Rockwell Automation Q2 2023 Earnings Call Transcript

Participants

Corporate Executives

• Aijana Zellner, Head of Investor Relations & Market Strategy
• Blake Moret, Chairman & Chief Executive Officer
• Nicholas Gangestad, Chief Financial Officer

Analysts

• Andy Kaplowitz, Smith Barney Citigroup
• Josh Pokrzywinski, Morgan Stanley
• Andrew Obin, Bank of America Co.
• Julian Mitchell, Barclays PLC
• Steve Tusa, JP Morgan Cazenove
• Nigel Coe, Wolfe Research
• Rob Mason, Robert W. Baird
• Andre Adams, Oppenheimer Holdings Inc.
• Phil Buller, Berenberg Bank
• Jairam Nathan, Daiwa Capital Markets

Presentation

[Operator]

Thank you for holding, and welcome to Rockwell Automation Quarterly Conference Call. I need to remind everyone that today's conference call is being recorded. [Operator Instructions] At this time, I would like to turn the call over to Aijana Zellner, Head of Investor Relations and Market Strategy. Ms. Zellner, please go ahead.

[Aijana Zellner, Head of Investor Relations & Market Strategy at Rockwell Automation]

Thank you, Julian. Good morning, and thank you for joining us for Rockwell Automation's second quarter fiscal 2023 earnings release conference call. With me today is Blake Moret, our Chairman and CEO; and Nick Gangestad, our CFO. Our results were released earlier this morning, and the press release and charts have been posted to our website.

Both the press release and charts include and our call today will reference non-GAAP measures. Both the press release and charts include reconciliations of these non-GAAP measures. A webcast of this call will be available on our website for replay for the next 30 days. For your convenience, a transcript of our prepared remarks will also be available on our website at the conclusion of today's call. Before we get started, I need to remind you that our comments will include statements related to the expected future results of our company and are, therefore, forward-looking statements. Our actual results may differ materially from our projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all our SEC filings.

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

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Thanks, Aijana, and good morning, everyone. Thank you for joining us today. Let's turn to our second quarter results on Slide 3.

We had an outstanding quarter of strong growth in both sales and earnings. Our double-digit sales and margin growth continue to reflect Rockwell's strong execution and focus on business resiliency as well as overall improvement in electronic component availability. The demand for our differentiated offerings continue to be strong even in this uncertain economic environment. Through the first half of this fiscal year, our total orders were $4.8 billion, spread evenly between the 2 quarters once we adjust for the estimated price-related pull forward in our fiscal Q1. As expected, our order cancellation rates remain in the low single digits through April.

Total sales grew over 25% versus prior year. Organic sales were up over 27% year-over-year and were above our expectations. Currency translation reduced sales by about 3% and acquisitions contributed over 1 point of growth this quarter. As in the prior quarters, the split of sales by business segment, region and industry, was largely driven by access to electronic components and the composition of our backlog. In the Intelligent Devices business segment, organic sales grew 27% versus prior year with broad-based growth across all businesses. We continue to see wider adoption of our Independent Cart Technology in new applications across semiconductor, food and beverage and life sciences. One example of a new application is wafer transport in semiconductor fabs.

We continue to see increasing demand for this offering, including an important win with a large U.S. company this quarter. This customer is investing in modernizing and expanding its material handling systems and our Independent Cart Technology helps increase wafer output and more efficiently utilizes existing fab space leading to increased capacity and significant savings. Software and Control organic sales increased over 40%. Strong growth versus prior year was led by logic, where we continue to see the benefits of our resiliency investments and an overall improvement in supply chain.

Lifecycle Services organic sales were up 12% year-over-year. Book-to-bill in this segment was 1.27, led by strong order intake in our Sensia business. Information Solutions and Connected Services sales grew about 10% versus prior year. We had another quarter of competitive multiyear wins across our software and cybersecurity services portfolio. Within Information Solutions, I am pleased with the increasing breadth of our new Plex customers as we continue to expand our SaaS, Smart Manufacturing platform to new industries and geographies.

One of our Plex wins this quarter was with AB-InBev, the world's largest brewing company and its start-up business EverGrain, focused on upcycling grain by product into sustainable supply of nutritious food ingredients. Our modular and cloud-native Plex software is helping EverGrain quickly deploy mission-critical quality management capabilities today while providing the functionality for the business to scale in the future.

In Connected Services, we saw another quarter of customer demand for our recurring cybersecurity and infrastructure as a service offerings as customers across many industries are continuing to invest in safety and security of their operations. One of these wins was with Darling Ingredients, a food processing company focused on reducing food waste by collecting and repurposing animal-based products. Our annual recurring revenue grew 15% year-over-year in Q2. Segment margin of 21.3% was up over 560 basis points year-over-year and was better than expected. Adjusted EPS grew over 81% year-over-year. We also completed the acquisition of Knowledge Lens this quarter which adds significant scale to our Kalypso digital services business.

Let's now turn to Slide 4 to review key highlights of our Q2 end market performance. Consistent with my earlier comments on the gradually improving supply chain environment, all 3 industry segments grew strong double digits versus prior year. Our discrete sales were up about 20% in the quarter. Within discrete, Automotive sales grew over 40% versus prior year. We saw a number of strategic wins in EV and battery this quarter both in the U.S. and China, where a combination of our core automation and strong partner ecosystem helped edge out our biggest competitors. While some customers are optimizing operating costs in the near term, they still continue to invest in building out new capacity to meet their production goals.

Semiconductor sales were up mid-teens year-over-year. I already mentioned 1 semiconductor win. Another example of how Rockwell is expanding our existing semi footprint now with wafer transport applications is our multiyear project win with analog devices. Our Independent Cart Technology was chosen to automate ADi's [Phonetic] material handling applications at several of their global fabs. By implementing our technology, ADi will improve operator productivity by at least 20% by moving away from manually delivering lots across the fab.

In E-commerce and Warehouse Automation, our Q2 sales were down mid-single digits versus prior year. While we continue to see a pause in greenfield announcements, e-commerce players, traditional retailers and many consumer packaged goods companies continue to invest in modernizing their warehouses.

Turning to our hybrid industries. Sales in this segment increased 35% year-over-year, led by strong growth in food and beverage. Food and beverage sales were up almost 40% versus prior year. We also saw a number of large orders this quarter with customers in this vertical continuing to invest in making their brownfield facilities more efficient and resilient. Demand in our dairy and agriculture processing business remains especially strong. Life Sciences sales grew 20% year-over-year. One of the important wins this quarter was with a leading European health care company, where our Kalypso digital services used our Emulate3D simulation software to model and test multiple plant layouts to eliminate potential bottlenecks and increase worker safety. Tire was up over 50% in the quarter.

Moving to process; this segment was up over 25% versus prior year, once again led by growth in oil and gas and metals. Within process, we had an important sustainability win. Through Occidental Petroleum's 1.5 subsidiary, Rockwell is providing control systems for direct air capture units that help remove carbon dioxide from the atmosphere. We are proud to be a part of Oxy's low-carbon strategy to deliver large-scale carbon management solutions that accelerate net zero economy.

Turning now to Slide 5 and our Q2 organic regional sales. Similar to prior quarters, our growth by region reflects the electronic component availability and what's in our backlog rather than the underlying customer demand. North America organic sales grew 23% year-over-year. Latin America increased 16%, and EMEA sales grew 42% and Asia Pacific was up 32%.

Let's now move to Slide 6, fiscal 2023 outlook. We have previously said that the fiscal '23 sales performance is primarily based on our ability to ship backlog. Given our performance in the first half, improving chip supply and the benefits of our resiliency actions, we are increasing our sales and earnings outlook for fiscal '23. Our fiscal '23 guidance projects total reported sales growth of 14.5%. We expect organic sales growth of 15% at the midpoint. We expect acquisitions to contribute over 1 point of growth and currency to be a headwind of 1.5 points. Nick will touch more on this later.

Organic ARR is expected to grow 15%. Segment margin is expected to increase by over 160 [Phonetic] basis points year-over-year. Adjusted EPS is expected to grow 25% versus prior year, and we continue to target 95% free cash flow conversion.

Before I turn it over to Nick, let me share some of our thoughts on the setup for fiscal year '24. With more than half of this fiscal year behind us and through our continued discussions with end customers, we believe we have better visibility into our full year orders and backlog levels. We expect our fiscal '23 orders to be about $9 billion, which implies a slight moderation of orders in the second half of this year. This is consistent with our expectations of improving component availability and the subsequent reduction in customer lead times.

With our current orders outlook, we anticipate exiting the year with backlog levels of around $5 billion, positioning us well for fiscal year '24. Also, as the largest pure play, we have an impressive record of earnings growth, and we expect that to continue given our unique market focus and differentiation.

Let me turn it over to Nick to provide more detail on our Q2 performance and financial outlook for fiscal '23. Nick?

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

Thank you, Blake, and good morning, everyone. I'll start on Slide 8, second quarter key financial information. Second quarter reported sales were up 25.8% over last year. Q2 organic sales were up 27.3%, and acquisitions contributed 130 basis points to total growth.

Currency translation decreased sales by 2.8% about 6 points of our organic growth came from price. Segment operating margin expanded to 21.3% and was higher than our expectations. The majority of this outperformance was driven by the higher revenue. The 560 basis point year-over-year increase in margin was driven by higher sales volume and positive price costs, partially offset by higher incentive compensation and higher investment spend.

Corporate and other expense was $29 million, in line with our expectations. Adjusted EPS of $3.01 was ahead of our expectations and grew 81% versus prior year. I'll cover a year-over-year adjusted EPS bridge on a later slide.

The adjusted effective tax rate for the second quarter was 17.4%. Free cash flow of $156 million was $110 million higher compared to last year, driven by higher pretax income, partially offset by higher working capital. The increase in working capital was primarily driven by higher accounts receivable given our Q2 sales outperformance.

We improved our days on hand in inventory by 7 days in Q2, and we expect reductions in inventory days to continue for the balance of the year. One additional item not shown on the slide, we repurchased approximately 140,000 shares in the quarter at a cost of $38 million. On March 31, $1.1 billion remained available under our repurchase authorization.

Slide 9 provides the sales and margin performance overview of our 3 operating segments. Organic sales grew double digits year-over-year in each of our operating segments. Turning to margins. Intelligent Devices margin increased by 560 basis points year-over-year due to positive price cost and higher sales volume, partially offset by higher investment spend and incentive compensation.

Segment margin for Software and Control increased 900 basis points compared to last year on higher sales volume and positive price costs partially offset by higher investment spend and incentive compensation.

Lifecycle Services margin decreased by 180 basis points year-over-year as the benefit of higher sales was more than offset by higher incentive compensation and onetime items to expand future profitability. We expect Lifecycle Services margin to expand sequentially and exceed 10% in Q4.

The next Slide, 10, provides the adjusted EPS walk from Q2 fiscal '22 to Q2 fiscal '23. Core performance was up $1.95 on a 27.3% organic sales increase. The impact of currency was a $0.15 reduction in EPS. The year-over-year headwind reflects a stronger dollar versus Q2 of last year. Incentive compensation was a $0.40 headwind. This year-over-year increase reflects our lower bonus in Q2 of last year and our higher growth and earnings expectations for this fiscal year.

Higher interest expense was a $0.05 impact. Our adjusted -- our higher adjusted effective tax rate was a $0.05 headwind and our reduction in outstanding shares added about $0.05.

Let's move on to Slide 11, guidance for fiscal '23. We are increasing our reported sales guidance to approximately $8.9 billion in fiscal '23 or 14.5% growth at the midpoint. We expect organic sales growth to be in a range of 13% to 17% or 15% at the midpoint. We expect volume to add 10 points of growth and price to add 5 points of growth. This guidance takes into account our performance through the first half of the fiscal year and is based on our current view of ongoing supply chain improvement.

In terms of the second half, we expect mid-teens organic growth in Q3 and high single-digit growth in Q4. This calendarization includes our view of chip availability in each of the next 2 quarters and our Q3 transition from one third-party logistics provider to another at 1 of our distribution centers. We now expect a full year currency headwind of 150 basis points, which is 50 basis points better than our previous guidance. This updated outlook primarily reflects the strengthening of the Euro against the U.S. dollar.

We expect full year segment operating margin to be about 21.5%, up from our prior guidance of about 21%, driven by higher volume and higher benefit from price costs for the full year. We now expect an over 200 basis point improvement to margin year-over-year from positive price cost. This represents a 100 basis point increase versus our prior guidance, split evenly between price and cost. Our updated guidance now assumes full year core earnings conversion of close to 40%. We now expect the full year adjusted effective tax rate to be around 17.5%, down from our prior forecast of 18% due to discrete items that were realized in Q2.

We are increasing our adjusted EPS guidance to $11.50 to $12.20. At the midpoint of the range, this represents 25% adjusted EPS growth, up from prior guidance of approximately 17% growth at the midpoint.

We expect full year fiscal '23 free cash flow conversion of about 95% of adjusted income. A few additional comments on fiscal '23 guidance. Corporate and other expense is still expected to be around $120 million. Net interest expense for fiscal '23 is still expected to be around $130 million. And we're assuming average diluted shares outstanding of 115.6 million shares.

Turning to Slide 12. Versus our prior guidance, we are increasing the midpoint for EPS by $0.75. Our guidance reflects an increase in our core of $1.05 driven by higher organic sales and our improved outlook in price/cost. We also deployed additional investments in sales and new product development as well as digital infrastructure that will generate future revenue growth and profitability. Currency is adding $0.05. Given the stronger outlook, our incentive compensation is increased by $0.40. And finally, our 50 basis point drop in our adjusted effective tax rate will add $0.05.

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

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Thanks, Nick. We are still operating in a dynamic environment and are laser-focused on execution through the rest of this fiscal year. With that said, we are continuing to accelerate new product development and investments in cloud-native technologies.

Revenue from our new offerings, both organic and inorganic is becoming a more meaningful contributor to growth and share gains. We are the largest pure-play automation company with market-leading solutions across discrete, hybrid and process industries and we are adding scale to our differentiated offerings through strong partnerships and strategic acquisitions.

Our recent acquisition of Knowledge Lens is adding 600 resources with cutting-edge data science, AI and cloud solutions to our existing digital services business. This expanded team is already working with our key customers on their next-generation plans. I want to welcome all Knowledge Lens' employees to Rockwell.

Our close relationships with end customers, our best-in-class ecosystem and our talent give us confidence in the continued momentum for growth and profitability this year and beyond. Aijana will now begin the Q&A session.

[Aijana Zellner, Head of Investor Relations & Market Strategy at Rockwell Automation]

Thanks, Blake. [Operator Instructions] Thank you.

Questions and Answers

[Operator]

[Operator Instructions] Our first question comes from Andy Kaplowitz from Citigroup. Please go-ahead, your line is open.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Hey, good morning, everyone. Blake, so just focusing on your comments in terms of the setup for '24. I know there will be some investors who will think about the $9 billion of orders and say, look at Rockwell [Phonetic] order deceleration in the second half. But how do you think about the cycle in the context of your $9 billion-plus solution, as we call it, that you're coming close to hitting this year and the $5 billion of backlog you end the year with. I know you suggested you're set up '24 earnings growth, but can you talk about how you're thinking about the durability of the automation cycle based on the conversations you're having? And do you have the capacity to grow beyond that $9 billion?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Sure. Well, let me take that first, Andy. We're continuing to add capacity. So at the same time that chip supply is improving. We're continuing to make sure that our labor and our facilities, our redundancy across our integrated supply chain operations is ready to handle continued growth. So let me start there.

Now in terms of the demand, this is playing out like we thought it would. We have said for some time now that we did expect orders and shipments to converge as lead times improve. And so that's exactly what you're seeing, but the orders are continuing at a strong pace. And to look at that, let's take kind of a vertical by vertical view, we've talked about the historic generational spending levels in certain of the verticals that are important to us, things like electric vehicle and battery and semiconductor.

We're seeing additional expenditures in energy, both as the fossil fuel providers decarbonize and as renewables become a bigger part of our business as well. But we're also seeing across all verticals an increased focus on automation, and that's due to large durable trends, things like scarcity of trained workforce and so the need to complement people with the technologies and the software and the services that we provide. So as I look across that while we continue to pay close attention to macroeconomic conditions, we think the setup for multiyear growth in automation and information is there.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Very helpful, Blake. And then maybe Blake or Nick, can you give us a little more color on your margins in the segments. If I look at Software and Control, it seems like when supply chain headwinds are not impacting that business, you can do sort of low to mid-30s and Lifecycle, obviously, still kind of lagging behind a little bit. So do you get Lifecycle up now starting in the second half of the year? And is that a fair assessment of Software and Control when it's sort of firing on all cylinders, it's an above 30% margin business.

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

Yes, Andy, let me take that. As far as Software and Control with what we're seeing in that business and the mix of what we're selling and the strength in the overall market there, we do see 30 -- over 30% as a sustainable margin for that business. In terms of Lifecycle Services, we see that -- that's going to be sequentially going up. And we had talked earlier about getting this to double digits. We see that happening in the fourth quarter. And we think that's a good trajectory we're going to expect to see happen beyond '23 as well. So that's where we're seeing margins in those 2 segments.

[Andy Kaplowitz, Analyst at Smith Barney Citigroup]

Very helpful, guys. Nice quarter. Thanks.

[Operator]

Our next question comes from Joshua Pokrzywinski from Morgan Stanley. Please go-ahead, your line is open.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Hi, good morning guys. So Blake, just on some of the order commentary, I want to square the circle here a little bit. Talking about, I guess, you kind of comp the comp sequentially. You had the pull forward that probably happened around the price increase. As you said, lead times are coming down a little bit. So presumably, customers sort of altering plans accordingly, but you still have, call it, flattish sequential order. So something seem to have gotten better. It seems like it's the same markets that get mentioned over and over again, like EV and battery and Life Sciences and a few others that come in there. But did anything, I guess, build momentum quarter-over-quarter and anything in terms of March or April exit rates that we should be aware of?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes, a couple of things. Josh, it was fairly broad, but in addition to the usual suspects, the things that we've been talking about for a while now, I'd say oil and gas orders were quite good. We had some major competitive wins in our Sensia business that built some great backlog there. And I would also say within the orders -- North American orders were relatively stronger than Europe and Asia, and we expect that to continue for the rest of the year.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Got it. That's helpful. And then I guess there's the obligatory question for Nick on investment spending since I think that gets pulled around a little bit, especially when things are a little better than expected. Nick, was there any kind of reallocation of investment spending to get more in this quarter? And how should we think about the rest of the year?

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

Yes. The investment spend for this particular for second quarter, it came up a few million dollars more than what we had in our initial plan for Q2. We are upping our investment spend in the third and fourth quarter. We started the year with, what I would call, a pretty conservative view of what we were going to do on spend, and we were holding some things in our back pocket that if things improve, we would be ready to invest in, and we are releasing that in the second half of the year. All in, that we see total investment spend up for the full year versus what we had previously estimated up by roughly $50 million. It's up year over year $180 million. I previously in the last guidance said it would be up $130 million, it's now up $180 million.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Alright. Thanks, guys.

[Operator]

Our next question comes from Andrew Obin from Bank of America. Please go-ahead, your line is open.

[Andrew Obin, Analyst at Bank of America]

Yes, guys, how are you?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Hey, Andrew. Good

[Andrew Obin, Analyst at Bank of America]

Good morning. Just we are getting questions on lead times. So how should I think about this $5 billion number? Is that just a nice round comp to where you were versus fiscal -- the end of fiscal '22 where you sort of showed you were slightly above $5 billion, right, and then sort of $9 billion matches, $9 billion is just very simple math. Or is there a sort of dynamic update to this number throughout the year? Is it just basically a placeholder to help us think about the big framework? Or is that a number sort of somebody manages to an update inside the company every quarter?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes, Andrew, you should think about that as a slight reduction of the current backlog, which sits at about $5.6 billion, but still held up by continuing strong order rates. So it's not intended to be precise, but on the other hand, it does reflect the trends that we're seeing and that is that as lead times improve, we're able to clear past due backlog, but the overall number stays quite high due to the continuing strength of orders.

[Andrew Obin, Analyst at Bank of America]

Got you. And just a question on Plex because you guys had a great demo at Hanover show. Can you just a, 15% ARR is pretty impressive. But can we just talk about Plex is doing? And how does Rockwell sort of manage historical focus on large enterprise and try to sort of deal with the product and F&B end market, just evolution of Plex what the experience has been, as I said, because clearly, a big focus at Hanover show.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Sure. Well, well, Plex continues to be a really exciting addition to our offering, and it's playing out like we hoped it would when we made that acquisition. Plex is smart manufacturing platform to be sure, has MES capability, but it also has quality management, supply chain and even ERP functionality for small- and medium-sized businesses. When we bought Plex, they had a great track record in certain verticals like tier automotives, but we knew that with our existing market access, we could expand that into food and beverage and EV and mining.

And we also knew that we had the opportunity to geographically diversify their customer base and we're doing just that with wins in Asia and with putting Plex on to Azure in Europe where we've already seen some nice wins there. So it's that synergy that's playing out, and there is lots of room to run with that.

So it's working well. I've mentioned before, one of the things that we've done is to take the seasoned veterans of selling cloud-native SaaS software and given them enterprise-wide roles within Rockwell. So software sales leadership, our Chief Marketing Officer and a number of other functions are coming from Plex. So it's not just the technology and the business, it's also the expertise that we're making sure that we don't vary in the organization.

[Andrew Obin, Analyst at Bank of America]

And growth rates sort of commensurate was 15%. Is it in line with 15% for the rest of the business, better or worse, if you could just sort of benchmark that if you're...

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Sure. Plex and Fix [Phonetic] are very supportive to the overall growth of our software business.

[Andrew Obin, Analyst at Bank of America]

Thank you very much.

[Operator]

Our next question comes from Julian Mitchell from Barclays. Please go ahead, your line is open.

[Julian Mitchell, Analyst at Barclays]

Hi, good morning. Maybe just wanted to try and drill into that book-to-bill element a little bit more for the back half being well below 1. It doesn't sound like you're perturbed by that. But just trying to understand, if we look at it in a little bit more detail, anything you'd call out around sort of hybrid versus process versus discrete markets, maybe where you see that book-to-bill or year-on-year orders pressure being most severe.

And just maybe a question sort of more broadly on that for Blake. You've had this component flush driving this huge revenue surge right now. Is there sort of a view on the world or the demand environment post that flush changed at all in recent months?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. So Julian, let me start. I wouldn't characterize the reduction in backlog is pressured. It's playing out in a way that we would hope it is in that we're clearing past due backlog and improving customer service levels and adding additional orders in the business. So you know historically that Rockwell has been fortunate to be able to ship out products pretty much in the same quarter that we get the order.

So this is unusual to have product backlog, and we intend to continue to reduce the lead times and products just as much as possible. At the same time, a 1.27 book-to-bill in our Lifecycle Services business gives us good confidence about continuing demand for longer cycle projects there. So I feel good about the way that this is working. We obviously are focused on execution as well as creating additional demand going forward, but we feel this is a very healthy environment.

To your second question about, has anything changed in terms of the component world, being able to get chips. I mean we're always going to have a larger effort than we did pre supply chain constraints on making sure that our designs are resilient, both in terms of reevaluating existing products as well as new products and to make sure that they will go forward unless we have new levels of resiliency in component supply and robust designs to be able to reduce dependencies on any one vendor.

So that's here to stay. We do believe, as Nick talked about, working capital with some of the inventory increases to go down, and that supports the good cash flow for the year. So certain of those things aren't going to change all the way back to, let's say, prepandemic, but we do expect a return to more normal levels in working capital and so on as we go forward as the chip constraints continue to resolve themselves.

[Julian Mitchell, Analyst at Barclays]

That's helpful, Blake. And when you sort of look at the 2 components of customer demand being strong and a good pipeline of projects coming up, plus at the same time, a sort of accelerated backlog conversion into revenue because of supply chain, do you think we could be in for quite a prolonged period of having that book-to-bill below 1? Or you're sort of thinking, no, we get some adjustments for a couple of quarters and then it moves back into sync [Phonetic] of sort of one-to-one like Rockwell's classic business model.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. Beyond kind of unusual levels of disclosure about the setup for '24 we've already given. I'm not going to guess further about that, but we do believe that the demand for automation in the specific verticals that I've talked about and as well as a general setup is something that's a positive read going forward. And our intention is to reduce product level lead times closer and closer to what they were before these constraints, but with an incoming order rate far above what they were prepandemic.

[Julian Mitchell, Analyst at Barclays]

Great, thank you.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. Thanks, Julian.

[Operator]

Our next question comes from Steve Tusa from JPMorgan. Please go-ahead, your line is open.

[Steve Tusa, Analyst at JP Morgan Cazenove]

Hey guys, good morning. Congrats on the execution on this backlog. I missed a part of the call. But did you guys talk about the sequential change in that -- in the backlog from 4Q -- or sorry, 1Q to 2Q?

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

Steve, what we talked about is that the backlog at the middle of the year for us now stands at $5.6 billion. That's versus $5.2 million that it was at the beginning of the year. so up $400 million for the first 6 months of the year.

[Steve Tusa, Analyst at JP Morgan Cazenove]

Okay. That's great. And then just on the margins at S&C, how much of that is like did you break down at all how much of that was the products-related price/cost spread? Maybe just a little bit more color on the year-over-year margin drivers? How much came from the products in that business and how much came from the software there?

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

I haven't provided the product versus the software mix. But in terms of the things that are causing the margin expansion. The biggest factor by far is the volume growth that we're experiencing and the leverage we're getting on that.

The second biggest thing that is improving that margin is the favorable price/cost versus where we were in second quarter last year. And then offsetting that, to some extent, to bring it down to a 900 basis point year-on-year increase. We have increased investment spend year-over-year in software and control, and we also are facing noticeably higher incentive compensation. Those are the 2 negative things on the margin in the year-over-year Q2 for Software and Control.

[Steve Tusa, Analyst at JP Morgan Cazenove]

And then where do you expect that margin to end? Where do you expect that margin to finish the year just for the annual S&C margin?

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

Yes. We think it will be over 30%. It's -- and that's up from what I have said in the past that we see that margin being able to sustain into the second half of the year. At levels fairly similar to what we're seeing in our second quarter. So full year, we're going to be above 30% could be a few percentage points above 30%.

[Steve Tusa, Analyst at JP Morgan Cazenove]

Great. Okay, thanks.

[Operator]

Our next question comes from Nigel Coe from Wolfe Research. Please go-ahead, your line is open.

[Nigel Coe, Analyst at Wolfe Research]

Thanks, good morning. Thanks for the question. So, I too missed some of the call, so I apologize if we're going to be sort of like -- I will be asking the questions you've been asked about 3 times. But just wondering about the backlog kind of conversion means supply chains, where are we versus normal in terms of lead times? And converting this backlog, is it more constraint of just the lead times? Is it labor? Is it customer acceptance, project timing? what could cause the backlog to convert even faster in the second half of the year?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. Nigel, this is a good development in that as the chip supply is easing that's really the primary limiting factor as we're clearing older backlog there. As we've said, we've got about $5.6 billion worth of backlog, and we're expecting that to go down to around $5 billion by the end of the year, but it's held up by continuing good order intake there. And also the contribution from Lifecycle Services with its strong book-to-bill. So it's primarily the chip supply.

We feel good about our ability to continue to add labor in our facilities around the world. We've been adding for some time now, additional equipment. But as you know, we're not really a very capital-intensive operation. So it's not like we're having to add a lot of heavy equipment because we're primarily an intellectual capital company. And so the equipment that we need has relatively shorter lead times than if we were in heavier manufacturing type operations.

[Nigel Coe, Analyst at Wolfe Research]

And then just another stab at the backlog. Are we seeing the mix of the backlog shifting to some of the larger projects, particularly with the systems, EV plants, et cetera. I mean, so are we seeing some of those larger systems orders coming through in the backlog? And then just kind of another part of that would be -- you point to $9 billion of orders, so obviously $4.8 billion in the first half, $4.2 billion in the second half. What's -- I mean, 4.2% is still a very healthy level, no question about it, but -- what's causing that drop down? Is it project timing? Is it lead times for customers -- channels are just not placing kind of the same rate of orders. What kind of visibility do you have to that second half deceleration in orders? Again, very healthy level but you are pointing to declining orders.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. So first of all, in terms of the composition of the backlog, I don't think we're seeing any fundamental change in the type of orders. Now obviously, as we move through the backlog has a richer pricing as we work through the year. So that's a good read. But in terms of the number of big EV projects or semiconductor, facilities management systems or Independent Cart or just continuing MRO, I don't think you're going to see a big change because a lot of these investment cycles in those areas are multiyear. We're in it for the long haul with some of these positive areas.

Now in terms of where you might see a little bit of the contribution from the moderation in orders, probably the most specific area is as lead times improve, as they are across a lot of our product lines, you'll see machine builders not having to provide orders of the same size to have as many months of coverage of their backlog.

So as they're concerned about their cash flow and they can look at shorter lead times, then they can reduce the size of their orders because they don't need as many months coverage for the machines that they've already booked. So I think that's probably the most specific contribution to some of the orders moderation.

[Nigel Coe, Analyst at Wolfe Research]

Makes sense. Sounds like, yes. Thank you.

[Operator]

Our next question comes from Rob Mason from Baird. Please go-ahead, your line is open.

[Rob Mason, Analyst at Robert W. Baird]

Yes, good morning. Thanks for the questions. Blake, I called out Sensia several times in and around oil and gas. So it sounds like things are positioned to accelerate further there. But any thoughts just on -- it still looks like maybe we're pulling through an operating loss just based on the minority interest, how profitability might shift as we go forward over the next 6, 12 months at Sensia.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. You said it. I mean, we're seeing some good growth there. We had a particularly strong orders, and there's a very strong backlog in the business. And so as we move through the coming quarters, we expect the positive contribution of Sensia both in terms of growth and profitability to have an impact first on Lifecycle Services and then more broadly across Rockwell.

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

And Rob, just to build on that. In my prepared remarks, I talked about some onetime costs that we took in the second quarter to expand profitability. Some of that is focused in the Sensia area where we made some investments to simplify business infrastructure for Sensia that we think will make it even more -- build it for more profitability in the future. And so that's part of what we're seeing in our second quarter results for Sensia.

[Rob Mason, Analyst at Robert W. Baird]

Excellent. Just as a follow-up to, any thoughts, I didn't hear any commentary specific to China, just exactly what you're seeing on the ground in China and how that recovery is playing out in your business?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. So a couple of things. First of all, in general, the growth is strong in China across the business. And it's a lot of the same contributors that we've seen in the past with areas like EV and Life Sciences and so on. So we think that our business there is posed for continued growth.

[Operator]

Our next question comes from Noah Kaye from Oppenheimer. Please go-ahead, your line is open.

[Andre Adams, Analyst at Oppenheimer]

Hi, this is Andre on for Noah. On the M&A pipeline, you've previously defined ISGS and market access in Europe and Asia and Advanced Material Handling as priorities. Could you give us any color on what's most near term for you as a focus and how active that pipeline looks today?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. Andre, it's a good pipeline, and you said it. Those are the priorities. That's fairly broad. But within that, there's a lot of information management software in the production world. So there's some decent targets there. Cybersecurity has been extremely successful for us both organically and as we've added additional capabilities through some acquisitions, advanced material handling. We talk all the time about our Independent Cart Technology, about some of the things we're doing in robotics applications as the lines get blurred between robot control and programmable line control, and we think there's some very interesting things going on there.

Obviously, add AI and autonomy to some of these areas, and there's new dimensions for value for customers. And then Europe and Asia, we're very happy, for instance, with what we're doing and it would be awesome, the Italian manufacturer of industrial PCs that also has some great software that's forming the basis for some of our most exciting new introduction. So I would say that the pipeline is good across all of those fronts.

[Andre Adams, Analyst at Oppenheimer]

Great. And can you also just give an update on pipeline and customer needs in the EV transition starting with the upstream opportunity in lithium and any impact of the IRA and domestic battery and vehicle production where customers in that vertical focused most right now?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Well, they're all focused on building up their fleet capacity so that they can get a return on these giant investments. You don't get that unless you put more jobs per hour out the door and so they're all working to be able to expand their production output. If you look on the on the road today, you still don't see a ton of electric vehicles and all of them, if you listen to those goals and you look at the trends, this is a multiyear process and -- from start to finish, starting with the lithium mines and the basic materials that are needed for the batteries, through the battery making facilities through the electric vehicle assembly.

All of that has to build out to be able to get us to a point where you start seeing electric vehicles come anywhere near approaching internal combustion vehicles on the road. So this is multiple years and all of these manufacturers are focused on debottlenecking that whole supply chain, which is going to be in the news for years to come.

I think the 1 other question. I mean the IRA, obviously, that helps there as well as it does with other renewable providers. We've talked before about First Solar, for instance. We talked about Oxy's 1.5 initiative. So we're seeing more and more of these come online across our verticals and people are doing it because it's important for their business models. And again, that's not a terminal thing. That's going to be over multiple years.

[Andre Adams, Analyst at Oppenheimer]

Great, thank you guys so much.

[Operator]

Our next question comes from Phil Buller from Berenberg. Please go-ahead, your line is open.

[Phil Buller, Analyst at Berenberg Bank]

Hi, good morning. Thanks for the questions. I was hoping you could expand on the topic of, I guess, the order funnel or pipeline rather than the backlog. I'm wondering if you're more excited about the funnel in process markets, generally speaking, more so than discrete or hybrid at this point. You've talked very helpfully about different customer examples in those like EVs and such. I'm just trying to get a handle on how it aggregates into those big process versus discrete buckets. So which funnel is getting fuller, if you will? And perhaps you can remind us if there's any structural margin differential between those, that would be great.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Sure. Yes, it's broad-based. I mean, we're very happy with the way that our business is balanced between discrete and hybrid and process applications with big opportunities in all of them. I mean, as we talk about EV and battery in discrete, we talk about food and beverage and Life Sciences, Food and beverage is our single biggest vertical and hybrid. And then in process, I highlighted some particularly strong order activity with Sensia, but we also continue to see good activity in metals as well. So it's across all of them.

Now in terms of the margin, one to the next there's high-margin opportunities in each one. I would say that the engineered systems are concentrated a little bit more heavily on the process side. Those customers are more often looking for engineering content to complement the hardware coming from the same provider. So you'd probably see a little bit lower margin there due to the people intensivity of that, but good opportunities in the funnel for near and midterm orders across all of the industry segments.

[Phil Buller, Analyst at Berenberg Bank]

Okay. Great. And just in terms of the different topic margins here. I know you've touched on the Software and Control margin. The drop through between the 3 different businesses is quite different, depending on which one you're looking at. And I know that there's been a lot of things bouncing around at the moment. So I guess I was just trying to get a handle on how you think about the H2 margin evolution for each of the 3 businesses relative to H1. Is there anything that you could point out that we should be bearing in mind beyond Software and Control, please?

[Nicholas Gangestad, Chief Financial Officer at Rockwell Automation]

Beyond Software and Control, which I've already covered still, when I look at intelligent devices, that's been a little over 20%, about 21% margin in the first half of this year. I think for the full year, it's going to be close to that, maybe between 20% and 21% for the full year margin for Intelligent Devices. Some of the things happening there, we continue to see good volume, good price growth, but as I talked about earlier, for the full year, we'll also be seeing higher incentive comp and higher investment spend. This is one of the places where we've been focusing some of our investment spend in resiliency and we'll see that continuing. So between 20% and 21% for Intelligent Devices.

And then soft -- excuse me, Lifecycle Services. I've talked about sequential improvement. I don't see us crossing the threshold into double-digit margin until the fourth quarter. So I see Q3 being a move in that direction from where we were in the first half where we're in the little over 5% margin. We'll be stepping it up, but not all the way to 10% and then going to 10% or over in the fourth quarter.

[Aijana Zellner, Head of Investor Relations & Market Strategy at Rockwell Automation]

Julian, we will take one more question.

[Operator]

Certainly, our last question will come from Jairam Nathan from Daiwa. Please go-ahead, your line is open.

[Jairam Nathan, Analyst at Daiwa Capital Markets]

Hi, thanks for taking my question. So I just wanted to spend a little time on the automotive. We are seeing, as the transition towards EVs, we are seeing the number of process steps coming down. And I understand Rockwell probably does not have a lot of content on welding, but do you see any implications as EVs or auto companies go from spot welding to giga casting and things like that?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes. So the net opportunity for Rockwell actually goes up as we go from internal combustion engines to EVs, and that's for a couple of reasons. First of all, the traditional drivetrain operations. That's a more subtractive manufacturing process, that's boring cylinders, that's finishing metal surfaces and things like that. And that's largely done with computer numerical control, which is not a technology that Rockwell directly has. We have good partnerships, but it's not something that we provide directly.

And so when that's replaced by some of the operations in electric vehicles, most notably, the battery formation and packing and assembly. That's more of an assembly type operation. And there's aspects at the front end of that with batch processes. And those are all applications that Rockwell has great readiness to serve.

Then when you look at what you specifically mentioned in the joining part of it, it's more complex press operations, and Rockwell has great press control systems. So as the metal formation becomes more complex, again, those are really good applications for Rockwell with our program of control as well as our expanded drive control. So we feel good about those opportunities. And then added to those basic automation applications. It's the software that's a more pervasive part of the electric vehicle and battery manufacturing process, and we have really good solutions there.

[Jairam Nathan, Analyst at Daiwa Capital Markets]

Okay. And 1 more, if I may. So I mean all the -- given your outlook, I think the 1 area which actually decline seems to be chemicals. I think you went from a high single digit from a low double -- double digits. So can you explain that a bit?

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

No. I don't have a specific answer for where chemical is moderating other than to say our focus in chemical is more on the specialty chemical, a fine chemical as opposed to bulk chemicals.

[Jairam Nathan, Analyst at Daiwa Capital Markets]

Okay, got it. Thank you.

[Blake Moret, Chairman & Chief Executive Officer at Rockwell Automation]

Yes, thank you.

[Operator]

We have no further questions. I'd like to turn the call back over to Ms. Zellner for closing remarks.

[Aijana Zellner, Head of Investor Relations & Market Strategy at Rockwell Automation]

Thank you, everyone, for joining us today. That concludes today's call.

[Operator]

[Operator Closing Remarks]