洛克威爾自動化 (ROK) 2010 Q2 法說會逐字稿

Welcome to Rockwell Automation's quarterly conference call. I need to remind everyone that today's conference call is being recorded. Later in the call, we will open the line for questions. (Operator Instructions).

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

Thanks, Anika. Good morning, everyone. Thank you for joining us for Rockwell Automation's second-quarter fiscal 2010 earnings release conference call. Our results were released this morning and the press release and charts have been posted to our website at www.RockwellAutomation.com. Please note that the press release and charts include reconciliations to non-GAAP measures. Additionally, a webcast of this call is accessible at that website and will be available for replay for the next 30 days.

With me today as always are Keith Nosbusch, our Chairman and CEO, and Ted Crandall, our Chief Financial Officer. Our agenda includes opening remarks by Keith that will include highlights of the second quarter and thoughts about our outlook for the remainder of fiscal 2010. Then Ted will provide more details around the second-quarter financial performance and our revised 2010 guidance. There will of course be time at the end of the call to take your questions and we will try to get to as many of you as possible. We expect the call today to take about an hour.

As is always the case on these calls, I need to remind you that our comments will include statements related to the expected future results of the Company, and are therefore forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from our forecasted projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all of our SEC filings. With that, I will turn the call over to Keith.

Thanks, Rondi. And good morning to everyone and thank you for joining us on today's call. At our last earnings release, I said that we believe we were seeing the signs of the start of a recovery. Our performance in Q1 had exceeded our expectations, particularly in our product businesses, and we significantly increased our revenue and earnings guidance in January.

Our second quarter provided more good news. It appears that an industrial recovery has taken hold, as evidenced by continued improvement in key global economic indicators like industrial production and PMI, as well as our strong sequential growth in the quarter. I will talk more about our second half outlook later, but first, let me give you my thoughts on the quarter. And as always, Ted will be discussing the numbers in greater detail in his remarks.

This quarter marked the return to year-over-year organic growth for the first time since Q4 of fiscal 2008. Product revenue in the quarter was once again better than our expectations. We think restocking in our channel benefited Q2 sales by about 3 points and we suspect that some of the strength in product business that we have seen in both Q1 and Q2 was due to pent-up MRO demand.

In our solutions and services businesses, revenue declined year-over-year as expected, but the book-to-bill was above 1 again this quarter. Growing volume leverage in the quarter resulted in a 7-point year-over-year margin improvement and a 2-point sequential margin improvement, in spite of the incremental costs in the quarter from reversing our temporary cost reductions and some other items that Ted will provide more detail on. And we have continued to deliver very strong free cash flow with careful management of both working capital and capital spending.

Here are some other positive developments in the quarter; over 13% sequential growth in the US and Canada with continued strength in automotive, strong growth in emerging Asia with 24% year-over-year growth in India and 15% in China, multiple process industry wins against entrenched competitors, especially in water waste water and oil and gas. OEM conversions started to bear fruit, validating our focus on these important customers during the downturn and this impact will become more important as market conditions improve. Finally, I want to thank our talented and dedicated employees and partners whose unwavering commitment to our customers enabled these great results. And I'm very pleased to announce that we are now able to implement a pay increase across our global employee base.

Let me set the stage for our outlook for the second half of the year. While the recovery is underway, the shape of the recovery remains uncertain. The strength in our product business through Q2 has been largely based on strong MRO demand, and smaller projects with some contribution from channel restocking. Even the improvement we have seen in OEM business has been more about machine level investments than production line levels. And we have yet to see any significant improvement in large capital project spending, and it is difficult to know when that might kick in.

For products, we believe the second half could range from flat to moderately up compared to the Q2 run rate. To get to the higher end of our revised revenue guidance, we need to see improvement in that large capital project business relatively early in the second half. For solutions and services, we do expect significant sequential revenue growth in the second half, given the orders performance in Q1 and Q2. With this backdrop, and with two quarters of solid performance under our belt, we are providing a revised outlook for fiscal 2010, full-year revenues of $4.6 billion to $4.8 billion, compared to our previous range of $4.4 billion to $4.6 billion.

As in our previous guidance, to achieve the high end of the range, we need to have meaningful second half over first half revenue growth. At these new revenue levels, we do expect to incur some additional compensation expense, and we will increase spending to support growth, particularly in technology, domain expertise, and customer-facing resources in emerging markets. We are also raising our earnings per share guidance to $2.60 to $2.90.

Before I turn this over to Ted, let me provide a few closing comments. The early part of this recovery has been surprisingly strong and we are now solidly on a year-over-year growth path. As I mentioned earlier, sequential growth rates in the product business will likely moderate in the second half of the year, but our long-term growth prospects are bright. I am excited by the new opportunities we are seeing every day, particularly in the areas of process controls, OEM's, and emerging markets. The entire organization is energized and committed to serving our customers' needs as the recovery progresses. And we know that this commitment to our customers' success has provided superior long-term returns for our shareholders in the past, and I believe that this will continue to be the case. Now, let me turn it over to Ted.

Thanks, Keith and good morning to everybody on the call. We have posted charts to our website and my comments will reference those charts. Building on some of Keith's comments, this was a very good quarter for the Company, with strong results in sales, earnings and cash flow. I will start the briefing on chart one, which is Q2 results summary.

Revenue in the quarter was $1,164,000,000, up 10% from Q2 last year with currency contributing 5 points to the increase. As Keith noted, Q2 represents a return to year-over-year growth and provides evidence of a continued recovery in market conditions. Total segment operating earnings were $177 million, up from $86 million in Q2 last year; very strong earnings conversion. I will discuss that further on the next slide.

General corporate net expense was $23.6 million, compared to $14.7 million a year ago. That's a significant year-over-year increase and primarily due to performance-based compensation where we reversed accruals in Q2 last year and incurred above-average expense this year. We also made a contribution to our charitable corporation in Q2 this year.

General corporate net was about $3 million to $4 million higher in Q2 than our expected quarterly run rate. The $4 million of income shown as a special item in Q2 last year was the reversal of previous restructuring accruals. The effective tax rate in the quarter was approximately 16%, and that's considerably below our previous guidance range for the full-year estimated rate. We experienced about a 5-point benefit in the quarter related to the favorable settlement of a prior-year tax matter.

EPS from continuing operations was $0.77, up from $0.29 in the second quarter of last year. The tax settlement I referred to contributed about $0.05 in this quarter's results. We recognized income from discontinued operations of $25 million in quarter two, or $0.18 per share, primarily due to the favorable resolution of tax matters related to the sale of our power systems business in fiscal year 2007.

In total, earnings per share for the quarter was $0.95. Average diluted shares outstanding in the quarter were 144.4 million and we resumed share repurchases during Q2 and repurchased approximately 463,000 shares for $25.5 million. We have $596 million remaining under our existing $1 billion repurchase authorization.

Now, if you would please turn to chart two, Q2 results, Rockwell Automation total. On the left side of this slide, you can see the 10% year-over-year sales increase. Sales were up 9% sequentially. We experienced robust growth in our product businesses, year-over-year and sequentially. Solutions and service business revenues declined year-over-year, but improved somewhat sequentially.

Moving to the earnings side of the chart, operating earnings increased by 106% compared to Q2 last year and you can also see here a significant sequential earnings increase. Operating margin for the quarter was 15.2%, up 7.1 points compared to last year and up 2.4 points sequentially. The year-over-year improvement was primarily due to higher margins in the architecture and software segment, but in total for the Company reflects strong volume leverage, improved mix and the impact of our cost reduction actions from last year.

This favorable margin performance in Q2 was realized despite some significant expenses -- expense increases in the quarter, primarily related to employee compensation. As we discussed in the last earnings release, we restored pay cuts and the 401K match effective on January 1. In addition, we have decided to implement wage and salary increases for employees globally. It will take us a few months to implement this pay increase, but we intend to make a payment at implementation to catch up back to January 1. And performance-based compensation expense increased significantly compared to Q2 last year.

In total, these three items, increased expense year-over-year by $42 million in Q2. As a partial offset to these incremental expenses, there were no restructuring costs in Q2 this year, compared to a $20 million restructuring charge in last year's second quarter. Obviously, a lot of puts and takes in the quarter with respect to operating earnings and margins, but taking all of that into account, still very strong earnings conversion.

In January, on our earnings call, I mentioned that we intended to begin to increase spending in Q2, and as Keith noted, particularly in the areas of technology, domain expertise, and commercial facing resources in emerging markets. Frankly, other than the compensation items I just covered, we didn't see much other spending increase in Q2. After clamping down so tightly last year, spending in these other areas is ramping more slowly than we expected. But we do expect to see increased spending, principally in the targeted areas, in the balance of the year and that's reflected in our revised guidance.

We continue to believe we are well-positioned to deliver exceptional year-over-year earnings conversion for the full year, and you will see that as well reflected in our guidance. Although not displayed on the chart, our trailing four-quarter return on invested capital was 13.2%. That's down from 18.7% last year, but up from 9.5% last quarter. Through the balance of the year, we expect return on invested capital to steadily improve as we continue to see favorable year-over-year earnings comparisons.

If you would turn to chart three, this chart summarizes the quarter two results of the architecture and software segment. Looking at the left side of this chart, you will see very strong sales performance in our architecture and software segment for the quarter. This is the fourth consecutive quarter of increased sales. Sales were up 31% compared to the same quarter last year, including a 6-point contribution from currency. Sequentially, sales increased 10%. Operating margin for the quarter was 23.8%. That's 15.4 points higher than the second quarter of last year, and predominantly due to volume leverage. Operating margin improved 2.7 points sequentially.

Chart four covers our control products and solutions segment. Sales in Q2 were down 2% compared to last year, an organic decline of 7% offset by a 4-point benefit from currency and 1 point of growth from acquisitions. Sales in control products and solutions increased 8% sequentially. In the products businesses of the control products & solutions segment, sales increased both year-over-year and sequentially at rates similar to the architecture and software segment.

In the solutions and services businesses of CP&S, sales were down in the mid teens compared to Q2 last year, but increased about 3% sequentially. Solutions and service orders have continued to improve with the book-to-bill for Q2 just slightly higher than the 1.15 that we experienced in Q1. Segment operating earnings and operating margin were up slightly from last year on lower sales, but better mix. On the right side of the slide, you can see a significant sequential operating and earnings improvement in Q2, and segment operating margins expanded by 2.1 points sequentially.

Turning to the next chart, chart five provides a geographic breakdown of our sales for Q2. The center column displays overall growth rates by region. The far right column shows growth rates, excluding the effects of currency translation. I will focus my comments on the far right column. In the US, sales were up 10% year-over-year, up 13% sequentially. Canadian sales increased 12% compared to prior year, but that included the effect of an acquisition made last year. Excluding sales from the acquisition, the year-over-year increase was about 4%. Sequentially, Canadian sales increased by 18%.

In EMEA, sales declined by 7% compared to Q2 last year, but increased 3% sequentially. Asia-Pacific increased by 12% compared to last year, and 1% sequentially. And emerging Asia, including China, saw 15% growth year-over-year. And as Keith mentioned, we had a standout quarter for India, with year-over-year growth of 24%. Latin America was down 4% year-over-year, with improved product revenues, offset by declines in the solutions and services business. You may recall last year, Latin America held up well through Q2 and then fell off. Compared to the other region, a relatively more difficult year-over-year comparison for Latin America. Sequentially, Latin America sales increased by 8%.

Now, please turn to chart six, free cash flow. We're continuing to see strong cash generation and conversion on net income. Free cash flow for the quarter was $167 million; that's despite some increased working capital to support higher sales levels. Year to date, free cash flow is $275 million, which represents about 145% conversion.

Our balance sheet also remains very strong. Related to that, during the quarter, we renewed our 364-day credit facility. The expiring facility was $267.5 million. The new facility is $300 million. There were no difficulties renewing, and we experienced strong interest from the banking community. We have a separate $267.5 million facility expiring on March 15, 2012, so the total amount available under the two facilities is now $567.5 million.

And that brings us to the last chart, which addresses our current outlook for fiscal 2010. As Keith mentioned, we're revising our full-year guidance. We have increased the range of full-year sales from the previous guidance of $4.4 billion to $4.6 billion to a new guidance range of $4.65 billion to $4.8 billion. Excluding currency effects, the new revenue range represents year-over-year growth of between 4% and 8%.

We expect currency to contribute about 3 points to year-over-year growth; that's 1 point lower than our January guidance. We have increased our estimate of segment operating margin to a range of 13.5% to 14.5%. As I mentioned earlier, there are a lot of puts and takes in the year-over-year margin comparisons, but overall, throughout the guidance range, we're expecting segment operating earnings conversion of about 60%.

We've increased our fiscal 2010 EPS guidance to a range of $2.60 to $2.90. That compares to our previous EPS guidance range of $2.00 to $2.40. We now expect a full-year tax rate of 19% to 21%, which is basically at the lower end of our previous tax rate guidance. Given that we are halfway through the year, as you can see, we have somewhat narrowed both the sales and the earnings guidance range and we continue to expect free cash flow conversion above 100%. And now I'll turn it over to Rondi to begin the Q&A.

Great. Thanks, Ted. Let's open the line for questions.

(Operator Instructions). Your first question comes from the line of John Inch with Merrill Lynch. Please proceed.

Thank you. Good morning, everyone.

Good morning, John.

Good morning. Ted, the catch-up payment for pay increase, I think through January, does that imply there is a charge coming in the current quarter? And if so, what is roughly the magnitude?

Actually, John, we incurred expense in Q2 with the plan catch-up of about $8 million.

Okay. That is already in there. There is no --

I'm sorry, that is already in Q2, and that run rate will not change in Q3 and Q4.

Okay. This $42 million that you called out, that is roughly the run rate per quarter. Is that correct?

Yes, I think that is fair.

Could you talk a little bit about the auto vertical, just maybe how much it was up. And then clearly, you've got a lot of vehicle launches on the come. Does that give you confidence that auto, which is obviously a very rich mix for Logix and other products, can continue?

Certainly automotive is one of the, I would say, greatest year-over-year improvements for us as a business. Just to put that in context, it is up in total over the run rate at the end of '09, over 100% on a year-over-year basis. First half to -- first half of '09 versus second half of -- second half '09 versus first half 2010. We're seeing that certainly domestically is probably where the greatest increases have come.

And you're right, it has not been largely driven yet by the new platforms, particularly the new platforms at Chrysler and at General Motors. Ford continued to invest throughout the period. I would say we probably won't see a significant delta there. But the comment I made about large CapEx spending having to pick up in the second half of the year for our products to grow, we do expect probably in our fourth quarter that we will see a pickup in automotive project spending, and therefore, some improvement in our product sales from that. And certainly the automotive is a very rich A&S content on those projects.

That is where I was going, Keith. Basically, are you classifying auto then as these large CapEx projects? Because it strikes me, I know what you said, they have to pick up. But it strikes me, at least in that vertical, it is almost guaranteed just based on what the OEs are planning, that would at least start.

That's true, John, but the comment was made in a somewhat of a broader context of which certainly automotive we think is -- we have the highest confidence in that picking up. Where the other areas that we're looking at is where you are looking for line expansions at OEM's. As opposed to just replacing an old machine, there has to be a capacity expansion in things like food and brewing and beverage, and home and personal care in particular where the capital spending is a more significant piece of the project.

And then also, we would be expecting it to grow -- or need it to grow, I should say, in the oil and gas sector, later in our fiscal year. With mining, we're expecting that to probably not pick up a lot in -- that we will see the revenue, but we do expect projects that will improve next year's large capital spending in that vertical. It is a mixture of -- across what I would say more of the heavy process industries. And then new lines in what I would call the consumer transportation types of industries, as to what we mean when we say the larger capital projects.

No, that's helpful. Just lastly, Keith, as we start this expansion cycle, how are you thinking of your global footprint, and perhaps the requirement to make investments? And how would you compare it to the start of the last cycle? And by investments, I'm thinking say manufacturing capacity, I don't know, new iterations of Logix. You've even talked about sales expansion right in emerging markets. How does your footprint in spending trajectory or requirements compare?

I would say there is a lot of pieces there so let me try to parse it a little and try to get the gist of your question. If you talk about our manufacturing footprint, we believe most of that spending is done at this point in time. If you remember, we started that probably about two years ago and made a significant transformation of our operating footprint into emerging markets. And in particular, at that point, we talked about China. We talked about Singapore. We talked about Latin America, in particular Mexico, to a smaller degree Brazil, and then Eastern Europe and in particular. Poland.

And the strategy was to grow that business -- grow that footprint, to be able to absorb the growth that we were anticipating at that point in the -- in particular, in the emerging markets. With the significant decline that we had, we accelerated some of those moves to be able to absorb that capacity quicker while we do see our footprint in the higher cost mature markets. That's been going on and our team has done a great job of moving I will just say in that direction. I think from an operation standpoint and a manufacturing capacity, obviously we have to add machines or a line or maybe a shift. But as far as significant investments, I believe those are behind us at this point in time.

The one area that we do have to continue spending in is the evolution of our business systems outside of the United States. And that is something that is still probably a couple of years of investments in our new business systems. We're getting close to completion of that, from the core functionality. But as far as moving it into Europe and into Latin America and into Asia-Pacific, we still have that in front of us, but I do not believe that will be an incremental spend that we have to take. It is I will just say a reallocation of our current spending from more North American and more function to more regional activities, so that is that piece of the spending.

Where we will see and need to increase the spending is in our core technology, in particular Logix. We are increasing, and will continue to increase over the next two years, spending to continue to expand the scalability of that platform, and also to increase functionality and performance of the platform. And that is something now that we have been talking about with the community, the financial community, for the last couple of quarters for sure, and that is what Ted mentioned. We didn't ramp up very much in the second quarter, but we know that is in front of us. And certainly is an important dimension of our portfolio and therefore, we need to continue to improve the investments in that technology.

The other area where we will have to continue to incrementally spend, and it is another point that Ted made, is in customer facing resources and domain expertise. And what that means is sales people and application engineering, or our solutions businesses that deliver the automation and/or information projects. Obviously there, we're expecting the greatest growth in emerging markets, so that is where you will see us putting more spending. It is an area that we tried to protect as best we could, because as you know, we made significant investments, particularly in Asia, a couple of years ago. We did not want to take any of that out in the downturn. And now, we are in a position and have started adding to that.

Investments in emerging markets will be important. And investments in the growth accelerators that we've outlined at our analyst day would be the areas that you're going to see us putting our next incremental investments into.

That's great color, Keith. Thank you.

You're welcome. And I'm sorry it took so long to get through it.

Your next question comes from the line of Bob Cornell with Barclays Capital. Please proceed.

Thanks, everybody. Well, it was worth the wait, Keith. Thanks very much.

Okay, Bob. I appreciate your consideration.

What does control products revenue have to do in the second half to get to your targets? You talked about the backlog and the book-to-bill and the overall guide, but control products is still running negative. When does that business break positive to -- or what is the outlook for control products revenues to -- in the guidance?

Obviously, control products is made up of the two pieces that we always say. But if you look at second half, we would expect, depending on where we are in the range, it would go anywhere from let's say, about 10% growth to the high teens at the high end of the range. That is what we would expect first half versus second half in CP&S.

Second half would be -- is that year-over-year growth or second half over first half?

No, I'm sorry, it is second half versus first half.

Okay. Now, I will let someone else ask the process questions, but one of the things that has always interested me is the growth in the machine control, the CompactLogix business. In the December quarter you mentioned a big order you got, and I think you've gotten a lot of design wins over the last year when the market was quiet and I think you referenced the fact that could percolate as the market comes back. Maybe you could just flush out the CompactLogix machine control market. And that market is not too far smaller than the whole process market.

No, you're right, Bob. And that's why we talk about a growth accelerator being the OEM market for Rockwell Automation. It is an area that we've focused on very aggressively the last couple of years, in particular when we came out with Compact-Logix, because it is a scalable part of the Logix architecture that is well-suited for machine builders. And certainly that is what the target was. With that, we can bundle around that, our motion portfolio and our components, in particular, our safety components. And that is a very strong package that we offer value to our machine builders.

When are we going to see the revenues? I understand you had design wins over the last 12 months --

The OEM growth is a big part of why A&S grew at the rate it did this quarter. It was probably the most significant contributor to growth, was the OEM improvement. We are seeing the growth, Bob. And in particular, CompactLogix growth in the quarter was up into the high 30s on a quarter-over-quarter basis.

We are seeing that pickup and we would expect that to continue, in particular as the volume of those machines where we made the conversions on over the last year starts to grow more revenue for the machine builders. We're very pleased with where we're at and that is on a global basis. We have very strong OEM programs in Europe, in the US, and in Asia-Pacific, in particular China, and to some degree the smaller markets in Latin America, both Mexico and Brazil. We are seeing the growth would be my comment, Bob, to your question.

Final question, processor growth group performance in the quarter?

Yes. We had -- the Logix business was up 36% year-over-year higher, basically 10 points higher than the A&S organic total. We see that as another very good sign for the future, and certainly puts us back into the higher rate of growth compared to the overall Company products average. And as I said, Compact was even a little bit higher than that. Or I should say, Compact was higher than Control and the combination was 36. We feel very good about that pickup in the quarter.

Legacy?

Legacy grew actually, as you would expect, given the fact that a lot of this is coming from MRO, and to some degree OEMs. A lot of those machines are designed with the legacy systems in, and so our legacy sales were up almost 10% on a year-over-year basis. We had been talking about 10% annual declines in our legacy products. We certainly expect over the cycle that that will continue, but it is another reason we believe pent-up demand and restocking and small machines, or I should say individual machine expenditures is what is occurring because of that growth that we saw in the legacy business.

Okay. Thanks.

You're welcome, Bob. Thank you.

Your next question comes from the line of Mark Koznarek with Cleveland Research. Please proceed.

Good morning.

Good morning, Mark.

Great quarter.

Thank you.

Could you elaborate a little bit more about that earlier comment about channel restock, contributing 3 points to growth? Was that your channel partners or is that end customers?

That was specifically a question about our channel, our distributors.

Okay. Now, from your perspective, has the channel restocked fully or will we still get some additional lift from that in the second half?

No, not at these run rates. We believe now that we have the appropriate levels of inventory for the current demand. And obviously we said that last quarter, but demand went up. We got a little more restocking push. But given our outlook now, what we talked about in our products business, we believe we have seen the benefit of that. And quite frankly that's one of the headwinds that we see in the second half is the loss of that restocking. The point in Q1, the 2 points in -- the 3 points in Q2 is something that we have to push against for the rest of the year.

Okay. And that together, with your prior comment about the Logix growth overall, would those two items suggest that we have had a richer-than-usual mix of products, and the type of products here in the first and second quarter and that will reverse some in the second half? Just setting aside the solutions business, just talking about products here.

Okay. It is tough to say, if we're just talking products. It really is some element of mix. Obviously, as Ted mentioned, if you took our product sales of CP&S, it looked a lot like A&S. It is not like we're seeing any deviation in products in total that says oh, no, it is all A&S products. I don't think the product per se is going to see a significant change.

The big mix is the one you discounted. The big mix shift for us in the second half is solutions growing in the mid to high teens, and products much lower. You will see that as a natural mix impact going into the second half that you didn't see in the first half.

Mark, I think there could be some small favorable mix impact in Q1 and Q2. It is really related to the strength we have seen in North America, where obviously we have a much larger install base and benefit from more MRO. We also look at Q1 and Q2 and think that in that period, MRO spending may have been a little bit overheated. I think there could be a small favorable impact, but as Keith noted, the big mix impact is really going to be solutions versus product.

Okay. Got it. And final one here is with the strong growth and the implied further acceleration in the second half here, can you talk about your own internal supply and logistics situation? We've been hearing a little bit about constraints on certain product categories. Is that likely to become more of an issue before it abates, because of the revenue acceleration that you're expecting?

Certainly, we don't believe that the logistics supply chain issues impacted our performance in the quarter of any -- significantly. There is no question that, given the increases that we've seen, that we are stretching the supply chain. And we're stretching it quite dramatically. In particular, we have issues on electronic components -- isolated issues on electronic components. Because of the growth in, I will just call it the high-tech industries and in particular consumer electronics, has put a number of those parts on allocation. And Rockwell really is being not treated differently than other manufacturers who are demanding the same parts, based upon the increase. And so we're managing through that.

The impact has been the greatest in a couple of our product lines in our small controller business, the MicroLogix business in particular and some isolated input/output devices. And really in the rest of our portfolio, we've been able to deal with it and that's one of the advantages of having a great channel. They're our first line of defense. And they've been working very hard and very diligently to help us get through a difficult period driven by increased -- a very quick increase in volume. And obviously, when the supply chain shrunk last year, it shrunk dramatically and people took capacity out, and now they're hesitant to bring it back.

We are experiencing some issues. They're isolated. We're managing those across the portfolios with our channel, with our sales organization. And we believe the increase that we will see in the second half will not create a bigger problem than we currently have. We think the backlog, if you will, has stabilized. We expect over the third quarter to work it down and to be able to put that behind us, once again, given the current delivery commitments on these parts. We think we're past the most difficult period, and that we will work our way through the remainder over the course of Q3 and certainly by the end of Q4 be in a very, very solid position.

Great. Thanks for the color, Keith.

You're welcome.

Your next question comes from the line of Stephen Tusa with JPMorgan. Please proceed.

Good morning.

Good morning, Steve.

Just to clarify on some of the costs you're loading into the back half, so 2Q, how much more costs do we have to go? How fully loaded is 2Q? If you could just maybe give a little bit more detail, I know you spend a little time on this, but I wasn't quite clear what the total incremental cost bump-up is in the second half.

Basically, Steve, let me walk through this and maybe remind you of the things we talked about last quarter. Basically regarding year-over-year cost savings from the restructuring actions, we're still counting on $120 million year-over-year. Basically all of that is in the Q2 run rate, so no significant change in savings as we go into Q3 and Q4.

Okay.

Compared to our previous full-year guidance, we now have additional cost headwinds of about $50 million related to additional compensation expense. That includes the cost of the pay increase that we talked about, and increased performance-based compensation. It is split roughly equally between those two. As it relates to performance-based compensation, the one thing I would remind you of is when we talk about that, that is a very broad-based performance-based compensation plan that works across all of our salaried and hourly employees. But compared to the Q2 run rates, there is minor increase in those expenses in Q3 and Q4.

Okay. In both quarters, so it steps up in both quarters?

Minor. Minor increases in those quarters. I would say the larger expected run rate change in the quarter is really that other spending that both Keith and I have talked about that is related to new product investment and our growth accelerators. And there, we're expecting about a $50 million increase in the second half of the year. I think if anything, it may be a little bit more heavily weighted toward Q4 than Q3, but it is about a $50 million increase in the second half.

Okay. Great. And then when you're talking about the book-to-bill, is that just in -- that's not entire CPS, that is just the services and -- that's the solutions book-to-bill, [it is not just a] part of CPS, right?

That's correct.

One more question on CPS. I think the answer to your question -- to Bob Cornell's question, second half over first half, you think at the low end, CPS is up 10% and at the high end, 19% for second half over first half. That would imply a relatively low rate of sequential growth at architecture and software. Is that in line with normal seasonality? Or what are you seeing in April? Is there anything in April that you're seeing that drives that caution? Or is it just you are looking at the back half of the year and your short cycle business so you're not sure of the sustainability of the product strength?

I think you hit upon a number of them. First, let me just say, we're not quite that high on CP&S at the high end. It is more in mid 17% at the high end. But you're right, it is about the component story. That is what has been driving the growth so far. We believe we will see some flattening out. And at the high end of our guidance, our products do grow, quite frankly in the second half, quite substantially. At the low end, the first half over second half -- or I should say second half over first half, we're expecting mid single digit growth in A&S. Certainly that is a significant step-up from where we are at this point in time.

And no, we're not -- obviously, there is some normal slowdown from a summer standpoint, if you will, in some of the major mature markets. But we're not expecting any, I will say, meaningful deviation from traditional rates in those businesses. It is just that solutions starts picking up, and we see that being the predominant growth driver in the second half of our year. We still expect and have targeted some product growth in both A&S and CP&S to hit our revenue guidance.

One last question. Just looking at the 24% margin in architecture and software, should we still think about the longer term targets here in the context of incremental margins? Obviously, anybody would be happy with a 24% to 25% margin, but I'm just curious as to longer term, where you think these things should go. There is only so much money you can throw at the business. If you're doing this this early in the cycle, little bit of revenue growth, do we think about this as stable margins? Is there continued room for improvement here? Last cycle you peaked out at 27%. I'm just curious as to the --

I think we have always said that we think reasonable margin targets for architecture and software are in the mid to higher 20s range. I would still -- I think we continue to believe that. I think what you're experiencing this early in the cycle is the very strong volume leverage we get in architecture and software, and our inability to ramp investment spending up as quickly as we might have liked.

Right. Okay. Thanks a lot.

You're welcome. Thank you.

Your next question comes from the line of Rich Kwas with Wells Fargo Securities. Please proceed.

Good morning.

Good morning.

Question on the MRO comments that you had earlier. You said it was pretty strong here. Is there some expectation that that fades as we move through the rest of the year? And to what degree? Just big picture, how should we think about that?

I think that is the other piece of Steve's question that I didn't answer. Thank you for the question. One of the reasons we do expect that that pent-up demand does taper off to some degree. And that's why we have a little slower growth in the second half of the year in our products business, because it has to come from new projects as opposed to just the MRO piece of it. That is the way to be thinking about the MRO. It leads going in, then it stabilizes at a slower growth run rate and that is the phenomenon that you're seeing in the second half of our year. And it is a normal phenomenon. I don't think there is anything here that we're surprised at.

The surprise was how fast it came, not the fact that it is going to be slowing down as the recovery continues to progress. But we certainly saw such a steep reduction in both CapEx and OpEx last in second half of last year, that the spending just had to come as production picked up. And so as IP, industrial production numbers, picked up, people had to support that with investments and that's what drove the MRO's strength. A natural phenomenon, very solid, very steep at the start because of the drop, and now starting to flatten out in the second half.

Okay. That's helpful, Keith. And then in terms of the restocking, it just seems that as you look at the second half of the year, I know there is some mix changes in the growth rate relative to this last quarter may not be as significant. But it just seems like there is some potential for some more restocking, based on your bigger picture outlook. Should we think of it as 3 points this quarter, it was 1 point in the fiscal first quarter. Do you -- it sounds like you still see some restocking taking place in the second half.

Rich, I think you got to go to the notion of what is reflected in our guidance for product. And as Keith mentioned, on the product side, our guidance says at the low end, it would be rather flat to the Q2 run rate. And at the high end, we're up mid single digits to the Q2 run rate. If we're up, if we hit closer to the high end, there will be some natural restocking. I think our message is we don't think that is a big number. It is not going to be another 3% per quarter going forward, even at the high end. It might be 1%.

Okay. That's helpful. Thanks, Ted. And then just last question, China, grew 15% year-over-year. Last year, at this time, China was on its back a little bit. I was just curious on your comp for that 15%. And then as you go through the rest of the year, given the recent strength in China, how do you see your growth rate there with customer wins and -- potential customer wins and just overall growth there right now?

Certainly, we expect in the second half of the year that China will be above the Company average in growth. We would expect to have similar numbers that you've seen this quarter on a year-over-year basis. We have made great inroads in China, particularly at OEMs. And also with the stimulus spending that has been going on in China, that has driven a lot of our business, and the automotive activities are also very positive there.

We see the continued evolution to a more consumer-based economy. We think that bodes well for us, in addition to the OEM activities and the pickup of our ability to address a broader perspective of -- a broader sweep of oil and gas industry applications in China are opportunities for us to continue to drive that higher growth rate.

And what was your comp last year at this time -- for last year's quarter for China?

I don't know that off the top of my head. That is something that we will have Rondi get back to you on.

Okay. That's fine. I will get it offline. Thanks so much.

Operator, I think we're about ready to wrap up the call. I want to thank everyone for joining us today and if anyone has any follow-up questions, just give me a call and we will go through that. Thanks a lot.

Ladies and gentlemen, this concludes the presentation and you may now disconnect. Thank you and have a good day.