Rockwell Automation (ROK) Blake D. Moret on Q3 2016 Results - Earnings Call Transcript

| About: Rockwell Automation, (ROK)

Rockwell Automation, Inc. (NYSE:ROK)

Q3 2016 Earnings Call

July 27, 2016 8:30 am ET

Executives

Patrick Goris - Vice President, Finance and Investor Relations

Blake D. Moret - President, Chief Executive Officer & Director

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Analysts

Scott Reed Davis - Barclays Capital, Inc.

John G. Inch - Deutsche Bank Securities, Inc.

Nigel Coe - Morgan Stanley & Co. LLC

Charles Stephen Tusa - JPMorgan Securities LLC

Julian Mitchell - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Shannon O'Callaghan - UBS Securities LLC

Jeffrey Todd Sprague - Vertical Research Partners LLC

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Joe Ritchie - Goldman Sachs & Co.

Jeremie Capron - CLSA Americas LLC

Operator

Ladies and gentlemen, 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.

At this time I would like to turn the call over to Mr. Patrick Goris, Vice President of Investor Relations. Mr. Goris, please go ahead.

Patrick Goris - Vice President, Finance and Investor Relations

Good morning and thank you for joining us for our Third Quarter Fiscal 2016 Earnings Release Conference Call. With me today are Blake Moret, our President and CEO; and Ted Crandall, 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 reconciliations to non-GAAP measures. A webcast of this call will be available at that website for replay for the next 60 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 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 the call over to Blake.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Patrick, and good morning, everyone. Thank you for joining us on the call today. As you probably all know by now, I succeeded Keith Nosbusch as President and CEO earlier this month while Keith remains Chairman of our Board. I am honored beyond words and humbled to lead this great company. I thank the board for the opportunity.

As several of you mentioned on the call last quarter, Keith had a tremendous run as CEO. He transformed Rockwell Automation into a technology company based on intellectual capital, expanded our served markets and increased market share by enhancing the value we provide to our customers. As a result, Keith has generated exceptional financial returns for shareowners during his tenure.

On a personal note, I'd like to thank Keith for demonstrating how to win the right way, by focusing on long-term customer value and rock-solid integrity. So, certainly big shoes to fill, but I'm very confident that with our dedicated employees, experienced management team and best-in-class partners we can continue to build on our track record of differentiation, above-market revenue growth and superior financial returns.

With that, I'll start with some key points for the quarter. so, please turn to page three in the slide deck. The quarter was generally in line with our expectations. Year-over-year organic sales were down about a point more than we expected and margins were somewhat better. As we projected, sales in our product businesses picked compared to the prior quarter. Orders in our solutions and services businesses improved sequentially but solutions and services orders and sales came in below expectations, particularly in the U.S. and Canada.

Globally the vertical picture is pretty much the same as in prior quarters. Heavy industry end markets remain challenging, with oil and gas, and mining the weakest verticals. Oil and gas was down over 30% in the quarter, more than we expected. Consumer and auto both continued to grow. Organic sales in the U.S. and Canada were down 8%. Heavy industries, including oil and gas, accounted for almost all of the year-over-year decline. In the U.S., we experienced some delays in larger projects generally but particularly in heavy industry end markets affecting our solutions and services businesses.

In China, conditions remained stable and we saw another quarter of sequential revenue growth as consumer and auto continued to outperform heavy industries. As expected, sales were down mid-teens in the quarter. I'm encouraged, however, that orders in China were up year-over-year.

EMEA had an excellent quarter with over 5% organic sales growth. I'm particularly pleased with our continued progress with machine builders in this region. Home and personal care, and food and beverage were the strongest verticals in this region.

In Latin America, sales were up 8% led by Mexico where strength remains broad based across most verticals.

Let me add a few comments about the quarter. Our Process Business was flat compared to the prior quarter and down 20% year-over-year. Logix was down 3% compared to last year but grew 4% sequentially. And I'm pleased that as expected, Architecture & Software margins improved and were up 300 basis points sequentially. This contributed to our strong segment margin performance in the quarter of over 21%. Ted will elaborate more on Q3 financial performance in his remarks.

Let's move on to our outlook for the fourth quarter of fiscal 2016. We expect continued improvement in our product sales but the weaker third quarter solutions and services orders and sales performance has caused us to reduce our sales outlook for the fourth quarter. We still believe we will see modest sequential sales improvement in the second half of the fiscal year, but not as much as we anticipated in April.

Globally, we expect heavy industries to remain weak and see a continued positive outlook for the consumer and automotive verticals. Taking all these factors into consideration, we are lowering our full year fiscal 2016 organic sales guidance to down about 4% at the midpoint, a point lower than our April guidance and are revising our adjusted EPS guidance to a new range of $5.80 to $6.00. Ted will provide more detail around sales and earnings guidance in his remarks.

Before I turn it over to Ted, let me add a few comments. Given the recent leadership transition, I recognize that many of you have questions about my vision for Rockwell Automation and what changes you can expect. I'll have the opportunity to share my thoughts with you in more detail at our Annual Investor Day at Automation Fair in November this year, but here are some initial points.

Rockwell Automation will continue to focus all of our passion and knowledge on making our customers more productive. We'll do that by building on the strong foundation Keith built and maximizing customer value by understanding our customers' best opportunities for productivity, combining a differentiated technology and domain expertise to deliver positive business outcomes for our customers and continually simplifying their experience. Understanding fosters loyalty. Combining technology and expertise increases customer share, preserves margins and reduces cyclicality. Simplification drives productivity for our customers and for us. Above-market growth will come from share gains, new value from the Connected Enterprise and acquisitions used as catalysts to accelerate our strategy.

We are very well positioned to bring the Connected Enterprise to life for our customers, given our technology, domain expertise, partners and market access. We are implementing a growing number of pilots to quantify this new value and I am pleased with the progress and diversity of these customer engagements.

Expansion of these pilots to multiple locations may take some time to play out and the pace will vary from vertical to vertical, customer to customer. However, we continue to earn the position of trusted partner at new customers every day as a single integrated business focused exclusively on making them more competitive.

Finally, I'd like to thank our employees and partners for their continued dedication in serving our customers.

With that, Ted?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Thanks, Blake, and good morning, everybody. I'll start on page four, third quarter key financial information. Sales in the quarter were $1.474 billion, 6.4% lower than Q3 last year. Organic sales declined 4.8% and currency translation reduced sales in the quarter by 1.8%. As Blake said, the organic sales decline was about 1 point worse than we expected and the shortfall was primarily in our solutions and services businesses in the U.S. and Canada. Currency was in line with our expectations.

Segment operating margin was 21.1% in the third quarter, down 70 basis points from Q3 last year, primarily related to the lower sales and unfavorable currency impact, partly offset by lower incentive compensation cost. Operating margin improved sequentially by 1.8 points.

General corporate net was approximately $17 million in the quarter compared to $22 million in Q3 last year. Adjusted earnings per share was $1.55, down $0.04 or 3% compared to third quarter of last year. The adjusted effective tax rate in the quarter was 25.1% compared to 27.9% in Q3 last year. We recognized a favorable discrete tax item in the current quarter and we're also benefiting this year from the R&D tax credit.

Free cash flow for Q3 was $250 million. Free cash flow conversion on adjusted income was 123% in the quarter. Our trailing four-quarter return on invested capital was 32.6%. A couple of items not shown here, average diluted shares outstanding in the quarter were 130.8 million, down about 3.5% compared to last year. Also, during the third quarter, we repurchased 1.1 million shares at a cost of about $122 million. Year-to-date, we've repurchased 3.5 million shares at a cost of $370 million.

In November, we talked about a full year repurchase target of $500 million. We're running very close to that pace through June. At the end of the quarter, there was $1.075 billion remaining under the previous share repurchase authorization.

The next slide presents the sales and operating margin performance of our Architecture & Software segment, both for the third quarter and year-to-date. I'll focus my comments on the third quarter results.

On the left side of this chart, Architecture & Software segment sales were $666 million in Q3, down 2.5% compared to Q3 last year. Organic sales declined 1.3%. Currency translation reduced sales in the quarter by 1.6%. Sequential organic growth was about 4.5%.

Moving to the right side of the chart, A&S margins were 27.6%, down 160 basis points compared to Q3 last year, primarily due to lower sales and unfavorable mix and currency impacts, offset in part by lower incentive compensation costs. Operating margin improved sequentially by 300 basis points.

Turning to page six, this is the Control Products & Solutions segment. In the third quarter, Control Products & Solutions segment sales were $808 million, down 9.4% year-over-year on a reported basis with organic sales down 7.5%. Currency translation reduced sales by 1.9%. Sequentially, organic sales for Control Products & Solutions declined by 1.5%.

On a year-over-year basis, organic sales for the product businesses in the segment declined about 4.5%. Organic sales for the solutions and services portion of the segment declined by about 10%. Decline in the solutions and services portion of this business was about $15 million larger than we expected and this was primarily in heavy industry verticals in the U.S. and Canada.

The book-to-bill in Q3 for solutions and services was 1.04. Particularly in the U.S., we saw a larger amount of project delays in our solutions and services businesses in Q3 and we expect this trend in delays to continue into Q4. Consequently, we've reduced our previous projections for sales in these businesses for the fourth quarter.

CP&S operating margin was 15.7%, down 40 basis points from 16.1% in Q3 last year. We consider that to be good margin performance on a significant top line reduction. The impact of lower sales was partly offset by productivity and lower incentive compensation costs.

Moving to the next slide. Page seven provides the geographic breakdown of our sales and shows organic growth results for the quarter, and the nine months through June. As you can see on the slide, the organic sales decline in the quarter was driven by the U.S., Canada and Asia Pacific with healthy organic growth in EMEA and Latin America. Blake already provided some regional colors so I'll just add a couple of notes.

We experienced a year-over-year decline of 1% in total Emerging Market organic sales with the decline in China more than offsetting growth in the balance of the emerging countries. Blake mentioned the weakness in the heavy industry including oil and gas being down over 30% year-over-year in Q3. That was a larger decline than we expected. Previously, we expected oil and gas to be down about 20% for the full year. We now expect a decline of about 25%.

Please turn to the next page, which is our updated fiscal year 2016 guidance. So, as Blake said, we are revising full year guidance and narrowing the guidance range. Given the sales and order misses in our solutions and services businesses in Q3, and a related reduced outlook for Q4, we're reducing the guidance midpoint for organic sales from a decline of minus 3% to minus 4%. You can think of the new guidance range as plus or minus about $50 million, so roughly minus 3% to minus 5% organically. We now expect currency to be a little more negative for the full year but still at about minus 3%.

We expect reported sales of approximately $5.85 billion at the midpoint. We continue to expect segment operating margin to be a little lower than 20.5%, so no change from previous guidance despite the reduced top line. We now expect an Adjusted Effective Tax Rate for the full year of about 24.5%, about a 0.5 point lower than previous guidance, and primarily due to the favorable discrete item in Q3 that I mentioned earlier.

Taking into account lower organic sales, our operating margin expectation and a modestly lower tax rate, the new guidance range for Adjusted EPS is $5.80 to $6. That puts us $0.05 lower than previous guidance at the midpoint. As usual, there are a lot of moving parts. But basically, the earnings contribution that we lost due to lower solutions and services organic sales we mostly offset with somewhat lower spending and a lower tax rate.

We continue to expect about 100% conversion of Adjusted Income to free cash flow. There are a few other items not shown here that I think are generally of interest. We continue to expect general corporate net expense to be approximately $75 million for the full year. We continue to expect average diluted shares outstanding to be about $131 million for the full year. And finally, our guidance continues to include a provision for potential restructuring charges of about $10 million in the fourth quarter.

And with that, I'll turn it over to Patrick for the Q&A.

Patrick Goris - Vice President, Finance and Investor Relations

Before we start the Q&A, I just want to say that we would like to get to as many of you as possible. So please limit yourself to one question and a quick follow-up. Thank you for that. And, operator, let's take our first question.

Question-and-Answer Session

Operator

Your first question comes from Scott Davis with Barclays. Please go ahead.

Scott Reed Davis - Barclays Capital, Inc.

Hi. Good morning, guys.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Good morning.

Scott Reed Davis - Barclays Capital, Inc.

One of the things – and welcome, Blake, to your first solo call.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Scott.

Scott Reed Davis - Barclays Capital, Inc.

You guys have done a pretty good job in this down cycle we're experiencing right now holding margins, keeping the wheels on and such. And when you think about your change in guidance kept margins flat versus prior guidance. How much of that is this lowered compensation dynamic? And how sustainable is that? When you think about – Blake, when you think about going into next year, I mean, you start thinking about compounding years of lower compensation. At some point I would imagine it's – you risk losing some people. So how do you think about that dynamic?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yes. So, Scott, to your first question, in terms of the April guidance to July guidance, there's no difference in the savings from lower incentive compensation. It's the same in both numbers. But to your question about sustainability. I mean, you're correct and we've been saying all year that when our sales and earnings start to improve once again, we will have to restore the incentive compensation to more normal levels. And so at some point we're going to have a headwind in our margins related to that.

Scott Reed Davis - Barclays Capital, Inc.

Okay. That's fair. And then as a quick follow-on, when you think about large project delays, are they being delayed because of macro conditions? Are they being delayed because of shortage of labor? I mean what is the primary cause?

Blake D. Moret - President, Chief Executive Officer & Director

Yeah. Typically, it's because the users don't need the additional capacity. So I don't think the shortage of labor is as big an issue as the users going slower on planned upgrades or capacity expansions.

Scott Reed Davis - Barclays Capital, Inc.

Okay. That's what I thought. All right. I'll pass it on. Thank you, guys.

Operator

Your next question comes from John Inch with Deutsche Bank. Please go ahead.

John G. Inch - Deutsche Bank Securities, Inc.

Thanks. Good morning, everyone.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Morning.

John G. Inch - Deutsche Bank Securities, Inc.

Morning. Oil and gas, can we talk about that for a second? Down over 30%. You got companies like Halliburton and Dover that perpetually called the bottom and say, things are going to get better. And then ITW basically said, no, we wouldn't call the bottom. I understand you're not an oil and gas company, but based on your front log and the impacts, I mean where – is this thing going to sort of sequentially continue to kind of dribble down here and get worse? Or what do you think on that front? And what's maybe baked into your guidance for the fourth quarter?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. Hey. So, John, so this is Ted. We were a little bit surprised by the Q3 results. We did not expect to see kind of a sequential decline in the oil and gas business. It was largely driven by Latin America, which was also a surprise to us, and it was related to some project push outs in the quarter because it was project specific it's a little bit hard to call whether this is a trend or whether it's just something unique to this quarter. I don't think we're comfortable calling a bottom in oil and gas but we're not expecting further sequential decline in Q4.

John G. Inch - Deutsche Bank Securities, Inc.

Ted, Latin America, by that you mean PEMEX and in that context you don't have to be an oil forecaster. You could probably look at PEMEX or whatever customer it is and try and ring fence the impact. I mean is – anything you can say on that front? Are we talking Mexico? And just my other comment, is this a customer-related issue or do you think it's just more broad?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

The only thing I would say is this was broader than PEMEX.

John G. Inch - Deutsche Bank Securities, Inc.

Okay.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

We saw this across oil, across Latin America. And so PEMEX was part of it but not the largest part of it.

John G. Inch - Deutsche Bank Securities, Inc.

Yeah. Well maybe it's Zika-related. Can I ask you about the down 20% Process? Honeywell didn't put up results like that. I realize you're not Honeywell, but maybe this is a dovetail question for Blake. Process has been one of Keith's signature sort of focal points. And I understand markets are weak. But why is Process down 20%? Was there any kind of incremental color you can provide? And I'd be curious if, Blake, in your own thoughts towards how you're going to prioritize Process or how you're thinking about it in the context of strategic opportunities?

Blake D. Moret - President, Chief Executive Officer & Director

Yeah. Thanks, John. First of all, Process remains at the top of the list in terms of our growth opportunities. It's the large part of our served market and we continue to invest in technology and domain expertise and in market access to take share in Process.

One of the factors I think contributing to our reductions in Process is we don't have the same historical installed base to be able to mine recurring revenue in the form of service contracts from those Process Systems that may have been installed 20 years or 30 years ago. So, that's one of the primary factors that we don't see the hedge, if you will, against the volatility in the project-based business.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

John, I think the other – I'm not an expert on Honeywell, but I think Honeywell's exposure in oil and gas is much more downstream oriented than ours. And I think that's another factor in the performance.

And then the biggest thing for us in Process is simply that a lot of our Process Business is solutions-related. Our solutions exposure is much more heavy-industry related. And with oil and gas down significantly and mining down significantly, it's hard for us to post better numbers in Process.

John G. Inch - Deutsche Bank Securities, Inc.

Yeah. No, Honeywell's definitely downstream for sure. So that – so just a last one. So just the Process then, is this dovetailing? I realize there's a lot of Venn diagram overlaps in Rockwell's results. Is this dovetailing with the Canada, U.S. kind of being a little worse? So what you're saying is your Process Business hasn't been there 30 years? So there's a lot more new project reliance. So if there's some heavy industry push to the right, which I'm assuming encompasses oil and gas, is this also explaining Process? Like is this all part of the same thing, if you will?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yes. That's right.

John G. Inch - Deutsche Bank Securities, Inc.

Okay. Okay. Got it. Thank you.

Operator

Your next question comes from Nigel Coe with Morgan Stanley. Please go ahead.

Nigel Coe - Morgan Stanley & Co. LLC

Thanks. Good morning. And, Blake, congratulations on the job.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks.

Nigel Coe - Morgan Stanley & Co. LLC

Yeah. So just to follow on to Scott's question. I think there's going to be a lot of questions on the impact of the compensation tailwinds. And I know that, Ted, you mentioned it's the same as the April quarter sorry, the Q2 fiscal. Maybe could you just maybe try and help us quantify what that tail could be as we think about next year's numbers?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Well, so I can't. I don't think I want to try to do 2017 guidance, especially on a specific number like incentive comp. But I can quantify it for this year. We have consistently said that the year-over-year savings that we got from incentive comp this year was tens of millions of dollars, but less than $50 million.

Nigel Coe - Morgan Stanley & Co. LLC

And that's obviously for the fiscal year rather than the quarter?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

That was for the full fiscal year 2016.

Nigel Coe - Morgan Stanley & Co. LLC

Okay. And then that range is still valid -- okay, that's very helpful. Thanks. Thanks, Ted. And then, I guess just thinking about the way that the quarter developed. It's obviously -- your guidance for 4Q is very similar to 3Q so it doesn't feel like there's a whole lot just changing. But there's obviously a big debate about auto and actually, Mexico as well. I mean, Mexican IP is close to negative, if it's not already there. Mexico has been a bright spot. So, first of all I guess, are you seeing any signs of tired legs on the auto cycle and some of the CapEx investments? And secondly, any signs of weakening in Mexico, just given the quite weak data that we see on the macro front?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Well, so on auto, we saw growth in auto in Q3 kind of as we expected. And we're expecting Q4 to be a good quarter. In Mexico, Mexico was not quite as good as we were thinking it could be in Q3, primarily around heavy industry. And I think our expectations for Mexico in Q4 are now a little lower than they were a quarter ago.

Nigel Coe - Morgan Stanley & Co. LLC

Okay. No surprise there. Thanks, Ted.

Operator

Your next question comes from Steve Tusa with JPMorgan. Please go ahead.

Charles Stephen Tusa - JPMorgan Securities LLC

Hey, thanks a lot. Good morning. Congratulations, Blake, best of luck.

Blake D. Moret - President, Chief Executive Officer & Director

Thank you.

Charles Stephen Tusa - JPMorgan Securities LLC

The Latin America oil and gas weakness, I assume that – is a lot of that offshore-related? Or is there a mix there?

Blake D. Moret - President, Chief Executive Officer & Director

There's a mix. When we talk specifically about PEMEX, that's going to be inclusive of both offshore rigs as well as onshore production. And then when we look at Brazil, again, a mix that would be a little bit heavier on the offshore side. But, of course, Brazil is very weak as they remain in a recession?

Charles Stephen Tusa - JPMorgan Securities LLC

Okay. And I think a lot of these guys asked a lot of good questions so far so I'll take the high level one. What are you seeing out there? How do you think this economy is trending over the next 12 months? I know we've got these kind of project delays. Are these project delays – do they represent pent-up demand or because of this capacity situation we're in, what do you kind of see from just a broad ISM or broad CapEx perspective out there from an appetite perspective as you talk to customers about the pipeline of activity? What's your sense of – how do you characterize these environments for the next 12 months to 18 months?

Blake D. Moret - President, Chief Executive Officer & Director

Steve, speaking specifically of the U.S., we'd characterize the U.S. market as stable. We are seeing some growth in consumer but continued weakness in heavy industry, including oil and gas.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

And, Steve, I think more than anything else this is just, what we're seeing is constrained capital spending in heavy industry.

Charles Stephen Tusa - JPMorgan Securities LLC

Right. And so is that phased? I mean, does anything else pick up – if those declines moderate, is there anything else you see there that kind of can accelerate going forward? Is there just kind of – oh man, I just wish we got a little catalyst, there's a big pipeline of opportunities. Or just kind of hand to mouth, more hand to mouth?

Blake D. Moret - President, Chief Executive Officer & Director

So if we look beyond oil and gas and we look for some of the pockets of relative strength in heavy industries, pulp and paper, we do see growth in pulp and paper. In water, wastewater we had a good Q3 and we expect continued growth there. Chemicals, the chemical industry continues to benefit from the lower cost feedstock from natural gas. And so we see strength in chemical as well.

Charles Stephen Tusa - JPMorgan Securities LLC

Okay. Thanks a lot.

Operator

Your next question comes from Julian Mitchell with Credit Suisse. Please go ahead.

Julian Mitchell - Credit Suisse Securities (USA) LLC (Broker)

Hi. Thanks. And welcome, Blake. I guess, my first question would be around the U.S. demand trends that you talked about. I think a lot of companies have seen pretty weak but steady demand in the last few months in the U.S. Clearly, things seem to be disappointing for you. So is that something that got worse as the quarter went on? Or was it something that was true pretty much of the whole last sort of three- or four-month period?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. So, Julian, there's some different questions there. The first thing I would say is from a quarterly progression point of view, this was a pretty typical quarter where we actually saw improvement as the quarter progressed.

In terms of overall U.S. market conditions, it's a little bit mixed right now. I mean, our product sales in the U.S. were up sequentially pretty much exactly as we expected, and I'd say we're seeing a positive demand trend on the product side. It was really the solutions and services businesses where we saw the unexpected decline and it appears to be very much related to heavy industry. As you know, we've got more exposure in solutions and services to heavy industry and a better exposure in product sales at consumer and automotive, and I think it's that dichotomy in the performance of those respective verticals that's causing that result.

Julian Mitchell - Credit Suisse Securities (USA) LLC (Broker)

Understood. Thank you, and then just within the margins within CP&S, they've been extremely resilient in the last nine months. I was curious if you're seeing in your backlog in the context of the weak orders and book-to-bill, if you're seeing anything from mix or worse, pricing that suggests that those margins in CP&S come under a little bit more pressure in the next three months to six months?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

So, if anything in CP&S we're benefiting from a little bit of favorable mix because the product sales growth has been outpacing solutions and services sales growth. Specifically, as it relates to pricing, on the product side, we saw about the same level of pricing in Q3 as we have seen in the earlier quarters this year. On the solutions and services side, in a down market like this, things tend to get more competitive, but I wouldn't say we're expecting any significant impact on margins in Q4.

Julian Mitchell - Credit Suisse Securities (USA) LLC (Broker)

Great. Thank you very much.

Operator

Your next question comes from Richard Eastman with Robert W. Baird. Please, go ahead.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Yes. Welcome, Blake.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Rick.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Just a quick couple of thoughts, if you will, on EMEA. I think the reference there on the growth rates of just under 6% was really around the more machine builders market. But could you maybe go one level deeper on the machine builders market and what is the exposure there? Is it on the consumer side? Is it exports? So just maybe a little better sense of what the customer base on the machine builder side looks like in EMEA and how sustainable that kind of mid-single digit growth rate might be here over the next couple quarters.

Blake D. Moret - President, Chief Executive Officer & Director

Yeah. Well, Rick, you said it. It is centered on the consumer side and food and beverage. So a classic OEM success story for us in Europe would be a packaging machine builder who's benefiting, quite frankly, from some of our recent product releases in our core platforms. And as they try to be more competitive, as they go after the mid range type of machines, especially in emerging markets, we've given them some new functionality that's allowed them to better compete. And so we're seeing growth in that segment of the OEM market.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

And just maybe as a follow-up question. I just want to follow-up on the CP&S business again. Looking at maybe the fourth quarter core guide, it does appear though as the CP&S business should seasonally show some fourth quarter strength over the third quarter. And is the backlog and your commentary around pricing and the solutions business, does the op profit in the fourth quarter respond to that higher volume sequentially?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. So, Rick, I think everything we have talked about around the weakness that we saw in solutions and services orders in Q3 and the delays that we think are going to carry over into Q4, the typical significant revenue uptick we get from Q3 to Q4 primarily related to our solutions and services businesses. We don't think we're going to see that this year, at least not to the same extent.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Correct.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

And so that is going to have an impact on operating margin. We're not going to get that same volume leverage, operating margin impact that we normally have in Q4. The other two things are going on in Q4, in Q3 spending came a little bit lighter than we expected. And I think there's going to be some catch up of that in Q4. And then I mentioned in my comments, we've got about $10 million of potential restructuring charges sitting in Q4 as well.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

And that is the $10 million of restructuring, presumably that's a pre-tax number. That's included in your guidance? Or excluded?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Included.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

And that is a pre-tax number.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Okay. And so just to clarify though, the revenue in CP&S for the fourth quarter will be lower than it is – than it was in the third?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

No.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

No.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

No, we will not be lower. We just won't have the magnitude of increase we typically see.

Richard Eastman - Robert W. Baird & Co., Inc. (Broker)

Correct. I understand. Okay. Thank you.

Operator

Your next question comes from Shannon O'Callaghan with UBS. Please go ahead.

Shannon O'Callaghan - UBS Securities LLC

Good morning, guys. And welcome, Blake.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Shannon.

Shannon O'Callaghan - UBS Securities LLC

Hey, Blake. Can you fill out your thoughts on kind of the Connected Enterprise updates you gave in some of the pilots? You talked about the number increasing and just sort of the nature of the timing and how you see it developing?

Blake D. Moret - President, Chief Executive Officer & Director

Sure. Just to set the context, the Connected Enterprise really is at the heart of the company's overall strategy. And so while we sometimes focus on the new value that comes from the Connected Enterprise with the networks and networks services, security and information management software, it really begins with our core platforms. And so the functionality that I talked about for a machine builder, those same products include the functionality that enables that higher-level productivity.

So just let me give an example with that same packaging OEM. They're using our new products, some of our recent CompactLogix releases, Motion, PowerFlex drives to get more performance out of their machinery and more flexibility and to be able to perform safety functions more elegantly. When that equipment is shipped to, say, a food producer, we enable faster line integration with our software. We can provide network design services to remove bottlenecks and we can remotely monitor that line and a hundred other lines around the world to benchmark performance to maximize up time. So the data that can be turned into information to make better decisions already exists in our plan for drives and controllers. And we've been asked by users in a wide variety of industries to get involved with pilots to quantify that value. So they're starting small so that they can have a discreet opportunity to look at the benefits of this new functionality before they roll it out to multiple locations. And that's going to take a little while to play out, and each customer's going to move at their own pace. But we're very encouraged by the early progress.

Shannon O'Callaghan - UBS Securities LLC

Okay. Great. Thanks. And then, Rockwell has always made great use of the partnership network, as well as alliances over the years. Is any of that changing? There's a lot of partnerships seeming to be formed out there, GE with Microsoft recently. And that's been one of your alliances for a long time as well. Does that change anything? Do you guys need to adapt at all in terms of your historical approach to partnerships and alliances? Or is it still the same approach?

Blake D. Moret - President, Chief Executive Officer & Director

No, Shannon. It's still the same approach. We don't anticipate any changes in our strategy, the closeness to Microsoft from the recent announcement because most of these partnerships are non-exclusive. And at the end of the day it's bringing positive outcomes to the user, combining the technology and the domain expertise that count. So that particular partnership is a lot around infrastructure and some of the specific cloud-level functionality.

What we talk about in terms of new value, importantly, is scalability, and so a lot of the benefit that we can bring to a user is going to happen without having to leave the four walls of a plant. But we continue to work closely with Microsoft and Cisco and AT&T and a host of other partners to be able to bring the functionality that, that customer needs to make them most productive.

Shannon O'Callaghan - UBS Securities LLC

Okay. That's great. Thanks a lot.

Operator

Your next question comes from Jeffrey Sprague with Vertical Research Partners. Please go ahead.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Jeff.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. I don't think we're looking at starvation of MRO and OpEx. And I think, Jeff, the health that we're seeing in product demand is indicative of some reasonable level of MRO spending ongoing. I mean, I think my comments about the vertical exposure on the product side was more related to projects.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Well, I'm not going to break out growth spending. I'll just talk about spending generally. Our sales are going to be down, if we're right about the guidance, by about 4% organically year-over-year. Spending I think is going to be close to flat year-over-year. So, on balance it's a little bit of a headwind to the margins. But when you look within spending I think what you would see is our R&D spending is actually up year-over-year a little bit in absolute dollars and up considerably as a percent of sales because of the sales decline and we've seen some reduction year-over-year in the SG&A areas.

Blake D. Moret - President, Chief Executive Officer & Director

Jeff, acquisitions still remain an important part of our growth strategy. And I look at acquisitions as catalysts to identify strategic growth opportunities for the company. So we're not going to get into acquisitions that take us into lines of business that we don't understand but to speed up activities that we've already begun internally. I see it as an important part of our overall growth plan. We remain focused on organic growth first. But then acquisitions as catalysts are in the second position. We have a strong pipeline now. We're pursuing acquisitions now and we're not constrained by any small size limit. The ones we've done recently have happened to be on the smaller side. But we'll look at bigger ones too if they make sense and they fit that model.

Jeffrey Todd Sprague - Vertical Research Partners LLC

Thank you.

Operator

Your next question comes from Andrew Kaplowitz with Citigroup. Please go ahead.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Good morning, guys. Blake, congratulations.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Andy.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

So, China down mid-teen in the quarter but orders up year-over-year. You mentioned consumer and auto still doing well there. I think your guidance before was for China to be down high-single digits to about 10% for the year. Is that still the case? And are you seeing any signs of tire and heavy industry at least bottoming, given some stability in China over the last couple quarters?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

So your first question, I think China's going to be down about 10% year-over-year. I mean, that's our expectation given the Q3 performance and what we're looking at for Q4. I'd characterize China generally, including heavy industry, as stable. It doesn't seem to be getting a lot worse. But I would not say that we think we've turned the corner yet either.

Blake D. Moret - President, Chief Executive Officer & Director

And, Andy, on the specific comment around tire. From a worldwide standpoint, there are a number of greenfield tire plants that are under construction or under design around the world. A lot of those are heading towards North America and Mexico. It's a bit of an issue of timing and which machine builders win the big portions of those facilities to determine where those will hit. We have a strong position in tire. That's going to be re-enforced with these new greenfields. But again, we're not exactly sure where all of those orders are going to be placed.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Okay. Thanks for that. And I think I know the answer to this, but I'll ask it anyway. Have you seen any improvement at all in metals and mining at this point? Or at least signs of a bottom? It might be too early for actual improvement but what about incremental discussions in the space?

Blake D. Moret - President, Chief Executive Officer & Director

No. Here and there, there are consolidations of steel mills and mines as people are trying to get productivity. We participate in some of the ongoing productivity projects within metals and mining. But the low cost of the resources and the overcapacity is still putting pressure on those verticals.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

All right. Thanks, guys.

Operator

Your next question comes from Steven Winoker with Bernstein. Please go ahead.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Thanks. And good morning, all. Just to put a finer point on one of your earlier answers. You said that auto saw growth in Q3 and expecting a good Q4. But last quarter you said it was specifically 3% up. What was the number this quarter?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. So auto was up about 1% this quarter.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Okay. And powertrain growth where you're taking some share?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. The powertrain is proceeding as we expected. We've gotten some great commitments this year. And I'd say we're kind of on track for the kind of $20 million incremental that we've been talking about.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Okay. Great. And, Ted, one other thing. On the whole restructuring question, you've got this $10 million placeholder for 4Q. When we had talked about this in the prior quarter, you had talked about $10 million, potentially $20 million. What did you end up executing in the third quarter? And why holding off longer given the broader environment that you're looking at?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. So a couple different pieces to that. First, we've always talked about in our normal course of business we'd expect to spend about $10 million on restructuring over the course of a year. And this year we had provided for an additional $10 million. We have spent some on restructuring earlier in the year. But given the slowdown that we saw in the solutions and services businesses in Q3 and the revised outlook for Q4, we're now kind of taking that into account, as well as assessing what we think we're going to see at least in the first half of next year and we're going through a careful assessment of one, do we need to adjust the cost structure, and two, if we don't need to adjust the cost structure, do we need to do some reallocation of resources so that we can get positioned for what we think the best growth opportunities will be next year. That's a combination of both of those things that have caused us to put some potential restructuring charges into Q4.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Okay. All right. I know we've talked a lot about the fourth quarter, but just so I'm just trying to get some clarity in terms of how you're thinking about that progressing. You've got 4.5 points of easier comps, I guess, up 2.2% to down 2.3% from Q3 to Q4 in 2015. You're calling for roughly down 4% organic growth on top of that in the fourth quarter. You mentioned the solutions and services pressures going into the fourth quarter. But given the lapping of the comps at this point, are you thinking about at least – and I know we don't get guidance for a little while for 2017, but are you thinking about exiting 2016 at that weaker rate for some time to come, or can you picture this as actually probably sort of a shorter-term issue?

Blake D. Moret - President, Chief Executive Officer & Director

So, we're going to defer any discussions about 2017 until we provide guidance in November. But I would say, particularly in the solutions and services businesses, our comparisons start to get a little bit easier after Q4.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Okay. All right. And they are getting easier in Q4 too though, right?

Blake D. Moret - President, Chief Executive Officer & Director

Well, not necessarily in solutions and services.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Okay. That's just the broader segment.

Blake D. Moret - President, Chief Executive Officer & Director

Yeah.

Steven Eric Winoker - Sanford C. Bernstein & Co. LLC

Okay. All right, I'll leave it there. Thanks.

Operator

Your next question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Joe Ritchie - Goldman Sachs & Co.

Thank you. Good morning, and congratulations, Blake.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Joe.

Joe Ritchie - Goldman Sachs & Co.

Yes. My first question I guess, maybe just a little bit of clarification on China auto. With the light vehicle tax stimulus potentially rolling at the end of this calendar year, have you guys sensed that you've gotten any benefit from the tax stimulus being in place in the first place?

Blake D. Moret - President, Chief Executive Officer & Director

No. We haven't seen any direct impact from that stimulus on accelerating or increasing the number of projects in the pipeline.

Joe Ritchie - Goldman Sachs & Co.

Okay. Great. And then, maybe a couple of quick hits on the margins. Ted, did you – this year, was there any impact from the FX hedges? I know last year you had some gains come through. Was there anything that was impacting your margins this year on the FX side?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. That's something else we've been talking about all year. Our hedges are rolling year-over-year and they're rolling kind of with a lower benefit. So we've still got hedge gains this year but lower hedge gains than we had a year ago. And it's about $13 million on a year-over-year basis.

Joe Ritchie - Goldman Sachs & Co.

Got it. The $13 million is incrementally lower than last year? Is that the right way to think about it?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. Yes.

Joe Ritchie - Goldman Sachs & Co.

Okay. All right. Great. And then maybe just on the 4Q margins. I know last year you guys had elevated R&D spend. Your margins in your A&S segment were down pretty significantly on a year-over-year basis. And so are there some potential tailwinds that we should expect in the fourth quarter from just a comps perspective?

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

There are always a lot of puts and takes on a year-over-year basis. But I think I'd repeat what I said earlier about fourth quarter margins. Sequentially, it's likely margin will be down a little bit Q3 to Q4. We don't expect to see the same pop in solutions and services sales that we normally see. So we're not going to have that volume leverage this year, that same volume leverage. I think sequentially spending is going to be a little bit higher in Q4. And we've got that potential restructuring charge sitting in Q4 where there was very little restructuring charge in Q3. So those are all the reasons that I think we're going to see a little bit lower sequential margin.

Joe Ritchie - Goldman Sachs & Co.

Okay. Gotcha. That's helpful. Thank you.

Blake D. Moret - President, Chief Executive Officer & Director

Operator, we will take one more question.

Operator

And our final question is from the line of Jeremie Capron with CLSA. Please go ahead.

Jeremie Capron - CLSA Americas LLC

Thanks. Good morning. And welcome, Blake.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks, Jeremie.

Jeremie Capron - CLSA Americas LLC

Just a quick question on the cash flows here. We've seen quite a bit of change in terms of your geographic mix now with North America business coming under pressure. I wonder how does this affect your ability to continue to return excess cash to shareholders in a tax efficient way. And are you willing to take on more debt as you did last year to continue with this strategy? Thanks.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Yeah. So subject to what our acquisition spending is we continue to be committed to deploying our full excess free cash flow to share owners either through dividend or share repurchase. And as you mentioned, we did that last year and it required taking on a little bit more debt. I think you're going to see the same thing this year. And so I think the answer to the question is yes. There was another question in there about kind of weakness in the U.S. and I'm guessing you're asking about distribution of cash flows. I would say that has not changed significantly for us as a consequence of the U.S. market conditions.

Jeremie Capron - CLSA Americas LLC

Thanks very much, and good luck.

Theodore D. Crandall - Chief Financial Officer & Senior Vice President

Thank you.

Blake D. Moret - President, Chief Executive Officer & Director

Thanks.

Patrick Goris - Vice President, Finance and Investor Relations

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

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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