Emerson Electric Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
August 4, 2021

There are 17 speakers on the call.

Operator

Good morning, and welcome to the Emerson Third Quarter 2021 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Pete Lilly, Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you so much. Good morning, everyone, and thank you again for joining us for Emerson's Q3 earnings conference call. Today, I am joined by President and Chief Executive Officer, Lal Carson Bay Chief Financial Officer, Frank Dellaquila And Chief Operating Officer, Ram Krishnan. I'd also like to introduce and welcome the new leader of Emerson Investor Relations And certainly an upgrade for the role, Colleen Mettler. Colleen joins us from the Automation Solutions Finance Organization and will be your main point of contact going forward as I transition to a new role in the operating business units.

Speaker 1

Many thanks to you all for your support and friendship over the past couple of years. It's been fun. I certainly wish you health and success. As always, I encourage everyone to follow along with the accompanying slide presentation, which is available on our website. Please join me on Slide 2.

Speaker 1

As always, this presentation may include forward looking statements, which contain a degree of business risk and uncertainty. Please turn to Slide 3, and I will turn the call over to Colleen to introduce herself and cover some exciting developments within Emerson.

Speaker 2

Thanks, Pete. I certainly have big shoes to fill. As Pete mentioned, I'm coming into this role from our Automation Solutions Finance organization, And I've been with Emerson for over 13 years. I'm certainly excited and humbled to be joining the Investor Relations team during this dynamic time for our organization. I look forward to speaking with all our investors and partners very soon.

Speaker 2

Now I would like to take a moment to highlight 2 areas of real ESG impact within Emerson. First, on Slide 3, in keeping with environmental sustainability framework of Greening of, by and with Emerson that we introduced in February, our first topic is about Greening by Emerson. It is a great example of how Emerson's solutions are relevant in enabling our customers' Emerson recently signed a multiyear agreement with Pure Cycle Technologies, which has a novel technology and process for fully recycling Plastic 5, polypropylene, back to a clear pellet. As some of you may know, Polypropylene is a common form of plastic that has not had great recycling options. Emerson is serving as their born digital automation partner going forward with initial plant projects in Ohio, Georgia and a remote operations center in Florida.

Speaker 2

Now please join me on Slide number 4. Our second topic is a greening with Emerson example. Leveraging our Helix Innovation Center in Dayton, Ohio, Emerson has collaborated with the Department of Energy and their Oak Ridge National Laboratory to advance next generation HVACR technology, Expanding the applicability of heat pump technologies, redesigning refrigeration architectures to maximize efficiency in food retail And working to minimize energy use and leaks in commercial HVAC applications are just a few of the exciting areas of cooperation. We have a number of collaborations with the Department of Energy and their labs. We look forward to continuing to build these relationships and support the development of novel solutions and real sustainability roadmaps going forward.

Speaker 2

Now please turn to Slide 5, And I will turn the call over to our CEO, Lal Karstenbein.

Speaker 3

Thanks, Colleen. Just a few words before I turn it over to Frank to go through The financial data. First, Pete, thank you very much. Godspeed and have a good luck in your new opportunity. We're all very excited for you.

Speaker 3

Thanks for all the hard work. Welcome, Colleen. It's great to have you here. Colleen and I had the opportunity to spend a couple of years together in Automation Solutions, and we're We're very blessed to have her join our Investor Relations team. So welcome.

Speaker 3

Thank you. I'd like to express my thanks to the leadership teams and the management and Our employees globally for what has been a very, very well executed quarter. And we have a lot of energy momentum behind us, And which was very exciting to see as we executed through the last three months. I'd also like to express my thank you to our shareholders. I had the opportunity over the last 6 months to meet many of you and I look forward to meeting more of you as I go through The next part of the year, but I appreciate your continued confidence, your challenges and of course your investment.

Speaker 3

A few things just that are non financially related that I want to mention to the team here. First of all, our cultural work is well underway. We will be announcing our new Chief People Officer later this month. We're all very excited about The selection process will be an outside hire and somebody who fundamentally will have the opportunity to come in here and really Help us as we navigate some of the challenges and create many of the pathways that we have as we evolve the culture of Emerson into the future. Secondly, our portfolio work is complete.

Speaker 3

We have We are now we're getting ready to review it with the Board, which will occur at the October Board meeting. We discussed briefly with the Board yesterday. And essentially what we have defined is multiple paths for our business to drive higher underlying sales growth And diversification of the portfolio. We're all very excited about the process that we underwent. It was very exhaustive.

Speaker 3

And we have Turn over a lot of different stones, defining broad markets with high growth and lots of optionality in terms of M and A And organic activity, very exciting there. I'll mention on the M and A side that industrial software continues to be critical As we think about share of wallet and we think about the potential for underlying growth acceleration, and there are many pathways there. Our OSI acquisition is performing incredibly well and ahead of our internal synergy board plans. So that's been very, very well done. But what stands out to me most above all is the execution by the team.

Speaker 3

Yes, there were market tailwinds and we'll talk about those, Particularly as they accelerated in automation solutions and continue to across our commercial residential businesses and they are relevant. But the execution was absolutely phenomenal. There were a lot of hurdles to overcome through the quarter, Material inflation, material availability, we did a lot of expediting. We had to get very creative in qualifying suppliers, Logistics and management of cargo around the world and of course labor availability in the United But the team just did a great job. And lastly, before I turn it over to Frank, the cost reset work It is well underway and we're now in the tail ends of the spend and we're seeing despite these operational headwinds, The value of that work being reflected in the incrementals of the company.

Speaker 3

The operating leverage, profit leverage at 34% was very strong And now most importantly has given us the room to accelerate investment in differentiating technologies and further That will further, I think, drive relevance increase relevance at our customer base. So very exciting headroom that's created And we started those investments and I'll share a number of those with you and we'll talk about that more as we go through the year. So with that, I'll turn it over to Frank and I'll speak towards the end of the call.

Speaker 4

All right. Thank you, Lal. Good morning, everybody, and thank you for joining us. We're especially pleased with the results in Especially in light of the operations challenges that Lal just described and Ram will talk about a little later in the call. If you please go to Slide 6.

Speaker 4

So, it continued recovery in our end markets combined with the benefits of the cost reset actions and it drove strong operating performance and financial results in the 3rd quarter. Adjusted EPS was $1.09 up 36% from the prior year. Demand continues to strengthen with sales coming in ahead of our expectations with underlying growth of 15% In June, trailing 3 month orders were at 26%. Automation Solutions notably turned positive this quarter in both sales and orders, Up 9% in sales and 17% on an underlying basis. Commercial and Residential Solutions continues to experience robust demand across the business And geographies with 29% sales growth and 43% orders growth on an underlying basis.

Speaker 4

The cost reset benefits continue to be realized as planned reading through to the margins and along with the additional volume and leverage, They drove adjusted segment EBIT growth of 40%, 280 basis points of increased margin to 19.6%. Cash flow continues to be very strong with operating and free cash flow up approximately 30% year over year and free cash flow conversion exceeding 150% of net earnings. We're continuing to implement the remaining elements of the cost reset program. In this quarter, we initiated $32,000,000 of restructuring actions. The program is on schedule and delivering the projected savings as we planned.

Speaker 4

Please turn to Slide 7. It's a bridge of the earnings per share increase from prior year. The operational performance was very strong. So the noteworthy thing on this chart is the green bar. Operations added 33% to adjusted EPS and it was balanced between the platforms.

Speaker 4

They both delivered strong profit leverage On the strength of volume increases and cost reduction benefits, as Lal mentioned, the leverage was 34% across the enterprise. Tax currency pension stock comp netted to a $0.05 headwind and there was a minor favorable impact from share repurchase. Again, in total, adjusted EPS was $1.09 up 36%. Please go to the next chart, chart number 8. So as I mentioned, underlying sales was up 15%.

Speaker 4

Gross profit increased 90 basis points to 42.4%, Driven mainly by the benefits of the cost reduction actions and then the leverage on the volume across the enterprise, we did offset The impact of price cost headwinds, which we are beginning to see intensify and which we will see in the next couple of quarters and we will talk about a little later in the call. Adjusted EBIT margin was 18.4%, up 3 10 basis points. Effective tax rate was 19 2% versus 1% in the prior year. Last year, we had several favorable discrete items, mostly around R and D credits That we described at the time, this was a $0.10 headwind year over year that we overcame. Adjusted EPS, as mentioned, was Adjusted segment EBIT again increased 40%, margin up 2 80 basis points, leverage on volume and cost reset benefits offset Material cost headwinds in the Climate Technologies business.

Speaker 4

Adjusted pretax earnings increased 3 50 basis points to 17.6%. Operating cash flow was very strong, up 31 percent at $1,100,000,000 Free cash flow was 977,000,000 Also up a little over 30%, driven by strong earnings growth and effective working capital management. Lastly, the trade working capital ratio improved to Turning to Slide 10, we'll look at Automation Solutions. Underlying sales turned positive this quarter at 8%, trailing 3 month orders accelerated to 17%. The improvement in the Americas is particularly encouraging and notable with continued momentum in life sciences, food and beverage and medical markets and a return to growth more broadly across the traditional process automation markets and sustainability related business.

Speaker 4

We're seeing increasing KOB 3 activity across our process automation customer base, mainly driven by shutdown turnaround and outage activity and OpEx spend. MRO spend is returning to pre pandemic levels from pent up demand and delayed STOs. CapEx spending is recovering at a slower rate with tailwinds from site based emissions and optimization projects. The platform continues to implement the comprehensive Restructuring actions that have been ongoing and the benefits are flowing through to the financial results. Adjusted EBIT margin increased 320 basis points and 310 basis points of adjusted EBITDA driven mainly by the flow through of the cost reset savings and by the volume leverage.

Speaker 4

The integration of OSI continues to go very well. We're very pleased with the acquisition and the results to date And we have increasing confidence in the synergy plan that we have. Backlog increased to $5,500,000,000 It is up 17% year to date. We'll talk a bit about the project funnel and other opportunities later in the call. Turning to Slide 11, we'll review Commercial and Residential Solutions.

Speaker 4

Sales were up on an underlying basis 29% versus the prior year. Orders continue to be strong And very broad based in their strength, the June trailing 3 month underlying orders were up 43% and it was very balanced across both Climate Technologies and Tools and Home All businesses and geographies showed strong double digit growth. Residential markets continue to be strong and growth has accelerated in cold chain and professional tools. The Americas were up 29% With continued strength across all end markets, Europe was up 37%, driven by continued heat pump demand and increasing sales of professional tools. Asia, Middle East and Africa was up 25% driven by cold chain and various heating technologies.

Speaker 4

Margins improved by 170 basis points of adjusted EBIT and 120 basis points of adjusted EBITDA driven by the strong volume leverage and the cost reset savings, which more than offset the price cost headwinds that we are seeing in the business. Please turn to Slide 12. I'm going to pass this over to Ram and he's going to talk a bit about Operations, what we've done in the quarter to deliver the results of some of the challenges that we face.

Speaker 5

Thanks, Frank. Clearly, as you can see, our operating environment remains very challenging as commodity inflation, electronic supply And labor availability continues to impact our global operations. Steel prices are at record highs with 11 months of consecutive increases and in our estimation have not peaked yet. Plastic resin prices remain elevated as our global teams have maneuvered expeditiously to find alternatives And while copper pricing has receded off record highs, it is still up over $1.40 a pound year over year. Our hedge positions lessened the impact to 2021, but the inflation impact in terms of copper will carry over into most of 2022.

Speaker 5

Electronic shortages are proliferating in most of our businesses, impacting both platforms and supply is expected to remain constrained well into 2022. Very little component inventory on microprocessors, controllers, linear integrated circuits are available in the open market And the number of shortages faced by our EMS suppliers is growing severely impacting lead times. And finally, Labor availability continues to be an issue across many industries in the U. S. And our businesses are impacted as well.

Speaker 5

Our V shaped demand recovery in many of our commercial and residential solutions businesses, local Competition driven by tight labor markets in many cities and rolling labor constraints as waves of COVID disruptions impact our sites has added a new level of complexity to our operational plans. It is important to note that price cost remains at an unfavorable $75,000,000 As we estimated last quarter, no change, but we expect the maximum impact of the commodity inflation to be felt in the next two quarters. Now despite these challenges, turning to Slide 13, I'd like to highlight some of the outstanding work by our global supply chain and operations teams Creative and nimble in a dynamic environment to serve the needs of our customers. Our supply chain teams have worked tirelessly in this environment to ensure continuity of material supply to our global plants. As you can see on the chart, many creative solutions are being implemented on a real quickly and effectively.

Speaker 5

Our regional footprint, both on the manufacturing side as well as supply chain that we spent many years developing, has certainly been an advantage for us in these challenging times. Many of our global plants are producing at record levels while ramping up capacity to meet surging demand and in many cases in sourcing critical elements of the supply chain to address sudden disruptions. I do want to take this opportunity to sincerely thank our global teams for delivering an outstanding operational quarter. With that, I'll turn it over to Wal to walk through our full year guidance and outlook.

Speaker 3

Thank you, Ram. Let's turn now to Slide 15. We are improving our sales outlook for the year based on the continued strength in our orders, the pace of business and the year to date profit performance. We now expect underlying sales growth to be near the top of our May guidance, approximately 5% to 6%, Commercial residential above their range in May at 15% to 16% and automation solutions closer to the top of their range at 0% to 1%. The strong volume and improved cost base will flow through to margins.

Speaker 3

Our estimates are now 50 basis points above the previous guidance, increasing adjusted EBIT margin and adjusted EBITDA by 0.5 percent to approximately 18% and 23%, respectively. There's no change to the restructuring, tax rate, capital spend or dividend. Strong profitability and working capital performance enable An increase in our operating cash flow and free cash flow estimates, both of which increased by $300,000,000 We are also raising our adjusted EPS guidance to $4.07 plus or minus $0.01 Our price cost headwind for 2021 currently remains as estimated in Q2 and Ram covered at $75,000,000 despite the current challenges that were highlighted. We continue to manage this through containment, Selective price actions, but the recent market developments that Ron described will be a challenge through the next two quarters as we navigate them. Stock compensation impact increases to $125,000,000 So now we'll go over to Chart 16 and I'll just frame the order environment that we've experienced through the last 3 months.

Speaker 3

Emerson's trailing 3 month orders continue to be very strong and have momentum from the last update we gave you in the 2nd quarter. With commercial and residential solutions continuing to climb higher in their order run rates and automation solutions turned sharply positive to the high teens in June. Commercial and Residential Solutions continues to see strength in residential, cold chain and the professional tools Business and all three very near to that average band of 43%. Discrete and hybrid markets and automation solutions continue to be very strong. While we see recovery in later cycle process automation markets, especially in North America, KOB 3 and KOB 2 are driving most of the recovery, but we are beginning to see some KOB 1 activity materialized, particularly in chemicals, power and biofuels.

Speaker 3

The Americas really strengthened, up 29% As deferred maintenance demand and site access drove momentum. Finally, as we have commented in the past quarters, Life Sciences momentum continues to be extremely strong. Let's now turn to Chart 17 and I'll review the underlying sales growth outlook. Q3 underlying sales were up 15% versus prior year, exceeding our management expectations, driven by the strength in commercial and residential solutions as well as the North America recovery just discussed. Full year expectations on underlying sales are between 5% and 6%, at the top end of our prior guidance of 3% to 6 and sales of approximately $18,400,000,000 The 4th quarter is expected to land in the high single digits to low double digit range.

Speaker 3

For the remainder of the year, we expect to see the North American business continue to recover in automation solutions As well as continued broad strength in commercial residential solutions, however, the impact of supply chain and labor issues will be a challenge. Let's now turn to Slide 18, and I'll review our outlook by geography. As Frank mentioned for the full year, we're expecting Automation Solutions sales to be flat to 1% And Commercial and Residential Solutions to be between 15% 16%, driving us to our overall 5% to 6% underlying sales expectations. So starting off in the Americas, quarter 4 is expected to be strong in automation solutions at approximately 20% growth. Broad based recovery across all industries led by continued strength in discrete and increasing strength in hybrid.

Speaker 3

Process is showing some recovery, although uneven with some strength from returning domestic oil demand, offset by reduced midstream investment and continued fiscal restraint in upstream. For KOB 3, we expect to see continued spend for deferred maintenance and increasing spend for site access There has been pent up from the pandemic with an expectation that we will see a strong fall shutdown turnaround season. In Latin America, strength in mining industries particularly are expected to continue. On the commercial and residential side of the business, Ongoing momentum in the residential markets driven by do it yourself trends, home starts and HVAC seasonality, as well as strength in professional tools and cold chain are expected to continue. Europe will continue to see demand in life sciences and bio on the automation side.

Speaker 3

Project wins in power, midstream, downstream and sustainability will drive low to mid single digit growth in Q4. Commercial and residential will see robust demand for heat pumps and professional tools as well as the continuation of the refrigeration market recovery in Q4. Turning to Asia, Middle East and Africa. Our Asia Automation business is seeing healthy project activity in marine, Nuclear, Life Sciences and Semiconductors and a positive trend for site level spending in the Middle East. On the commercial and residential side, we are seeing the commercial recovery across the region, specifically with commercial AC and cold chain solutions.

Speaker 3

Ongoing COVID restrictions continue to be a challenge across the organization, particularly this part of the world. Let's now turn to Chart 19, and we'll review the business funnel for Automation Solutions. So back in February, we commented that our traditional large project funnel was $6,400,000,000 and this should be something that is very familiar to those of you who watch this carefully. Since February, we have booked approximately $80,000,000 of projects, some LNG and one most notably in Mexico. New projects added include clean fuels, hydrogen, renewable diesels, Lithium Mining and LNG Projects, while projects removed from the funnel since February, were mostly oil and gas and downstream refining projects.

Speaker 3

The August 2021 funnel is now valued at $6,300,000,000 and approximately 180 projects. And below in the donut pies, you can see the industry mix of our traditional funnel. We have identified new decarbonization opportunities and though generally Smaller than our traditional definition of projects for our funnel classifications, these projects are increasingly relevant to our business. They're being added into this view so that they because they have the potential to grow in nature over time. Today, as depicted on the chart, these opportunities are worth $400,000,000 and approximately 120 projects.

Speaker 3

The combination of our traditional project funnel And the new sustainability funnel is now valued at $6,700,000,000 And below is the combined industry mix, where we are working to diversify our funnel. On the right side of the chart, we are introducing the business opportunities With our recent OSI acquisition, which gave us an important foothold into the transmission and distribution automation space, These opportunities have slightly different characteristics from our traditional project funnel definition and therefore We are keeping it separate for our discussion purposes today. Generally, these opportunities are smaller and more numerous compared to our large traditional project funnel, but they are clearly strategically important. The value of these opportunities is $1,500,000,000 and are made up of 530 projects. To give you some perspective on the scale and how differentiated it is, Approximately 15% of that $1,500,000,000 has a value of greater than 5,000,000 and 50% of it is between $1,000,000 $5,000,000 The funnel is global, although approximately $1,000,000,000 of it is in North America and Europe.

Speaker 3

Overall, we have strong opportunities ahead and I'm bullish on overall project outlook as we diversify and expand into new spaces. Now let's turn to Chart 20. This is a very important chart. And as Frank mentioned in our financial results showcase, our robust cost reset plan is being incredibly well executed across the enterprise. As a reminder, this comprehensive plan began in late 2019 and will be fully realized by 2023.

Speaker 3

It involves over $600,000,000 in spend and approximately $650,000,000 in savings. In February, we also introduced our mid range targets of 24% Adjusted EBITDA margins and $4.75 to $5 in adjusted EPS. We are very much on track to reach those targets by 2023. Importantly, however, the recent outperformance and momentum through the end of 2021 is creating some headroom for critical investments and I'm particularly excited about this. Particularly as I think about Key technologies that will enable our business to outperform over the long term.

Speaker 3

As you can see, revenues, margins and cash flow are all better than February expectations and are enabling this acceleration in technology investments. I've outlined 4 examples below, and will come out over the next months and in-depth in February As to how we're managing and thinking about these very significant investments, the examples outlined are the Copeland K7 Scroll, which is the largest new product investment in the history of our air conditioning business. This drives obviously increased performance and meets the 2023 efficiency regulations and is optimized for 2025 refrigerants. The Greenlee Remote Cutters, an award winning tool on the right hand side of the chart, which enhances safety for cutting underground cables The Geminis, which is our next generation pressure and temperature device being developed in our measurement solutions business, which will have next generation electronics, unmatched safety and process insight. And lastly, Alphabet WebOptics, our integrated operational performance platform, which unifies data, And with that, I will Turn the call over to the operator, and we'll begin the Q and A.

Speaker 3

Thank you.

Operator

We will now begin the question and answer The first Question comes from Julian Mitchell with Barclays. Please go ahead.

Speaker 6

Hi, Good morning and look forward to working with you, Colleen. In terms of, I suppose, allow the Automation Solutions Sort of revenue outlook. So a lot of very good color in the slides. It looks like the guidance is embedding sort of Mid single digit type growth in the 4th quarter in auto sold organically. When we take your comments together in terms of a sort of stable funnel since February and maybe an ongoing sort of subdued Oil and Gas CapEx backdrop, should we take that as a good sort of medium term or into next 12 months sort of Placeholder, that mid single digit type auto sold growth rate.

Speaker 3

Hi, good morning, Yulian. Thank you. Thanks for the question. I think that's fair. Look, the recovery has been largely fueled by modernizations and MRO spend Across facilities, there has been, as I indicated, some KOB1, but that's not what's going to drive us going forward.

Speaker 3

So what I would expect is that I think that conversion in of those two segments of the business into from orders into sales would continue and I The guidance is I think that's a fair assumption.

Speaker 6

Thanks very much. And then maybe switching to The margin aspect, maybe clarify how much of that €75,000,000 price cost Headwinds sort of falls into the Q4. And when we look at ComRes margins in that context, Can that business sustain a sort of 20 plus percent incremental margin the next 6 months or does it Get sort of pushed below that by the price cost headwinds?

Speaker 3

Great question as well, Julian. Clearly, That's where the challenge is going to be, is it on the incrementals in commercialresidential over the next 6 months. The team is working both sides of the equation, Julien, price and cost, we're getting very creative in terms of the contact structures and the negotiations with our major customers. But we also have opportunities to continue to work availability of materials, sourcing from different world areas, Moving a few things around, but that's where the biggest challenge is. And I would suggest that your assertion is correct that The incrementals in that business are going to be the most challenged as we go over the next 6 months.

Speaker 4

Great. Thank you.

Operator

The next question is from Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Speaker 3

Wow, that got nailed there, Josh.

Speaker 7

Yes, yes, must have had some Cliff notes on that. I'm going to hear your voice. A couple of questions. I guess first On some of the kind of extra funnel additions, particularly on decarbonization, nice to see that tick up. I guess Yes.

Speaker 7

If you add some more

Speaker 3

context there, if you wouldn't mind.

Speaker 7

I mean, on one hand, your customers have some of your legacy customers are Pretty big emitters. Is there more push on those folks to sort of diagnose, measure and improve? Or is more of the funnel that you're tracking sort of on more green technologies, like you mentioned hydrogen, like which one of those is showing up more and which you think could be kind of a bigger needle mover here in the medium term?

Speaker 3

Yes, great question. And I think there's a little bit of both in the funnel. I think if you look at the traditional 6 $300,000,000 funnel, there was already embedded in that a lot of the biofuel conversions, emissions monitoring, Work that's being done downstream, particularly in refining and other parts. What's in the green bar, what's in the new I think are significantly incremental investments and those are Partially driven by things like green diesels, which is basically the manufacturing of diesel, but using a feedstock that is a sustainable feedstock For the investments in hydrogen, if you recall back in February, we talked about $1,000,000,000 opportunity for hydrogen That was framed around 2,030. However, as we now bring these projects into our and this is a very defined pursuit Process that we run within the business, we now bring those into that pursuit and we are pursuing those to 2023 And that's the view of the $400,000,000 I expect that to increase over Time and the number, not just the number, but the scale of those projects to become more and more meaningful, which is why we're talking about it today.

Speaker 3

You're absolutely right. I think our core integrated oil customers upstream Through the midstream and downstream, they're all spending dollars, incremental dollars on emissions, sustainability, reliability, productivity, All around those automations to drive their to their ESG commitments and that can come in the frame Of conversions or of optimizing current processes.

Speaker 7

Got it. That's helpful. And Just on the price cost side, I know some of what you guys have out there, particularly in ComRes has Some kind of pricing contracts that we set periodically, maybe annually. I would imagine that that puts you a bit more behind the curve this year. Can you maybe talk about what just flipping the calendar or flipping the fiscal year sort of sets up in terms of price cost?

Speaker 7

I know Ram Talked about some of the hedges postponing things like copper inflation, but I think there's probably a little pent up pricing opportunity as well. Could you maybe kind of match up How those things work together?

Speaker 5

Yes. So I'll take that. From a pricing perspective, as Lal mentioned, our Commercial and residential teams are working that diligently. Many of the pricing, particularly with the large OEMs, some will happen in October, but many of it will happen in the Jan Time frame, so you'll expect the pricing to kick in, in a big way into our second quarter, and that's All well underway. In terms of the steel and copper pricing, certainly the copper hedges will flow through the year.

Speaker 5

We've modeled that out. On the steel side, We do expect the next 3 to 6 months to be pretty tough, but outside of that going into the second quarter, We'll start seeing the better pricing on steel come through as well. So I would say from a pricing perspective, a lot of the pricing From our perspective is modeled in the Jan timeframe.

Speaker 7

Okay. So after that 6 month timeframe, it is a bigger step up. Understood. Appreciate it. Thanks for the color, both.

Speaker 7

You're welcome. Thank you.

Operator

The next question is from Andrew Obin with Bank of America. Please go ahead.

Speaker 8

Hi, guys. Good morning.

Speaker 3

Good morning, Andrew. Hey, Peter.

Speaker 8

Hey, just was wondering if you can talk about Sort of internal bottlenecks and specifically I'm thinking ComRes, it seems Resi HVAC is doing very well. You're talking about V shaped recovery in tools. Do you need to add capacity at Copeland and Tools to deal with demand? And how are you thinking about it?

Speaker 5

Yes. We are clearly in a position where we are adding capacity and will add more capacity As we go through this plan, certainly at this point, we're fighting labor challenges In terms of short term capacity in many of our current U. S. Locations, but we are adding capacity both in the U. S.

Speaker 5

As well as Mexico For both the Climate Technologies business as well as the Tools business. So the answer is yes.

Speaker 8

Excellent. But it's not a constraint, right? How much of a constraint is it to growth, I guess?

Speaker 5

It is not a constraint at current levels. I mean, outside of the labor As we model out the long term growth dynamics of the business and certainly the regulation changes that are coming down the pipe, It's important for our longer term plans.

Speaker 8

Got you. And just a follow-up question. I think you disclosed systems and software now. Can you just break down how much what is organic growth and I mean clearly the balance would be M and A And also specifically hone in on growth trends that you're seeing in OSI

Speaker 3

Power, the funnel is very impressive there. So as Frank and I mentioned in the comments, Andrew, we're very pleased with the performance of OSI Power. We were actually up there for a growth planning session just earlier, late July. So the team is performing incredibly well. Management, we've retained management and they're executing the plans.

Speaker 3

And what we're seeing is actually higher than expected ability to leverage existing relationships that PWS and Ovation across the large power companies in North America, but more importantly, the opportunity To greatly geographically expand this business at a far higher rate than we expected at the time of the acquisition. So Validating the technology, validating the applicability and the customer relevance has been very important for us. So we're excited. There is an opportunity to build around this business and there is a vision to continue to transform this into more of a Pure software play in terms of the evolution from perpetual into subscription, in terms of outsourcing services Focusing on software and looking around measures that are relevant for software businesses such as annual recurring revenues and things of that. So we're working that very aggressively within the business.

Speaker 3

In terms of growth rates, I would suggest high single digits on the systems and solutions Business and I would suggest that the data management layer grew slightly above that, but on average. I don't have that number in front of me, but that would be based on What I have seen and heard, my understanding, Andrew. Yes. Sorry for a lot of follow ups and thank you for answering them. Thanks.

Speaker 3

Thanks, Andrew.

Operator

The next question is from Jeff Sprague with Vertical Research. Please go ahead.

Speaker 9

Hey, thank you. Good day, everyone.

Speaker 1

Hi, Jeff. Hey, Jeff.

Speaker 9

Hey, Walt. Thanks for all the transparency on your Thought process here about strategic review and everything. But it is interesting, I guess, You say that you've concluded it and you will review it with the Board in October. So I suppose that suggests any idea of any Large scale strategic change or something like that is not on the board, so you wouldn't be sitting on that till October. And instead we should think about you're cultivating a investment pipeline and kind of an M and A pipeline.

Speaker 9

And As you said, kind of looking at ways to create new growth sectors and potentially diversify a bit. Is that the right read on what you said in your opening remarks?

Speaker 3

It's an interesting read, Jeff. I'll tell you this, the M and A pipeline is evergreen. We're working a number of opportunities as we Which are related to and aligned with the strategic portfolio study that we've done. So we're very excited about those and we've been speaking to the Board about those opportunities through the summer and we'll continue to do so through this month because some They come sooner rather than later. But that's okay.

Speaker 3

Now in terms of the overall study, look, this management team believes that the path to the higher multiple and to the total shareholder return Performance is driving and increasing the underlying sales growth of the company. And we need to fall into this bucket of 4% to 6%. So as we look at our optionality Around the makeup the current makeup of the portfolio and the potential to invest in new areas, that's really what the study and the portfolio Study focused on and those are really where the engagements and debates with the Board will take place. But we're walking and chewing gum at the same time. We haven't stopped pursuing opportunities as a management team and as a Board simply because we haven't covered the details Of the study with the Board, but they're very much aware of it.

Speaker 9

Understood. Thank you. And then just thinking about the Investments, right. It would seem like you're certainly on a pretty good glide path to kind of hit or beat those 2023 targets. But It sounds like you are cautioning us a little bit that the investment spending and the bias to make sure there's growth kind of beyond 2023 Potentially tempers the upside of those targets.

Speaker 9

Is that kind of a correct perspective?

Speaker 3

No. Honestly, Glytap is generous. It does a lot of hard work to hit those targets, Jeff, by everyone engaged. And there are always obstacles in the way as we're experienced we have experienced this quarter with labor and materials as Ram and Frank described. That's a lot of hard work to get there and we're not taking our eye off the ball.

Speaker 3

Having said that, not only do we need to work Portfolio opportunities that I just mentioned with pluses and minuses, but we need to elevate the organic Investments and organic sales growth of the company. And with that, We have to make those investments for the future. So it's both. We have the capacity to do both. We have the opportunity to do both like many businesses, We're taking full advantage of that.

Speaker 9

Great. Thank you for that awesome color. I appreciate it.

Speaker 3

Thanks, Jeff.

Operator

The next question is from Nigel Coe with Wolfe Research. Please go ahead.

Speaker 10

Thanks. Good morning, everyone. Thanks for the question. So, Lal, we're getting close to fiscal 'twenty two. So I know you're going through the PAM process, but given that the funnel is building here and the activity levels in automation, I'm just curious, normally early phases of recovery, we see solid double digit growth in automation.

Speaker 10

Is there anything that's changing In terms of the profile of the frontlog or backlog or anything that suggests that that's not going to be the case this time, can we expect Double digit type growth in 'twenty two formation.

Speaker 3

Yes. So hi, Nigel. Great to hear your voice. A very thoughtful question actually. And if you go back through the last couple of growth cycles in automation, There was an important component which we have to watch very carefully in this sub cycle, which is the KOB1 element.

Speaker 3

We benefited from that in the 10 to 14 run. We surely benefited from that in the prior run-in 2018. But in this one, it's been subdued to date and that's going to be the differentiating. Now keep in mind that we Just underwent a significant investment in LNG that is being absorbed by the market. We have yet one big large project to go, but it's that that would be the I'd suggest the differentiator between the high single digits the double digit type of organic opportunity in Automation Solutions, if that makes sense to you.

Speaker 10

It absolutely does. Thanks for the color there. And then just coming on top of Jeff's question on portfolio and the October board pitch, I guess, you heard that loud and clear. But given the emphasis on diversification, is it fair to say that you're focusing here more on acquisitions as opposed to disposals? I know you've done a couple of smaller disposals, but in terms of material acquisitions of disposals?

Speaker 3

Yes. We announced The divestiture of the Daniel Oil and Gas Business. And what I'm going to tell you is it's both. We're looking at the portfolio both in terms of opportunities to acquire and opportunities to divest. It's a very fluid conversation.

Speaker 3

We went through it with an element of that with the Board yesterday and got their support. It's both because to solve Whether it's the equation around diversification from oil and gas and or elevate the underlying sales growth of this company, we're going to have to press both of those

Operator

The next Question is from Andy Kaplowitz with Citigroup. Please go ahead.

Speaker 11

Hey, good morning, guys.

Speaker 3

Good morning, Andy.

Operator

Well, can you

Speaker 11

talk about how you're thinking about the longevity of the commercial and residential solutions cycle at this point? Obviously, strength and interest has seemed relatively enduring. I I think you were worried a bit about residential comparisons toward the end of this year. So how are you thinking about during residential strength as you go into 'twenty two as well as the improvements You've continued to see in commercial construction, cold chain and tools.

Speaker 3

Great. So I will bifurcate that into The 3 the 2 pieces, the climate piece and the tools professional tools piece. Obviously, the professional tools has a different cycle, Partly some of it driven by the similar set of investments that we're The residential growth, the do it yourself investments, which impacts our home products Side of the tools. But the professional tools area, the rigid and the green lease, they will be driven by infrastructure spend, Capital cycles, not dissimilar to what we see in our mid cycle automation businesses. And so those I think have Sustained opportunity as we go well into 2022.

Speaker 3

On the the one we're watching very carefully As I look at climate is the air conditioning residential cycle. And we're watching those orders. We're staying very close to Our OEM customers, the trains and carriers of the world in terms of communicating, understanding their demand. But for now, I would expect a more subdued quarter as we go from an order perspective, As we go into the fall season, but we're watching it very carefully. But that would make sense in the cycle that it subdues and comes on.

Speaker 3

And we've seen in our trailing Already that commercial residential has turned and that's partly driven entirely driven by that residential AC business. Ram, do you have any

Speaker 1

more color to give?

Speaker 5

No, I would. Okay. I think that's spot on.

Speaker 11

Thanks for that guys. And then Lal, you've talked about being well into your cost out program, which has been focused on automation solutions, as you know, and Incremental margins continue to be strong there. I know you already talked about margin pressure in C and RS, but as we look at Automation Solutions margin going forward, Given your cost out programs should continue to drive margin tailwind, could you continue to generate average or better than average incremental margin for that business in 'twenty two and beyond?

Speaker 3

I think so, Andy. We printed 41% incrementals in that platform this quarter, And the team has begun their significant investments around their technology and people there. Their business is Structurally different than the business that I took on in 2018 today in the way it goes about and the way it manages and the way it approaches customers. So there's a lot of room there. The target I've given the business is obviously 30% incrementals.

Speaker 3

But as we ramp up investments I think we're likely to see higher than those types of numbers as we go forward.

Speaker 11

Appreciate it, Lal.

Speaker 3

Thanks, Andy. Thank you.

Speaker 1

I think our next question is from Scott Davis. Scott, are you there?

Speaker 12

I'm here, yes. Good morning, guys.

Speaker 3

Hey, Scott. Hey, Scott.

Speaker 12

Now I don't know if we messed up or whatever, but A couple of clarification issues just allow. When you think about kind of price cost in your backlog, Do you get to a parity number kind of a calendar 4Q? I'm just trying to think about how cadence is in Or if you still are kind of fighting that headwind well into the next fiscal year?

Speaker 3

Yes, it does It does bleed into the next fiscal. Ram described the next two quarters as being the most challenging, which is right. So that period, it really arrives in our first Fiscal excuse me, our 1st calendar of 2022. So our 2nd fiscal of 2022.

Speaker 12

Okay. Sorry if you said it before. I just didn't hear it. No,

Speaker 3

it's okay.

Speaker 12

And then again to clarify on the cost reduction actions and You just had a big board review. Is that largely complete or there and can you I guess, do you need to start going in the other direction, I suppose, which I think Andrew asked that question about adding CapEx as such, but do you need to actually start spending more money just given the size of the backlog overall?

Speaker 3

No, I think Ram answered that well. I think we're looking at Optionality around capacity increases in the existing footprint and in the footprint That we have initiated as part of the cost reset plan. We have operations in construction of significant size in India, In Mexico and in Eastern Europe, and all those are underway. Some will begin production later this year, others in early 2022. So we feel really good.

Speaker 3

The challenge for us, Scott, which is not thematically honestly and not dissimilar from anyone out there is the labor availability in the United States. And to me, that's the biggest single constraint and what we're fighting on a daily basis across most of our facilities.

Speaker 12

Yes, that makes sense. Thank you for the clarification. Good luck, Lyle and team.

Speaker 3

Thanks, Scott, and good evening, your voice.

Operator

The next question is from Steve Tusa with JPMorgan JP Morgan, sorry. Please go ahead.

Speaker 3

Steve, you got a new name and a new company.

Speaker 1

Looks like we may have lost Steve, so we can move on to the next call. Next question? Looks like our next question is from Deane Dray. Deane, are you with us? Yes, I am.

Speaker 13

I missed that whole introduction too. So that's the reason for the delay. Sorry about that. Good morning. So Page 16, the whole 3 month underlying orders.

Speaker 13

Can you give us some color on July because it looks like Automation Solutions is pivoting And just any kind of color on July would be helpful there.

Speaker 3

I don't have a number To share with you, Dean, but I will tell you, I think that excuse me, somebody came on the line here. That is a fair assumption. We continue to see increased momentum in Automation Solutions. Obviously, we're watching Parts of the world carefully, particularly Southeast Asia and India. But in our large significant markets, Europe, North America In China, we continue to see good order momentum, driven by KOB 2 and KOB 3.

Speaker 13

Got it. And then second question has been really good color on the call here, Especially in the portion from Ram on the focus on the cost inputs, labor, commodities, But not as much focus on price realization. Can you give us for the 2 segments more color on pricing? And I know one of the headwinds on commercial and Resolute Solutions on like Copeland is locked into longer term contracts. So Just price realization color would be helpful here.

Speaker 5

Yes. So first off, I'll answer the question with As it relates to automation, automation has been green on price cost and has been very, very disciplined in getting price this year and That dynamic will continue into next year. So we see no issues as it relates to price or price cost on the automation side of the business. And On the commercial and residential side, particularly in the climate business, the price realization, which is a function of our long term OEM contracts, We'll start unlocking in the January timeframe of significance. Now we do have pricing that will go into effect in October, But the big impact we will start to see in the Q2 of fiscal 'twenty two, which in turn, Assuming the commodities start softening, we'll turn them into the green category into the Q2 of next year.

Speaker 5

So that's how we see it. A lot rides on our contracts which open up in the Jan timeframe.

Speaker 13

Got it. So you said Q2 fiscal next year, but in answering your earlier question, it sounded like you would be at parity in the 1st fiscal

Speaker 3

I missed it. I corrected myself there, Dina, and I did say second. It's second. 1st calendar.

Speaker 13

Good. Thank you.

Speaker 1

Yes, sir.

Operator

The next question is from Steve Toza with JPMorgan. Please go ahead.

Speaker 14

Good morning. Can you hear me now?

Speaker 3

Yes. Yes.

Speaker 14

Sorry, you guys usually have the call in the afternoon, so I sleep in these days. So I was just I fell asleep there for a second during the Q and A. Just to clarify some of this price cost up, what was price cost in the quarter and then What has it been? Just remind us of what that's been year to date?

Speaker 5

So Frank, you got that for?

Speaker 4

Yes, I mean price cost in the Quarter total enterprise, Steve, this is Frank, is roughly about negative 50. So we were positive in the first half. We'll see that intensify in the 4th and the first quarter as both Ram and Lal have said, and we're going to have to work through that Right through the Q2 of next fiscal year, but it was order of magnitude around $50,000,000 in the 3rd.

Speaker 14

Negative. Negative.

Speaker 3

Negative. Negative. All of it. All of it is

Speaker 4

commercial residential.

Speaker 14

Right. So you're like absorbing a pretty decent amount this quarter already in your ops?

Speaker 3

Yes, sir.

Speaker 7

Okay.

Speaker 14

Just trying to make that clear. Lal, just on the go forward incremental margins, I mean,

Speaker 3

You kind

Speaker 14

of throw out we need to invest. I mean every company needs to invest. Nobody under invests. I mean some companies do, but it doesn't seem like that way for you guys over time. What is kind of the normal incremental margin on that mid single digit growth rate that you can expect out of this business model over the next you know that you would expect and you would be comfortable with over the intermediate term?

Speaker 3

Yes. Steve, I continue to assert that 30% number as we go through the long term. You'll see that's flux up and down, but that's the target. And as we executed the cost reset plan, that's the How we frame that with the businesses. There'll be quarters as we saw with automation where we'll print higher than 40 and there'll be quarters as we sell with commercial residential that will More than 30.

Speaker 3

So it will flux, but 30 is the way I'm thinking about it.

Speaker 14

Got it. And then just one last It's a nitpicky one. Stock comp is obviously up massively this year. I know that there's historically like every few years there's like a I don't know if that's where the reset is or if it's somewhere else maybe in corporate. Is 235 kind of a run rate number for stock Going forward or does that the prior 2 years were in the low 100s, is that does that reset lower?

Speaker 4

Steve, definitely not. As you know, it's mark to market driven. It's driven almost entirely as a function of the change in the stock price. We had The dip in the stock price last year related to COVID. We've had good stock price performance this year and a big delta year over year.

Speaker 4

But no, That is not a run rate that should be expected, the 2.50 range. It's more like a 150 to 170 number give or take

Speaker 14

Okay. Got it. So tailwind. And then, sorry, one last one. The orders conversion, I know there was an earlier question about mid single digit growth in the 4th quarter.

Speaker 14

I mean, you're coming off of a 17% orders comp and I know that orders don't completely equal Revenue in the immediate term, but I mean with that kind of orders projection and with you guys talking about Turnarounds being good in the fall, I mean, why would organic growth slow in Automation Solutions? It's a tougher comp, but it's only a couple of 100 basis points, Whereas the orders are just obviously inflected. So I mean, why would that go from 8% to like 5% at the midpoint of that guidance? Is there something about timing or is that just conservatism around COVID or whatever?

Speaker 3

Well, less so COVID, more so the availability of materials, particularly electronics, Steve, that are A challenge in that business and I think as we guided Automation Solutions within that band, I think it's There's momentum on the order side. The question is, can we convert in the plants? And it is a hand to hand combat. I can't emphasize that enough In terms of material arriving and our ability to have the labor to convert it. And it's and that is what keeps me A little bit more guarded in terms of the order to sale conversion in the Q4.

Speaker 14

Right. And that's kind of like a couple of $100,000,000 difference, You think in kind of your ability to fulfill?

Speaker 3

Yes. Well, I don't know. I really don't know what it is. It's probably around the $75,000,000 to $100,000,000 range.

Speaker 14

Yes. Okay. Still doesn't quite bridge the gap, but that's helpful. All right. Thanks, guys.

Speaker 14

Appreciate it.

Speaker 5

Okay. Thank you.

Operator

The next question is from Gautam Khanna with Cowen. Please go ahead.

Speaker 3

Hi, Gautam.

Speaker 4

Thank you. Appreciate the questions. I had

Speaker 15

a couple. First, just Fiscal 'twenty two, based on your comments on the project funnel at Autosol, are you thinking that the KOB 3 mix Stays pretty similar to what it was in fiscal 2021 as a percentage of sales? And what is that?

Speaker 3

Yes. So the funnel I think the funnel has shown resiliency as we've gone through the last 6 months So staying at that fixed level, the makeup of it obviously is different, smaller projects, different types of projects That we've seen in our from our customer base. Having said that, it's all about the movement from right to left, the ability to convert The projects to be funded and then to be actioned. And that's what we've got to watch and could be a differentiating element as we Heading to 2022 for Automation Solutions. I have a high degree of confidence, Gautam, that the transmission distribution funnel moves forward aggressively, That the renewables are sustainable, decarbonization part of the funnel moves forward successfully, that the conversions, the biofuels, the green fuel investments, the propylene plastic renewables that Colleen described Move forward aggressively.

Speaker 3

What I've got to watch very carefully is the larger, particularly LNG jobs that the one big remaining one, the J. Rice:] No fuel expenditure, how does that move and how do those folks think about the funding of that and as it moves forward. But that will be differentiating into 2022.

Speaker 5

And Gautam, if you were asking about the KOB 3 mix in addition to the funnel, it's in the high 50s and we expect to operate At that range for the next several quarters, probably into the low 60s into 2022.

Speaker 15

Okay. That's very helpful. And as a follow-up to one of the earlier questions at C and R RAS in aggregate next year, do you think the business grows Organically, just given kind of the outsized strength that we've seen this fiscal?

Speaker 3

I believe so, Gautam. And what we are going to and you've seen in the numbers today is that the backlog situation Across the businesses at $1,100,000,000 And that's what that's the impetus to drive the organic growth Despite what happens in the residential AC cycle, and that will support the organic growth In the business for 'twenty two.

Speaker 5

In the longevity of our commercial businesses as well.

Speaker 15

Okay. Last question, just your comments on M and A and portfolio.

Speaker 4

Any change to how much we should earmark For M

Speaker 15

and A in our models over the next couple of years

Speaker 3

to come out with guidance as we think about things. Obviously, as I mentioned earlier, Gautam, we are our funnel is very fluid right now and there's a number of activities underway. And so but we'll give you some kind of guidance as we go into and as we come out in November.

Speaker 15

Said differently, are there any large properties bigger than OSI that you guys are looking at? Thank you.

Speaker 3

Yes, I will yes, there's a range. I would suggest that we're looking more in the larger than we are in the bolt ons right now, Gautam.

Speaker 4

Okay. Thank you very much. I appreciate it.

Operator

Our final questioner today is John Walsh with Credit Suisse. Please go ahead.

Speaker 16

Hi, good morning and thanks for taking the questions.

Speaker 5

Hi, John. Hey, John. Hey, John.

Speaker 16

A lot of ground covered, but maybe thinking about OSI Power and your customers there, I mean, we picked up that there's some activity in Spain and a couple of states in the U. S. Are you seeing the customers waiting for more clarity around stimulus before they're going ahead With projects or is there just enough demand there given where renewables sit in the grid that they're moving forward these projects and There's no kind of delay caused by who's going to pay for it?

Speaker 3

No, I think it's the latter, absolutely. Aging infrastructure, advent of renewables onto the grid that are causing all kinds of challenges. There are just Strong underlying drivers that I think overwhelm the need for stimulus spend there. So infrastructure bill, In particularly in the United States, we'll help, no doubt about it and we'll benefit, but there's incredibly strong underlying demand as is in the traditional utilities, particularly in Western Europe and North America.

Speaker 16

Great. And then maybe just circling back to an earlier question around kind of supply chain and backlog. Did you grow backlog your sequential backlog growth, was that kind of Demand driven or do you think there was some supply chain stuff that you wouldn't have been able to ship and that's why you were able to grow Backlog, just trying to understand if there's some delayed sales or deferred sales there because of supply chain?

Speaker 5

I think the answer is both. Certainly on many parts of the Automation Solutions business and some in ComRes, the demand side was very strong. And On both platforms, we were not able to fully execute elements of the backlog given the constraints in labor primarily on Commercial side and electronic supply on the automation side. So the backlog growth was driven by both fronts, supply and demand.

Speaker 16

Great. Thanks for taking the questions.

Speaker 1

Excellent, John. Thank you. Thank you.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Lal Carsonby for any closing remarks.

Speaker 3

Well, thank you very much. Thank you, everyone, for your time and confidence in us. We're excited about the quarter ahead, And I look forward to seeing many of you as we go through the next 3 months. And until our next call, stay healthy and safe and stay well. Thank you.

Operator

The conference has now concluded. You may thank you for attending today's presentation. You may now disconnect.

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