Rockwell Automation, Inc. (NYSE:ROK) Q1 2024 Earnings Call Transcript

Rockwell Automation, Inc. (NYSE:ROK) Q1 2024 Earnings Call Transcript January 31, 2024

Rockwell Automation, Inc. misses on earnings expectations. Reported EPS is $2.04 EPS, expectations were $2.62. ROK isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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

Aijana Zellner: Thank you, Juliane. Good morning, and thank you for joining us for Rockwell Automation’s first quarter fiscal 2024 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 of our SEC filings. So, with that, I’ll hand it over to Blake.

Blake Moret: Thanks Aijana and good morning everyone. Thank you for joining us today. Let’s turn to our first quarter results on Slide 3. This quarter, we saw double-digit sequential growth in orders, with all business segments and regions up from the trough in Q4 of last year. While we are continuing to see the impact of excess inventory in the channel, the underlying demand from machine builders and end-users remain strong. Total sales were up 3.6% year-over-year. Organic sales grew 1% in the quarter, led by North America. China was the single largest drag on our shipments. Currency translation increased sales by over 1 point, and acquisitions contributed almost 1.5 points of growth. Our organic sales did come in below our expectations, largely due to the timing of our recovery to a more normal product book-and-bill process.

As a source of our demand shifts from older backlog to new orders that need to be shipped as soon as they are received, we are working through some lingering shortages and line constraints. Our supply chain team is expected to complete this transition in Q2 with little impact on the full year. In our Intelligent Devices business segment, organic sales were down 4.5% versus prior year. While product shipments in this segment experienced the biggest supply chain constraints in the quarter, we were able to offset some of that impact with strong performance from our configure-to-order businesses and from recent acquisitions. Our Clearpath and CUBIC acquisitions had a strong quarter, both on topline and bottom-line, showcasing the tremendous value these offerings are bringing to our customers across new verticals and applications.

Last quarter, I talked about our presence in datacenter build-outs and CUBIC’s momentum with large cloud service providers continues to fuel our growth in this end-market. I’ll touch on some of the important Clearpath wins later on the call. Software & Control organic sales increased 4% year-over-year and were in line with our expectations. Logix continues to demonstrate unique value in the marketplace, and we’ve made some major software investments in this segment over the last few years. We are seeing the value from this innovation, demonstrated by double-digit sales growth in our cloud-native and on-prem information software offerings. Lifecycle Services organic sales grew over 8% versus prior year, better than we expected. Book-to-bill in this segment was 1.13, with strong order activity across solutions, services, and our Sensia joint venture.

I’m pleased with how our Sensia team is making progress, with profitable growth in the quarter. Q1 orders and sales were up over 25% year-over-year. One of the strategic Sensia wins this quarter was with Mellitah Oil & Gas joint venture, one of the largest oil and gas companies in Libya. Sensia’s advanced measurement technology is helping this customer modernize all of their liquid metering skids and establishes Sensia as one of the key players in the region for major metering turnkey solutions. Another highlight of the quarter was our continued growth in ARR. Total annual recurring revenue was up 20% year-over-year, with strong growth across our Plex and Fiix SaaS offerings and recurring services, including our growing cybersecurity business.

The impact of these contracts on our financial performance is also increasing, especially in a year with relatively low product growth. This quarter, our Plex SaaS platform was selected by EOS Energy, an energy start-up focused on grid scale storage for utility companies. EOS Energy, in partnership with Acro Automation Systems, has selected Rockwell Automation to provide Plex MES and QMS information software to compliment Acro’s battery manufacturing solution built on Rockwell’s control platform. Acro is currently building out the first state-of-the-art manufacturing line that will manufacture EOS Energy’s next gen Z3 batteries. Segment margin of about 17% and adjusted EPS of $2.04 were both down versus prior year. The adjusted EPS was below our expectations, and Nick will discuss this further in a few minutes.

Let’s now turn to Slide 4 to review key highlights of our Q1 industry segment performance. Before we get into the individual verticals, keep in mind that the more product-intensive industries were the most impacted by planned shipments moving to Q2 and later in the year. Our discrete sales were down 10% year-over-year. Within discrete, automotive sales were down high single-digits. While auto customers are focused on near-term profitability and temporary slowdown in EV demand, they continue to fund new EV and battery CapEx programs. In addition to these investments, we are seeing increased activity across our traditional ICE and plugin hybrid platforms as brand owners and tier suppliers are looking to diversify their exposure in response to consumer demand and infrastructure limitations.

As you know, Rockwell has a substantial installed base with these established automotive customers, and is well positioned to capture additional market share, regardless of the application. This quarter, our Logix platform was selected by Akasol/Borg Warner, a global battery producer and automotive tier supplier developing innovative battery manufacturing processes for their production plants in Seneca, South Carolina and Darmstadt, Germany. This customer plans to increase their production volume in Europe and North America and scale to more plants globally. Another exciting automotive win this quarter came from Clearpath Robotics, where a large brand owner will be using over a hundred of our Otto autonomous mobile robots in their US sub-assembly applications.

Semiconductor sales were also down high-single-digits versus prior year. While the industry is still navigating through a myriad of challenges, including geopolitical risk, excess memory capacity, and workforce shortages, we continue to see new announcements and orders for greenfield projects and legacy fab upgrades, along with continued momentum in our wafer transport solutions. Within our eCommerce and Warehouse Automation industry, sales declined mid-teens and were in line with our expectations. Customers across many verticals continue to modernize their existing operations to match the current market’s needs. In addition to a strong funnel of these warehouse transformation projects, we are starting to see renewed CapEx plans from our eCommerce customers for fulfilment center builds later in fiscal year 2024 and in fiscal year 2025.

Moving to our hybrid industries. Within this industry segment, growth in life sciences and tire were offset by declines in food and beverage. Food and beverage sales were down high-single-digits versus prior year. Given the mix of products serving this customer segment, our Q1 performance in this vertical was most impacted by our internal capacity constraints mentioned earlier on the call. Similar to previous quarters, we continue to see large end users investing their digital and cyber capabilities across their global footprint. This quarter, we had another sizeable Clearpath win at one of the largest food and beverage manufacturers in the world, where the customer chose our Otto AMRs to replace their existing AGV system to increase throughput and flexibility, while enhancing material movement security.

It is clear our customers across many industries are focused on augmenting their existing workforce through autonomous and innovative solutions to drive further productivity, safety, and sustainability in their operations. Life sciences sales grew 10% in the quarter. Note that our life sciences revenue is more weighted to software and services versus products. In addition to our MES and cybersecurity services momentum, we are continuing to see increased investments in high-growth areas, such as Advanced Therapy Medicinal Products and GLP-1 diabetes and obesity drugs. Tire was up high-single-digits. Moving to process. Sales in this industry segment grew over 10% year-over-year, once again led by strong growth in oil and gas, metals, and mining.

Oil and gas sales were up over 25% this quarter. I already mentioned our performance in Sensia, and we continue to see follow-on orders from our customers’ decarbonization and digitization projects worldwide. Let’s turn to Slide 5 and our Q1 organic regional sales. North America organic sales were up over 4% year-over-year. North American manufacturers are continuing to invest, and we expect this region to be our strongest-performing market this year. Latin America was down half a point. EMEA sales were down about 2%, and Asia Pacific sales declined over 7%. Similar to the last few quarters, we continue to see challenges in the Chinese manufacturing economy, with high cancellations and pushouts relative to the rest of the world. Sales in China were down high teens versus prior year.

Moving to Slide 6 for our fiscal 2024 outlook. We continue to expect our full-year orders to grow low-single-digits versus prior year, with strong sequential growth through the balance of this fiscal year. Factoring in our performance through January, our continuous analysis of distributor inventory levels, and strong pipeline of customer projects, we are reaffirming our fiscal 2024 sales guidance range with organic sales projected to grow 1% at the midpoint. Currency is also expected to increase sales by 1%, and we now expect acquisitions to contribute a 1.5 of growth. ARR is still slated to grow about 15%. Segment margin is expected to increase slightly versus prior year, with significant second half increases coming from increased product volume, spending discipline, and the growing benefit of productivity initiatives being taken in Lifecycle Services.

Nick will share additional calendarization detail in his section. Adjusted EPS is slated to grow 5% year-over-year at the midpoint, again weighted to the back half of the year, and we still expect Free Cash Flow conversion of 100%. Let me turn it over to Nick to provide more detail on our Q1 performance and financial outlook for fiscal 2024. Nick?

Nick Gangestad: Thank you, Blake and good morning everyone. I’ll start on Slide 7, first quarter key financial information. First quarter reported sales were up 3.6% over last year. Q1 organic sales were up 1%, and acquisitions contributed 140 basis points to total growth. Currency translation increased sales by 120 basis points. About 3 points of our organic growth came from price, in line with our expectations. Segment operating margin was 17.3%, compared to 20.2% a year ago. This 290 basis point decrease reflects higher investment spend, mix between products and solutions, and lower supply chain utilization. While our Q1 spend was down sequentially, we had a difficult year-over-year comparison due to an abnormally low investment spend in Q1 of last year.

Key areas of year-over-year spending increases include investments in new products, digital infrastructure, and commercial resources. I’ll comment later on the expected progression of our investment spend when I cover our full year outlook. As Blake mentioned, orders inflected upward sequentially, and we expect strong sequential order growth through the remainder of the year. The expected slope of orders is consistent with what we have discussed over the last couple of quarters. Adjusted EPS of $2.04, down 17% compared to last year, was below our expectations, primarily due to lower-than-expected sales and lower segment operating margin. The devaluation of the Argentine peso was an additional $0.10 adjusted EPS headwind in Q1. I’ll cover a year-over-year adjusted EPS bridge on a later slide.

The adjusted effective tax rate for the first quarter was 18%, slightly above the prior year rate. Free cash flow was negative $35 million, compared to a positive $42 million in the prior year. Our lower year-over-year free cash flow generation in the quarter was driven by higher incentive compensation payout during the quarter, which was tied to our fiscal 2023 performance. Working capital decreased in Q1, driven by lower accounts receivable, partially offset by lower accounts payable. One additional item not shown on the slide. We repurchased approximately 400,000 shares in the quarter at a cost of $120 million. On December 31st, $800 million remained available under our repurchase authorization. Slide 8 provides the sales and margin performance overview of our three operating segments.

Blake discussed our top line performance in the quarter, so I’ll focus on our margin performance. As I mentioned earlier, our investment spend in the year-ago quarter was lower than normal as most of the incremental fiscal 2023 investments started in Q2 of last year. This resulted in a difficult year-over-year margin comparison in Q1 for both Intelligent Devices and Software & Control. Intelligent Devices margin decreased to 16.2%, compared to 22.4% a year ago. The decrease from prior year was driven by lower sales volume, the timing of prior year investment spend, and the impact of acquisitions, partially offset by positive price/cost. Our Clearpath and CUBIC acquisitions, both part of Intelligent Devices, are performing well and are making commercial — and we are making commercial and technical investments here to accelerate profitable growth.

Software & Control margin of 25% decreased from 29.2% last year. The lower margin was driven by the timing of prior year investment spend and lower supply chain utilization, partially offset by price/cost. Lifecycle Services book-to-bill was 1.13. Lifecycle Services margin of 10.4% doubled from the year-ago margin of 5.2%. Strong margin performance was driven by higher sales, lower incentive compensation, and higher margins in Sensia. We are realizing productivity benefits from Lifecycle Services restructuring actions we took last year and those benefits are coming in as expected. The next slide, 9, provides the adjusted EPS walk from Q1 fiscal 2023 to Q1 fiscal 2024. Core performance was down $0.10 on a 1% organic sales increase as positive price/cost was more than offset by negative product mix and lower supply chain utilization.

Higher investment spend was a $0.40 EPS headwind. Incentive compensation was a $0.20 tailwind. This year-over-year improvement reflects a lower projected bonus payout this year versus an above-target payout last year. The impact from acquisitions was a $0.10 headwind and aligned with our expectations. The year-over-year impact from currency was a $0.05 headwind, with the $0.10 headwind from the Argentine peso revaluation more than offsetting the positive impact from other currencies. The $0.05 — the net $0.05 currency headwind was offset by a $0.05 tailwind from interest expense. Share count and tax rate were each immaterial to the year-over-year change in EPS this quarter. Let’s now move on to the next slide, 10, guidance for fiscal 2024.

We are reaffirming our guidance for fiscal 2024 of reported sales growth of 0.5% to 6.5%, and organic sales growth in the range of negative 2% to positive 4%. As Blake mentioned earlier, we now expect acquisitions to add 150 basis points to growth, up from 100 basis points in our prior guidance, as the growing pipeline of projects from Clearpath is leading to higher expected growth. Given this improvement, Clearpath is now expected to dilute adjusted EPS by $0.20 versus our prior expectation of $0.25. We now expect a full year currency tailwind of 100 basis points, down from 150 basis points in our prior guide because projections for the euro and the Canadian dollar have weakened slightly for the year. 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%. And we are reaffirming our adjusted EPS guidance range of $12 to $13.50. We expect full year fiscal 2024 free cash flow conversion of about 100% of adjusted income. This reflects our continued expectation that inventory days on hand will drop to approximately 125 days by the end of fiscal year 2024, compared to 140 days of inventory we had at the end of fiscal year 2023. We continue to expect free cash flow conversion in the first half to be well below 100%, mostly tied to the higher incentive compensation payment made in Q1 relative to our fiscal year 2023 performance, and higher income tax payments related to the realized capital gain on the sale of our stake in PTC, as well as our Tax Cuts and Jobs Act transition tax payment.

From a calendarization perspective, we expect Q2 sales dollars and segment margin to be similar to Q1 levels. We previously expected the lead-times on our last constrained products would return to normal by the end of Q1. This is now being pushed back to the middle of the year. This means that our split between first half and second half revenue will be even more weighted towards the second half. Our plan was and continues to be for balanced spend across the four quarters of fiscal year 2024, compared to our upward trajectory of spend in fiscal year 2023, as confidence in supply chain recovery pace grew. Given the split of sales between first and second half, that means first half margins will be noticeably lower compared to the year prior and second half margins noticeably higher.

We expect margins in Q2 to remain similar to what they were in Q1 and then increase to the mid-20s in Q3 and Q4. That expansion in margin is virtually all — driven virtually all by revenue returning to levels consistent with end demand. We anticipate investment spend to be relatively flat across the four quarters of fiscal year 2024. From a year-on-year perspective, Q2 and Q3 increases in investment spend will be approximately $10 million each and then a year-over-year decrease in Q4. A few additional comments on fiscal 2024 guidance. Corporate and other expense is expected to be around $125 million. Net interest expense for fiscal 2024 is expected to be about $120 million and we’re assuming average diluted shares outstanding of 115.1 million shares.

We expect to deploy between $300 million and $500 million to share repurchases during the year. With that, I’ll turn it back over to Blake for some closing remarks before we start Q&A. Blake?

Blake Moret: Thanks Nick. Despite geopolitical volatility, our detailed discussions with our distributors, machine builders, and end-users point to fairly healthy market conditions. Our outlook for fiscal year 2024 is based on an acceleration of new product orders as distributors and machine builders reduce excessive inventory. Our operations team is working around the clock to ensure we can convert these new orders into shipments at lead-times that are as good or better than pre-pandemic lead-times. We continue to gain share across our key platforms, especially here in North America. We are seeing early orders from customer projects facilitated by economic stimulus, and automation continues to be an important way to maximize the productivity of available workers.

Our recent acquisitions are performing well on both revenue and cost, with Clearpath Robotics being a standout addition to Rockwell’s portfolio. We’ve seen multimillion dollar wins across diverse end-markets, including automotive, food and beverage, and even warehousing and logistics and this is just the beginning. We have a unique portfolio of high-value assets that we’ve built and bought with the best partner ecosystem in the business. Our focus is now to integrate these elements as only a pure-play can, growing share, profitability and cash flow by driving efficiency and synergy. Aijana, we’ll now begin the Q&A session.

Aijana Zellner: 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. Juliane, let’s take our first question.

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Q&A Session

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

Andy Kaplowitz: Good morning everyone.

Blake Moret: Hey Andy.

Andy Kaplowitz: Blake and Nick, you mentioned that your orders were up double-digits sequentially. Could you tell us where backlog was ending Q1? And regardless, you did reiterate your low single-digit order growth for FY 2024. So, are you beginning to see a more substantial turn in orders here in fiscal Q2 as your distributors bottom out their inventory levels? And if so, what end-markets would you say are inflecting the most?

Nick Gangestad: Yes, Andy, we ended last year with a backlog of $4.1 billion all in, and it went down high single digits in — during the first quarter. In terms of what we’re seeing with orders, you’re exactly right, we’re seeing an inflection up in the orders from the Q4 trough. And we’re expecting that to continue into the second quarter of double-digit growth into the second quarter. In terms of where that — where we’re seeing that, I’ll turn that over to Blake.

Blake Moret: Yes. Let me just mention additionally, Andy, that distributor inventory is coming down. So, as we’ve talked about before, we have good visibility into our distributor inventory based on our channel model, and we are seeing that going down as we expected. As we’re seeing the orders, it’s a good mix across industries, including some of the industries that were pressured by the lower shipments in the first quarter like auto and food and beverage, we’re also seeing it across the entire portfolio, as we talked about annual recurring revenue, very strong from a software and a high-value services standpoint and other aspects of Lifecycle Services. But we do expect that that order recovery is going to be broad-based across our key industries, including in discrete and hybrid, to complement the continuing good performance in process such as oil and gas.

Andy Kaplowitz: Very helpful, guys. And then you didn’t change your adjusted EPS guidance for the year, but you did mention that you expect modest EPS growth that’s back-end loaded. I know, Blake, you suggested that your supply chain team should catch up with a more book-and-bill type environment in Q2, and Nick, you talked about the margin jump starting in Q3. But maybe you could talk more about confidence level in getting that margin jump you expect in Q3. And does a relatively slow start for EPS for the year suggests modest EPS growth for FY 2024, meaning somewhat lower in that $12 to $13.50 EPS range? Or are you not trying to single that?

Blake Moret: No. Well, we’re reaffirming the guide that we introduced in November. The significant increase in EPS in the second half of the year is based on the increased volume. You’ll recall last year, we went from roughly $2 billion of shipments in the first quarter of fiscal year 2023 to an exit of around $2.5 billion. And we’re expecting to see something similar in this year, in fiscal year 2024, from the Q1 that we were talking about of $2 billion roughly of shipments to around $2.5 billion at the end of the year. That’s what’s going to drive the higher margins and EPS. Last year, the causal for that ramp was based on getting chip supply. This year, it’s the ramp of orders.

Andy Kaplowitz: Appreciate it guys.

Blake Moret: Thanks Andy.

Operator: Our next question comes from Jeff Sprague from Vertical Research. Please go ahead, your line is open.

Jeff Sprague: Thank you. Good morning everyone.

Blake Moret: Hi Jeff.

Jeff Sprague: Can we just drill back into the supply chain comments? They seem inconsistent, right, when we think about it. Revenues this quarter are lower than revenues in the prior three quarters, right? So, you’re getting a lot more out the door the prior three quarters. So, can you just elaborate a little bit more on what exactly happened in supply chain? What kind of bottlenecks you’re dealing with? Are they at the Rockwell factory level? Are they at a supplier level? Just please clear that up for us, if you could.

Blake Moret: Sure Jeff. So, what we’re seeing is the shift in the timing going from a dynamic of shipments that’s been based entirely on reducing large amounts of backlog, to a recovery to a more normal product book-and-bill process. So, the big shipments that we saw over the last year were based on chips coming in with a very visible really mass of past-due backlog that was in a relatively concentrated set of SKUs for us. So, whether it was variable speed drives or motion control or Logix IO. We had very good visibility into what we needed to ship as soon as we got the chips. We’re seeing the shift in Q1, which should be complete in Q2, of moving to a more normal distribution of having the vast majority of our shipments in the quarter based on book-and-bill, that is, new orders coming in that get turned around in the quarter.

The things that hampered us in Q1 were the lingering tail of those past-due backlog items that we talked about taking a little bit longer than Q1 to clear out, as well as some continuing component challenges, and then the shift to being able to build safety stock to be able to handle those incoming orders. That progress continues in Q2. We expect to be substantially complete with that in the quarter. But that’s the difference of what we were shipping out last year versus what we’re shipping out now. I should also mention, we’ve talked in the past about our capacity being over $10 billion and that remains true. Our capacity to ship in terms of physical plant and labor is over $10 billion and that’s going to be important as we continue to grow.

Jeff Sprague: Okay, right. And then again, if we could just talk a little bit more detail, maybe it’s for Nick. I think you’re pretty explicit on sort of the margins for Q2. Maybe just give us a little bit of color though on kind of the mix and what’s driving that. I mean it does sound like you’re expecting some sequential revenue lift in Q2. So, why would margins be roughly similar to Q1?

Nick Gangestad: Yes, we’re expecting dollar revenue to be very similar in Q2 to what it was in Q1 and a very similar margin. The mix of what we’re selling in Q1 to Q2, in Q1, we had more of it coming out of our backlog and less from current quarter book-and-bill. In Q2, that will be shifting — that mix will be shifting to more coming out of current quarter orders as we continue to bring that backlog down. On the margin front, many of the things that we saw in the first quarter, we’re going to be keeping investment spend very similar to what — in Q2 very similar to what it was in Q1. The year-on-year change of that will come down, but the sequential will be almost identical. And then mix will probably not be as — was a drain — was a negative to us in Q1.

And we expect mix to continue as a negative into Q2, both from a segment mix where we expect higher growth in — our highest growth in Lifecycle Services, but also within segments where we’re seeing more of our sales in Intelligent Devices coming from our configure-to-order business.

Jeff Sprague: Great. Thank you

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

Andrew Obin: Yes, good morning.

Blake Moret: Morning Andrew.

Andrew Obin: Just to follow-up, I guess, on Jeff’s question. If we go back to your Analyst Day, I think the message is that this is a transition year, and then revenue growth mean-reverts to plan next year, which means it’s going to accelerate very nicely. Can you just expand, how do you make sure that, over the next 18 months, Rockwell can actually deliver the volumes? Are there any structural changes that you’re making to your internal processes and supply chains to sort of ensure a smooth ramp-up?

Blake Moret: Yes, Andrew, there is. As I mentioned before, the first is to make sure that we have the fixed assets in place. We’ve been working on that for over a year, which allowed us to get to the $9 billion worth of shipments last year, which was a fairly healthy step-up from prior. And we’ve kept going to where, today, we feel like we have over $10.5 billion worth of capacity in terms of the assets. As you’ll recall, we’re a fairly asset-light manufacturing process. It’s assembly, it’s test fixtures, it’s surface mount machines and so on. And we’re making sure, not only in our organic business, but also with the acquisitions where we’re seeing such strong growth, that we’re making the investments to be able to fuel that growth.

Labor is the other area. We have adequate product labor in place currently. We are continuing to ramp up based on the growth in our engineered-to-order business and the share gains that we’re seeing there, the labor through the year in that. And in some cases, we’re holding labor in place to make sure that it’s there as we see that order ramp continue through the year. From a structural standpoint, we are working through ways to drive efficiency, to get scale throughout the organization. Some of this is standard lean concepts. But it’s also adding the things that we’ve learned about needing resilience in terms of redundancy across multiple plants, in some cases, redundant sources of supply to be able to reduce the dependence on single suppliers in single parts of the world.

So, we’re working all of those plays in operations as well as with the engineers. Andrew, going back to your first comment, we do expect to be exiting fiscal year 2024, as we go through this transition, with margins that are very encouraging, as Nick talked about, as well as volume that supports continued growth in 2025 and beyond.

Andrew Obin: Thank you. And just a follow-up question. We’ve been getting some incoming calls, just folks concerned about slowdown in packaging CapEx. I think there were specific headlines. Also mining, another area of concern, I know sort of discrete and process. But can you just comment about these two specific markets, maybe a little bit more granularity what you are seeing around the world? Thanks so much.

Blake Moret: Sure. So, for us, packaging is typically being incorporated as part of our vertical industries of food and beverage, consumer packaged goods. And we are seeing the machinery builders in those areas, in Life Sciences as well, I should mention, there’s packaging of medicine in Life Sciences, of course. And we are seeing those machine builders, similar to our distributors work, through inventory in their system. It’s in a similar kind of profile to what we’re seeing with our distributors, in that we expect over the coming few months, that works off and exposes what we continue to see from direct conversations with those customers, with those machine builders strong underlying demand. With respect to mining, we actually are seeing relative strength in mining in the areas that we focus on. Some of that is driven by materials for batteries. But in general, we do expect to see low single-digit growth in mining in the year.

Andrew Obin: Thanks so much.

Blake Moret: Thanks Andrew.

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

Nigel Coe: Thanks. Good morning. Sorry about that. Thanks for the question. I’m sorry, I missed a part of the call, Nick, where you were running through the guidance point. Did you call out the degree of order acceleration? I know you called out double-digit growth sequentially. Just wondering if you quantified the order and backlog exiting the quarter.

Nick Gangestad: Yes, I did call some of that out. First, we saw double-digit order growth sequentially in Q1, and we expect double-digit order growth sequentially in Q2. And then further ramp into Q3 and Q4 for orders. And that’s being driven by the progress we’re seeing with excess inventory in the channel coming out. In terms of the backlog, we ended fiscal year 2023 with a backlog of $4.1 billion, and we saw that come down high single-digit percent in the first quarter.

Nigel Coe: Okay. That’s very helpful. Thanks and sorry I missed that. Are we still looking at $3 billion as the point where this stabilizes and where we start to see that real inflection in order rates?

Blake Moret: I’m sorry, the $3 billion?

Nigel Coe: Yes, $3 billion of backlog. I think that’s what you called out as sort of normal-ish level.

Nick Gangestad: Yes, what I said on the last call is that we expect the backlog in a more normal range of 30% to 35% of our revenue. I think that we still see that as a good point. I’d say our current projections see us at the high end, closer to the high end of that 30% to 35% range now for fiscal year 2024.

Nigel Coe: Okay, that’s great. And then my follow-on question, Nick, is I understand that the mix impacts from Lifecycle services are growing, the Software Control and ID. But maybe the 240 basis points of gross margin compression year-over-year, maybe just unpack that for us in terms of mix versus M&A impacts. Just curious because that — given that pricing was 3 points, price/cost positive, that’s a fairly big delta.

Nick Gangestad: Yes. So, if you look at our press release, we have gross profit down 240 basis points year-on-year. About a third of that is coming from the investment spend that I talked about year-on-year, that that’s because our R&D spend is part of that growth. So, that’s about a third of that decline in the margin there. Our acquisitions, Clearpath and Verve, are 30 basis points are a small part of that. And then the rest of it would be coming from mix and underutilization of our — underutilization of our supply chain in the first quarter.

Nigel Coe: Okay, that makes sense. Thanks Nick.

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

Steve Tusa: Hi, good morning.

Blake Moret: Morning.

Nick Gangestad: Hey Steve.

Steve Tusa: So, I guess just from a stability perspective on the deliveries. Is there a particular end-market or anything like that that’s driving this what kind of looks to be a very choppy outcome on delivery? Is it like are there certain segments of the market or product types that are not maybe flowing as smoothly as they have in the past?

Blake Moret: No, Steve, it’s really — I mean, it is product and it’s centered in the Intelligent Devices. So, where you have the greatest diversity of SKUs between variable speed drives, motion control. And these are the areas where you’re seeing that shift that I mentioned earlier, where we were bringing down a significant amount of past-due backlog, and now we’re moving towards what is a more normal book-and-bill environment. But there’s no unsurmountable challenges that we don’t expect to be resolved in Q2. It was the shift that we saw really Q1 and a little bit into Q2, is that move from having the vast majority of our shipments as past-due backlog moving to more book-and-bill, centered within the Intelligent Devices segment.

Steve Tusa: Okay. I guess just also, just, Nick, from an earnings perspective, first half is going to be relatively low, is how much of a linear step-up do you think for 3Q and 4Q as we just think about the seasonality here?

Nick Gangestad: Yes, it will really be bringing us where the first two quarters of this year are, I’d say, under-reflecting end-demand for our products as that excess inventory is being worked through. And then Q3 and Q4 are getting back to a more normal. So, yes, that makes it more heavily weighted to the back half of the year. But given our plans of what we’ll be doing from spending, the type of earnings growth, is very consistent with what we expect with that kind of uptick in revenue into Q3 and Q4.

Steve Tusa: Okay. And just lastly, just on the orders, we’re getting to something in the kind of 1., I don’t know, 1.6, 1.7 range. Is that about right?

Blake Moret: Yes, we haven’t given the specific number, Steve. We talked about double-digit sequential growth from the trough in Q4 to Q1, with expected continuing double-digit sequential growth from Q1 to Q2, and really continuing through the year.

Steve Tusa: Okay. Thanks a lot.

Blake Moret: Yes, thank you.

Operator: Our next question comes from Chris Snyder from UBS. Please go ahead, your line is open.

Chris Snyder: Thank you. I wanted to ask about the guided step-up in margins from the high teens level in the fiscal second quarter to about mid-20s in the fiscal third quarter. I understand volumes are getting better sequentially, but that implied sequential incremental is much, much sharper than what we would kind of say is normalized for the company. So, can you just sort of talk about other drivers of that sequential margin uplift into the back half beyond just volume?

Nick Gangestad: Yes. There’s three things I’ll point out on that, Chris. The vast majority, I’ll say 75% of that margin expansion, is just coming from the volume increase in holding investment spending flat across the year. The second and third pieces are pretty equal. One is coming from the improved utilization of our factories that we’ll — and our supply chain that we’ll see as a result of that. And then the third is we saw good progress on our Lifecycle services margin, and we expect that to continue, and that’s also going to be part of our continued margin expansion from the first half to the second half.

Chris Snyder: Thank you. I appreciate that. And then on some of the supply chain constraints you guys called out that weighed on shipments in the first quarter. I don’t think I caught it, but could you provide any sort of magnitude on how much sales were impacted by that? And it does not seem like that’s coming back in the second quarter. It seems like they are then kind of deferred into the back half of the year. Is that right? Thank you.

Nick Gangestad: Yes, I would put the — we had originally guided that we expected low single-digit growth in the first quarter. We came in at 1. So, there is — there’s a portion, but it’s probably in the $50 million to $70 million range of what we’re talking about there. And yes, much of that is going into the second half of the year. That is correct.

Chris Snyder: Thank you.

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

Julian Mitchell: Hi, good morning. I just wanted to try and square sort of the comments on capacity utilization and the supply constraints with inventories. I think they’re running — we’ll wait for the Q for the end-December balance, but it sounds like those are sort of stable sequentially maybe. And they’ve been running at a mid-teens share of sales versus sort of 8%, 9% pre-COVID. And they rose a lot the last 12 months even as sales rose. So, I just want to understand sort of — it sounds like inventories to sales, inventory days, should fall in the balance of the year. But do you need sort of some — is that based on a much faster sell-through out of the plant? You need to sort of underproduce somewhat to get the inventory back down? Or do you think that inventories will stay much higher now as a share of sales medium term than pre-COVID for some reason, even though lead-times are normal?

Nick Gangestad: Yes, Julian, there’s a few things that will change there. First of all, you know our projection that we’re going to move from 140 days of inventory down to 125. That’s been there and that’s unchanged. Now, the mix of that, as we’re looking at this shift to more and more of our revenue coming from current quarter orders that we’re booking and billing, part of our action plans there is we see some increased needs for safety stock of those finished goods. So, as we go through the balance of this year, there will be some places where finished goods go up. But that will be more than offset by the reductions that we’re seeing in our components driven by the improved lead-times we have for those components as well as our work in progress. So, we’re expecting, as we progress through 2024, just to be seeing that kind of shift. The 125 days will still be well above our pre-pandemic levels where we were typically under 100 days of inventory.

Julian Mitchell: I see. But I guess — I get it. Sort of two years ago, sort of people would have said you need higher inventory because backlogs are very high and you need inventory to sort of satisfy projects and backlog. But now you’re saying as you go back towards a more normal book and ship business, that also requires sort of higher inventories. I just want to sort of understand what’s kind of changed in the thinking there.

Nick Gangestad: Yes, in order to have sufficient inventories to be able to ship products very quickly to our customers and our distributors when they want it, we’ve been working on getting our products recovery back to where we can ship. Now, part of the progress we’re making in the next couple of quarters is getting all of our safety stocks on our — for our finished goods to where we feel they should be in order to make sure we’re performing and executing to our customers’ expectations. That’s part of that plan. And so finished goods will not decline, but we expect all of our decline to be coming in the — in our raw materials and work in progress.

Julian Mitchell: That’s helpful. And just the follow-up on that would be, when you look at your sort of customers and distributors, how are you seeing them managing their inventories of kind of your product? And how are they feeling about those inventory levels today, please?

Blake Moret: Yes, we expect our distributors to be carrying a little higher amount of inventory given the customer service challenges that the industry has had over the last couple of years, we expect that equilibrium that distributors get to be a little higher level than it was pre-pandemic. And that’s with very specific discussions with them about how they’re thinking about the balance of customer service and working capital. We’re also seeing with our machine builders that, as I mentioned before, some of them are still continuing to work down inventory in their own system, but we expect that to be complete over the coming months. I don’t know of any difference in the way machine builders are looking at carrying levels of inventory and working capital. But with our distributors, we do expect them to normalize at a little higher level than they would have traditionally.

Julian Mitchell: That’s very helpful. Thank you.

Blake Moret: Thank you.

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

Noah Kaye: Thanks very much. I just want to ask one final one on the production constraints. Can you help us understand a little bit better, what is different about the configure-to-order business versus the type of products that you’ve been working down a backlog? Is there focus on different lines? Does it require different personnel? Just help us understand some of the actual operational dynamics you are going through as you kind of reconfigure for a more normal book-and-ship environment?

Blake Moret: Sure. Let me just clarify that. The shift that’s going on that we saw challenges in the first quarter was the move from servicing backlog of products to shipping out book-and-bill of products where the orders come in in the quarter. We continue to have a certain amount of configure-to-order business, our motor control centers, our big drives, our independent cart technology and so on. That isn’t representing the biggest challenge to us. Those are very different processes. Those configure-to-order businesses come in with varying degrees of customization specific to a customer. But the big dynamic that we’ve been talking about in Q1 is the move from a somewhat concentrated list of SKUs that we have backlog building — that backlog built up because we couldn’t get the chips, moving to book-and-bill of a more diverse set of SKUs as we see the largest portion of our shipments coming from orders received in that quarter, not one or two or three quarters prior.

So, that’s the main dynamic that we’re working through. You have much less visibility to what’s coming in from that book-and-bill profile. So that’s one of the changes. And what Nick was talking about in the previous question is we’re in the process of building up safety stock in those areas so that we can deal with the ebb and flow of the normal order book, in a quarter being able to turn that around and convert those orders to shipments in the quarter. So, those are the processes that are somewhat different from what — the world we’ve been living in for the last year or so, to what we’re transitioning to and we’ll continue to operate in, we hope, for a long time.

Noah Kaye: Thanks Blake. If I could ask just one follow-up. I think you’re not — you reiterated your organic industry segment outlook essentially for the full year. Is there any change or shift you’ve seen in the timing of demand and orders for any of the major segments or subsegments? It does seem like most of the cadence here is really driven by your own production considerations and where channel inventory is. But is there any shift in timing you can see among the end-customers?

Blake Moret: Yes, I think you said it right. The largest impact is based on getting those shipments out the door, being able to see the distributors return to equilibrium. We continue to see good activity in process applications. We talked about oil and gas, specialty chemical, mining. These are all areas that are relatively strong. Certainly, we’ve seen some slowdown in certain of the EV projects, but those projects are continuing. We’re continuing to win new business in those areas. And as I talked about in my prepared remarks, in traditional internal combustion engines and in hybrid manufacturing, we have very good readiness to serve in those areas as well, with a lot of experience. So, in a year of low growth, we’re not seeing any big ebbs and flows in the vertical end-market needs being the predominant factor in any changes through the year.

Noah Kaye: Understood. Thanks Blake.

Blake Moret: Thanks.

Aijana Zellner: Juliane, we’ll take one more question.

Operator: Our last question will come from Joe O’Dea from Wells Fargo. Please go ahead, your line is open.

Joe O’Dea: Hi, good morning. Thanks for taking my question. First, I just wanted to ask about the back half of the year margin profile. And it does seem like a transition from maybe a higher concentration of a narrower band of products that you would have had shipping out of backlog in 2023 compared to more kind of book-and-shipping quarter in 2024 is a bit of a mix headwind. And so when we think about back half of 2024 margins being better than back half of 2023, can you expand on that a little bit? Is it Devices is up, Lifecycle is up, maybe Software and Control is down a bit year-over-year? Just trying to contemplate what could still be a year-over-year mix headwind as you broaden out the book and ship?

Blake Moret: Yes, I think what you’re seeing from a positive standpoint is the greater percentage of products as those orders increase through the year. To be sure, we are seeing some headwind based on the comparables with the year where Logix grew over 30% last year as one of our most profitable product lines. But the other point is that, recognizing the puts and takes in this year, we did take cost out beginning in Q4 of the last year. And so that gives us help to being able to push those margins at the exit of 2024 higher than they were. That’s in — across our business and functions, most noticeably in Lifecycle Services.

Joe O’Dea: Great. And then just on the sort of channel inventory observations, and it sounds like taking a little bit longer than previously anticipated to get channel inventories to targeted levels, what are your observations of why that is in terms of kind of end market demand patterns or maybe a little bit more inventory out there than you appreciated for why it would be more middle of the year versus first half of the year where we would have seen channel inventory correct?

Blake Moret: We’re really talking about variability that could be in the area of weeks or a month. I wouldn’t read too much into talking middle of the year versus second quarter. We did see a good double-digit sequential increase in orders in Q1. We expect that again in Q2. January represents a sequential increase based on what we’ve seen so far from Q1. And so we continue to see that inventory at our distributors coming down pretty much as we expected.

Nick Gangestad: Yes, Joe, I’ll just add. I mean, we’re obviously in close dialogue with all of our distributors, and a high percentage of them are affirming to us that they expect to be done with — they’re reducing excess inventory sometime during Q2 and that they’re at an equilibrium point there.

Joe O’Dea: That’s really helpful. Thank you.

Aijana Zellner: Thank you, everyone, for joining us today. That concludes today’s conference call.

Operator: At this time, you may disconnect. Thank you.