艾默生電氣 (EMR) 2021 Q4 法說會逐字稿

Good day and welcome to the Emerson Fourth Quarter 2021 Earnings Conference Call. (Operator Instructions)

Please note today's event is being recorded.

I would like to turn the conference over to Colleen Mettler. Please go ahead.

Thank you. Good morning and thank you for joining Emerson's Fourth Quarter and Fiscal Year-End Earnings Conference Call. Today, I am joined by President and Chief Executive Officer Lal Karsanbhai, Chief Financial Officer Frank Dellaquila and Chief Operating Officer Ram Krishan. I encourage everyone to follow along with the slide presentation, which is available on our website.

Please join me on Slide 2. As always, this presentation may include forward-looking statements, which contain a degree of business risk and uncertainty. Please take time to read the safe harbor statement and note on non-GAAP measures.

As I turn to Slide 3, I would like to highlight 2 areas where Emerson is making a difference. First, Mike Train, our Chief Sustainability Officer, will be attending this year's United Nations Climate Change Conference, COP26, in Glasgow. Mike will be a panelist at the adjacent Sustainable Innovation Forum, participating in 2 notable discussions. The first discussion will be how to support small to medium enterprises to adopt net zero pathways; and the second, on supporting breakthrough innovation to green, hard-to-abate sectors. Mike has worked this year to drive many greening of, by and with Emerson initiatives.

One notable greening -- green by example is in the recent announcement between BayoTech and Emerson to accelerate production of (sic) [and] distribution of low-cost, low-carbon hydrogen. In the agreement, Emerson will deliver advanced automation technology, software and products in support of BayoTech building hundreds of fully autonomous hydrogen units to enable hydrogen fuel cell commercial trucking fleet and abatement projects in steel and cement.

Another exciting initiative is our $100 million commitment to corporate venture capital, Emerson Ventures, designed to accelerate innovation by providing insight into cutting-edge technologies that have the potential to solve real customer challenges. The investment commitment will advance the development of disruptive, discrete automation solutions, environmentally sustainable technologies and industrial software in key industries. A formal announcement and more information will be seen in tomorrow's press release.

Finally, our investor conference historically has been in February. However, due to the recent announcement with AspenTech, we have decided to move our investor conference to May. It will be located at the New York Stock Exchange on May 17, 2022.

I'd like to now turn the presentation over to Emerson's President and CEO, Lal Karsanbhai, for his opening comments.

Thank you, Colleen, and good morning, everyone.

2021 was a phenomenal year for Emerson. It developed very differently, obviously, than we planned a year ago. For one, I was named CEO and brought a new value-creation agenda to the table. But equally important, we operated in an environment which was both rewarding and challenging for the organization.

Through it all, our teams around the world did a fabulous job. I want to express my sincere gratitude to all the Emerson employees around the world. Thank you. I would also like to thank Emerson's Board of Directors and our shareholders for your support and confidence in the management team.

2021 was characterized by strong demand in our residential air conditioning business as well as our hybrid and discrete markets in automation. Furthermore, we have experienced a recovery in process automation markets. The automation KOB 3 mix for 2021 was up 2 points to 59%. And Emerson's September 3-month trailing orders were plus 16%.

We grew 5.3% underlying and leverage at 38% operationally, inclusive of a $140 million swing in our price/cost assumptions from November through to the end of the fiscal year. The earnings quality of this company continues to be excellent with free cash flow conversion of 129%.

The fourth quarter, however, was challenged significantly by supply chain, logistics and labor challenges. And that is not dissimilar from anything you've heard before. This was experienced in the form of material cost inflation, notably steel, electronics and resins, and lead time extensions. In addition, we experienced logistics challenges in availability of lanes and costs. And lastly, U.S. manufacturing labor, which was characterized by higher turnover rates, absenteeism and overtime costs.

In the quarter, we missed sales by $175 million. And alongside a challenging price/cost environment in our climate business, it resulted in a negative $0.14 impact to EPS for the quarter and a $0.19 impact to 2021 EPS. Having said that, the company grew 7% in the fourth quarter and had 19% operating leverage.

Turning to '22 and some initial thoughts.

The first half of the year will not look dissimilar from the fourth quarter with slight sequential improvement as we go to Q2. Price/cost and supply chain challenges unwind in the second half of the year against the backdrop of continued strong demand. The price/cost assumption in the year will be a positive $100 million for 2022.

I'm very optimistic for 2022. The operating environment has unpredictability, but it is significantly more stable than a year ago and demand is much stronger. The residential A/C cycle will moderate as we go through 2022. However, we expect automation markets to continue to strengthen driven by digital transformation and modernizations, replacement in MRO markets and select LNG and sustainability-driven KOB 1, most notably methane emissions reduction projects and carbon capture. I have confidence that we will deliver 30% incrementals on our underlying sales in 2022. This addresses execution, and as you know, that's one of the 3 pillars we identified as a management team for accelerated value creation.

We have equally taken significant steps in our journey to modernize our culture and advance ESG initiatives. The Board named Jim Turley as the company's Independent Chair of the Board, we named Mike Train as the company's first Chief Sustainability Officer, and we hired Elizabeth Adefioye as Emerson's first Chief People Officer.

I'm very proud of the diversity targets we set for the enterprise, the changes to our long-term compensation and annual bonus structure to include ESG measures and the commitments we have made to accelerate greenhouse gas intensity reductions.

Lastly, turning to the portfolio. Please turn to Slide 4.

We recently concluded a comprehensive portfolio review, which culminated in a 2-day session with our Board of Directors in early October. We left the meeting with a defined portfolio road map and pathways. The key elements were as follows.

Firstly, in terms of the portfolio today and how we are thinking about it. Diversification is critical. We will continue to divest upstream oil and gas hardware assets. Secondly, we will action low-growth or commoditized businesses. And lastly, we will action disconnected assets. All 3 of these actions will take place over time with intentionality, with patience and a keen awareness of cycles and meeting the value-creation proposition to our shareholders.

Secondly, we identified 4 large, profitable, high-growth end markets, each with at least $20 billion of size and projected to grow higher than 4% a year into the future supported by macros. The 4 end markets will be the hunting ground for our M&A activity.

Lastly, we defined 2 possible end states for the portfolio and the journey that we'll embark up and have embarked on.

One of the 4 markets is industrial software, a $60 billion segment that we identified growing at 9%. The AspenTech transaction is an exciting step for Emerson and a very important transformational step for this corporation. AspenTech is one of the best-run industrial software companies in the space with highly differentiated technology and a phenomenal leadership team led by Antonio Pietri for who I have the greatest personal admiration.

The AspenTech company will be a highly diversified business with transmission and distribution as its largest served market and is uniquely positioned to enable our energy customers to transition to a lower-carbon future. I'm optimistic of the synergy opportunities that exist and believe the new AspenTech, which will be 55% owned by Emerson shareholders, will be a differentiated platform for future industrial software M&A. I'm very excited about this, as I hope you can tell. We expect to close the transaction in the second quarter of 2022 following the completion and approval of the customary regulatory items.

With that, I will now turn the call over to Frank Dellaquila, Emerson's Chief Financial Officer.

Thank you, Lal, and good morning, everyone. Please turn to Slide 6, if you would.

So we're really pleased with the financial results for fiscal 2021. As Lal said, we ended the year with a great deal of uncertainty and far exceeded the expectations we had at the beginning of the year.

The underlying demand environment developed much as we thought it would. There was continued strength in global discrete and hybrid automation markets, and the North America process markets began to gain momentum later in the year. The global demand in our commercial/residential markets was strong and broad based, particularly in the U.S. residential air conditioning market, and it far exceeded the expectations that we had going into the year.

Our operations team successfully worked through labor and supply chain issues, particularly toward the end of the year, and delivered strong results that we're able to report to you today. Toward the end of the year, the intensifying combination of rising material costs, supply chain challenges and labor constraints in the U.S. did begin to weigh on sales volume and profitability. We've worked through that in the fourth quarter. We will continue to work through that in the first half of fiscal '22.

Despite these fourth quarter challenges, we're pleased to report that we achieved the key financial targets that we committed to you in August regarding underlying growth, adjusted EBIT margin, adjusted earnings per share and cash flow, and you can see all of that in the table. This was achieved in the face of an unexpected increase in key raw materials, mainly steel and copper, that resulted in an unfavorable price/cost swing of $140 million during the year versus the expectation and the guidance that we gave you a year ago. We're very grateful for the extraordinary effort of our operations teams at every level and the manufacturing employees who made this happen under some of the most challenging conditions that we have seen.

Please turn to Slide 7. This slide highlights our strong 2021 results.

The continued recovery in our end markets drove strong full year underlying growth of more than 5%. Net sales were up 9% year-over-year, including a 1 point impact from acquisitions, mainly OSI, which closed at the beginning of the fiscal year.

Adjusted segment EBIT benefited from strong leverage in operations, 38%, as Lal just mentioned, and adjusted EBIT from underlying volume and the benefit of cost reset actions that were begun 2 years ago.

These cost reductions more than offset price/cost headwinds, which, as I said, were $140 million versus our expectation at the beginning of the year, and the supplies chain challenges that raised costs and reduced availability.

Cash flow was robust, up 18% year-over-year attributable to the strong earnings growth and working capital efficiency. Free cash flow conversion of net earnings was 129%.

Adjusted earnings per share was $4.10, exceeding our guide by $0.03 at the midpoint and up 19% for the year. Automation Solutions grew -- underlying growth was flat year-over-year. Growth turned positive in the second half driven by strong discrete and hybrid markets, while the later-cycle process automation markets delivered sequential improvement as we moved through the year.

Adjusted EBIT increased 230 basis points due to the strong leverage driven by cost reset benefits. Commercial & Residential saw exceptional growth, up 6% underlying year-over-year due to broad strength across the residential and commercial markets with mid-teens growth in all world areas.

Adjusted EBIT increased 20 basis points versus prior year. Price/cost headwinds worsened in the second half, particularly in the fourth quarter, as we anticipated on the call in August, but were offset for the full year by strong underlying leverage and spending restraints.

Please turn to Slide 8.

Operational performance was strong throughout the year, adding $0.59 to adjusted EPS, overcoming a $0.19 headwind from supply chain and $90 million of unfavorable price/cost. Operations leveraged at more than 35% on volume and cost actions. Nonoperating items contributed $0.02 in that, overcoming a significant headwind from the stock comp mark-to-market accounting. Share repurchase totaled $500 million, as we guided, and added about $0.03. In total, adjusted EPS was $4.10, as I said, an increase of 19%.

Please turn to Slide 9.

Regarding the fourth quarter, strong end market demand drove underlying growth of 7% with net sales up 9%. This growth was achieved despite a $175 million impact from supply chain, logistics and labor constraints that affected both platforms in somewhat different ways.

Adjusted segment EBIT dropped 10 basis points, reflecting a 200 basis point impact from supply chain volume constraints across the company and from the increasingly negative price/cost headwind in commercial/residential.

Free cash flow declined 39% mainly due to higher working capital to support the growth versus the prior year.

Adjusted earnings per share was $1.21, exceeding the guidance midpoint by $0.03 and up 10% and versus the prior year.

Automation Solutions underlying sales were up 3% with strong recovery in the Americas, particularly in the power generation and chemical markets, partially offset by declines in other world areas. Sales were reduced by about $125 million or 4 points due to supply chain constraints. Our backlog was up 16% year-to-date and now sits at $5.4 billion, $100 million less than at the end of the third quarter. Typically, our backlog would reduce more in Q4. However, due to strong orders and supply chain constraints, backlog remains elevated above the levels we would otherwise have expected. Strong leverage and cost reductions drove a 170 basis point improvement in adjusted EBIT.

Commercial & Residential underlying sales increased 13% and driven by continued strength in North America residential HVAC and home products as well as heat pump demand in Europe. Sales were reduced by about $50 million or 3 points due to supply chain constraints, which, together with sharply increasing material cost headwinds, which were expected, perhaps a little worse than we expected in August but are expected, drove a 340 basis points decline in adjusted EBIT.

With that, I'm going to turn it over to Ram to provide color around the price/cost and some of the other operational issues that we're dealing with.

Thank you, Frank. Please turn to Slide 10.

Clearly, as you can see, the operating environment is a challenge as commodity inflation, electronic supply, logistics constraints and labor availability continues to impact our global operations. Net material inflation headwinds accelerated through fiscal 2021, as you can see on the chart, primarily driven by steel prices, with majority of the impact being felt by our Climate Technologies business.

North American cold-rolled steel pricing increased once again in October, extending the streak of monthly price increases to 14 months. However, the magnitude of the increases have declined in recent months, and more importantly, hot-rolled steel prices dropped around $20 a ton in October, a positive sign for us. We do anticipate steel prices to start to flatten out over the next few months and net material inflation to peak in the first half of fiscal '22.

We continue to stay focused and diligent on our pricing plans by executing on our contractual material pass-through agreements, surcharges for freight and more aggressive annual general price increases. We remain confident that price/cost will turn green and will be a strong positive for the second half of fiscal '22. Our current plans indicate that price/cost will be approximately a $100 million tailwind for the fiscal year.

Turning to the next slide. On the commodity front, while steel prices are at elevated levels today, as I mentioned earlier, they are showing some signs of flattening, providing optimism that we will see North American cold-rolled steel prices start to decline in the coming months. Plastic resin prices have remained elevated due to high price, inelastic demand and weather-related supply challenges. Copper prices have also surged as of late, but our hedge positions will dampen the impact to the fiscal year.

Now while COVID-related restrictions are improving in Southeast Asia, capacity at key electronic suppliers remains constrained. Several key component suppliers have extended lead times and pushed out delivery forecasts, which has increased shortages and decommits to our EMS suppliers. Furthermore, we are closely watching the impact of industrial power outages in China, which have become a common occurrence at manufacturers and has led to an increase in silicon prices. For us, electronic shortages are impacting multiple business units in both platforms, and supply is expected to remain a challenge into fiscal '22.

Extended logistics lead times, particularly on ocean freight, has had an impact on our global operations, port congestion in the U.S., weather and COVID-related disruptions in China being the key drivers. These dynamics are highlighting how critical regionalization is even on lower-variation parts and components, and the work we have done over the past many years to regionalize are clearly proving the importance of this strategy. This is exemplified by several of our businesses with strong regional supply bases which have performed very well and avoided expensive airfreight and significant expediting costs.

Finally, hiring and retention challenges continue in many of our U.S. plants, predominantly in the Midwest, as competition for available labor is intense. High levels of turnover and absenteeism in these locations have impacted productivity and driven increased overtime.

Now on Slide 12, despite the unprecedented challenges, our supply chain and operations teams have worked tirelessly to continue to meet the needs of our global customers. Many creative solutions are being implemented on a real-time basis to ensure continuity of materials supply to our global plants and availability of freight lines to make our shipment commitments. Our teams have leveraged strong supplier relationships, utilized prequalified alternate sources, leveraged contractual agreements and stepped in to assist our suppliers where needed.

Our regional manufacturing footprint and the enhanced resiliency of our supply network through multi-sourcing that we spent years developing has certainly been an advantage for us in these challenging times. Accelerated actions around hiring and production shifts to plants with stable workforces has ensured we continue to meet our customers' needs. Many of our global plants are producing at record levels as our disciplined investments in factory automation have allowed us to unlock additional capacity to combat labor availability challenges.

Finally, I want to take this opportunity to sincerely thank our global teams for delivering an outstanding operational year.

With that, I'll turn it over to Lal to walk through our fiscal '22 outlook.

Thanks, Ram. Let's please turn to Slide 14, and I'll give the team some color on the current environment.

And looking forward to 2022, demand continues to be strong across both of the platforms. The trailing 3-month orders for Automation Solutions were up 20% versus the prior year driven, as I said prior, by continued automation investments in discrete and hybrid markets, and we believe that will continue into '22, and, of course, the strengthening of the process automation spend. While KOB 2 and KOB 3 drove most of the orders growth in 2021, the new infrastructure bookings for LNG and decarbonization will improve, I believe, through 2022, providing further upside.

Increased site access will drive increased walkdown and shutdown turnaround activity in the business. To give you perspective, 2021 walkdowns were up 50% year-over-year with more than 5,000 globally, with each walkdown driving substantial KOB 3 pull-through.

Shutdown turnaround bookings were up -- for -- in '21 10% year-over-year driven by strong spring season that extended into the early summer. 2022 shutdown turnaround outage activity spend is expected to be up mid-single digits, led by chemicals and refining, leading to high single-digit bookings growth.

Turning to Commercial & Residential Solutions. The U.S. and Europe order rates continue to be strong heading into 2022, while Asia has begun to moderate. Overall, the trailing 3-month orders were 9% in September. And thinking a little bit further into 2022, many of our key climate technologies end markets will continue to have momentum, including aftermarket refrigeration, commercial HVAC, food retail and foodservice driven by new store builds and quick service restaurants and residential heat pumps.

Turning to Slide 15.

Looking ahead to 2022, it will be a year characterized by strong underlying demand and an improving operating environment. The late-cycle process automation business will continue its recovery with mid-single-digit annual growth. Meanwhile, discrete and hybrid momentum will endure with high single-digit and mid-single-digit growth, respectively. Growth will moderate in residential markets as demand stabilizes, but improving commercial and industrial environments will benefit Commercial & Residential Solutions. Decarbonization and sustainability projects, as noted earlier, will provide further growth opportunities as budgets get allocated towards these projects.

Based on this macro landscape, we believe -- we continue to expect demand to be strong in 2022. Supply chain and price/cost headwinds continue through the first half, pressuring first quarter leverage but turn to significant tailwinds in the second half and end positive in the year.

The team has done a significant amount of work progressing our restructuring programs. Emerson's 2021 adjusted EBITDA of 23.1% surpassed our previous record. Over 90% of our restructuring spend communicated in our investor conference is complete, and over 70% of the savings have been realized with remaining longer-term facility projects left to be completed. Great work as a team.

Let's turn to Slide 16 and talk about guidance.

So given this landscape, we expect underlying sales growth of 6% to 8% in 2022 and net sales growth of 4% to 6%. Underlying sales growth for Automation Solutions will be 6% to 8%, while Commercial & Residential Solutions will be 6% to 9%. As Ram discussed, we expect price/cost to turn into tailwind for the year of approximately $100 million.

$150 million of restructuring activities includes the minimal remaining spend on our cost reset program and additional programs, including footprint activities, that have been identified and are planned in the fiscal year. Historically, our adjusted EPS excludes restructuring and other items like first year purchasing accounting in the calculation.

Looking at the 2021 column of the bridge to the right, our prior adjusted EPS of $4.10 increases to $4.51 when removing the impact of intangibles amortization expense of $0.41. For 2022, the amortization expense is expected to be approximately $0.42 driven by -- driving, excuse me, our adjusted EPS to between $4.82 and $4.97. Additional details on the calculation are provided in the appendix as well as accounting tables in the press release.

Please note that all guidance does not include the impact of the AspenTech transaction, which is expected to close, as I said earlier, in the second quarter of calendar year 2022.

Turning to Slide 17.

We expect a first quarter 2022 underlying sales growth of 7% to 9% with broad underlying strength across Automation Solutions and Commercial & Residential Solutions. Automation Solutions will experience underlying sales growth in the mid to high single digits, while Commercial & Residential Solutions underlying sales growth will be in the high single digits to low double-digit range.

Adjusted EPS is expected to be between $0.98 and $1.02. Amortization for the quarter is expected to be roughly $0.10.

And with that, I'll turn the call back over to Colleen Mettler. Thank you.

Thank you, Lal. We will now turn the call to the operator to start the Q&A portion of our call.

(Operator Instructions) Your first question is from Andy Kaplowitz with Citi Group.

Lal, maybe you could give us a little more color into how you're thinking orders play out in FY '22. Obviously, a nice recovery has continued in Automation Solutions, but you mentioned that you think KOB 1 bookings could come in LNG and decarb. So when do you see those types of projects hitting? And could they help maintain bookings growth at current levels as comps begin to get more difficult over the next few months? And then in C&RS, it's held up, obviously, very well despite Asia moderating a bit. So maybe more color into what you expect there.

No, I think the environment -- I'll start, Andy, with automation. The strength -- I see the strength in the process automation business to continue throughout the year. Very honestly, we're in an environment where $100 oil is not uncertain right now, and we're seeing some restraints in the U.S. shale and discipline at OPEC and things of that sort. That's going to free up significant capacity, particularly at NOCs and some of the larger integrated companies, to move forward on a lot of the programs that will drive the decarbonization initiatives. We've seen that already with many flaring type of projects in the United States, and we'll continue to see that with carbon capture and others accelerating. So I'm highly optimistic about that.

On the LNG side, there are 2 significant programs that we're pursuing which will be awarded likely, Andy, towards the second half of the year. One is the Baltic LNG investment and, of course, the Qatar North Field expansion being the 2 largest. Those are very significant in terms of capacity additions and investment in automation for us. So both in pursuit.

Turning to commercial/residential. Yes, I see the residential air conditioning market moderating as we go through the year, and -- but with -- upheld by the commercial strength in the marketplace, which obviously for us is very relevant. So I do see a bit of a mix -- more of a mixed bag in the commercial and residential business driven by that moderation in residential AC.

Well, that's helpful. And then obviously, one of the main concerns that we've heard from investors post the announcement of your deal is that Emerson, instead of diversifying, actually doubled down on oil and gas. So I'm sure you anticipated that concern. So maybe you could address it head on, Lal. Ultimately, I know you think industrial software is a different market. You just said that in your prepared remarks. But is the view that you believe AspenTech gives you the best chance also of hitting or exceeding those long-term guides you gave us earlier in the year?

I do. I obviously think that the solutions that AspenTech brings to the table are incredibly broad in terms of particularly the sustainability journey. And what we're seeing is that the importance of the software, particularly in terms of design and the optimization of assets, will be incredibly relevant as these customers embark on the new projects. And so I regard the energy position as important, but I regard it more importantly from the transition and the share of wallet spend that they'll -- that will be undertaken in the Energy segment.

Having said that, the platform for investment and diversification, which has been a core component of the Aspen Board for a long time, will continue to be important here as we go forward. And the opportunity, whether it's for M&A and for growth in [TOD] and other segments, is a core part of the synergy value.

The next question is from John Walsh with Crédit Suisse.

Just wanted to talk a little bit more about kind of the margin bridge here through the year. I think in your prepared remarks, you remain confident in the 30% underlying leverage. The guide for Q1 implies we're certainly starting, I think, below that. Is it all just price/cost timing driven? Or is there something else there that we should be aware of for our models about the Q1 margin performance?

Yes, this is Frank. Yes, it is primarily price/cost driven. We will be below the 30% assumption for the first half of the year. And then as the price rolls through, which we have firm plans for that to happen, the margins will -- the leverage will increase as we go through the year. So that's how we will get there. But we're very confident that we will, in fact, get there.

Obviously, Automation Solutions, the leverage is good as we go throughout the year. And then it's in commercial residential where we have the ramp as the price/cost normalizes and then turns positive in the second half of the year.

Great. And then maybe a question, Lal, around -- earlier in the call, you talked about still some portfolio pruning around some of the upstream oil and gas assets, disconnected assets within the portfolio. Could you size that for us? Just kind of what is the revenue size that you're talking about for that bucket?

No. John, I'm not going to do that. But I'll tell you that the activities on the divestitures will be done over time. As I have noted earlier, they'll be done very carefully, at times timed with incoming assets as well. Obviously, we have a large impending transaction on the horizon here. So that's what I'll tell you.

I do -- I am a firm believer that share of wallet in the Energy segment will continue to move to the 0s and 1 and away from a hardware structure. And hence, we are going to continue to drive down that path. But in terms of sizing that entire bucket for you, I apologize, John, I'm not going to do that.

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

So one question we got in particularly looking at the results from one of your peers yesterday in Auto Sol, how do you guys reconcile 20% year-over-year orders growth, 16% year-over-year backlog growth and then 6% to 8% FY '22 organic revenue guidance? What's incorporated into the FY '22 revenue guidance? I know you gave us some color but just the disconnect.

Obviously, as we finished the -- as we went into September and into the first quarter, we have some comps that are still favorable in the business. So that's one element of it. And then I think normalizing as we go into what will be, I think, still a very strong environment and how I felt it was important for us to guide in that business, Andrew. I think that the opportunities across the 3 served segments of the market are very strong. I think the underlying demand is very strong. But in terms of guiding with certain -- some uncertainties remaining in the supply chain environment, I want to be somewhat cautious as well. But having said that, the demand picture is very optimistic.

No, makes perfect sense. Another question we sort of get a lot of big debate with investors, just sort of sense of inventories in the channel and your customers, right? Because one big theme this earnings season is a lot of companies bringing up -- even companies with very short cycle businesses bringing up these very strong backlogs even for companies that don't have backlogs usually. And I think investors are just worried that this may not end well sometime midyear next year. What's your sense of inventories in the channel and your customers? How do you think that plays out throughout your fiscal '22 or calendar '22, however you want to discuss, because your team has seen many a cycle and this one seems to be a little bit different that way?

Yes. And I'll start. I'll turn it to Ram for a couple of comments as well.

Look, on the automation side, I really don't see that as a concern. Most of the -- a high part of the business, obviously, 59% in the year, was booked shipped KOB 3, and it went directly into -- not into inventories but into predominantly application -- end user application. As you turn into the climate business, Ram, perhaps a few comments from you.

Yes, I would say across both our OEMs and in the wholesale community, Andrew, I would say inventories are slightly elevated to where they would be in normal times as people anticipate supply chain challenges and have been bringing in more material. With that said, I think the inventory is getting out into the end customer base through the wholesale channel and through our OEMs. So I would say it's not a big issue per se. And it may be at these slight elevated levels, but it's not something that is unreasonable or unseasonal.

The next question is from Tommy Moll with Stephens.

I wanted to start on your outlook for Automation Solutions. I think you called for 6% to 8% underlying in the 2022 outlook. I'm curious what your visibility and assumptions are there for oil and gas customers. You're planning your fiscal year here several months in advance of when a lot of them will. And I'm just looking at $80 crude and wondering potentially, when those budgets are rolled out at year-end or early next year, if there's some substantial upside potential.

It's a great question. Obviously, we are 3 months ahead or 4 months ahead of seeing those budgets -- or capital budgets. What we are seeing and have assumed, Tommy, is a continued strength in the operating budget spend, which is, as you know, where a significant amount of the KOB 3 and some KOB 2 falls into. And that strength picked up in the second half of fiscal '21, and we assume and believe it will continue to accelerate as we go through 2022.

But in terms of the capital environment, beyond the 2 LNG jobs that I -- that are obviously funded and moving through bidding phases, we'll see what else comes out of the capital plans. But I would expect, Tommy, that there would be sustainable type of investments. Again, the methane emissions is a big deal, and I think we saw something from the U.S. around those standards and, of course, carbon capture, of which I think will be more and more significant as we go through the year. So we'll see. But you're right, we'll watch that very carefully as we go into Jan.

That's helpful. I wanted to pivot to OSI. Can you refresh us on what the top line contribution was in '21, what your plan is for '22? And I think it's likely going to be fair to say you've realized some revenue synergies since acquiring the asset, and any anecdotes you could share on how you're able to drive those in such a short time frame would be helpful.

Yes. So a phenomenal first year for the company, approximately $190 million in revenue in 2021, growing to approximately $220 million in 2022, well ahead of synergy Board plans, great execution globally. We won our first transmission/distribution project in Europe with a very large customer in the Netherlands and Northern Germany. We won our first transmission/distribution project in Australia, in Tasmania, again planting critical flags. And we're significantly engaged with the large power producers and transmission companies in the United States. So realizing the synergies and great growth and profitability. So I feel really good about the acquisition. And as it goes into AspenTech, it goes in with lots of momentum into the business.

The next question is from Josh Pokrzywinski with Morgan Stanley.

Well, just wondering on the Auto Sol side, I'm maybe helping to -- hoping to shore up some of the kind of growth differential you guys are looking at versus Rockwell yesterday. Any observation on kind of the mechanical or, say, balance and controls-type business versus more of the software and automation side? Like is there a wider spread in that outlook for '22 than usual?

Well, I -- not really. Not really. Obviously, our systems and software business has outgrown our device business. Our digital transformation initiatives, which are both software and device based, have outgrown the remainder of the business.

But having said that, I really don't -- I wouldn't note a significant difference as we go through. A lot of the KOB 3 business is device layer type of business. Where you'd see perhaps a little bit of a bifurcation, to be honest, is if you look at that KOB 1-heavy, dependent businesses, some of those in Final Control. But beyond that, I'd suggest I think we'll see broad portfolio alignment as we go through, and it's really a delta of 1 point or so between them.

Got it. That's helpful. And then just shifting over to C&RS. I guess, first, what is the -- and I apologize if I missed it. What's the price embedded in that outlook? And then you mentioned steel is coming down maybe prospectively based on futures. I know some of that is sort of contractually set. Like as that comes down, does that go into the calculation for how prices is kind of defined with the OEM relationships there?

Yes, go ahead. Go ahead.

Yes. So this is Ram Krishnan. On the -- I'll answer the steel question first. So obviously, as -- if steel were to come down in the second half -- now we've modeled it as a moderate decline in the second half, but any significant delta to that really doesn't impact '22 but will translate into our pricing dynamics for '23. So it's not necessarily a concern for us in '22, and we'll watch that carefully. Obviously, we'd like it to come down, which will impact the second half or help us in the second half. So that's on the steel piece.

On the pricing piece, I think whatever is the inflation, I don't think we're going to give out an exact price number. But obviously, the inflationary dynamics of '21 will translate and convert into material pass-through price that we will realize in '22.

The next question is from Deane Dray with RBC Capital Markets.

A quick question for Frank, if I could. Free cash flow was well below your third -- your 4Q average. I know you called out working capital pressures. Maybe some color there would be helpful.

Yes. I mean just the nature of the sales ramp and the comparison versus prior year, when we were taking cash off the balance sheet, I think we have a little bit of a dislocation there in the fourth quarter, Deane, that will normalize. So, I mean, the year was very, very strong, but the cash flow was kind of lumpy just given the way the year played out in particular in commercial and residential.

Got it. And then for Lal, on the expectation focusing M&A on industrial software. So this is a new structure for us with Aspen Technology. When you say industrials for acquisition, is that Emerson driven? Is it Aspen? Would it be folded into Aspen? Does Aspen have -- are they part of the review process and so forth?

Yes, sure. Sure, Andy (sic) [Deane]. no, industrial software M&A will occur at AspenTech and it'll be -- it will occur at AspenTech. Having said that, Industrial Software is only one of the 3 large market segments being -- that we'll be acquisitive in, and you'll see those as we play those out. You -- obviously, they'll become public knowledge. But no, I -- and we've got a great platform there to transact M&A in software with what I believe will be a market multiple that will enable the economics to work from a transaction perspective and from a value creation perspective.

The next question is from Jeff Sprague with Vertical Research.

Just back to the portfolio review, the comment about 2 end states. I would suppose that means you do kind of the addition and subtraction you're talking about and then continue to march as Emerson. There's option 1 and option 2. As you do that and then perhaps separate, if there's more that you can share on your thought process there or what might be kind of the triggering mechanisms of one over the other, that would certainly be interesting.

Yes. No, I think we're going to play this out, as I had mentioned earlier, over time. And I think I used the expression when we were in New York for the AspenTech transaction announcement that this is a marathon, that we're going to be very deliberate and thoughtful as we go through this. We're going to be keenly aware of the value proposition to the shareholders and impacts to free cash flow and impacts to value creation as we go through the journey.

The end game, of course, is to create a portfolio that's more connected, a portfolio that has an underlying sales potential that is higher and consequently can deliver, through cycles, double-digit EPS. That's the objective here. And so for that, we need to expose the portfolio to more of those markets.

And between the strong balance sheet of the company, the strong balance sheet that AspenTech will have as well and the divestiture work on this side, I think we can -- we get there over a number of years. But there were meaningful conversations with our Board. There were great debates. Obviously, this was a body of work over a number of months, almost 4 months, that our partners did alongside management. And -- but we have pathways now and optionality. And this is why we have 2 potential end states here.

Great. And then just as a follow-up, sort of a bundled question around price/cost and margins and the like. The price/cost positive of $100 million, does that arithmetic get you to margin neutral on price/cost?

And then kind of separate, but I guess related, just the additional restructuring that you're doing, can you elaborate on that a little bit and what sort of kind of savings tailwind you're expecting in '22 from both the actions you took in '21 and the new actions you're talking about here in '22?

This is Frank. So the -- I mean, we're thinking about it in terms of delivering the leverage on the business for the -- and the price/cost in isolation, obviously, on the way up, it's not necessarily margin accretive, okay? So we're just looking at it holistically in terms of delivering 30%-plus operating leverage for the business for the year.

The price/cost, given the way it has rolled and will roll through, very lumpy, very distortive within the quarters, so we're just very focused on getting to that goal for the year, delivering up margins and -- for the enterprise and delivering the operating leverage.

Regarding the restructuring, I'll take a quick stab and then either Ram or Lal can come in. And your question was around continued restructuring spend.

So as we go through this, we identify additional opportunities in both businesses. some of it is footprint consolidation. I mean the cost reduction in March -- it was kind of a never-ending March. We identified obviously very significant opportunities that we've executed on for the most part when we talked about driving to previous peak margins. But there's more to do in a complex business. We're continually trying to improve the cost position.

And frankly, much of what we do in terms of CapEx and restructuring over the next couple of years will be around capacity expansion for the growth that we expect to see in both businesses. So we may be engaged in some restructuring that's a little bit higher than our historical levels. But it's all around continuing -- improving the cost position and putting in the capacity in the right places.

I'll call the next question?

Yes.

The next question is from Scott Davis with Melius Research.

Best of luck for 2022. And I had a couple of questions here for you guys. First, like the 30% incrementals that you referenced, Lal, is that more of a baseline or a goal? Does that include the price -- the $100 million price tailwind? If you answered some of that, I apologize, but just little bit more color around that.

No. Yes, sir. No. Yes, sir. No, that is the plan. That's what the fiscal plan rolls up and the commitment we're making. It does include the price. Obviously, it's all in. It's all in of first half headwinds that we described and second half turning into tailwinds, whether that's price/cost or supply chain. But as Frank, I think, said, that will be below in the first half as we -- and improve as we get into the second half, obviously. But for the year, I feel very, very good about the 30 points of incrementals on the underlying sales.

Okay. And then the comments that you made around carbon capture in methane, LNG, is there a point where you can start to measure what percentage of your orders those particular types of projects represent where we can get a sense of the materiality of the future growth there?

Yes. No, I think that's a great question, Scott, as well. So we identified approximately $1 billion of KOB 1 projects. Now that includes also transmission/distribution but also a whole slew of sustainability and renewable jobs inclusive of hydrogen, including carbon capture, et cetera, biofuels and other things. So as we go forward, I -- and then we've continued to look at our funnel and address our funnel and how we communicate the funnel. I think it'll be important for us to break those out and give you some visibility to it. So I think that's a fair question.

The next question is from Julian Mitchell with Barclays.

Just wanted to start with the Automation Solutions organic growth guide. So you're assuming that, that business grows about 7% this quarter and then the same over the subsequent 3 quarters even as the comps get a lot more difficult. So I just wanted to understand, is sort of everything in that segment steady state as you go through the year in terms of hybrid versus process versus discrete or KOB 1, 2 and 3? Or is there something changing across either of those axes kind of as you move through the year that allows the organic growth rate to hold steady even with tougher comps?

Yes. Great question, Julian. Good to hear your voice, yes. So backlog situation, normally, if you look at our typical performance in automation, Q3, Q4 last year, for example, I believe we've reduced backlog by about $400 million. This year, we reduced it by $100 million. A lot of that was reflected in that $125 million miss in the quarter for Automation Solutions. So the backlog situation coming into the -- obviously, is stronger. But having said that, we do expect KOB 3 to remain strong. I think the data that we're seeing and the commitments our customers are making, particularly around STO activity, is very, very robust.

And then secondly, modernization programs and the KOB 1 that I outlined, whether that is sustainability or LNG, I think, will come in and support the second half of the year. Obviously, KOB 1, for the most part, will not turn into revenue with the exception of perhaps some of the earlier feed stuff that -- in our systems business, as you know, Julian, but robust and will pick up as we go through the second half of the year.

That's helpful. And then just switching to com res, 50% plus of the revenues in that business are residential facing. You do call out the slowdown that you're embedding in resi through the year. But it doesn't sound as if any major cliff is looming as you see it today. Maybe discuss sort of how you're thinking about the situation of the OEMs in resi and how confident you are that you can sustain kind of positive growth through the year in resi even with tough comps.

Our perspective is that we've got a couple of looming regulatory changes on the environment, efficiency and obviously referred to in (inaudible) in '23 and refrigerants in '25.

It's been an interesting cycle to call where we've -- I've spent time with 2 of our largest OEM customers this quarter. I went down in Carolina and visited with Train. I went down to Miami and visited with Carrier. And we're staying very lockstep in terms of understanding their demand and their projections for demand as we go through the fiscal. But we do believe that there's a moderation, not a cliff as we go through the year.

Great. Well, Julian, thank you very much. And with that, I think we're going to close the call. I thank you all for your time this morning and appreciate the questions. And thank you for your support.

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