You since you've been the CFO at Rockwell, clearly supply chain's been at the forefront. Can you maybe just start just by talking about what you've done to help improve the resiliency of your own supply chain? Obviously we'll talk about current trends as well.
Sure. Yeah, it has been an interesting last couple years. Some of the things Rockwell we've been doing at Rockwell is, first of all building and making investments in our own resiliency, and that often involves redesigning parts of our product line, to make them capable of using semiconductor chips that we think have more of a viable supply going forward. Sometimes it involves re-qualifying a second source of supply for chips. Working to... In some cases, we're working with our suppliers and entering into longer term supply agreements where we can be assured of having continued continuity of supply.
We've also been investing in our own capacity, working hard to make sure that as we see some improvements in semiconductor availability, that we have the internal capacity to be able to move product through our own manufacturing as quickly as possible. That's been part of the CapEx we've been doing the last couple years. While you mention it, you probably were thinking more about the chips themselves. I'll just say one of the things we've been doing as far as our own agility and resiliency is we changed our pricing model to make us more agile in our ability to be able to adjust price for what we're seeing for dynamics with inflation. Whereas before, a couple years ago, we had a model where it could take quite a bit of time.
We've moved that to be more agile. What we're seeing right now is we are seeing improved. We've been saying for quite some time we'd be seeing gradual improvements in availability and access to semiconductor chips. We are seeing that happen. I would also say we are seeing improved reliability, meaning when a semiconductor manufacturer is telling us that we can count on a certain number of chips in certain time periods, their ability to deliver to what they said is improving. That was part of our challenges in the last 18, 24 months, is limited supply, but also poor visibility of what to actually really expect.
Mm-hmm.
Those are some of the things we see going on now and what we've been doing.
Yeah. Now look, it was, it was great to see the growth in Software & Control this quarter, north of 40%. Clearly seems like it benefited to some degree from either lead times improving, supply chain getting better. I'm just curious.
Yeah.
Are there still, like, certain product categories that are still kind of well behind where the lead times are still very long and you haven't seen much improvement at this point?
Yep. In the case of Software & Control, what we're seeing there is a combination of several things. We've done quite a bit of effort around redesigning our products, and the strong growth we saw in the second quarter is benefiting from that as well as just overall better access to chips on a macro basis. Both of those things are helping. Remind me the second part of the question.
Yeah. Are there certain product categories-
Oh, yeah. Different product categories. Most of our portfolio still has longer, noticeably longer lead times than what we had pre-pandemic. We've been seeing in most of our portfolio some reductions in the lead times, but I would say the majority of our revenue is still in lead times where they're extended over what they were pre-pandemic. We expect in the second half of this year we will continue to see some improvements in those lead times, and that's part of we'll ultimately get to, I'm sure, part of how we're thinking about orders in the second half of the year, that as our lead times come down, we expect that will lead to some softening of orders as customers don't have to place orders quite as far in advance as they have been the last couple years.
Sure. I mean, since you segued for me, you know, you talked about your backlog, you know, this past quarter, $5.6 billion. slight reduction quarter-over-quarter, still, really good, you know, in terms of your visibility. Maybe just talk about like now your expectation for orders going forward and that confidence in maintaining that $5 billion backlog exiting the year.
Yeah. At the end of the first quarter, we didn't provide guidance about what we were seeing for orders, and I'm not sure we're always going to be in the mode of wanting to provide order guidance. There's enough dynamics that we felt it would be helpful for people to share exactly where we are with orders and what we're seeing for the full year, as well as what we're projecting with our backlog. If I go pre-pandemic, our backlog never exceeded $2 billion. Now while as the company's growing, I don't know if we'll get down to that level again, but it's like numbers like $2.5 billion-$3 billion, that might be a more natural landing spot for us when we're completely through some of these supply chain challenges.
Partly what we wanted to share is, where we stand with orders and when we, based on dialogues we're having with customers, what we're expecting with lead times. We expect for the full year orders to be around $9 billion, which then implies a backlog of around $5 billion. Partly what that does is sets up that, even with a strong fiscal year 2023, we are anticipating to be exiting the year with a much larger than normal backlog that we think gives us opportunity for continued growth into 2024 in a variety of economic scenarios.
Yeah. So that's, that's actually probably a good segue to what we were talking about before, this conversation really kicked off, was really just around the U.S. manufacturing renaissance and where we are today. Are you already starting to see a lot of activity on semi fab plants, EV battery plants? Maybe just talk about like the opportunity that lies ahead, and how that's changed maybe over the last 12 months for you.
Yeah. We think the U.S. or North America is a very good place for manufacturing, and it's what I would call our home base, where we have strong market share, market capability. What we're seeing in the U.S. manufacturing environment is, yes, places like semiconductor, where there is projects been announced, been started in many cases, and Rockwell being part of those projects. We are seeing that. In particular, a place like semiconductor, one of the reasons we talk about it is the amount of investment going into it, but also Rockwell changing our penetration in that market.
Historically, Joe, if you and I were talking a few years ago, most of our penetration into a market like semiconductor would have been around things that have managed the environment in a fab. Increasingly, we have new capabilities. For instance, Independent Cart is playing a big role in wafer transport. We're seeing penetration into the wafer transport part of the line. Our offering of cybersecurity, we also see as a strong offering that we're providing to some of these greenfield semiconductor construction going in. What we're excited about is not just the total amount of capital, but also that we feel we have more places to be winning in the semiconductor space.
EV is another space where you hear us talk about it quite a bit because this is something where we feel we're the net benefactor. Many of the things in an automobile that have traditionally relied on Rockwell technology, those are still there. We've traditionally had very little content that goes into the internal combustion engine itself. That just doesn't really fit what a lot of what Rockwell solutions provide. Now you have a whole ecosystem building up around the EV itself and the new capital going into that, as well as the support for things like battery and how can Rockwell Automation be solving problems around the battery assembly.
These are places we are seeing a lot of activity and Rockwell winning a lot of share, a lot of the bids that we're getting involved in there. That said, we are still seeing beyond these things where there's something structural changing, we're also seeing, like brownfield, a lot of our customers in the U.S. saying they need to make their facility, their brownfield facilities more resilient and more productive. Sometimes in a case where they have challenges in hiring people, how can they upgrade their manufacturing capability? I would just say now is a good time for U.S. manufacturing.
Yeah, that's super helpful. Maybe just following on there, a couple questions. You know, there's been, you know, over, call it $400 billion or so outlined for semi fab plants. I think $200 billion or so has already broken ground. If you think about kind of like the life cycle of a plant, maybe talk a little bit about how you benefit, you know, from beginning to end of construction. Secondly, if you think about your own content, I recognize that you're now, you know...
Yeah
you're now playing differently than you did before. How does your content stack today versus what it used to be a few years ago?
Well, as I mentioned earlier, we feel we have more places to win. I'm pretty sure Blake has gone on record saying that in some cases, some of these semiconductor fabs, we see our potential in the tens of millions of dollars of what Rockwell content can be. A high percentage of that content will come in the early stages as we're providing the help in getting it set up, getting it designed, the actual hardware going in. It doesn't end there. Part of what we provide are the services going forward and how it's being monitored, how things are operating. Case of cybersecurity, which I mentioned earlier, that would be often a annual recurring revenue that we're getting in a space like that.
Just ongoing MRO, where there becomes a revenue stream of ongoing maintenance and supply. Part of Rockwell's strategy and how we're structured is to be able to create value for the customers throughout the life cycle there, not just at the beginning, but through the whole thing. In some of these cases, where greenfield investment in a place like semiconductor, a high percentage does come early in the manufacturing of that fab.
Okay. That's super helpful. Maybe just talking about the most recent quarter, you know, incredible growth, I think probably top quartile in our coverage at 27%. I saw you took up the guidance for the year, now 13%-17%. First half ran ahead of it. Supply chain's getting better. Why wouldn't we sustain a higher growth rate than what the current guidance is for the full year?
Yeah. Joe, I'll just start out. I think you're being somewhat kind in that we did have an easier comp in the first half of the year. In particular, second quarter of last year was one of our more challenging quarters. We're not trying to manage specifically like be conservative or aggressive in how we're guiding. I will say we are trying to manage the company conservatively, and that means, like, planning for there are unexpected hiccups that can occur. In your first question, Joe, I was talking about there will be things that happen, that we get the call from a supplier that says, "We know you were counting on this level of chips from us next month and next quarter, we can't do it." Those calls still come.
They don't come as frequently as they were a year ago, but we are managing conservatively, planning for the unexpected to occur. We think that's a wise way to be managing the company right now, given a number of uncertainties out there. Yeah, it could be everything goes right, and we end up at the higher end of our range, but we're trying to lay it out exactly how we feel, how we're managing the company, and how.
Yeah
How we're planning, our results for the coming quarters.
Yeah. I know, last year particularly, there was a lot of concern around double ordering and cancellations. It seems like things are still kind of running on trend for what you guys would expect. Maybe give us a little bit more color on what you're hearing from a cancellation perspective and whether that's impacting any particular business more than others.
Yeah. Cancellations for us in any particular quarter have traditionally been in the low single digits. They continue to be in the low single digits, and we're really not hearing anything that would indicate that that's going to change. I think just one other thing to point out. At the beginning of this calendar year, we did institute a order cancellation policy, and we characterize that as just good hygiene. We want to make sure as orders are being placed with us, that they're being placed with good thought and planning, that this is the right underlying demand for that, and that because we are making commitments, based on projected on demand coming in to our suppliers. We also want our customers having a level of commitment as well for these.
We think that's good hygiene that's gonna keep our order quality high. We think that's part of why we're continuing to see low, low, low cancellations. In terms of color, I don't think there's any color to say. It's been low, it's staying low. It is something we continue to monitor if it's any kind of early tell. So far we're not seeing anything.
Okay. Helpful. From what I remember, a lot of that policy was in place in, you did it with a lot of your Asian customers, as it was more kind of like status quo in that region. It was re-interesting to me, take a look at your China growth rates this quarter. It was a lot better than some other companies that we've seen, as other folks are seeing a more uneven recovery. Maybe just talk about China specifically, what you're hearing and seeing on the ground there?
Yeah. We have a broad range of things that we have in China, like our products that we sell. We also have a fairly significant Lifecycle Services presence in China. Much of what you see of revenue growth in from a geography standpoint, so for instance, China or Asia Pacific, I'd say in the interim period right now, it's really more being driven by product availability and chip availability and the state of the backlog than it is underlying demand. We're still seeing very strong demand in a place like China, in a quarter like this or even for the year, as we're posting strong growth rate in a particular geography, it's at this point more driven by where our backlog is.
Mm-hmm
and where the product availability is. Partly I'm saying don't overread too much. It's, you're likely gonna continue to see growth there, but it's more us working through our backlog in different geographies of the world.
Got it. That makes sense. I'll turn the questions over to the investor base in a second, but maybe one last one before I turn it over, see if anybody's got questions. Price cost was a big theme for a lot of companies this quarter. You mentioned you putting in new.
Mm-hmm
... New procedures in place to.
Yep
... Have better pricing discipline across your business. What inning are you in in terms of, you know, having more sophisticated pricing? We'll get to the cost side of the equation as well.
In terms of more sophisticated pricing, what you're talking about is where we changed part of our model and pricing to give us more agility in how we can pass that on. There we're actually in the late innings. We have completed most of that change. I will just challenge a little. I would say we had some fairly sophisticated pricing capability before we would actually realize the price, and that we've corrected that, and we're virtually done with that.
Great
... That transition. In terms of price cost, we started the year with an expectation that price costs would be adding about 100 basis points to our margin. Where we are now, at the midpoint of the year, I've now said it's going to be a little over 200 basis points of margin expansion for the full year. That's a combination of price being a little better than what we expected and input costs being also a little better than what we expected. If I was just to clarify a little on the input costs, we're still seeing input cost inflation on our semiconductor chips. That is playing out almost exactly how we had planned.
Conversely, when it comes to our logistics costs, we had planned for some modest increase there, and actually it's gone the other way, and we're actually seeing year-on-year declines in our logistics costs. That's from an input cost, we're seeing improvement from where we started the year.
Are you still... Just one follow-up there. Are you still using brokers for your chips?
Yep.
Is it still above normal?
Yeah. We're still using brokers to supplement what the chips we can access, and we're seeing some improved availability in the broker market. We're also seeing some moderating of pricing in the broker market. Still at elevated levels, but not as elevated as what they were six, nine, 12 months ago. We anticipate we will continue to leverage the broker market where we feel it can give us accelerated access to some chips that give us the ability to meet our customers' needs for timing.
Great. I'll turn it over to the audience. Any questions from the audience? In the back there.
Thanks, Joe. Hey, Nick. Just a quick question on orders. You guys are talking about, you know, a moderating order rate in the back half. You guys did almost $5 billion in the first two quarters. You're talking about another $4 billion in the back half. Just think out a little bit longer term, you know, obviously, you mentioned that you've sort of had over ordering maybe by the customer because of all these shortages. If you sort of look out in the next year, right? I know it's too early to forecast that, but the annualized back half, let's say, you're running at like $8 billion, which would match up with sort of lead indicators indicating things are down. How do you think about, you know, 2023 is great.
You're working off order backlogs, not just you, but your peers. How do you sort of think about 2024 when the back half order outlook is, you know, now comping well below 2024 revenue run rates?
Yeah. I Thanks for the question. I wanna put it in perspective. We had orders in fiscal year 2022 of approximately $10 billion. Some of that $10 billion, and it's a very difficult thing to quantify. Some of that $10 billion was being driven by the fact that we had extended lead times for many of our products. As we look at where orders where they've progressed in the first half of 2023, and what we're expecting, what's driving our estimation of orders coming down in the second half of the year is really being driven by what we think will be rational behavior as our lead times continue to contract.
While $10 billion of orders in fiscal year 2022 could be an overestimation of what the underlying demand was just because of the lead times. As we see some contraction in those lead times, the types of orders that we're going to see in fiscal year 2023 could actually be an underrepresentation of the underlying demand. I think the truth is we're not gonna know the full answer of that until we're getting further into the year and into 2024. For us, our view in how we guided orders was really being driven, not so much by something going on from an economic perspective, but what we think is rational behavior as we're continuing to see our lead times contracting.
Any other questions from the audience? Okay, we'll keep going. Can we just maybe turn the discussion to margins for a second?
Sure.
Software & Control margins this quarter, I think we're north of 33%. I mean, incredible. Like, what's the right long-term margin entitlement for this business? How should we think about it going forward?
Yeah. The margin in the second quarter was being benefited by, we were seeing improved access to semiconductor chips as well as some of the redesign effort I talked about. We're also seeing strength in the software portion of our business in Software & Control. As a reminder, A couple acquisitions, a couple one and two and a half years ago, seeing those as they continue to progress as we move through some of the integration spend. We're seeing those continue to improve. All in, as I guided for the margin for the full year, we think the Software & Control staying above 30% is a natural spot.
I'm not sure I'm ready to give guidance beyond 2023, but right now as I look at it, I'm not sure of something that I could say that would take us off of a 30%+ margin in 2024 as well. It looks like a strong business that could, should, could and should continue to be able to generate strong 30%+ operating margins.
Let's talk about your software business for a second.
Sure.
I think roughly, you know, the pure software business is around like $800 million, so correct me if I'm wrong on that number, going to $1 billion at some point. You guys have talked a lot about, you know, FactoryTalk and helping scale your business. When I was at ProMat, it was interesting for me to hear how many customers actually use Emulate3D. Just maybe talk about the suite of software offerings that you have today, and then driving towards that goal of it being a much bigger part of your business over time.
Yeah. Yeah, thanks for the question. First of all, just to set the record straight on a few things. Like, some of our main KPIs that we internally manage to and share externally, we have an Information Solutions and Connected Services. That last year we broke through $800 million. We expect double-digit growth in that. There's a portion of software that's part of that. We also talk about annual recurring revenue and an expectation that that's We expect that to grow about 15% in fiscal year 2023. Those are some of the KPIs we look at, probably less so a pure software metric itself of the revenue.
Our software offering, I think I just want to make it clear, we're not trying to become a software company. I mean, software is an important part of the value we are creating and delivering for our customers, but we look at what we provide, the hardware, the software, the services as part of how we provide the complete solution. Yes, we do see software continuing to grow and the importance of that offering that we're providing. Overall, there's a lot of software that can be used on a factory floor. Rockwell, we've been pretty intentional about there's a few places that we feel we should be playing. First on the design.
The way that, the way that's being designed, the factory floor being designed, the way it's being emulated before you actually start putting metal in place, that you can see how it's operating, often with a digital twin. That design and getting it configured the right way, efficiently and effectively. Software offerings, both on-prem and cloud offerings there. Second place where we have an offering is operate. Sometimes a big part of that is the manufacturing execution system, where we have on-prem and cloud offerings for the way the factory floor is operated. The last piece is maintain, where the way our customers choose to maintain their assets.
As simple as keeping a record of every asset, what needs to be maintained, but increasingly connecting that maintain to what's operationally happening, 'cause we have a vision of actually moving more and more into the predictive analytics to maintain even more efficiently those assets. Those are the three places that Rockwell has scoped out as where we're gonna continue to play. A couple of them, we've supplemented inorganically, both in the operate and in the maintain. Our Plex acquisition and our Fiix acquisition, we think were key adds to our portfolio in the cloud perspective there of what we offer.
Yeah. That's super helpful. Maybe just going back to kind of like the near term and thinking about the rest of the year. You know, I know that you've kind of talked about a incremental margin target of, you know, 30%-35%. It was better than that in the first half of the year. It seems like you've got good pricing coming through, good volume growth. Why wouldn't it be better than that for the year? Also, if you could maybe just provide some commentary, you know, the two buckets we always talk about with you guys, incentive comp and investment spend for this year, and how that's running versus normal.
First on the core conversion, the incremental margin, part of our financial framework is that we have, we expect 30%-35% core conversion. That's partly how we started the year with our expectations. With the added growth that we're seeing and with the improving price cost that I talked about, we have. Our latest guidance, you are exactly right. We actually have gone north of 35. We're approaching 40% in the core conversion expectation that we have for the full year. So that's on our core conversion or incrementals. That includes the next couple things I'm gonna that you asked about.
From a incentive compensation perspective, because we are exceeding the expectations we had at the beginning of the year, we have called out that incentive compensation is going to be a higher expense for us in total versus our plan at the beginning of the year. It's going to be about $75 million higher than what we had at the beginning of the year as a plan. Compared to fiscal year 2022, going to be, I believe, roughly $150 million higher because fiscal year 2022 was noticeably below the planned level. That's a dynamic, and we're delivering that approaching 40% core conversion inclusive of that type of change in our incentive compensation.
In terms of investment spend, I mentioned it on the earnings, the last earnings call. As we started the year, I said we've been managing conservatively. There was some investment spend that we had on the docket that we thought we could do, but we really wanted to see how things were progressing from a supply chain before we did it. As we've gained confidence on that continued improvement in the supply chain, we did up some of our investments. All in for the year, we're now estimating that, our increment in increase in investment spend is going up approximately $180 million. Some of that is going into some development of new product development.
Some of it's going into our sales and marketing organization where we see opportunities for continued growth with some of the targeted investments we've put in there.
Got it. I mean, typically it's like $100 million in incremental, so it's another 80 on top of that.
Yeah. We started the year with an expectation of about $100 million. We upped it some at the end of the first quarter, now a $180 million increment, from prior year.
Last question for me. You guys have announced a bunch of partnerships and smaller acquisitions over the last several years, whether that's, you know, PTC, CUBIC, you know, it's just recently an announcement with Doosan Robotics. Do you have to do anything large scale or is there any attractive opportunity for you that would help you scale your either, I know you're not trying to be a software company, but that would help you scale your business even better if you did a larger type acquisition because these tend to be a little smaller in scope? I'm just curious like how you guys are thinking about that strategically.
You know, we keep looking at our portfolio of what do we think makes sense for the offering and I'm not sure we have any kind of big move like you're talking about in the off short-term outlook. We keep looking at is there something different we should do. We largely think what we're doing is.
Perfect
... The right approach. You talked about a couple of these partnerships. I would say that is something that is core to what we do at Rockwell, we don't always go into everything saying we have to control everything. There's parts of our portfolio where we feel we are the domain expert and we should do that. There's also some parts of what goes into automation on a factory floor where some of our partners have done some really good things, and then we'll partner with them. For instance, the Doosan partnership that you saw us talk about, like they're doing some great things with robotics and we have some great solutions around the PLC controllers and an agreement of how we're gonna collaborate together in a partnership to make that work together.
I'd say that's core to how Rockwell operates, is not feeling we have to control everything, but feeling we can work with a lot of partners to provide the best solution possible to our customers.
Great. Nick, thanks so much for spending time with us today. Good to see you.
Thanks, Joe. Thanks for being here.