Earnings Call Transcript - ROK Q2 2023

Operator, Operator

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

Aijana Zellner, Head of Investor Relations and Market Strategy

Thank you, Julian. Good morning, and thank you for joining us for Rockwell Automation's second quarter fiscal 2023 earnings release conference call. With me today is Blake Moret, our Chairman and CEO; and Nick Gangestad, our CFO. Our results were released earlier this morning, and the press release and charts have been posted to our website. Both the press release and charts include reconciliations of these non-GAAP measures. A webcast of this call will be available on our website for replay for the next 30 days. For your convenience, a transcript of our prepared remarks will also be available on our website at the conclusion of today's call. Before we get started, I need to remind you that our comments will include statements related to the expected future results of our company and are, therefore, forward-looking statements. Our actual results may differ materially from our projections due to a wide range of risks and uncertainties that are described in our earnings release and details in all our SEC filings. And with that, I’ll hand over to Blake.

Blake Moret, Chairman and CEO

Thanks, Aijana. And good morning everyone. Thank you for joining us today. Let's turn to our second quarter results on Slide 3. We had an outstanding quarter of strong growth in both sales and earnings. Our double-digit sales and margin growth continue to reflect Rockwell's strong execution and focus on business resiliency as well as overall improvement in electronic component availability. The demand for our differentiated offerings continues to be strong even in this uncertain economic environment. Through the first half of this fiscal year, our total orders were $4.8 billion, spread evenly between the 2 quarters once we adjust for the estimated price-related pull forward in our fiscal Q1. As expected, our order cancellation rates remain in the low single digits through April. Total sales grew over 25% versus prior year. Organic sales were up over 27% year-over-year and were above our expectations. Currency translation reduced sales by about 3% and acquisitions contributed over 1 point of growth this quarter. As in the prior quarters, the split of sales by business segment, region and industry, was largely driven by access to electronic components and the composition of our backlog. In the Intelligent Devices business segment, organic sales grew 27% versus prior year with broad-based growth across all businesses. We continue to see wider adoption of our independent cart technology in new applications across semiconductor, food and beverage and life sciences. One example of the new application is wafer transport in semiconductor fabs. We continue to see increasing demand for this offering including an important win with a large U.S. company this quarter. This customer is investing in modernizing and expanding its material handling systems and our independent cart technology helps increase wafer output and more efficiently utilizes existing fab space, leading to increased capacity and significant savings. Software and Control organic sales increased over 40%. Strong growth versus prior year was led by logic, where we continue to see the benefits of our resiliency investments and an overall improvement in supply chain. Lifecycle Services organic sales were up 12% year-over-year. Book-to-bill in this segment was 1.27, led by strong order intake in our Sensia business. Information Solutions and Connected Services sales grew about 10% versus prior year. We had another quarter of competitive multiyear wins across our software and cybersecurity services portfolio. Within Information Solutions, I am pleased with the increasing breadth of our new Plex customers as we continue to expand our SaaS, Smart Manufacturing platform to new industries and geographies. One of our Plex wins this quarter was with AB-InBev, the world's largest brewing company and its start-up business EverGrain, focused on upcycling grain byproducts into a sustainable supply of nutritious food ingredients. Our modular and cloud-native Flix software is helping EverGrain quickly deploy mission-critical quality management capabilities today while providing the functionality for the business to scale in the future. In Connected Services, we saw another quarter of customer demand for our recurring cybersecurity and infrastructure as a service offerings as customers across many industries continue to invest in safety and security of their operations. One of these wins was with Darling Ingredients, a food processing company focused on reducing food waste by collecting and repurposing animal-based products. Our annual recurring revenue grew 15% year-over-year in Q2. Segment margin of 21.3% was up over 560 basis points year-over-year and was better than expected. Adjusted EPS grew over 81% year-over-year. We also completed the acquisition of Knowledge Lens this quarter, which adds significant scale to our Kalypso digital services business. Let's now turn to Slide 4 to review key highlights of our Q2 end market performance. Consistent with my earlier comments on the gradually improving supply chain environment, all 3 industry segments grew strong double digits versus prior year. Our discrete sales were up about 20% in the quarter. Within discrete, automotive sales grew over 40% versus prior year. We saw a number of strategic wins in EV and battery this quarter both in the U.S. and China, where a combination of our core automation and strong partner ecosystem helped edge out our biggest competitors. While some customers are optimizing operating costs in the near term, they continue to invest in building out new capacity to meet their production goals. Semiconductor sales were up mid-teens year-over-year. I already mentioned one semiconductor win. Another example of how Rockwell is expanding our existing semiconductor footprint now with wafer transport applications is our multiyear project win with Analog Devices. Our independent cart technology was chosen to automate ADI's material handling applications at several of their global fabs. By implementing our technology, ADI will improve operator productivity by at least 20% by moving away from manually delivering lots across the fab. In e-commerce and warehouse automation, our Q2 sales were down mid-single digits versus prior year. While we continue to see a pause in greenfield announcements, e-commerce players, traditional retailers and many consumer packaged goods companies continue to invest in modernizing their warehouses. Turning to our hybrid industries. Sales in this segment increased 35% year-over-year, led by strong growth in food and beverage. Food and beverage sales were up almost 40% versus prior year. We also saw a number of large orders this quarter with customers in this vertical continuing to invest in making their brownfield facilities more efficient and resilient. Demand in our dairy and agriculture processing business remains especially strong. Life sciences sales grew 20% year-over-year. One of the important wins this quarter was with a leading European healthcare company, where our Kalypso digital services used our Emulate3D simulation software to model and test multiple plant layouts to eliminate potential bottlenecks and increase worker safety. Tire sales were up over 50% in the quarter. Moving to process, this segment was up over 25% versus prior year, once again led by growth in oil and gas and metals. Within process, we had an important sustainability win. Through Occidental Petroleum's 1.5 subsidiary, Rockwell is providing control systems for direct air capture units that help remove carbon dioxide from the atmosphere. We are proud to be a part of Occidental’s low-carbon strategy to deliver large-scale carbon management solutions that accelerate the net zero economy. Turning now to Slide 5 and our Q2 organic regional sales. Similar to prior quarters, our growth by region reflects the electronic component availability and what's in our backlog rather than the underlying customer demand. North America organic sales grew 23% year-over-year. Latin America increased 16%, and EMEA sales grew 42% and Asia-Pacific was up 32%. Let's now move to Slide 6, fiscal 2023 outlook. We have previously said that the fiscal '23 sales performance is primarily based on our ability to ship backlog. Given our performance in the first half, improving ship supply and the benefits of our resiliency actions, we are increasing our sales and earnings outlook for fiscal '23. Our fiscal '23 guidance projects total reported sales growth of 14.5%. We expect organic sales growth of 15% at the midpoint. We expect acquisitions to contribute over 1 point of growth and currency to be a headwind of 1.5 points. Nick will touch more on this later. Organic ARR is expected to grow 15%. Segment margin is expected to increase by over 150 basis points year-over-year. Adjusted EPS is expected to grow 25% versus prior year, and we continue to target 95% free cash flow conversion. Before I turn it over to Nick, let me share some of our thoughts on the setup for fiscal year '24. With more than half of this fiscal year behind us and through our continued discussions with end customers, we believe we have better visibility into our full year orders and backlog levels. We expect our fiscal '23 orders to be about $9 billion, which implies a slight moderation of orders in the second half of this year. This is consistent with our expectations of improving component availability and the subsequent reduction in customer lead times. With our current orders outlook, we anticipate exiting the year with backlog levels of around $5 billion, positioning us well for fiscal year '24. Also, as the largest pure play, we have an impressive record of earnings growth, and we expect that to continue given our unique market focus and differentiation. Let me turn it over to Nick to provide more detail on our Q2 performance and financial outlook for fiscal '23.

Nick Gangestad, CFO

Thank you, Blake, and good morning, everyone. I'll start on Slide 8, second quarter key financial information. Second quarter reported sales were up 25.8% over last year. Q2 organic sales were up 27.3%, and acquisitions contributed 130 basis points to total growth. Currency translation decreased sales by 2.8%. About 6 points of our organic growth came from price. Segment operating margin expanded to 21.3% and was higher than our expectations. The majority of this outperformance was driven by the higher revenue. The 560 basis point year-over-year increase in margin was driven by higher sales volume and positive price costs, partially offset by higher incentive compensation and higher investment spend. Corporate and other expense was $29 million, in line with our expectations. Adjusted EPS of $3.01 was ahead of our expectations and grew 81% versus prior year. Free cash flow of $156 million was $110 million higher compared to last year, driven by higher pretax income, partially offset by higher working capital. The increase in working capital was primarily driven by higher accounts receivable given our Q2 sales outperformance. We improved our days on hand in inventory by 7 days in Q2, and we expect reductions in inventory days to continue for the balance of the year. One additional item not shown on the slide, we repurchased approximately 140,000 shares in the quarter at a cost of $38 million. On March 31, $1.1 billion remained available under our repurchase authorization. Slide 9 provides the sales and margin performance overview of our 3 operating segments. Organic sales grew double digits year-over-year in each of our operating segments. Turning to margins, Intelligent Devices margin increased by 560 basis points year-over-year due to positive price cost and higher sales volume, partially offset by higher investment spend and incentive compensation. Segment margin for software and control increased 900 basis points compared to last year on higher sales volume and positive price costs, partially offset by higher investment spend and incentive compensation. Lifecycle services margin decreased by 180 basis points year-over-year as the benefit of higher sales was more than offset by higher incentive compensation and one-time items to expand future profitability. We expect lifecycle services margin to expand sequentially and exceed 10% in Q4. The next Slide, 10, provides the adjusted EPS walk from Q2 fiscal '22 to Q2 fiscal '23. Core performance was up $1.95 on a 27.3% organic sales increase. The impact of currency was a $0.15 reduction in EPS, reflecting a stronger dollar versus Q2 of last year. Incentive compensation was a $0.40 headwind. This year-over-year increase reflects our lower bonus in Q2 of last year and our higher growth and earnings expectations for this fiscal year. Higher interest expense was a $0.05 impact. Our higher adjusted effective tax rate was a $0.05 headwind and our reduction in outstanding shares added about $0.05. Let's move on to Slide 11, guidance for fiscal '23. We are increasing our reported sales guidance to approximately $8.9 billion in fiscal '23 or 14.5% growth at the midpoint. We expect organic sales growth to be in a range of 13% to 17% or 15% at the midpoint. We expect volume to add 10 points of growth and price to add 5 points of growth. This guidance takes into account our performance through the first half of the fiscal year and is based on our current view of ongoing supply chain improvement. In terms of the second half, we expect mid-teens organic growth in Q3 and high single-digit growth in Q4. This calendarization includes our view of chip availability in each of the next 2 quarters and our Q3 transition from one third-party logistics provider to another at one of our distribution centers. We now expect a full year currency headwind of 150 basis points, which is 50 basis points better than our previous guidance. This updated outlook primarily reflects the strengthening of the Euro against the U.S. dollar. We expect full year segment operating margin to be about 21.5%, up from our prior guidance of about 21%, driven by higher volume and higher benefit from price costs for the full year. Our updated guidance now assumes full year core earnings conversion of close to 40%. We now expect the full year adjusted effective tax rate to be around 17.5%, down from our prior forecast of 18% due to discrete items that were realized in Q2. We are increasing our adjusted EPS guidance to $11.50 to $12.20. At the midpoint of the range, this represents 25% adjusted EPS growth, up from prior guidance of approximately 17% growth at the midpoint. We expect full year fiscal '23 free cash flow conversion of about 95% of adjusted income. A few additional comments on fiscal '23 guidance. Corporate and other expense is still expected to be around $120 million. Net interest expense for fiscal '23 is still expected to be around $130 million. And we're assuming average diluted shares outstanding of 115.6 million shares. Turning to Slide 12. Versus our prior guidance, we are increasing the midpoint for EPS by $0.75. Our guidance reflects an increase in our core of $1.05 driven by higher organic sales and our improved outlook in price/cost. We also deployed additional investments in sales and new product development as well as digital infrastructure that will generate future revenue growth and profitability. Currency is adding $0.05. Given the stronger outlook, our incentive compensation is increased by $0.40. And finally, our 50 basis point drop in our adjusted effective tax rate will add $0.05. With that, I will turn it back over to Blake for some closing remarks before we start Q&A.

Blake Moret, Chairman and CEO

Thanks, Nick. We are still operating in a dynamic environment and are laser-focused on execution through the rest of this fiscal year. With that said, we are continuing to accelerate new product development and investments in cloud-native technologies. Revenue from our new offerings, both organic and inorganic, is becoming a more meaningful contributor to growth and share gains. We are the largest pure-play automation company with market-leading solutions across discrete, hybrid and process industries and we are adding scale to our differentiated offerings through strong partnerships and strategic acquisitions. Our recent acquisition of Knowledge Lens is adding 600 resources with cutting-edge data science, AI and cloud solutions to our existing digital services business. This expanded team is already working with our key customers on their next-generation plans. I want to welcome all Knowledge Lens employees to Rockwell. Our close relationships with end customers, our best-in-class ecosystem and our talent give us confidence in the continued momentum for growth and profitability this year and beyond. Aijana will now begin the Q&A session.

Aijana Zellner, Head of Investor Relations and Market Strategy

Thanks, Blake. We would like to get as many of you as possible, so please limit yourself to 1 question and a quick follow-up. Thank you.

Operator, Operator

Our first question comes from Andy Kaplowitz from Citigroup. Please go ahead. Your line is open.

Andy Kaplowitz, Analyst

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

Blake Moret, Chairman and CEO

Sure. Well, let me take that first, Andy. We're continuing to add capacity. So at the same time that chip supply is improving, we're continuing to make sure that our labor and our facilities, our redundancy across our integrated supply chain operations is ready to handle continued growth. So let me start there. Now in terms of the demand, this is playing out like we thought it would. We have said for some time now that we did expect orders and shipments to converge as lead times improve. And so that's exactly what you're seeing, but the orders are continuing at a strong pace. And to look at that, let's take kind of a vertical by vertical view, we've talked about the historic generational spending levels in certain of the verticals that are important to us, things like electric vehicle and battery and semiconductor. We're seeing additional expenditures in energy, both as the fossil fuel providers decarbonized and as renewables become a bigger part of our business as well. But we're also seeing across all verticals an increased focus on automation, and that's due to large durable trends, things like scarcity of trained workforce and so the need to complement people with the technologies and the software and the services that we provide. So as I look across that while we continue to pay close attention to macroeconomic conditions, we think the setup for multiyear growth in automation and information is there.

Andy Kaplowitz, Analyst

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

Nick Gangestad, CFO

Yes, regarding software and control, we are seeing that business achieve sustainable margins of over 30%, supported by a strong market and the mix of our offerings. As for lifecycle services, we expect it to increase sequentially. We previously mentioned our goal of reaching double-digit margins, which we anticipate will occur in the fourth quarter. We believe this positive trend will continue beyond 2023. These are the margin expectations for those two segments.

Operator, Operator

Our next question comes from Josh Pokrzywinski from Morgan Stanley. Please go ahead. Your line is open.

Josh Pokrzywinski, Analyst

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

Blake Moret, Chairman and CEO

Yes, a few points. Josh, while the discussion was broad, beyond the usual areas we've mentioned, I would note that oil and gas orders performed quite well. We achieved significant competitive successes in our Sensia business, resulting in an impressive backlog. Additionally, orders from North America were notably stronger compared to Europe and Asia, and we anticipate this trend to persist for the remainder of the year.

Josh Pokrzywinski, Analyst

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

Nick Gangestad, CFO

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

Operator, Operator

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

Andrew Obin, Analyst

We are receiving questions about lead times. How should I interpret the $5 billion figure? Is it simply a reference point compared to your position at the end of fiscal year 2022 when you indicated being just above $5 billion? You mentioned $9 billion, which appears to be straightforward math. Alternatively, is there a chance this figure is updated throughout the year? Is it just a way for us to understand the larger context, or is it something that is actively managed and revised within the company each quarter?

Blake Moret, Chairman and CEO

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

Andrew Obin, Analyst

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

Blake Moret, Chairman and CEO

Plex continues to be an exciting addition to our offerings and is performing as we anticipated since the acquisition. It is a smart manufacturing platform that includes MES capabilities, as well as quality management, supply chain, and even ERP functionality tailored for small and medium-sized businesses. When we acquired Plex, it had an impressive track record in specific sectors such as tier automotive, but we recognized the potential to expand into markets like food and beverage, EV, and mining thanks to our established market access. Additionally, we saw an opportunity to diversify their customer base geographically, which we are doing with successes in Asia and by launching Plex on Azure in Europe, where we have already achieved some notable wins. The synergy we expected is materializing, and there is significant growth potential ahead. I’ve previously mentioned that we've appointed seasoned veterans from the cloud-native SaaS software sector to take on enterprise-wide roles within Rockwell. This includes software sales leadership, our Chief Marketing Officer, and several other key positions coming from Plex. Thus, we are not just integrating technology and business but also ensuring that we retain the expertise within the organization.

Andrew Obin, Analyst

And growth rates sort of commensurate with 15%. Is it in line with 5% for the rest of the business, better worse, if you could just sort of benchmark that?

Blake Moret, Chairman and CEO

Sure. Plex and Flix are very supportive to the overall growth of our software business.

Operator, Operator

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

Julian Mitchell, Analyst

Maybe just wanted to try and drill into that book-to-bill element a little bit more for the back half being well below one. It doesn't sound like you're perturbed by that. But just trying to understand, if we look at it in a little bit more detail, anything you'd call out around sort of hybrid versus process versus discrete markets, maybe where you see that book-to-bill or year-on-year orders pressure being most severe. And just maybe a question sort of more broadly on that for Blake. You've had this component flush driving this huge revenue surge right now. Is there sort of a view on the world or the demand environment post that flush changed at all in recent months?

Blake Moret, Chairman and CEO

Yes. So Julian, let me start. I wouldn't characterize the reduction in backlog as pressured. It's playing out in a way that we would hope it is in that we're clearing past due backlog and improving customer service levels and adding additional orders in the business. So you know historically that Rockwell has been fortunate to be able to ship out products pretty much in the same quarter that we get the order. So this is unusual to have product backlog, and we intend to continue to reduce the lead times and products just as much as possible. At the same time, a 1.27 book-to-bill in our Lifecycle Services business gives us good confidence about continuing demand for longer cycle projects there. So I feel good about the way that this is working. We obviously are focused on execution as well as creating additional demand going forward, but we feel this is a very healthy environment. To your second question about, has anything changed in terms of the component world, being able to get chips. I mean we're always going to have a larger effort than we did pre-supply chain constraints on making sure that our designs are resilient, both in terms of reevaluating existing products as well as new products and to make sure that they will go forward unless we have new levels of resiliency in component supply and robust designs to be able to reduce dependencies on any one vendor. So that's here to stay. We do believe, as Nick talked about, working capital with some of the inventory increases to go down, and that supports the good cash flow for the year. So certain of those things aren't going to change all the way back to, let's say, prepandemic, but we do expect a return to more normal levels in working capital and so on as we go forward as the chip constraints continue to resolve themselves.

Julian Mitchell, Analyst

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

Blake Moret, Chairman and CEO

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

Operator, Operator

Our next question comes from Steve Tusa from JPMorgan. Please go ahead. Your line is open.

Steve Tusa, Analyst

Congratulations on effectively managing the backlog. I missed part of the call. Did you discuss the sequential change in the backlog from the first quarter to the second quarter?

Nick Gangestad, CFO

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

Steve Tusa, Analyst

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

Nick Gangestad, CFO

I haven't provided the product versus software mix. But in terms of the things that are causing the margin expansion, the biggest factor by far is the volume growth that we're experiencing and the leverage we're getting on that. The second biggest thing that is improving that margin is the favorable price/cost versus where we were in the second quarter last year. And then offsetting that, to some extent, to bring it down to a 900 basis point year-on-year increase. We have increased investment spend year-over-year in software and control, and we also are facing noticeably higher incentive compensation. Those are the 2 negative things on the margin in the year-over-year Q2 for Software and Control.

Steve Tusa, Analyst

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

Nick Gangestad, CFO

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

Operator, Operator

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

Nigel Coe, Analyst

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

Blake Moret, Chairman and CEO

Yes. Nigel, this is a good development in that as the chip supply is easing that's really the primary limiting factor as we're clearing older backlog there. As we've said, we've got about $5.6 billion worth of backlog, and we're expecting that to go down to around $5 billion by the end of the year, but it's held up by continuing good order intake there. And also the contribution from lifecycle services with its strong book-to-bill. So it's primarily the chip supply. We feel good about our ability to continue to add labor in our facilities around the world. We've been adding for some time now, additional equipment. But as you know, we're not really a very capital-intensive operation. So it's not like if we're having to add a lot of heavy equipment because we're primarily an intellectual capital company. And so the equipment that we need has relatively shorter lead times than if we were in heavier manufacturing type operations.

Nigel Coe, Analyst

Are we noticing a shift in the backlog towards larger projects, especially with systems and ED plants? Are we seeing more large systems orders reflected in the backlog? Additionally, you mentioned $9 billion in orders, with $4.8 billion in the first half and $4.2 billion in the second half. While 4.2% is still a healthy figure, what is causing that decrease? Is it due to project timing or longer lead times as customers aren't placing orders at the same rate? How much visibility do you have regarding the slowdown in orders for the second half? It’s worth noting that, despite the decline, the order levels you indicated remain strong.

Blake Moret, Chairman and CEO

Yes. First of all, in terms of the composition of the backlog, I don't think we're seeing any fundamental change in the type of orders. Now obviously, as we move through, the backlog has a richer pricing as we work through the year. So that's a good read. But in terms of the number of big EV projects or semiconductor, facilities management systems or independent card or just continuing MRO, I don't think you're going to see a big change because a lot of these investment cycles in those areas are multiyear. We're in it for the long haul with some of these positive areas. Now in terms of where you might see a little bit of the contribution from the moderation in orders, probably the most specific area is as lead times improve, as they are across a lot of our product lines, you'll see machine builders not having to provide orders of the same size to have as many months of coverage of their backlog. So as they're concerned about their cash flow and they can look at shorter lead times, then they can reduce the size of their orders because they don't need as many months coverage for the machines that they've already booked. So I think that's probably the most specific contribution to some of the orders moderation.

Operator, Operator

Our next question comes from Rob Mason from Baird. Please go ahead. Your line is open.

Rob Mason, Analyst

I mentioned Sensia multiple times regarding the oil and gas sector. It seems that developments there are likely to pick up pace. However, I'm curious about the current operating loss tied to the minority interest and how profitability at Sensia might change in the coming 6 to 12 months.

Blake Moret, Chairman and CEO

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

Nick Gangestad, CFO

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

Rob Mason, Analyst

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

Blake Moret, Chairman and CEO

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

Operator, Operator

Our next question comes from Noah Kaye from Oppenheimer. Please go ahead. Your line is open.

Unidentified Analyst, Analyst

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

Blake Moret, Chairman and CEO

Yes. Andre, it's a good pipeline, and you said it. Those are the priorities. That's fairly broad. But within that, there's a lot of information management software in the production world. So there's some decent targets there. Cybersecurity has been extremely successful for us both organically and as we've added additional capabilities through some acquisitions, advanced material handling. We talk all the time about our independent cart technology, about some of the things we're doing in robotics applications as the lines get blurred between robot control and programmable line control, and we think there's some very interesting things going on there. Obviously, you had AI and autonomy to some of these areas, and there's new dimensions for value for customers. And then New York and Asia, we're very happy, for instance, with what we're doing with Awesome, the Italian manufacturer of industrial PCs that also has some great software that's forming the basis for some of our most exciting new introductions. So I would say that the pipeline is good across all of those fronts.

Unidentified Analyst, Analyst

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

Blake Moret, Chairman and CEO

Well, they're all focused on building up their fleet capacity so that they can get a return on these giant investments. You don't get that unless you put more jobs per hour on the door, and so they're all working to be able to expand their production output. But if you look on the road today, you still don't see a ton of electric vehicles and all of them, if you listen to those goals and you look at the trends, this is a multiyear process and from start to finish lines and the basic materials that are needed for the batteries, through the battery-making facilities, through the electric vehicle assembly. All of that has to build out to be able to get us to a point where you start seeing electric vehicles come anywhere near approaching internal combustion vehicles on the road. So this is multiple years, and all of these manufacturers are focused on debottlenecking that whole supply chain, which is going to be in the news for years to come. I think the one other question, I mean the IRA, obviously, that helps there as well as it does with other renewable providers. We've talked before about First Solar, for instance. We talked about Occidental's 1.5 initiative. So we're seeing more and more of these come online across our verticals and people are doing it because it's important for their business models. And again, that's not a ephemeral thing. That's going to be over multiple years.

Operator, Operator

Our next question comes from Phil Buller from Berenberg. Please go ahead. Your line is open.

Phil Buller, Analyst

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

Blake Moret, Chairman and CEO

Sure. Yes, it's broad-based. I mean, we're very happy with the way that our business is balanced between discrete and hybrid and process applications with big opportunities in all of them. I mean, as we talk about EV and battery in discrete, we talk about food and beverage and life sciences, food and beverage is our single biggest vertical in hybrid. And then in process, I highlighted some particularly strong order activity with Sensia, but we also continue to see good activity in metals as well. So it's across all of them. Now in terms of the margin, one to the next, there's high-margin opportunities in each one. I would say that the engineered systems are concentrated a little bit more heavily on the process side. Those customers are more often looking for engineering content to complement the hardware coming from the same provider. So you'd probably see a little bit lower margin there due to the people intensivity of that, but good opportunities in the funnel for near and midterm orders across all of the industry segments.

Phil Buller, Analyst

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

Nick Gangestad, CFO

Beyond Software and Control, which I've already covered still, when I look at intelligent devices, that's been a little over 20%, about 21% margin in the first half of this year. I think for the full year, it's going to be close to that, maybe between 20% and 21% for the full year margin for Intelligent Devices. Some of the things happening there, we continue to see good volume, good price growth, but as I talked about earlier, for the full year, we'll also be seeing higher incentive comp and higher investment spend. This is one of the places where we've been focusing some of our investment spend in resiliency, and we'll see that continuing. So between 20% and 21% for Intelligent Devices. And then lifecycle services, I've talked about sequential improvement. I don't see us crossing the threshold into double-digit margin until the fourth quarter. So I see Q3 being a move in that direction from where we were in the first half, where we're in the little over 5% margin. We'll be stepping it up, but not all the way to 10% and then going to 10% or over in the fourth quarter.

Aijana Zellner, Head of Investor Relations and Market Strategy

Julian, we will take one more question.

Operator, Operator

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

Jairam Nathan, Analyst

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

Blake Moret, Chairman and CEO

Yes. So the net opportunity for Rockwell actually goes up as we go from internal combustion engines to EVs, and that's for a couple of reasons. First of all, the traditional drivetrain operations. That's a more subtractive manufacturing process, that's boring cylinders, that's finishing metal surfaces and things like that. And that's largely done with computer numerical control, which is not a technology that Rockwell directly has. We have good partnerships, but it's not something that we provide directly. And so when that's replaced by some of the operations in electric vehicles, most notably, the battery formation and packing and assembly. That's more of an assembly-type operation. And there are aspects at the front end of that with batch processes. And those are all applications that Rockwell is ready to serve. Then when you look at what you specifically mentioned in the joining part of it, it's more complex press operations, and Rockwell has great press control systems. So as the metal formation becomes more complex, again, those are really good applications for Rockwell with our program of control as well as our expanded drive control. So we feel good about those opportunities. And then added to those basic automation applications. It's the software that's a more pervasive part of the electric vehicle and battery manufacturing process, and we have really good solutions there.

Jairam Nathan, Analyst

I have one more question. Given your outlook, it seems that the area experiencing a decline is chemicals. You've moved from a high single-digit growth to low double digits. Can you elaborate on that?

Blake Moret, Chairman and CEO

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

Aijana Zellner, Head of Investor Relations and Market Strategy

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

Operator, Operator

That concludes today's conference call. At this time, you may disconnect. Thank you.