Rockwell Automation's CEO Discusses F2Q2014 Results - Earnings Call Transcript

| About: Rockwell Automation, (ROK)

Rockwell Automation, Inc. (NYSE:ROK)

F2Q2014 Results Earnings Conference Call

April 29, 2014, 08:30 AM ET

Executives

Rondi Rohr-Dralle - Vice President of Investor Relations

Keith Nosbusch - Chairman and Chief Executive Officer

Ted D. Crandall - Chief Financial Officer

Analysts

Scott Davis - Barclays

Shannon O'Callaghan - Nomura Securities

John Inch - Deutsche Bank

Joe Ritchie - Goldman Sachs

Steve Tusa - JPMorgan

Steve Winoker - Sanford Bernstein

Mark Douglass - Longbow Research

Josh Pokrzywinski - MKM Partners

Nigel Coe - Morgan Stanley

Rich Kwas - Wells Fargo

Richard Eastman - Robert W Baird

Operator

Good day, ladies and gentlemen, and thank you for holding and welcome to the Rockwell Automation’s Quarterly Conference Call. I need to remind everybody that today’s conference call is being recorded. Later in the call, we will open up the lines for questions. (Operator Instructions)

At this time, I would like to turn the call over to Rondi Rohr-Dralle, Vice President of Investor Relations. Ms. Rohr-Dralle, please go ahead.

Rondi Rohr-Dralle

Great. Thanks, Frieda. Good morning. Thank you for joining us for Rockwell Automation’s second quarter fiscal 2014 earnings release conference call. With me today are Keith Nosbusch, our Chairman and CEO, and Ted Crandall, our Chief Financial Officer.

Our agenda includes the opening remarks by Keith that will include highlights on the company’s performance in the second quarter and the first half, plus the outlook for the full year. And then Ted will provide more details on all of that. And then, of course, we’ll take questions at the end of Ted’s remarks

Our results were released this morning and the press release and charts have been posted to our website, at www.rockwellautomation.com. Please note that both the press release and charts include reconciliations to non-GAAP measures. A webcast of this call is accessible at that website and will be available for replay for the next 30 days.

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 forecasted 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 Keith.

Keith Nosbusch

Thanks, Rondi and good morning, everyone. Thanks for joining us on the call today. I’m sure you are all happy to be in the homestretch of earnings season. I’ll start with some highlights. So please turn to page four in this slide deck.

We had another strong sales quarter with 7% organic growth and growth in all regions for the first time in over a year. Let me provide some more color on organic growth by region. The US grew 8% in the quarter, oil and gas continues to be the strongest performing vertical. In addition, we are now starting to see increased activity in chemicals. Auto remains relatively flat at high levels and the consumer goods industries are showing healthy growth.

OEM sales were also strong in the quarter. Canada sales were up slightly, but [technical difficulty]

Rondi Rohr-Dralle

We are hearing some feedback or delay. So, I don't know, Frieda, can you do something to make that go away?

Operator

Okay, is it okay now?

Rondi Rohr-Dralle

I don't know, Keith, go ahead.

Keith Nosbusch

We will start up again. Canada sales were up slightly but there is continued weakness in resource-based industries. EMEA had another good quarter with 4% growth led by emerging markets. Our OEM business remains solid across the region. China's sales increase of 14% was the strongest driver of Asia-Pacific, 10% growth. Latin America had a better quarter and better growth this quarter at 9%. Double-digit growth in Mexico and Brazil offset the sales decline in the rest of the region.

Emerging markets in total grew 11% in the quarter. I've got a couple of other comments on the topline, process sales grew 3% in the quarter, but quarter’s growth was stronger. For the first half, process sales grew 5% and we expect higher than 5% growth in the second half of the fiscal year.

Logix grew 7% in the quarter with the highest growth in Asia-Pacific. In China, we're seeing good OEM adoption of our compact Logix controllers.

Moving onto earnings, you often heard me talk about the quarterly variability of our earnings performance and the first two quarters this year clearly demonstrate that. It's more meaningful and more indicative of underlying trends to talk about our performance in the first half and we had a very good first half performance.

On 7% organic sales growth we delivered over one point of segment operating margin improvement. Adjusted EPS grew 10% in spite of a significant headwind from a higher tax rate and cash flow was also very good in the first half with 92% free cash flow conversion on adjusted income.

At the halfway point in the year, we are where we expected to be and are well-positioned as we entered the second half. Based on that, along with our expectations for continued stable market conditions, we are reaffirming sales and adjusted EPS guidance with a few tweaks.

Compared to our previous guidance, organic growth will be a bit higher, offset by lower sales due to currency and acquisitions. And we're maintaining the adjusted EPS guidance range of $6 to $6.35 in spite of a higher tax rate. Ted will provide more color on the full-year and second half of the year in his remarks.

I would like to take a moment to mention something that I’m very proud of. We recently received the Ethisphere award for the sixth time, naming us “One of the World’s Most Ethical Companies.” This recognition reflects our commitment to integrity, responsibility and accountability, all of which drive value for employees, partners, customers and shareholders.

Before I wrap up, I just want to remind you of the Integrated Control and Information opportunity that we talked about at our investor conference last November. Integrated Control and Information, or ICI, is the next wave of innovation in the evolution of the integrated architecture, intelligent motor control and Logix’ multi-disciplined controls.

It will provide the next generation of manufacturing and industrial productivity, thus, delivering business value to our customers across the entire automation investment lifecycle. ICI solutions enable the connected enterprise and makes manufacturing processes smart, productive and secure. We have the innovative technology, the smart people and the partners needed to deliver ICI and expand the value we provide to our customers and shareholders.

Now, I’ll turn it over to Ted. Ted?

Ted D. Crandall

Thanks, Keith, and good morning, everyone. I’ll start with chart number five – second quarter results summary. So another good quarter operationally with continued strong top line growth and pretty good underlying earnings conversion. There are a couple of unusual items impacting the year-over-year earnings comparison. I’ll highlight those, as we move through the charts.

Revenue in the quarter was $1,601 million, up 5% compared to the second quarter of last year. Organic growth was 7% and currency fluctuations reduced sales by approximately 2 points. Q2 last year is our easiest comparison quarter but even given that still very good organic growth performance, and as Keith mentioned, pretty broad-based geographically

Segment operating earnings in the quarter and the current period were $302 million, up 6% compared to Q2 last year. I’ll provide some additional color on operating earnings with our next chart. General corporate-net was $18.9 million in Q2 compared to $18.1 million in Q2 last year. The adjusted effective tax rate in the second quarter was 27.9% that compares to an adjusted effective tax rate in the same period last year of 23.6%.

In Q2, last year we benefited from a catch-up adjustment related to the extension of the US R&D tax credit. The benefit last year coupled with the absence of an R&D credit this year, increased the tax rate in Q2 by approximately 4 points accounting for pretty much of all the year over year increase. This is one of the unusual items I referred to.

Adjusted earnings per share were $1.35 that compares to $1.33 in the same quarter last year, so up only about 2%. The higher tax rate reduced adjusted earnings per share by $0.08. Average diluted shares outstanding in the quarter was 140.2 million. We repurchased approximately 900,000 shares in the second quarter at a cost of about $111 million. At the end of Q2 there was 314 million remaining under our $1 billion share repurchase authorization.

Through the first half of the fiscal year, we’ve repurchased 1.9 million shares for approximately $221 million, so on pace to hit the $440 million full-year repurchase expectation that we talked about on the previous earnings calls this year.

Moving to chart six, this is the graphical version of total company results for the second quarter. On the left side the chart you can see the 5% year-over-year sales growth; as I mentioned, that was 7% organic growth. Sales increased 1% sequentially.

On the right side of the chart you'll note the year-over-year increase in segment operating earnings, total segment operating margin in Q2 was 18.9%, up 20 basis points from the second quarter of last year. Last quarter, we said we intended to increase spending, spending was up about 4% sequentially and about 6% year-over-year, so pretty much in line with our organic growth.

Incremental earnings conversion was 22%, lower than would be expected with 7% organic growth. That brings me to the second unusual item. Conversion margin in Q2 was impacted by a significant year-over-year increase in variable compensation expense.

Due to last year benefited from a year-to-date adjustment that reduced variable compensation expense that was related to a change to our full-year guidance at this time last year. The lower than normal variable compensation last year is causing about an $8 million negative comparison to the current quarter. If you adjust for that, conversion margin would be about 32%, within our target range and pretty good given a more aggressive spending increase in Q2. While not on the chart, our trailing four-quarter return on invested capital was 30.6% at the end of the second quarter.

If you’ll turn to chart number seven, it summarizes the Q2 results of the Architecture & Software segment. Again, looking at the left side of this chart, sales reached $687 million, up 7% year-over-year as reported and up 9% organically. Sales were down in the segment 1% sequentially.

Keith mentioned that Logix growth was 7%, a little below the segment average. Q2 was a very strong quarter for growth in our Motion Control business, and that’s consistent with continued success with OEM customers.

Operating margin for the quarter was 27.7%. That’s up 1.1 points compared to Q2 last year. The 9% organic growth provided considerable volume leverage, which more than offset the effect of increased spending, a little unfavorable mix and the increased variable compensation expense.

The next page, chart eight, covers our Control Products & Solutions segment. Compared to Q2 last year, sales were up 3% as reported and up 5% organically. Organic growth in both the Product business the Solutions & Service businesses was about 5%.

Sales for the segment increased 2% sequentially, with the Product businesses and Solutions & Service businesses both up sequentially. Book-to-bill for the Solutions & Services businesses was 1.1 in Q2.

On the right side of the chart, you’ll note that operating earnings were slightly lower than Q2 last year and operating margin declined by 0.8 year-over-year. The benefit of higher sales was more than offset by increased spending, increased variable compensation expense and larger than normal negative currency effects in the quarter.

The next chart is a geographic breakdown of our sales in the quarter. I think Keith covered this one well in his comments, so I will turn to chart number 10 which is free cash flow. Free cash flow for the quarter was $188 million, another strong quarter. Year-to-date conversion on adjusted income is about 92%, that's a very good result for the first half of the year and we continue to expect conversion of about 100% for the full year.

Turning to the next chart, this provides an EPS walk from the first half of last year for the first half of this year. It was a very good first half. Keith mentioned the quarterly variability of our results, that variability is a consequence of many factors including, for example, the two unusual items I talked about that impacted results this quarter. Because of the quarterly variability, the first half maybe a better representation of our underlying performance than either quarter taken alone.

Looking at the bridge, EPS was up 10% increasing from $2.56 to $2.82. That's on organic sales growth for the first half of 7%. The 10% increase in EPS is despite a pretty significant headwind from tax rate which you can see here is worth about $0.11. A small increase in general corporate-net expense was offset by lower share count. And segment earnings were up 12% with incremental margin of about 38%. And that takes us to the final slide, chart 12, which addresses our current outlook for fiscal year 2014.

As Keith mentioned, we continue to expect sales to be about 6.6 billion. However, we now expect organic growth for the full year to be about a half-point higher across the range. 3.5% to 6.5% organic growth compared to the previous guidance of 3% to 6%. That change will offset about a half-a-point of negative impact related to our updated estimates of the full-year currency effects and a little lower sales from acquisitions.

We continue to expect segment margin for the full year to be about 20%. We are reaffirming guidance for adjusted EPS in the range of $6 to $6.35. We now expect a tax rate for the full-year of approximately 27%, that's at the high-end of our previous guidance of 26% to 27%.

We still expect to spend about $440 million on share repurchases this year. And finally, we continue to expect general corporate net expense to be about $85 million for the full year. I know you all are aware that we don't provide quarterly guidance, but perhaps the following notes on the second half will be helpful as you start to put together your models.

We expect healthy sequential growth in the second half, but solutions and services growth will be heavily weighted to Q4. That's a typical pattern for our solutions and services businesses. And the year-over-year comparisons, for the second half, growth rates will moderate compared with the first half, because the comparisons get more difficult. That's particularly true in the solutions and services businesses and, especially, in Q3.

As I’ve said, we expect operating margin to be about 20% for the full year. Consistent with my comments on the pattern of second half sales growth, we would expect margin performance to also be weighted to Q4.

Finally, we expect a lower tax rate in the second half due to the expected recognition of discrete tax benefits. It’s difficult to know for sure how that will fall out by quarter, but we expect the discrete tax benefits will be primarily in Q4.

And, with that, I’ll turn it over to Rondi, and we can begin Q&A.

Rondi Rohr-Dralle

Okay. Ted, thanks. Before we start the Q&A, I just want to say we do have quite a few callers in the question queue today, and we do want to get to as many of you as possible. So if you could limit yourself to a question and a follow-up and then get back in the queue, if you’ve got another topic that you want to talk about, so we’d appreciate your cooperation.

And, Frieda, let’s take our first caller

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Please stand by for your first question. So your first question comes from the line of Scott Davis from Barclays. Please proceed.

Scott Davis - Barclays

Good morning, everybody.

Keith Nosbusch

Good morning, Scott.

Rondi Rohr-Dralle

Hey, Scott.

Scott Davis - Barclays

I wanted to get a sense – I mean; it sounds like your order book is good. If you look at your full year guidance, it implies the mid-point would be 5% core for the full year and you did 7 in the first half. So that would mean more like 3 in the second half.

I mean, what leads you to that conservatism? Is there something that you’re seeing that – I know your comps are tougher. I get it. But it shouldn’t be to that extent, I wouldn’t think, but maybe you can dig into that a little deeper?

Keith Nosbusch

Well, I think the way you characterize it is exactly right, the percentages and the differences to the 5% number. We don't believe its conservative. The comps get much more difficult in the second half and certainly while the year-over-year will be lower, we still are going to see a significant sequential growth in both the third and fourth quarters. So we think its solid operating performance and nothing really happening in the markets themselves at this point in time.

Scott Davis - Barclays

Okay. So, okay, I guess we will see where that comes out to and then just to clarify in 2Q some of the one-time expenses you had the true up on variable comp and such like that, is there things you identify in the back half the year that will mute some of your operating leverage that we should think about?

Keith Nosbusch

So I think in terms of sequential comparisons, improve margin in the back half of year is going to come primarily from volume leverage.

Scott Davis - Barclays

Okay. But I guess my question is, are you expecting a more normalized operating leverage, volume leverage, in the back half versus 2Q or you know, clearly it was muted due to the higher cost.

Keith Nosbusch

Certainly compared to Q2 but if you look at the first half, our conversion margin was 38%. I mean that's pretty close to what we would expect in second half.

Scott Davis - Barclays

Okay. That's good color. Okay, I will pass it on. Thank you, guys.

Keith Nosbusch

Thanks, Scott.

Operator

Thank you for your question. Your next question comes from the line of Shannon O'Callaghan from Nomura Securities. Please proceed.

Keith Nosbusch

Good morning, Shannon. How are you?

Shannon O'Callaghan - Nomura Securities

So just to clarify a little bit, just on this 2Q incrementals in the first place. So, I mean I get the point around some of these spending increase and the comp, but the A&S incrementals were really strong and it was mainly focused in CP&S, so was the comp issue more weighted to CP&S and you also mentioned an unusually large FX impact there, could you maybe just size the impact specifically between the segments?

Keith Nosbusch

Yeah. So, on the $8 million year-over-year increase in the variable comp expense, which I want to remind you is really consequence of lower expense last year. About 60% of that is CP&S and the remainder A&S. So, because CP&S is our heavier more people intensive business, it bears a larger share of that.

CP&S also had an unusually large earnings impact on the currency translation impact in the quarter and that's a consequence primarily of our exposure in CP&S, both more to emerging markets, so countries like Brazil, Argentina, South Africa where we’re seeing some larger currency swings and also higher CPS exposure in Canada where we’re seeing continued weakening of the Canadian dollar.

Shannon O'Callaghan - Nomura Securities

And how big was that – that approximately the FX impact?

Keith Nosbusch

The currency year-over-year was ballpark about half-a-point.

Shannon O'Callaghan - Nomura Securities

Okay. And then, just on the chemical market, you mentioned you're starting to see some activity there. Can you just mention maybe where you're seeing that occur and also how Rockwell is playing into those projects?

Keith Nosbusch

Yes. Well, we're seeing that as the down stream effects of the production expansions that have been going on, particularly in North America at this point. And we’re seeing that as it flows into the chemical plants.

You’ve heard about the expansion of petrochemical. But now we’re also seeing some of that – and this activity is really at the front-end coating and engineering studies that take place. But it’s also in the specialty and fine chemical areas as well.

And we think those are very good opportunities for Rockwell given that it’s much more batch-oriented and, certainly, something that the integrated architecture and our safety capabilities have a great footprint to be able to be successful in.

Shannon O'Callaghan - Nomura Securities

Okay. Great. Thanks a lot, guys.

Keith Nosbusch

Thank you, Shannon.

Operator

Thank you for your question. Your next question comes from John Inch from Deutsche Bank. Please proceed.

John Inch - Deutsche Bank

Yeah. Thank you. Good morning, everyone.

Keith Nosbusch

Good morning, John.

John Inch - Deutsche Bank

Good morning. What was the dollar amount of the spending this quarter – the heightened spending this quarter versus last quarter or year-over-year? How does that split between A&S and the CP&S?

Ted D. Crandall

So year-over-year spending increase was about $25 million. Sequentially, it was about $20 million. About half of the sequential increase was our normal merit increase that occurs January 1, and it’s split roughly 50/50 between the segments.

John Inch - Deutsche Bank

And do you expect that cadence of spending, Ted, to continue for each of the next two quarters?

Ted D. Crandall

No, I think the sequential ramps will be somewhat less then the next couple of quarters and I think what I would expect to see is about a 5% increase in spending year-over-year in the second half.

John Inch - Deutsche Bank

All right. What are you actually spending on and I'm assuming this is mostly people but could you flush out a little bit in terms of whether some of these investments and what kind of a payback do you expect on some of the spending?

Keith Nosbusch

The areas are really in two primary categories. The first one would be development engineering and that would be around a number of the things that we discussed at the investor meeting particularly the integrated control and information opportunities that we've identified as our ability to expand our certain market. The second would be in customer facing resources sales resources. We are adding those in different regions and countries of the world where we see the best growth opportunities.

And as far as the payback on these investments, as you know these investments take time to be able to generate the new products so this is not something that we will see in the remainder of this calendar year. The sales resources will start helping, although it starts helping next fiscal year, although depending on where they are, sometimes the ramp-up and whether they are newer experienced employees, can be from 12 to 24 months before they become fully productive. And our product – our project schedules tend to be 12 to 30 months, depending on the scope and what exactly that project is and then we would have a ramp-up of sales after that period of time.

So it's really investments for the future and that's why I did mention the fact that we believe we do have these growth opportunities and we've been talking about adding the investment for a number of quarters here. And certainly in the second quarter we were able to bring a lot of people on board and certainly we look forward to the benefits of that down the road.

John Inch - Deutsche Bank

Yeah. No, I understand. Are you doing this in Asia or Europe or North America, or where's the emphasis?

Keith Nosbusch

Well, the development resources would be in our development centers and the majority of those would be in the US but we also would be adding development people in the Czech Republic and Poland, and then Singapore and China would be the two major ones in Asia.

When you look at the salespeople, we have been adding salespeople in some of the emerging Europe markets. We've been adding in Latin America and to some degree in the US given some of the strength that we've seen in this country and we believe the longer-term potential.

John Inch - Deutsche Bank

Yeah, okay. And then, just as a technical question, Ted, what if the R&D credit later this year is renewed? How does that work? Are you guys going to be able – are you going to go back and retroactively adjust your tax rates? Like you give us tax hit now, and people sort of assume it’s just part of ops.

And then is there some sort of big fourth quarter number because the risk is Wall Street is just going to think that’s a one-time adjustment? Like how does this work in the past and maybe you could just talk us through the mechanics of that?

Ted D. Crandall

Yeah. So if the R&D tax credit were renewed before the end of our fiscal year – and, remember, we’re on a September fiscal year, not December. If it were renewed before the end of the fiscal year, then we would do a – and assuming it was renewed with retroactive application, we would do a catch-up adjustment for the full year. So that would be probably about 0.6, 0.7 point of lower tax rate for the year, if that happens.

John Inch - Deutsche Bank

Okay. Got it. Thanks very much.

Keith Nosbusch

Thank you, John.

Operator

Thank you for your question. The next question comes from line of Joe Ritchie from Goldman Sachs. Please proceed.

Joe Ritchie - Goldman Sachs

Hello, everyone.

Keith Nosbusch

Good morning.

Joe Ritchie - Goldman Sachs

So I understand the cadence on the CP&S organic growth for the remaining part of the year, as comps get tougher. But I was a little surprised by the growth this quarter of roughly 5% because you had easier comps, and then the book-to-bill on the Solutions side seemed to be pretty good both last quarter and this quarter. So just, perhaps, you can provide a little bit of color on the growth in that business specifically this quarter.

Keith Nosbusch

Well, I think, the book-to-bill is not really a good current quarter substitute for the CP&S Solutions business. It tends to be six months to a longer period before those projects really will enter into a shippable state. And so we do have this lag between the orders and the project completion. The second part of it is project business is lumpy. And depending upon where you are in the cycle of the project where the customer is and if they are doing some acceptance testing or if there has to be a delay because their project is delayed, the project business just is one that is very difficult to predict with certainty as to which ones will make it in a quarter and which ones will either fall out into the next quarter or a longer period of time. So it’s just a challenge from a forecasting standpoint, but book-to-bill is not the only indicator particularly you have to look at the aging of that book-to-bill as to when it is shippable in the future.

Joe Ritchie - Goldman Sachs

Okay, that's helpful, Keith. And I just had one follow-up question on the – I just want to make sure I heard this correctly. So earlier you talk about incremental margins for the second half of the year. I think you said 38% which was comparable to first half. If I'm doing the math correctly, to get to the midpoint of your guidance, it looks like the implied incrementals are closer to 25%. And so are -- you effectively feel confident in the higher end of year guidance for the full-year by expecting 38 for the second half of the year?

Ted D. Crandall

Now Joe, I think you are doing the math incorrectly, but why don't you get with Rondi after the call. I think what you're going to see is the incrementals in the second half are in the high 30s.

Joe Ritchie - Goldman Sachs

Okay. Fair enough.

Rondi Rohr-Dralle

So we do it on segment operating margins, so I don't know if that's the difference between the way you do it, but...

Joe Ritchie - Goldman Sachs

Yeah. No, I was doing it on the segment level as well. We can catch up after the call though.

Rondi Rohr-Dralle

Yeah.

Operator

Thank you. Your next question comes from line of Steve Tusa from JPMorgan. Please proceed.

Steve Tusa - JPMorgan

Hey, guys. Good morning.

Keith Nosbusch

Good morning.

Steve Tusa – JPMorgan

Just a very helpful color on the sequencing in the second half, I guess the seasonality from 2Q to 3Q has been a bit all over the map. I think the 1.1 book-to-bill and to your comments, is kind of similar to 1.1 or 1.15 you’ve done in the last couple of years, so nothing really stand out there.

But I guess last year you were up 5% sequentially, second quarter to third quarter, is that kind of the right range to think about? As always I’m asking, I know you don’t give quarterly guidance, but you’re trying to kind of baseline our models here, because there are – it's seems like there are some moving parts with the lumpiness.

Keith Nosbusch

I think – well, without providing quarterly guidance I think I would say the 5% sequential increase last year was unusually large.

Steve Tusa – JPMorgan

Okay. Okay. So I guess the then year-over-year comp will be similar third quarter, fourth quarter, I guess, is that the right way to look at it? Or a little bit weaker in the third?

Keith Nosbusch

Yeah, I suspect a little weaker in the third.

Steve Tusa – JPMorgan

Okay. And then you mentioned the margins, you guys did 20 bps of segment margin improvement this quarter. Is that the right kind of framework for the third quarter?

Keith Nosbusch

Steve, I don’t want to get that detailed in the quarterly numbers.

Steve Tusa – JPMorgan

Okay. And then one last question on the ForEx. Companies like 3M which are seeing similar kind of foreign exchange impact or seeing a lot of price go through in kind of a related way. So the ForEx change was pretty dramatic in Latin America, and your organic growth was very strong. Was there an unusual kind of pricing element in the 9% organic there or is it not kind of the same dynamics for you guys?

Ted D. Crandall

No. I would say there is no unusual pricing item in the organic.

Steve Tusa – JPMorgan

Okay. All right. Thanks for the detail. I appreciate it.

Keith Nosbusch

Thank you, Steve.

Operator

Thanks for your question. The next question comes from the line of Steve Winoker from Sanford Bernstein.

Steve Winoker - Sanford Bernstein

Thanks and good morning.

Keith Nosbusch

Good morning.

Rondi Rohr-Dralle

Good morning.

Steve Winoker - Sanford Bernstein

Can you maybe comment on the incremental growth versus your prior expectations? I mean, it clearly sounds likes you’re seeing acceleration and some momentum here. But where specifically and which segments and vertical and geographies, did you actually see the extra kind of -- are you comfortable with the extra 0.5% or is it just too widespread?

Keith Nosbusch

Well, it would be pretty widespread. But, certainly, we’ve seen strong organic growth in A&S. That’s been the better performing segment with respect to the Product sales that we’ve seen year-to-date.

And then, certainly, I would say, the US has continued to perform probably a little bit stronger, and we don’t see any reason for that to change. And it’s really those two that told us we could offset the currency. And acquisition was a little stronger organic growth for the year. And that's basically how we came at what we call the tweak of the make up of the sales number which stayed the same.

Steve Winoker - Sanford Bernstein

Okay. And on the process growth side, you mentioned up 5%, and I think going higher and it was, what, 8% last quarter and this has clearly been a two-pronged story in terms of both end markets and penetration. How are you viewing that opportunity, Keith, particularly you talked about the downstream opportunities, etcetera, but is that kind of -- where is the biggest opportunity there and you expected to stay in that range or sort of consistently go higher?

Keith Nosbusch

Well, we do expect the second half process to be higher than the first half and the first half as you've said was 5%. So we are expecting it to go up and we see the best opportunity there continue to be in oil and gas. We will get a little bit of help with vMonitor acquisition that we talked about which is really focused at least at this point of its growth into the oil and gas industry. So it’s a nice play into that space. But we are also at least in North America we are beginning to see some investment in the legacy pulp and paper applications.

And so it’s a very aged old installed base and we see that starting to have a little bit more of a pickup and we have a pretty good footprint there in our motor control and now with the process capabilities we can do the wet end of the paper plans as well. So – but really the strongest play is oil and gas and we got a couple of other opportunities that we believe will get us to that higher growth in the second half.

Steve Winoker - Sanford Bernstein

Okay, great. I'll pass it on. Thanks.

Keith Nosbusch

Thank you, Steve.

Operator

Thank you. The next question comes from the line of Mark Douglass from Longbow Research. Please go ahead.

Mark Douglass - Longbow Research

Hi. Good morning, everybody.

Keith Nosbusch

Good morning, Mark.

Mark Douglass - Longbow Research

Keith, can you talk some more about China? It's interesting how your growth has been so strong this half with the Pia mine, other indicators in China being weaker, whereas last year you had really – you have had declines in a – what seemed to be a better macro. Can you talk about squaring that circle and what's going on in China for you?

Keith Nosbusch

Sure. Well, the first one, you've kind of touched upon and that is, we had a very weak first half last year and then obviously a much stronger second half, but which is why we're talking about the tough comparables, and China will be one of those tough comparables.

But really, we're seeing continued growth for us into the consumer related industries. So auto continues, Food & Beverage, the – as they continue to build out and grow the middle class, they’re taking – and the concerns they have over quality and safety of their food supplies. These are all areas that are very important to us.

Oil and gas continues to be a good growth for us in China, and the OEM performance was probably the leader there. The OEM was very strong this quarter. And that’s just some of the work that our team did there last year, as we – as quite candidly as we struggled in the first half. We’ve really focused on a couple of areas where we thought the best opportunities were.

And, particularly, as their infrastructure spending comes down and there is no spending in the metals, minimal spending in the cement industry now compared to historical, we had shepherd our resources into the areas where we could see the growth. And we added capabilities and put resources into OEMs and into the consumer products industries. And I think we’re seeing the benefits of some of that activity now.

Mark Douglass - Longbow Research

Okay. Thank you. And then can you do a walk-around of what you’re seeing in automotives around the globe as far as their investment spending?

Keith Nosbusch

Sure. The spending in Europe continues to be very weak, and we don’t see that changing dramatically, as time goes on here. The US spending continues to be relatively high. But we haven’t seen it growing, but it’s at a higher level. And we believe that the projects will continue, as time goes on. So that's been a very positive part of our US business, but we don't see the US spending increasing. Latin America, the strength has been Mexico and Brazil and there has been -- as you know a significant investment from the foreign car manufacturers into Mexico and we continue to see investment going on there.

If we go to Asia, we don't do much in Japan, but certainly China is where all the action is in automotives. And there we see mainly the spending in the passenger car side and heavy with the joint ventures. And that's where we've been able to make most of the inroads. We do participate in the domestic market, the domestic car manufacturers, but they are not investing at the same levels and rates as the joint ventures are. So it’s a little more weighted to the JV.

So really we see the automotive industry as one that continues to provide opportunities for Rockwell. In particular, it’s a very automation intensive industry and automation intensive for a lot of the A&S product portfolio. And then I only will finally comment that we also as we have mentioned activities that we work with FANUC on with powertrain. We see the powertrain as a longer-term growth opportunity in a space that we did not participate fully in all the applications and that will help us in the future.

Mark Douglass - Longbow Research

Great. Thank you.

Keith Nosbusch

You're welcome. Thank you, Mark.

Operator

Thank you for your question. The next question comes from the line of Josh Pokrzywinski from MKM Partners. Please proceed.

Josh Pokrzywinski - MKM Partners

Hi. Good morning, guys. Can you hear me?

Keith Nosbusch

Yes, we can, Josh. Go ahead.

Josh Pokrzywinski - MKM Partners

Thanks. So maybe just a little more color on the cadence of business through the quarter, any impacts from weather, it seems like you guys aren’t really calling that out as much. And then, any dispersion between larger project and more small – small ticket business, maybe outside of the bigger stuff in service and solutions, but maybe more in kind of the core automation?

Keith Nosbusch

Sure. The – with respect to the quarter itself, it was a pretty typical quarter. March is always the strongest month for us and this March was. And I would say that nothing inconsistent in how the quarter flowed. If we talk about the project activity, we're not seeing any, I'll say, meaningful change in project delays or anything like that. So it seems like that continues to be at the pace that we have seen earlier.

And then, secondly, your comment about the size of the projects, that would depend on where we are. I would say that the majority of the projects in North America are the smaller projects. We have not seen large ones at this point in time. So that means most of it is modernization as opposed to, I’ll say, Greenfield capacity at this point. And my comments about pulp and paper fit right into that type of a scenario.

If we go outside, in particular, emerging markets is where we see more of the Greenfield. And certainly there is the major project tend to be less resource-driven in China at the moment or, I should say, less metals in heavy industry – less metals, less cement and, certainly, tend to be more in the consumer space at this point in time.

From a weather standpoint, we had a couple of days where our service engineers couldn’t get to customers. But given all the other moving parts we had this quarter that was certainly not one to point out. It cost us a little bit but, certainly, not to the extent that the other two or three that Ted mentioned earlier in his comments.

Josh Pokrzywinski - MKM Partners

Got you. That’s helpful. And then just a follow-up on the comment that you're not seeing a lot of Greenfield work in North America. Do get the sense that your customers are sitting back on their heels right now and watching? Or is that something that is maybe more of a next year dynamic and for the time being there's really not a lot of, I will call, a pent-up demand for Greenfield spending?

Keith Nosbusch

In the US, I don't think we've seen a lot of Greenfield spending other than when the automotives came back from their downturns and I would say the automotives came back meaning that, when they do new lines and new models you can think of it as Greenfield because we basically re-do it. I think where we are starting to see some of the indications and why I mentioned chemicals is, I think we are starting to see the generation of new chemical plans and that's a broad spectrum, but I think it’s really the downstream from the energy play that's been going on whether it be oil or gas. We are now seeing -- we will see more Greenfield or I should say just large projects as they move that down the process and stream.

Josh Pokrzywinski - MKM Partners

Got you. Thank you.

Keith Nosbusch

You're welcome, Josh.

Operator

Thank you for your questions. And next question comes from Nigel Coe from Morgan Stanley. Please proceed.

Nigel Coe - Morgan Stanley

Thanks. Good morning, guys.

Keith Nosbusch

Good morning.

Nigel Coe - Morgan Stanley

We've covered a lot of ground, so just a couple of quick follow-ups, so Ted you gave some color on 3Q already, more color than someone who doesn’t give quarterly guidance, yet, FX relative to what we saw in 3Q, does it look similar in 3Q, down about two points?

Ted D. Crandall

I think right now I would expect FX earnings impact to be lower in Q3 than Q2.

Nigel Coe - Morgan Stanley

Okay. That's helpful. And then the 50 bps impact to CPF margins from FX. Is that because the – kind of the Brazil etcetera, carry higher margins or is there another reason, is there some sort of revenue cost this much closing that pinch?

Ted D. Crandall

No. I mean I don’t think it's higher margins in those countries, it's just – it's a consequence of the impact on the transactions in those countries in the currency depreciation as well as summary measurement losses on the balance sheet.

Nigel Coe - Morgan Stanley

Okay, great. And then just wanted to dig into, I think you mentioned some discrete tax items which probably hit in 4Q, Ted. Number one, were those in your guidance originally and since we're now looking at $0.27 tax rate for the year that implies 3Q is going to be higher than $0.27?

Ted D. Crandall

The discrete items were largely in our original tax guidance at the beginning of the year.

Nigel Coe - Morgan Stanley

Okay.

Ted D. Crandall

And it's hard to call exactly how those will fall out in the balance of the year, but I think they will be more weighted to Q2 which would suggest – I'm sorry, Q4. So if you think about an average in the second half of about 26%, I think we're going to be higher than that in Q3.

Nigel Coe - Morgan Stanley

Okay. That's really helpful. Thanks Ted.

Ted D. Crandall

Thank you.

Operator

Thank you. Your next question comes from line of Rich Kwas from Wells Fargo. Please proceed.

Rich Kwas - Wells Fargo

Hi. Good morning, everyone. Just a quick one for me. On the book-to-bill, the 1.1 – last quarter, it was 1.1 as well. And my impression was that you’d expect some kind of tick-up here in Q1 versus Q1.

So could you just give us some color on how that relates to expectations? And then if it was below expectation for the quarter, was there just – I know, Keith, you just said there wasn’t really any project push-outs, but it is a lumpy business. But just what are you seeing that would have pushed that number to be flat sequentially?

Ted D. Crandall

So, Rich, this is Ted. So I’d say the 1.1 in Q1 was lower than what we would normally expect to see in Q1. 1.1 in Q2 is pretty much normal expectation for Q2, so no big surprise here. It came in pretty much the way we expected it to come in.

Rich Kwas - Wells Fargo

Okay. So no real change versus what you were thinking going into the quarter?

Ted D. Crandall

Correct.

Rich Kwas - Wells Fargo

Okay. Thank you.

Keith Nosbusch

Thank you, Rich.

Rondi Rohr-Dralle

Okay. I think we’ve got time for one last caller.

Operator

Okay. The next question comes from line of Richard Eastman from Robert W Baird. Go ahead, please.

Richard Eastman - Robert W Baird

Yeah. Keith, could you just talk to – as we look to the end of the fiscal year and you’ve got your core – Rockwell has got their core revenue growth guidance on the board.

When you look at how the two segments will play out relative to that guidance, it appears as though the Architecture & Software business will be towards the high end from a growth perspective. Maybe, core growth will be 6, 6.5% versus the CP&S business will be towards the lower end.

And I’m – I am just curious, from your perspective, is there a message in those growth rates relative to where we are in the cycle, or is spent, again, are getting this ICI theme? I mean, how do you view the growth rates in those two pieces of business relative to the cycle, global business cycle?

Keith Nosbusch

Well, for the full-year A&S would be at the higher end to your point, probably around 7% and CP&S would be lower, probably around 4 to get you to that average that you talked about. We don't believe that that indicates anything from the cycle. I think what we are seeing is that the industries where we see the best growth is the US and certainly the US is a heavier A&S content then CP&S because of two reasons.

One, the types of the industries that we support and then secondly, there is a very mature system integrated market here and many of our product go through the system integrators as opposed to through our solutions business in the US, particularly in the consumer products industry. And so we get solidly heavier product content in that. When we go outside the US, it’s more our people have to supply the project work and so it’s different in that regard, so.

Richard Eastman - Robert W Baird

Okay, I understand. And then just one last question, on the OEMs side of the business and the OEM sales, has there been any shift in end markets or applications that's noticeable?

I tend to think of the OEM business as being kind of packaging, food and bev oriented. There's been so much talk and investment into the robotics industry, the collaborative side, the smaller payload robots. Is there any shift in that business towards a compact logic or anything that suggests that that could be a growth driver going forward?

Keith Nosbusch

Well, we certainly believe the OEMs would be a growth driver. And as I mentioned, our Motion business had a strong quarter and we had good OEM growth in China, in the US and parts of Europe. So – and part of that is because of compact Logix to your point. It allows us to have a better price point and sell the Architecture across to customer's complete portfolio of machines.

But you have to think a little broader of the OEM space, if you will. Certainly, the most recognizable one is packaging and quite frankly, when you go to pack expo, that's what it is all about. It's around packaging machines and those are big displays whether it’d be in Chicago or Las Vegas or Europe.

But the other segments are very important. Tire is a very important segment. We do very well in that globally. We have process skewed OEMs that equipment comes into a processing plant. And many times, our controllers are what are on that equipment, including drives and instrumentation with our partner.

So there are multiple segments. We have the heavy industries’ activities, the energy, some of the compressor and turbine OEM. So it’s much broader than just packaging. Material handling is a very important segment. And then to your point, robotics, and a lot of times we work on that with a lot of the end of the line packaging equipment as well as robotics into automotive.

So we have like six segments in the OEM space that we focus on, and I would say we haven’t seen any dramatic shift in those segments. Packaging has been very strong for the last couple of years. Tire has been very strong.

And we’ve been improving our ability to compete particularly in the process skid with our Process initiative. And then also some of our drive technology has opened up more opportunities in converting print and web, in particular, converting into home and personal care side is a very important segment for us as well.

Richard Eastman - Robert W Baird

Okay. Very good. Thank you.

Keith Nosbusch

Thank you, Rick.

Rondi Rohr-Dralle

Okay. With that, we’re going to wrap up today’s call. So we just want to thank all of you for joining us. And, of course, I’d be available to answer any more questions after the call. Thanks.

Operator

That concludes today’s conference call. At this time, you may disconnect, and thank you for joining.

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