Rockwell Automation, Inc.

Q2 2024 Earnings Conference Call

5/7/2024

spk05: released earlier this morning and the press release and charts have been posted to our website. Both the press release and charts include, and our call today will reference, non-GAAP measures. Both the press release and charts include reconciliations of these non-GAAP measures. A webcast of this call will be available on our website for replay for the next 30 days. For your convenience, a transcript of our prepared remarks will also be available on our website at the conclusion of today's call. Before we get started, I need to remind you that our comments will include statements related to the expected future results of our company and are therefore forward-looking statements. Our actual results may differ materially from our projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all our SEC filings. With that, I'll hand it over to Blake.
spk04: Thanks, Sajana, and good morning, everyone. Thank you for joining us today. Before we return to our second quarter results on slide three, I'll make some initial comments. At a high level, our performance in Q2 was good, but I am not happy with the reduced guidance for the full year. The impact of high inventory levels at machine builders is larger than we expected. Borders are still expected to return to -over-year growth in Q3 and continue to increase during the year, but the slower ramp is impacting shipments for the second half. Consequently, here's what we are doing. We are accelerating actions to bring costs in line with the revised outlook on current year orders aligned with the more comprehensive program to expand margins introduced during our investor day in November. We will save $100 million in the second half of this year from accelerated actions being taken now, creating a beneficial starting point for fiscal year 25. We will see incremental savings of $120 million next year from these actions alone, plus a larger amount of additional savings from the more comprehensive program targeting sourcing, manufacturing, and SG&A. And we will provide a more detailed view of this program on our next earnings call. We are improving our forecasting with new perspectives on the team, processes that include a deeper analysis of channel information, and better decision support technology. I'm optimistic about our position when we exit fiscal year 24, regardless of next year's growth, for several reasons. Rockwell has built an unmatched portfolio to meet the world's growing need for smart manufacturing. Our home market, North America, is expected to grow faster than the worldwide PAM. We are winning major new business today with both our traditional offerings and new sources of value across discrete, hybrid, and process industries. As we couple this with our focus on margin expansion through cost discipline, operational excellence, and organic growth, we will achieve the longer range targets introduced in November and create significant share owner value. Turning to the quarter, as we indicate on slide three, we return to good operational performance in the second quarter with both organic sales and adjusted EPS above our expectations. Sales of product, configured order offerings, software, and lifecycle services were all at or above our forecast. In products, we converted incoming orders at a much higher level than in Q1, and we now have sufficient mix of safety stock in place to convert orders at the current level or higher through the fiscal year. We are essentially back to booking and billing product orders in the quarter they are received at pre-pandemic conversion rates. Our orders were up low double digits sequentially. With continued recovery across all business segments and regions, North America had the highest sequential increase in the quarter. Year over year, total sales were .5% in the quarter based on an organic sales decline of 8% and a .5% of acquisition growth. In our intelligent devices segment, organic sales declined about .5% year over year. I am pleased with our execution to meet our shipping commitments and build safety stock in the quarter for these products. We also continue to see strong performance from our recent ClearPath acquisition, with sales of autonomous mobile robots contributing almost two and a half points to ITD growth in the quarter. One notable ClearPath win this quarter was with the Hershey Company. The Hershey Company continues to advance digital capabilities to enhance agility and efficiency across its operations, including supply chain and manufacturing processes. As part of their efforts, Hershey has selected auto motors technology to improve productivity in both fulfillment and manufacturing operations. Q2 margin performance for ClearPath was also better than expected. Software and control organic sales were down 23% versus prior year, largely as we expected. As you know, this segment is significantly impacted by difficult year over year comparables in our Logix business. In Q2 of last year, we had 42% growth in software and control. There are particularly high levels of these products in inventory at our machine builders. Despite this temporary correction, we are gaining Logix share and winning new business across our software and hardware offerings. I am proud of the vitality of our product development here, demonstrated by recent organic product launches and partnerships with Microsoft and Nvidia that are focused on specific customer use cases, especially those that will benefit from simulation and simplification using artificial intelligence. These partners recognize that machines and manufacturing processes represent an enormous, largely untapped source of data and petabytes of this data flow through our controllers. They also know we have the manufacturing domain expertise to select the best use cases for their technology. Life cycle services organic sales grew over 12% year over year and continue to outperform our expectations, driven by strong process and markets. Book two bill in this segment was 1.07, led by good order growth in our solutions and Sensia businesses. Our Sensia JV saw another quarter of over 25% year over year sales growth in Q2. The life cycle services segment also continues to contribute strong growth from our high value services, including cyber security, which saw orders growth of almost 50% in the quarter. We are making substantial progress to expand life cycle services margin. We saw 16% margin this quarter and we're not done working on the performance of this business segment. Total ARR was up 20% again this quarter. We continue to see strong, profitable, recurring growth from both high value services and software. Rockwell's segment margin was 19% and we're at 17%. This would have been about 17% without the reversal of the bonus accrual we recorded in the quarter. Adjusted EPS of $2.50 was above our expectations even after adjusting for the reversal of the bonus accrual. Nick will cover this in more detail later on the call. Let's now turn to slide four to review key highlights of our Q2 industry segment performance. Sales in our discrete industries were down high teens versus prior year. The impact of high product inventory levels in the channel are most pronounced in our discrete and hybrid industry segments. Automotive, e-commerce, and other warehouse automation sales were all impacted. Within discrete, automotive sales were down 20%. Much of this year over year weakness is driven by excess product inventory in our channel. However, we're also starting to see some impact on our fiscal 24 sales as customers take time to reevaluate the timing of their EV investments. While we are not seeing any EV or battery project cancellations, we are seeing push outs of certain production start dates. As we mentioned, given our strong install base and expanded portfolio, Rockwell is well positioned with automotive customers whether they are investing in electric vehicles or adding more hybrid options in the near term. They are all interested in increasing efficiency. In addition to our traditional sources of value, ClearPath autonomous mobile robots helped us secure over half a dozen wins with major brand owners and tier one suppliers this quarter. Semiconductor sales declined 25% year over year with continued geopolitical pressures and a temporary oversupply of legacy chips weighing on semi-customers capex investments. Our sales in e-commerce and warehouse automation were down high teens this quarter. We did see an improvement in sequential growth and increased our full year sales outlook. We're traditional retailers and global shipping and logistics customers. Turning to our hybrid sales, this industry segment was down mid teens year over year. The weakness in this industry segment was led by food and beverage and home and personal care. Food and beverage sales declined 20% in the quarter driven by slower activity at our packaging OEMs who are still working through their excess inventory. There are also some signs of slower end user capex spend. Food and beverage end users are continuing to fund capacity expansion in emerging markets like India and Southeast Asia and modernization and resilience projects across their existing facilities. We had wins in the quarter including the AMR project I mentioned earlier and cyber security projects at new customers. Life sciences sales were down high single digits. Results in the quarter were mainly driven by project delays, especially in China. Outside of that region, we continue to expand our installed base with newer software and hardware offerings. One example of new value in this vertical was an important Q2 order with an innovative contract manufacturer, National Resilience, who selected ClearPak comprehensive AMR solution as they bring cell and gene therapies to market. Moving to process, our sales here grew high single digits year over year, supported by continued strength in oil and gas and mining. Oil and gas sales were up over 20% this quarter with continued momentum in energy transition projects. In Q2, we secured multiple decarbonization projects including applications for carbon capture, storage and hydrogen. Let's turn to slide five in our Q2 organic regional sales. The Americas continue to be our strongest region this year with Latin America growing 8% versus prior year and North America organic sales down about 4% in the quarter. EMEA sales decreased 19% due to high machine builder inventory in Germany and Italy, particularly in consumer packaged goods. Asia Pacific sales declined 17% in the quarter with sales in China down almost 30% versus prior year. We expect a combination of weaker market conditions and slower distributor de-stocking to continue to impact our China performance through the balance of this fiscal year. Moving to slide six for a fiscal 2024 outlook. As I mentioned at an investor conference in March, while orders continue to increase sequentially from the trough in Q4 of last fiscal year, we have not yet seen the acceleration we expect once distributors and machine builders work through their excess inventory. The result is that some of the demand they are seeing does not to an equal amount of orders placed on Rockwell. I also said that if the pace of orders continued on its current trajectory, we would expect our full year 2024 financial results to track closer to the low end of both our organic growth and EPS range. Since then, we have seen lower than expected order activity. While distributors and machine builders are continuing to work through their excess inventory, we have underestimated the amount of overstock at our machine builders. Based on information received directly from our largest machine builders, our downward revision is based largely on the size of their inventory and the expected pace of the reduction, resulting in a slower ramp of orders in the fiscal year. Again, we do expect to return to -over-year growth in orders for the third quarter, and our updated forecast still implies sequential order growth in Q3 and Q4. We believe we are taking share in our major product lines, globally and in the U.S. North America is our strongest market, and we are starting to see an increased order impact from customer megaprojects as the year progresses. We now expect our full year orders to be down low single digits versus prior year. Based on our performance to date in the lower than expected order ramp, we are revising our fiscal 24 sales guidance range with organic sales projected to decline 7% at the midpoint, and we continue to expect acquisitions to contribute a point and a half of growth. ARR is still expected to grow about 15%. Segment margin of 20% is now expected to decline versus prior year, which still implies an increase in the second half and specifically in fiscal Q4, driven by higher volume and the accelerated cost down actions I mentioned earlier. Nick will share additional detail in his section. Adjusted EPS is slated to decrease 13% -over-year at the midpoint. We are increasing plan share repurchases to roughly double our original plan for the year, and we expect free cash flow conversion of 80%. This is a reduction from our prior guide, and Nick will cover this in more detail later. The reduced guide for the fiscal year only strengthens our commitment to building a strong foundation for future growth and profitability. The company-wide program to comprehensively take cost out of our products and operations will positively impact our results next year. Savings will be used to expand margins and reinvest to drive future growth. We will provide additional detail no later than the Q3 earnings call. Our intention is to manage our business segments for consistent, forecastable performance. You have also seen the announcement of Nick's upcoming retirement. A search has been underway, and we expect to announce a new CFO in the coming months. Nick will be fully engaged in the transition to his successor, and he will now provide more detail on our Q2 performance and financial outlook for fiscal 24. Nick?
spk03: Thank you, Blake, and good morning, everyone. Although my family and I are excited about what comes next in retirement, my continued focus is on delivering our plans for this year and ensuring a smooth, seamless transition to a new CFO. I'll start on slide seven, second quarter key financial information. Second quarter reported sales were down .6% compared to last year. Q2 organic sales were down 8.1%, and acquisitions contributed 140 basis points to total growth. Currency translation increased sales by 10 basis points, and about 150 basis points of our organic growth came from price, in line with our projections. Segment operating margin was 19% compared to .3% a year ago. This 230 basis point decrease reflects lower sales volume, partially offset by lower incentive compensation. Adjusted EPS of $2.50 was higher than expectations. Given our lowered outlook for fiscal 24, we did not accrue any bonus expense in Q2, and we reversed the prior quarter bonus accrual. This resulted in a total adjusted EPS benefit of approximately 30 cents in the quarter. Even without the bonus impact, our Q2 adjusted EPS was ahead of our expectation due to better than expected conversion of incoming orders into sales. I'll cover a -over-year adjusted EPS bridge on a later slide. Adjusted effective tax rate for the second quarter was .8% below the prior year rate. Free cash flow was $69 million compared to $156 million in the prior year. Our lower -over-year free cash flow generation in the quarter was driven by lower pretax income and higher tax payments, partially offset by decreases in working capital. The increased tax payments relate to our gain on our sale of PTC shares in fiscal year 23 and our payments on the 2018 TCJA transition tax. One additional item not shown on the slide. We repurchased approximately 700,000 shares in the quarter at a cost of $195 million. On March 30, $600 million remained available under our repurchase authorization. Slide 8 provides the sales and margin performance overview of our three operating segments. Intelligent devices margin decreased to .5% compared to .2% a year ago. The decrease from the prior year was driven by lower sales volume and unfavorable mix, partially offset by lower incentive compensation. Higher sequential margin was driven by better volume and lower incentive compensation, partially offset by mix. Software and control margin of .7% decreased from .6% last year. The lower margin was driven by lower sales volume, partially offset by lower incentive compensation, positive price cost, and favorable mix, driven by higher software sales. Higher sequential margin was driven by lower incentive compensation, partially offset by lower volume. Life cycle services margin of .6% tripled from a year ago margin of 5.5%. The margin performance was driven by lower incentive compensation, higher sales, and higher margins in Centsia. Higher sequential margin was driven by volume, lower incentive compensation, and ongoing improvements in productivity. Life cycle services booked to bill was 1.07, indicating continued strength and underlying demand. The next slide, 9, provides the adjusted EPS walk from Q2 fiscal 23 to Q2 fiscal 24. Core performance was down $1.15 on an 8% organic sales decline. The EPS decline was driven by lower volume and unfavorable mix, and was partially offset by positive price cost. Incentive compensation was a 55-cent tailwind. This -over-year improvement reflects no projected bonus payout this year versus an above-target payout last year. The dilution impact from equity was in positions with neutral due to better than expected profitability in ClearPath and VIRB. The -over-year impact from tax was a 10-cent tailwind. Let's now move on to the next slide, 10, guidance for fiscal 24. We are lowering our guidance for fiscal 24. We now expect reported sales to decline in the range of negative 6 to negative 4%, and organic sales to decline in the range of negative 8 to negative 6%. As Blake mentioned earlier, we continue to expect acquisitions to add 150 basis points to growth. We now expect currency to contribute about 50 basis points to growth as we are seeing continued strengthening of the U.S. dollar. We continue to expect price to be a positive contributor to growth for the year. We expect the full-year adjusted effective tax rate to be around 17%. We are lowering our adjusted ETS guidance to a range of $10 to $11. We now expect full-year fiscal 24 free cash flow conversion of about 80% of adjusted income. The lowered expectations for free cash flow conversion is driven by the fact that the positive earnings impact from zero incentive compensation recorded this fiscal year does not result in better cash generation this year. This is because the payout of any annual incentive compensation occurs in the first quarter of the following fiscal year. Therefore, we will see the benefit of this on our cash flow conversion in fiscal year 25. From an inventory standpoint, we continue to expect that inventory days on hand will drop to 125 days by the end of fiscal year 24 compared to the 140 days of inventory we had at the end of fiscal year 23. From a calendarization perspective, we expect -single-digit sequential order growth in Q3 and high teens sequential order growth in Q4. We expect Q3 sales, dollars, and segment margin to be lower than Q2 levels. Now that we have largely cleared our product backlog, we are generating most of our product sales from new orders in the quarter, which are ramping up slower than we expected. We expect Q4 to be the highest revenue dollar and margin quarter of the year. From a sequential margin perspective, we expect margins in Q3 to be about 250 basis points lower than in Q2 due to the non-repeat of the bonus accrual reversal that benefited Q2, also lower volume and mix. By segment, we expect our Q3 margins to be up slightly in intelligent devices, down significantly in software and control due to lower Logix controller sales and flat and lifecycle services. As Blake mentioned, we are adjusting our spending level with the lower outlook for this fiscal year. Last quarter, we expected our full-year 24 investment spending to increase by $60 million year over year or to be up about 2%. We now expect our full-year spend to be down approximately $50 million versus prior year. This roughly $100 million spend reduction in the second half of fiscal 24 is driven by a combination of structural and temporary cost-out actions, which will help protect our margins in the current fiscal year and will set the right foundation for fiscal year 25 and beyond. Some examples of temporary cost reductions items include not filling open positions, reducing contractor spend and further reducing our travel and marketing spend for the year. In terms of structural actions, we are expecting about $60 million of restructuring charges related to headcount reductions in the second half of the fiscal year. The expected restructuring charges are excluded from our adjusted EPS. These savings in our continued cost structure optimization are aligned with our longer-term productivity focus and profitability targets. A few additional comments on fiscal 24 guidance. Corporate and other expenses now expected to be around $130 million. We are assuming average diluted shares outstanding of 114.3 million shares. We expect to deploy between $600 million and $800 million to share repurchases during the year. This is an increase from our prior range of $300 million to $500 million and reflects a higher near-term prioritization of returning cash to shareholders versus acquisitions. Net interest expense for fiscal 24 is now expected to be about $135 million. With that, I'll turn it back over to Blake for some closing remarks before we start Q&A. Thanks, Nick.
spk04: We are focused on getting synergies and efficiencies throughout the entire organization. The portfolio of capabilities that we have built and bought is second to none and now is the time to knit all these pieces together. This will help us drive more customer value, efficiency and cost savings which in turn will yield higher margins and funds for reinvestment. Aishana will now begin the Q&A session.
spk05: Thanks, Blake. We would like to get to as many of you as possible so please limit yourself to one question and a quick follow-up. Julianne, let's take our first question.
spk06: Certainly. If you would like to ask a question, please press star followed by the number one on your telephone keypad. To withdraw any questions, press star one again. Our first question comes from Andy Kaplewitz from Citigroup. Please go ahead. Your line is open.
spk07: Good morning, everyone. Nick, congrats and thank you for all your help.
spk03: Hi, Andy.
spk07: Blake or Nick, could you give us more color into what's now embedded in terms of order trajectory in your $10 to $11 EPS guidance? Have you seen continued positive improvement orders here to start Q3? Obviously, you still need a pretty big order step up, especially in Q4, as you said, given your guidance. It's been difficult to tell for you, I think, how much excess inventory has been out there, especially with machine builders. What are you doing to try and get better visibility into when they may bottom with their inventory and ultimately you won't have to lower EPS again?
spk04: Sure. Andy, I'll start and then Nick may have some additional comments. We're expecting mid-single digits sequential growth in Q3 on orders. This is after low double digit sequential order growth that we saw in Q2. And then we expect high teens sequential orders growth in Q4. And that's based on our analysis of the levels of existing inventory in distribution, as well as in the machine builders. For distribution, we expect that largely to clear by the end of the third quarter in most regions. China is probably an outlier that goes a little bit longer, but we're tracking those inventory levels, and that's consistent with the direct feedback from those distributors. As we go out to the OEMs and have specific discussions with the largest OEMs, particularly in Europe and in North America, we're expecting that inventory to be largely cleared at the machine builders in Q4. This is imperfect because we have some of those machine builders that are buying direct from us, and then we have a lot that are going through distribution. So that's still evolving, but we have much better view today than we did at the beginning of the year, and that's the primary reason for the reduced guidance for the year.
spk03: Andy, one thing I'll just add on that. What we've seen in April orders is completely consistent with our guide of our expectation of order growth of 5% sequential order growth.
spk07: Helpful guidance. And Blake, maybe just trying to step back and separate out the channel noise you've been seeing from the CAPEX weakness you mentioned, for instance, in food and beverage. I know you mentioned you achieved the long-term targets you set in November, but could you talk about your conviction at this point that ROC can resume that 5% to 8% organic growth trajectory, ex-acquisitions, sooner or later? Can you give more color into the market share gains you mentioned in North America, and which core end markets would you think would drive ROC back to that improved growth?
spk04: Sure. So we are confident that those growth ranges are reasonable as we look through the cycle. It's based on our offering. It's based on the higher growth that we see in North America, which of course is our home market where most of our sales are. And it's our portfolio that we've built that's winning today in the market. So we see that through the individual projects that are competitive, the growing impact of mega projects I and my team are directly involved with versus our toughest competitors around the world with a good win rate of those projects. We also see in the industries the win rates looking good. And when I talk about market share gains, obviously Logix controllers is one of the key areas. And we do see those gains both when we look at the U.S. and when we look around the world in terms of the reports on that important product line. And there's some other areas as well, motor control centers for instance, as we get those reports for our offering in North America, but also with the new cubic offering, which is a space that was virtually unserved by us previously. And then with the autonomous mobile robots, you heard several examples of those wins in the production logistics space from our ClearPath acquisition. That's already a $5 or $6 billion market growing much faster than the general automation market. And so that gives us a lot of confidence with these new sources of value, as well as the products that make up the majority of our business. We're confident about these long-term targets. And again, it's not just about the above market growth. I think you've heard the tone on this call. And in the last few months, putting that together with the margin expansion is absolutely fundamental to our plans going forward.
spk07: Appreciate all the color.
spk04: Thanks, Andy.
spk06: Our next question comes from Nigel Koh from Wolf Research. Please go ahead. Your line is open.
spk08: Oh, thanks. Good morning, everyone. Morning. Nick, enjoy your retirement. So just wondering if we maybe can get a bit more color on the kind of the third quarter that Kelly provided. So the mean I'm back into an EPS close to two bucks per share for third quarter. So make sure that aligns with your model. And then, you know, in terms of the order rates that you're pointing to, missing the percentage increase sequentially, is that sort of back into it like a $2 billion order number? Just trying to get a bit more quantification there. That'd be great.
spk03: Yeah, Nigel, in terms of what you're backing into from an order rate in Q3, that's consistent with how we're seeing this too. In terms of EPS, the one nuance I will point out from a quarterization on our tax rate, we expect our Q3 tax rate to be lower than the average and our Q4 tax rate to be higher than the average. That's just based on discrete items that are expected in the second half of the year in the timing. That's the only other nuance I'd say on this. But otherwise, I'd say your modeling is matching pretty closely what we're estimating.
spk08: Okay, that's helpful. Thanks, Nick. And then on the cost savings, just on the $100 million of cost savings in the second half of this year, just want to make sure that that doesn't include any of the bonus accrual reversals or the investment spending pullback. That's all sort of additional cost savings. It feels like it's mainly temporary costs in the back half of this year and then we have more structural costs coming in in 2025. Is that the right way to think about it?
spk04: Let me start with some general comments and then Nick can add some detail to that. The $100 million of savings that I mentioned for the second half of the year is totally separate from anything with the incentive comp. So that's additional savings that's totally separate from that. Embedded in that is a reduction in force of approximately 3%. So those are not temporary savings and that will provide additional incremental benefit into next year. There's also some of the temporary actions that Nick talked about, but there's a meaningful reduction in force that's structural and is the front end of the additional structural actions that I alluded to and that will provide more detail.
spk03: And Nigel, part of what we were talking about there is the $100 million we're expecting in the second half of this year. Those actions we expect to have a tail into fiscal year 25 of an additional $120 million. And I'm saying that in reference to your comment about temporary, some of it is temporary, but the majority of it is sustainable and makes that tailwind impact better. So that's a benefit into fiscal year 25.
spk02: Okay, thanks Nick.
spk06: Our next question comes from Julian Mitchell from Barclays. Please go ahead. Your line is open.
spk01: Hi, good morning and wish you all the best Nick. Thank you for the help. Thanks Julian. Just maybe circling back on the EPS walk. So you've got that very helpful slide 11 for example. But if I think about three big buckets of cost you've talked about this morning, you've got incentive compensation, you've got investment spend, and you've got these fixed cost reductions relating to headcounts. So it looks like for 2024, you've got about a $2 EPS tailwind year on year from incentive comp and investment spend combined. Is the right way to think about it that a lot of that reverses in 2025. And then on the other hand, you've got these savings that maybe are worth about a dollar of EPS from headcount cuts in 2025. Just trying to understand of the incentive comp and investment spend, kind of how does that reverse in a substantial way kind of in the following year naturally.
spk03: A couple points Julian. First of all, we certainly intend that the incentive compensation does reverse in fiscal year 25. But the productivity actions that we're doing with the structural cost savings, we do not expect the majority of that investment spend that I know on that slide to reverse. And that's why we're talking about the 120 million of carry forward benefit into fiscal year 25. So two different answers. The incentive comp absolutely does reverse. But investment spend does not. And again, investment spend in total for next year will be dependent on the opportunities we're seeing. We haven't set what that number is, but the benefits of what we're doing here, we are confident that will create this $120 million tailwind benefit into next year. Yeah,
spk04: just at a high level, the actions that were taken now with their benefit this year, then the incremental benefit next year, when you add that to the more structural actions that we're beginning to more comprehensive program that I mentioned, we expect that to more than offset the headwinds from returned incentive comp investment. And so on as we as we go into fiscal year 25.
spk01: That's really helpful. Thank you. And then just my follow up would be trying to circle back to that point on sort of your revenues and your inventories and your customer inventory. So it sounds like you have this Q3 sales dip. I think sequentially, Nick, you'd mentioned. Maybe help us understand why that's happening if orders are up sequentially in the second quarter finished and the third quarter that we're in now. And, you know, your own inventories on your balance sheet have been stuck at sort of the same dollar number for a year now. How are you so sure that your customers inventories are coming down when your own are very stable? Yeah,
spk03: so as of the end of the second quarter, Julian, our our product backlog is essentially back to normal. We've had good success working through with our supply chain and we've brought our backlog back to normal. So going forward, our we expect to be operating what we were like pre pandemic where orders in a particular quarter are very much like what our sales are in a particular quarter. In our second quarter, we were still benefiting from drawing down some of that backlog. We brought down our backlog in high single digits in the second quarter. And that's why our sales in the second quarter were higher than our orders. That phenomenon will end going into the second half of the year. And that's why even though we expect orders to be up sequentially, we expect revenue to be down sequentially.
spk02: Super helpful.
spk03: Thank
spk02: you. Yep.
spk06: Our next question comes from Noah K. from Oppenheimer. Please go ahead. Your line is open.
spk11: Thanks so much. Maybe talk about some of the choices you're making around where to reduce investments and the business. I'm not sure if it's related to that. Maybe you can talk about it if possible on the segment level or by a protocol.
spk04: Sure. No, I'll make some comments and Nick may have some additional ones. Most of the reduction in force that we're looking at is affecting SG&A. And that does include sales and marketing and headquarter functions. I think as we look at guiding principles, we're directing the spend to the highest value activities that's both geographically and from a product portfolio standpoint, going through and taking a look at what is generating the best returns in those areas. We're also integrating recent acquisitions with existing Rockwell resources and looking for the cost synergies there. So we're getting good performance out of our acquisitions. And as we look at ways to get the efficiencies and, as I said, knit together what we built and bought, the actions we're taking are consistent with that. And then there's opportunities, as always, for back-office efficiencies by leveraging technology. And we see that in SG&A. We see it in our development activities as well. There is some reductions in cost of sales, including some in manufacturing operations, as we're tuning our capacity to match what we're expecting near term in terms of output. And that's product specific, right? Some of our lines are growing very well year over year and are expected to continue. Others, as we've gotten back to full safety stock, we can tune that to reduce some of the variances in those operations. So that's the current list of actions that we're doing. As we look at the more comprehensive program, we'll be focusing on areas like sourcing. There's a big opportunity for us with the spend of direct material and other items. And then there's also additional opportunities for manufacturing efficiencies as we look at our portfolio and the wide range of SKUs that we offer.
spk03: Nick? Yeah, the one piece I'd add to that, many of these costs are in organizations or functions that support multiple of our reporting segments. Given the way we allocate these costs across segments, intelligent devices and software control will see the greatest impact from these actions that we're doing.
spk11: Right, makes sense. Thank you. And then, you know, very helpful on the walk sequentially on orders and your commentary around margins for three Q. That does seem to imply again, we're doing math here on the fly. A pretty big step up sequentially and margin for four Q. I'm getting to something like six points here. Maybe just talk to, you know, the margin math around how you see exiting the year and what apart from the cost reductions you've announced would help that step up.
spk03: Yep, there's a few things impacting our margin progression as we go through the second half of the year. And you are correct. And we expect Q4 to be by far our highest margin quarter of the four quarters. The biggest contributor to that is going to be volume that is positively impacting the margin, particularly in software and control. That's followed by the structural and temporary cost savings that we're doing. And then the third is we will be having a more favorable mix of revenue that will be benefiting margin. So it's volume is the largest and then followed by the cost savings and then the mix all contributing to that sequential improvement in margin in Q4.
spk12: Very clear. Thank you.
spk06: Our next question comes from Steve Tusa from JP Morgan. Please go ahead. The line is open.
spk10: Hey guys, good morning. Hi, Steve. When you talk about these investments, what's the trend on R&D this year relative to last year as a percentage of sales or on an absolute basis?
spk03: Yeah, Steve, R&D as a percent of revenue is going to be pretty consistent at six percent of revenue. As a percent of revenue, it's not really changing from last year.
spk10: Okay. And then I guess just more philosophically thinking about the story. And I know you guys have talked about your business being more of an intellectual property business over time, certainly a part of the story at least. And I just what I struggled with a little bit higher level is whipping bonus accruals around, you know, basically altering investments based on near term sales. I guess that just seems juxtaposed with kind of an IP type business. How do we have confidence that you're not rocking the boat with a lot of that core, you know, where the technology comes from? That would be kind of my biggest concern longer term. How are you guys managing that?
spk04: Yeah, Steve, this is Blake. As Nick said, our development expense remains at six percent. We continue to invest robustly in areas like new product introduction, which is actually increasing over the last few years in terms of what we're delivering to the market, both in terms of the hardware products as well as new software as well. And so I think it'd be incorrect to talk about whiplashing that piece of it. We're looking for efficiencies that are taking cost down that had built up over the last few years of volatility as we've gone from pandemic to supply chain shortages and making sure that we're tuned for growth going forward with that. The incentive comp philosophy hasn't changed there in that we operate in a pay for performance culture. We had great payouts last year because we performed really well with high teens, top line growth and even better EPS. This is a year that is below expectations and we're not paying a bonus, but it's going to come back. And that's the way we've operated for as long as I've been in the business. So in no way it implies some sort of short term activity to manage results at the expense of the long term value that we continue to provide.
spk10: And then just one last one on the 3Q to the 4Q. I know that the second half of this year was dependent on obviously the sales being there. I mean, how dependent are we going from the two-ish to four from 3Q to 4Q on sales actually being there? Is it the same kind of dynamic as we've been seeing, we're seeing in 3Q?
spk03: Just
spk10: similar to the comments you made last quarter.
spk03: The sales dynamic is the single biggest contributor to the increase in EPS from 3Q to 4Q. Followed second by on a smaller scale the cost actions. The total cost actions that we're projecting in the second half of the year, we expect about a third of that to be impacting 3Q and about two thirds of that to be impacting 4Q. So that is part of it, but it's still a smaller number compared to the reliance on revenue growth occurring in fourth quarter.
spk10: Great. Thanks as always for all the details. Very helpful and congrats on the coming retirement, Nick. Appreciate all the help.
spk06: Our next question comes from Rob Mason from Baird. Please go ahead. Your line is open.
spk02: Yes, good morning. I wanted to see if you could provide a little more color around the step up in orders that you're expecting, sequential step up in orders that you're expecting in the fourth quarter. I know you mentioned distributor channel inventories normalizing at that point. Is that the entirety of the high teens growth or are you expecting some shift in, more positive shift in demand as well?
spk04: There's a few elements of what informs that guidance, Rob. The first is a significant reduction in packaging machine builder inventory. So within the OEM inventory, packaging machinery has been particularly affected by that. And the feedback we're receiving from the conversations directly with them indicates that that reduces significantly as we go through the third quarter and into the fourth quarter. The distributor inventory actually is expected to clear again in regions outside of China before that. And so those two factors are an important part of it. We also see the normal seasonality in our engineered to order and life cycle services shipments. There's always a higher shipment amount at the end of the year there and that would include Sencia as well. And then we see the growing impact of mega projects and we do have a line of sight to some of those projects that are expected to come in with ordering and shipments beginning in the fourth quarter. We're seeing some of that now. Think of that as kind of a drumbeat that increases through the year and again into next year.
spk02: Should we think about the fourth quarter order level as a solid jumping off point as we go into 2025 now, absent the engineered to order normal seasonality there?
spk04: Yeah, I mean, in this in this volatility that we've been operating in in the last four years, I'm going to reserve a view, but I think we're setting up the foundation so that we have an attractive cost base, regardless of what orders do next year.
spk02: Very good. Thank you.
spk06: Our next question comes from Joe Ritchie from Goldman Sachs. Please go ahead. Your line is open.
spk09: Thanks. Good morning, everybody. And Nick, wish you the best in retirement. No more back and forth. Thanks for all the help. Thanks, Joe. Yeah, so maybe can I just maybe just start on that last comment on medical projects spending specifically and trying to square the comments around EVs earlier and some push outs. And if I think about, you know, where we're seeing the biggest kind of like expectation for mega project pickup, it would probably be in semi-fab cap X and then also on the like EV slash battery plants. And so help me just kind of square the comments on EV pushing out and where you're actually starting to see some kind of, you know, some good, you know, green shoots on the mega project side.
spk04: Yeah. So I mentioned that we're seeing some push out on EV, but we are not seeing cancellations in those projects. And it doesn't mean that they've all gone away. EV is still about a third, a little bit more than a third of our total automotive business. So there's still some of those projects, EV projects that we're winning and getting business for now. If we look at some of the other areas of mega projects, the facilities management and control systems for semiconductor fabs, we've got great capabilities there. And are playing a major role in a lot of the fabs that have been announced and are currently under construction in the U.S. But around the world, that's been a good business for us in Asia for over a decade. So it's not a new application for us. Renewables is another area that we're seeing a good investment playing in solar. We are seeing meaningful business in solar as well as wind, particularly with our cubic acquisition. And then another area that is we think has bottomed and we're seeing an impressive funnel building is in the area of warehouse automation and really the overall space of production logistics. And again, I'll go back to the capabilities that we have that's somewhat unique with AMRs, the mobile robots combined with the fixed automation that we've always had. We're tracking some major projects there and we've had some wins. And I talked about some of them on the call. But to give you an example of how those are playing out, there are a couple of customers that we've talked to in the last couple of months that have come off of discussions with the U.S. Department of Labor and have made it clear that they want to complement their people with technology to a greater extent over the next few years. And those have resulted in multimillion dollar wins for Rockwell as a result of moving more aggressively into adding technology to complement their scarce resources. And so those are the kinds of examples of mega projects that are starting to come in.
spk09: That's super helpful, Blake. Thank you. And then if I can maybe just make sure that I've got it totally squared for next year on the on the buckets of cost saving. So you mentioned one hundred twenty million for next year. We're going to get something more on the structural side and an incentive comp goes to zero this year. And so in a normal year, that would be like roughly basically about one hundred and twenty, one hundred and thirty million dollar headwind in a normal year. So that is that just just just baselining it. Is that the right way to think about it?
spk03: Joe, you got it all right, except for the last one. Our normal bonus expenses in the one sixty to one seventy million dollar range.
spk09: OK, perfect. Thank you.
spk05: Julianne, we'll take one more question.
spk06: Certainly our last question will come from Joe O'Day from Wells Fargo. Please go ahead. Your line is open.
spk12: Hi, good morning, everyone.
spk04: Morning.
spk12: Blake, when you talk about packaging, delivering better order activity from Q3 to Q4, just want to level set on sort of what how that kind of size is overall for the business. And so you're talking food and beverage and household and personal care. And we should be thinking about twenty five percent of revenue that would be seeing that pickup.
spk04: Yeah, actually, so if you think about those verticals and that's about the size of the overall verticals, they're about 60 percent of our business in consumer packaged goods covered mainly by those two verticals is the OEMs, the machine builders. So that's the way you can kind of do the calculus of how much of that business has been suppressed by the higher inventory levels. And we're expecting that to to to be dissipating over the over the coming quarters.
spk12: Got it. And then the the bridge on sort of prior guide to to revised guide and the core piece and the three dollars and seventy five cents sort of EPS impact on core. It looks like that could be something like a 60 to 70 percent decremental. And if that's the case and we think about the flip side, do you think about sort of a reversal of these headwinds is translating to better incrementals than what you would traditionally think about sort of through a cycle absent some of the temporary structural cost actions that are underway?
spk03: Yeah, when you when you strip out things like incentive compensation and what we're showing there from investment spend, because those things would normally be part of what we talk about in terms of our incrementals and decrementals. But we stripped out those two details to give you more detail of the underlying moving parts in there. But there are many parts of our portfolio where incrementals and decrementals like that in that 60 percent range are certainly normal. They're normally offset by some degree of incentive compensation or or investment spend, though.
spk04: Yeah, I think but directionally, I think you're right in that logic. We've seen the biggest correction based on the really tough comps with the huge growth from last year. And as that comes back in, that hardware does have high incrementals and high decrementals. We'll put a lot around it with annual recurring revenue and so on, which does does help us and continues to grow. But there's there's no getting around that. Logics is very profitable. We have high incrementals and high decrementals there.
spk02: I appreciate it. Thanks.
spk05: Thank you, everyone, for joining us today. That concludes today's conference call.
spk06: At this time, you may now disconnect. Thank you.
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