Rockwell Automation, Inc.

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. If you have a question at that time, please press star one. At this time, I would like to turn the call over to Ajana Zellner, Head of Investor Relations. Ms. Zellner, please go ahead.

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 Moretz, our chairman and CEO, and Nick Gangstad, 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 the 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.

Thanks, Ayjana. And good morning, everyone. Thank you for joining us today. I want to also take this opportunity to congratulate Ayjana on her promotion since our last earnings call. Let's turn to our third quarter results on slide three. 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 order 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 and control organic sales growth of over 13% versus prior year was above expectations. Our strong performance here reflects both an improvement in the chip supply and some early benefits from the recent resiliency investments. Sales of our Vue operator interface panels, which we redesigned to optimize our component supply, were up almost 60% year over year. Our software sales through 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 and connected services orders and sales both grew strong double digits in the quarter, with particular strength in 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 a 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 Zebex, 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 FIX, 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 by 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%, and 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 four to review key highlights of our Q3 end market performance. As I mentioned earlier, while 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, Cherry 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 Duer Clean Technology Systems to provide an end-to-end coding process. from powder handling and slurry mixing to coating and drying. Semiconductor sales declined 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 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 Calco, a Brazilian nature-based ingredients manufacturer, who chose Rockwell and our 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 plan in China. A combination of industry-leading MES and IoT software and the multi-discipline Logix 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 continue 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 Prometheon Tire 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 grew 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 multi-million 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 five 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 six, an update to a new slide we had provided last quarter. As you can see, order cancellations remain 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 22 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 two and a half points of profitable growth, more than offsetting a two-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 and resiliency actions are progressing well. as we develop deeper relationships with key suppliers, complete redesigned 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 22. Nick?

Thank you, Blake, and good morning, everyone. I'll start on slide nine, 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 lifting 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 30th, $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 and 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 improved sequentially by 510 basis points driven by positive price cost and higher volume. Software and 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 again 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 21 to Q3 fiscal 22. Starting on the left, court performance was up about 15 cents, including about 25 cents from higher sales. Price cost contributed 5 cents. Strong execution led to about 10 cents 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 35 cents. In the prior year, we made about 10 cents of non-recurring accelerated investments that mostly impacted our software and control business. Currency negatively impacted our earnings by about 10 cents. On a year-over-year basis, incentive compensation was about a 20-cent tailwind. This brings us to our total adjusted EPS of $2.66. Let's move to the next slide, 12, our guidance for fiscal 22. We are updating our sales guidance to a new range of approximately $7.7 to $7.9 billion in fiscal 22, 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 2 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 the 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 22 free cash flow conversion of about 85% of adjusted income. A few additional comments on fiscal 22 guidance. Corporate and other expense is now projected to be around $110 million. Net interest expense for fiscal 22 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 deleveraging. 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 midpoints 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 5 cents. A more favorable tax rate adds 5 cents, 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 15 cents. With that, I'll turn it back over to Blake for some closing remarks before we start Q&A. Blake? 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, our relentless focus on helping customers creates long-term differentiation and value. Ajana will now begin the Q&A session.

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.

At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. Your first question comes from the line of Scott Davis. Your line is open.

Good morning, guys. Good morning, Ajana.

Morning.

A 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 there some way to kind of size that?

Hey, Scott, 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. Yeah.

Okay. Sorry, Blake.

Yeah. Scott, I was just going to add, you know, when we talk about orders, you know, just to give some scale to the magnitude of the orders, they remain around 45% above pre-pandemic level. So, in addition to the very large existing backlog, we're continuing to add that at a rate above our expectations.

No, that's good to hear. And then you gave the example, the cherry win example, Blake, which I thought was interesting. 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?

Scott, most of our transactions in a country like China are priced in U.S. dollars. 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.

Really helpful. All right, I'll pass it on.

Good luck. Thank you. Thanks, Scott.

Your next question comes from the line of Josh Pokerwinski. Your line is open.

Hi, good morning, team. Josh. Just software and control, you know, pretty solid quarter there, I guess. You know, 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 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 trend line would be helpful.

Sure. Well, Josh, you know, first of all, limited pull through or pull forward in that, you know, 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 and control as having less skews than intelligent devices. you know, the chip availability was relatively higher for software and control, being able to ship logics, compact logics, and the associated I.O. So in the quarter, it was less impacted. And again, you know, with the kind of backlog that we have and 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.

Got it. That's helpful. And then just a quick follow-up on the orders. Anything that you can kind of break down further in there, whether it's any currency headwinds. I know it's net of cancellations, but any kind of change in that growth, so have cancellations stepped up and you know, project size, like are those getting bigger or smaller? Thanks.

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.

And the FX piece, did that move around at all?

FX is one of the things impacting our orders within Europe, 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 total global orders that we reported in Q3.

Super helpful. Appreciate it. Best of luck. Your next question comes from the line of Julian Mitchell. Your line is open. Rex, let's move on to the next one. Excellent.

Your next question comes from Andy Kaplewicz. Your line is open.

Hey, good morning, everyone. Good morning, Andy. Blake, can you elaborate on your comments regarding an improving supply chain? Did you see continued improvement in component availability throughout the quarter and through July here? And I know you mentioned chips starting to get better. Maybe give us a little more color around that. Do you have visibility toward more normalized growth, you know, less pressure by supply chain as you go into FY23?

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, you know, we saw the more severe changes 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 continue to see gradual improvement in Q4 and into our fiscal year 23. But it remains a volatile situation. You can't count the chips until they show up on your receiving dock, but we do see a gradual improvement that continues into the, you know, early part of Q4.

And thanks for that, Blake. And then, Blake or Nick, I know you don't want to talk too much about 23, but, you know, when you think about incremental margin, obviously it's picked up here in the second half, as you said, Nick. You know, as you look at next year, maybe talk about the puts and takes. You know, remind us about investment spend and incentive comp as we're in the second half at this point. And then, you know, obviously growth is picking up. Usually you guide to 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?

Yeah, so some of the puts and takes that we're thinking about for fiscal year 23, 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 23. So all of those things in, oh, the other one, 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 23. All of those things in combination, we think our financial framework around core conversion of 30% to 35% remains a good starting point to think about 23 and profit and margin expansion for us.

Thanks for that, Nick. Your next question comes from the line of Julian Mitchell.

Your line is open.

Thanks very much and good morning. Nick, I know there was an effort there to talk about next year's EBIT bridge moving parts, but if we just focus on 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, you know, 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 five cents figure, but anything perhaps to mention on investment spend or productivity or the incentive comp for Q4?

Yeah, in Q4, a couple things that are changing. I had mentioned in my prepared remarks, corporate items, well, it's a a benefit for Q3. We expect some of that is timing and will 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 than 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.

That's very helpful. Thank you, Nick. And then maybe sort of a broader question. The software and 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 second fiscal half overall, you have a low 30s sort of software and control operating margin. Is that a reasonable sort of run rate looking into 23 and the medium term, or are there any sort of exceptional mixed tailwinds or something that you'd call out that are bolstering that software and control margin right now?

Yeah, so a few things to keep in mind when you're looking at the margins that we've been experiencing and experiencing right now. Now, the higher margin that we had in Q3, our 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, 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 and control.

That's very helpful. Thank you. Your next question comes from the line of Noah K. Your line is open.

It's interesting, the question. You know, Blake, obviously, it 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 and possibly in the longer cycle type parts of the business? You know, it can all be green lights at this point. So I'm 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.

Yeah, thanks, Noah. You know, I think e-commerce in particular has been the outlier that we've seen so far in that they've taken a pause in some of the expansion areas. 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 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, you know, 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, you know, a positive IP number in our served markets, especially in the U.S. So EV continues strong. You know, 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, you know, too much against these verticals. But again, e-commerce, we have seen some softening. And in general, the closer to the consumer you are, you know, maybe recreational vehicles. But that's obviously, it's not a big part of our overall auto number there.

Yeah. 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 relatively stronger orders trends on some of your cloud-native offerings? Can you talk about that balance generation? Sure.

No, it's a good question. I mean, you know, 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, you know, to either acquire the assets, you know, servers and such, and the IT staff you can deploy a cloud-native solution much quicker. And that's why, you know, offerings like Plex and Fix 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, you know, 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. You know, these are new verticals that they just didn't have the resources to address, and we're seeing some wins there. And similarly with FIX, 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 partnership. on-prem offering with our production center-based MES that continues to grow well, and then Plex and Fix are doing what we expected them to do for us.

Okay. Thanks for the call, Blake. Appreciate it. Sure.

Your next question comes from the line of Steve Tusa. Your line is open.

Hey, good morning. Hey, Steve. Good morning, Steve.

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

Yeah, orders are going quite well in process. And I would say, you know, 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, you know, 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 with Schlumberger, Sensia, Calypso, you know, that expertise along with the steady drumbeat of new technology introductions, are helping to 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.

Just to follow up on the S&C margin and then the cash flow, Nick, what do you think is your long-term cash conversion? 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, 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?

Yeah, thanks for that question, Steve. On the cash flow conversion side, 100% is what I consider our normal run rate. In fiscal year 22, 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 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 in total dollars to be coming down in the fourth quarter. And that's why we're expecting a pretty 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 bounces. It won't get to normal in 22, but in 23 and 24, 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 and control margin. Is there something in particular you wanted to talk about on that, Steve?

Yeah, 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?

Yeah, 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's 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 these. margin benefit impacting that. We were also benefited by price cost flipping from negative in the first half of the year to being positive in the third quarter and 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.

Got it. Great. Thanks, Dr. Keller.

Yep.

Your next question comes from the line of Andrew Obin. Your line is open.

Yes.

Good morning.

Good morning. Hey, Andrew. Hi, Andrew. Morning. Hey. How are you? 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 Lamb 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.

Yeah, it's a good question, Andrew. You know, 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, you know, 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 the end of this calendar year. So, you know, TI has a couple of plants coming online, analog devices, Intel, you know, with their tower acquisition recently and some of their new investments. So we look closely at, you know, the new capacity, and while a lot of it is in the leading edge nodes 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, you know, 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, you know, are we getting increased allocation? Are redesign efforts going to have an impact, such as with the VUE 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.

Thank you. And just a follow-up question also to keep it on chips. You know, there's 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, you know, the spending seems to be very, very material. I think $200 billion is what the number is used. You know, the pushback we get on this thesis that this is important for you guys is that historically, You know, 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.

Yeah, I would characterize the opportunity as growing both in terms of, you know, the base of total announced capex as well as our ability to serve. So traditionally, the majority of our business in semiconductor has been the facilities management control systems, the FMCS systems, which are, you know, 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've won a few of those here recently that are noteworthy. Independent cart for material handling is also a technology, you know, that we didn't traditionally have. And as that technology gets qualified for clean room environments, we're seeing increased opportunities there. Cybersecurity. So, you know, 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 cybersecurity 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.

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 you have not been present just to grow organically or through M&A?

Yeah, for sure, because you've got ecosystems. You know, it's one thing to announce a fab and, you know, for Intel or TI or, you know, Micron or Samsung. know to build their facility but they need a village right they need an ecosystem in each of these areas for the uh chemicals that are need the substrates the lead frames all of those things uh and those are all opportunities for us particularly in the us you know where we have uh you know overwhelmingly the strongest support uh and uh installed base very much

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

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 aheads. 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. accelerating. You talked about larger order sizes, whether that plays into that dynamic that you spoke to.

Yeah, 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, you know, only placed orders to cover X months of that, those bookings that they have in their backlog and their needs for our automation equipment. And they may have doubled that, you know, at this point to be able to cover that. But that's the machine builders. And I think, you know, 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.

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 23, or are you still expecting that year-over-year benefit to rise as you go into 23?

So the fourth quarter will be the highest benefit of all the quarters, Rob. While I'm not guiding for 23 yet, the first half of 23 will be getting the benefits of of the fact that we don't anticipate it to be negative as it was in the first half of 22. So just the absence of that negative we think creates some year-on-year benefit in the first half of fiscal year 23. I'm not yet guiding for the full year of 23 what we're expecting for the net price cost.

Understood. Thank you.

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

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

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