months. We're watching that carefully as we execute the LNG wave we've completed. There's a few things, obviously, in Qatar that will come our way, so we're watching that carefully. But that deferred maintenance and the modernization, sustainability, and digital is what's driving the bulk of the KOB3 to a large extent for us as well. Thank you. Thanks.

Our next question comes from Andy Kaplowitz with Citigroup. Please go ahead.

Good morning, guys. Good morning, Andy. Last quarter, you mentioned good confidence in 30% incremental margins for the company for FY22. 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 We're 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, I appreciate the question, Dean. 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 all for dollar on incrementals on automation. But I expect that to normalize as we go through the year, and I think that 30% guide is So 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 nothing one time in the quarter per se in that business, right? Oh, no. No, sir. Got it. And then... I think your comments were exactly in line with Aspen Tech Management's comments. 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 in the upstream markets? I mean, 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 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 and production. And I expect that to be strong. So it's consistent with what Aston Tech has seen. across the process industries, which has been a bit of a laggard to discrete, obviously, and hybrid that we experienced through 2021. Thanks, Will. I appreciate it. Thank you.

Our next question comes from Steve Tusa, JP Morgan. Please go ahead.

Hi, guys. Good morning. Morning, Steve.

Good morning, Steve.

Hey, can we just get a little 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 you're guiding to an expanded spread there. How much of that spread is from – I would assume all of that spread is from increased price, and ultimately what's your price capture this year in revenue?

Yeah. Hi, Steve. This is Frank. So, you know, 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 two items. So in terms of how the thing models out, I mean, we will... You know, 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 in revenues, percentage-wise?

Yeah, 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 your Resi HAC business. Is there a quarter this year? that you're planning to be down on that business is kind of, you know, 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.

It could be tight in the fourth quarter, Steve.

Yeah, down volume in the fourth quarter, but we'll be, you know, obviously we're getting price, so I think we'll be right around flat in the fourth quarter from a rising perspective, but down volume. Got it. Great. Thanks, guys. Thank you, Steve.

Our next question comes from Andrew Obid with Bank of America. Please go ahead.

Yes. Good morning.

Hi, Andrew.

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, you know, 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? Thank you.

Yeah, look, we continue to be very excited about the commercial opportunities with Aspen Tech, 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, Andrew. Even I, as I make customer calls in Houston three weeks ago, engaged at both the Emerson and the Ascotek level in terms of defining opportunities across those businesses. So I think those will come into more clarity as we get closer to close. In terms of the software assets, Ron, if you want to comment on the performance of the assets.

Yeah, I think the two software businesses, GSS and OSI, had a very, very good first quarter. 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, Andrew, I think we were up 2% on systems and solutions, and primarily that was driven by electronic shortages in our systems business, our Delta V 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.

Thank you. And just to follow up on commercial and 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? Thank you.

Yeah, 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 you know, the transition that's going to happen Jan 1st. 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. Thanks so much. Thanks, Andrew.

Our next question comes from Nigel Coe with Wolf Research. Please go ahead.

Thanks. Good morning, everyone. So I just want to go back to the price-cost, you know, Steve's question. Is that $175 still being captured, you know, wholly within Comres, or is it spread more across the two segments? I think the $100 was primarily within Comres.

Yeah, 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 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.

Okay, thanks Frank. And then on AS, you know, obviously the margins that have been touched on already, you know, 1Q is normally the weakest, or rather the lowest quarter for margins. So I'm just curious, you know, this is not a normal year or anything, but would you still expect 1Q to be the low bar for margins and sequential improvement from there? Then just on the guide for 7 to 9, To get to the mid to high end in that range would require a pretty significant ramp up in the second half of the year. I'm just curious, you know, what does the backlog tell us about the second half and how much confidence 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. But 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 and the backlog more than supports that, and it's all about conversion. 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. We feel pretty good about it.

Great. Thank you very much.

You're welcome.

Our next question comes from Joe Ritchie with Goldman Sachs. Please go ahead. Thanks. Good morning, everyone.

Good morning, Joe. Good morning, Joe. My apologies if I missed this earlier, but I know you spoke a little bit about KOB 1, you know, roughly six and a half 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, you know, I had the opportunity to spend a few days in Houston with customers face-to-face, which was 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 a billion dollars 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 KOP1s that do remain, whether they're North America-based LNG or Qatar. Those are moving forward. We've 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 COB1 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 six and a half, but we could tell you that the pace of FIDs or final investment decisions continue to improve just given the 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. So it's clearly, obviously, you know, it's the large acquisition at the end of last year on the software side. I'm just curious, like, 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 comparatives 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, you know, we'll stay active. Our balance sheet is in very good shape. I think we have firepower if we're 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 there, 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.

Okay, great. Thank you. Nice start to the year. Thank you, sir.

Thank you.

Our next question comes from Marcus Mittermeier with UBS. Please go ahead.

Hi. Good morning, everyone.

Good morning, Marcus.

Hi. morning um if i could come back to the budget please um i understand it's shifting increasingly to sustainability as you said where would you characterize sort of the absolute level of these budgets versus say you know the last cycle peak in 1819 sort of um maybe that's one question trying to get to the total profit pool and then how easy is it now to get these budgets released when you when you speak to your customers

Okay, sure, sure, Marcus. I'll be happy to give you some insights. So year over year from last year, budgets overall, or the size of budgets, they're up undoubtedly on the KOB1 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 out, outlaid to increase capacity of LNG. So they're down on that basis. overall so you know 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 finer question on the comments around redesign of products I know you have to have to do that given the shortages of

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 chip and I 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, Marcus. This is Ron 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 Volander and his team are fundamentally redesigning components 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, you know, 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.

Got it. Thank you. Good luck.

Thank you.

Our next question comes from John Walsh with Credit Suisse. Please go ahead.

Hi. Good morning, everyone. Hi, John. John, good morning.

Hi.

Maybe a first question just around China. Obviously, you called out very strongly growth there around sustainability, de-carb, 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 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. But we 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 businesses, I think, testament to that.

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 reduction has been mentioned several times. You have product that helped that. Are you actually seeing sales today that can attach, you know, that as the reason for why you're getting the sales order? Just thinking about how they have to upgrade their install 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 one of the examples that I shared with you at the offset around emissions was exactly that. So 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, Rob, if you've got something to add.

Yeah, 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 his 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.

Great. Appreciate the color, and I'll pass it along. Thank you.

Thank you, sir. Thank you, John.

Our next question comes from Tommy Moll with Stevens. Please go ahead.

Good morning, and thanks for taking my questions. Thanks, Tommy. I wanted to circle back on the strong implied exit rate for your auto sale 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?

Now, look, I'll give you a perspective from an industry perspective, Tommy, and just from a world view 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. Potential. Potential. That's the potential that we see out there. geographically 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 better.

Thank you, Alan. 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, hi. 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'll 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. You know, if there is a divestiture and there's no... major divestiture in flight right now, but obviously if there's any divestiture, you know, those proceeds will go towards the cash portion of the purchase.

Thank you, Frank. I appreciate it, and I'll turn it back.

You're welcome.

Our last question today will come from Jeff Sprague with Vertical Research Partners. Please go ahead.

Thank you. Good morning, everyone. Jeff, good morning. I'll make it one question because my second was about divestitures, which Frank just addressed. I'm just wondering if you could give us a little color on actually labor costs 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, yeah, 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 1st, they increased minimum wage, entry-level wage by 22%, and frankly, this is one of four 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 plants, 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.

Can you size labor as a percent of COGS, maybe Frank?

DL is about high single digits.

Obviously a little higher in climate tech and commercial residential, a little lower in automation solutions, but high single digits on the profit waterfall as a percent of sales.

Great. Thanks for that, Collin. I'll leave it there.

Thank you, Jeff. Thanks, Josh.

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