Greetings and welcome to the Emerson Second Quarter 2026 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Doug Ashby, Director of Investor Relations. Please go ahead.
Good afternoon and thank you for joining Emerson's Second Quarter 2026 Earnings Conference Call. Today, I'm joined by Emerson's President and Chief Executive Officer, Lal Karsanbhai; Chief Financial Officer, Mike Baughman; and Chief Operating Officer, Ram Krishnan. As always, I encourage everyone to follow along with the slide presentation, which is available on our website.
Please turn to Slide 2. 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 the non-GAAP measures.
I will now pass the call over to Emerson's President and CEO, Lal Karsanbhai, for his opening remarks.
Surendralal Karsanbhai
CEO & President
Thank you, Doug. Good afternoon. I'd like to begin by thanking our colleagues around the world.
At this moment, it is important to highlight our teams in the Middle East who persevered in a challenging, at times, dangerous environment. All of our employees and families remain safe and we continue to serve our customer needs throughout the region. What defines our company is a high-performance culture based on deep respect for each other and an unwavering commitment to our customers.
Led by Liam Hurley, our team in the Middle East brought this to life. Thank you. Please turn to Slide 3.
We are committed to ongoing Board refreshment. And today, we announced the newest member elected to our Board of Directors. Jennifer Newstead is the Senior Vice President and General Counsel of Apple.
Prior to joining Apple in January 2026, Jennifer served as Chief Legal Officer at Meta. She previously held multiple senior roles at the U.S. Department of State, White House Office of Management and Budget and the Department of Justice. Jennifer also spent 12 years in private practice, advising technology, media and financial services firms on litigation and regulatory matters.
Her unique expertise in corporate governance, global business and technology and innovation will be a tremendous addition to the Emerson Board. Jennifer will officially join our Board on August 3, 2026. This will expand Emerson's Board to 11 members and we are excited to have Jennifer join us.
Please turn to Slide 4. End market demand remains strong. Underlying orders grew 5% in the second quarter, led by Software & Systems, which saw robust investment in our growth verticals and sustained momentum in North America and India.
I will discuss more details on demand on the next slide. Emerson's second quarter results reflect our ability to deliver in a dynamic environment. Underlying sales growth of 0.5% was below expectation due to a 1-point impact from the Middle East conflict.
Test & Measurement continued to exceed expectations, up 12% year-over-year and our Ovation business was up mid-teens, driven by the secular demand for power. Adjusted segment EBITDA margin of 27.6% exceeded expectations and we delivered adjusted earnings per share of $1.54, near the top end of our guidance. As expected, annual contract value of our software grew 9% year-over-year and ended the quarter at $1.64 billion.
We are updating our full year guidance to reflect the impact of the conflict in the Middle East and we now expect sales growth of 4.5% with underlying growth of 3%. Adjusted segment EBITDA margin is still expected to be approximately 28% and we are raising the bottom and midpoint of our adjusted EPS guide, now expecting $6.45 to $6.55 per share. We remain confident in our second half plans for 2026 based on the orders momentum we are seeing and the visibility we have from our backlog, which is up 9% year-over-year.
Throughout the first half, Emerson completed $542 million of share repurchases and we remain committed to returning approximately $2.2 billion of capital to shareholders this fiscal year. Finally, I want to highlight the strength of our differentiated industrial software portfolio to address concerns in the broader software market regarding AI. We are seeing healthy growth in ACV and expect to finish the year up 10% plus.
Our software is based on decades of deep domain expertise and serves mission-critical applications in highly regulated industries. These applications require real-time compute and traceability of data, where being right 99.9% of the time is not good enough. Further, we are well positioned to benefit from embedding AI in our solutions.
This represents a great opportunity for Emerson as we advance the journey to autonomous operations. Emerson recently deployed an AI-driven optimization solution for Aramco, one of the world's leading integrated energy and chemicals companies. Emerson's Aspen Hybrid Models were integrated into Aramco's existing refinery planning network to create one of the world's largest multisite optimization models and give Aramco a scalable, robust tool for global refinery planning.
Next week, AspenTech and NI will both host user conferences, where Emerson will showcase our latest innovations, which will help customers unlock greater levels of optimization and productivity across their operations. AspenTech will hold their OPTIMIZE event with over 1,100 customers from 49 countries, including keynotes from ExxonMobil, TotalEnergies and Exelon. NI Connect will feature keynote addresses from prominent customers, including NVIDIA and Alstom with over 1,600 attendees from 38 countries.
Please turn to Slide 5. Underlying orders grew 5% in the second quarter, consistent with our expectations and supporting our second half sales plan. North America and India continue to drive orders performance.
Demand in Europe remains stable but soft, while China has started the year slower than expected. Software & Systems orders grew 18% year-over-year, with Test & Measurement and Control Systems & Software both up 18%. We saw sustained robust investment in power with orders in our Ovation business up 41% and ACV in AspenTech's digital grid management suite up 31%.
We expect our growth verticals to be multiyear drivers of growth, supported by secular tailwinds and we are seeing significant capital being deployed in projects. Emerson won approximately $450 million from our project funnel in the quarter, with 85% from our growth verticals, led by power, life sciences and LNG. The funnel grew to $11.2 billion, driven by new opportunities in power.
Now I want to highlight a few key recent project wins. First, Emerson was selected by Oncor, the largest electric delivery company in Texas, to enable the delivery of reliable power to more than 13 million residents. Oncor will use AspenTech's DGM to modernize and scale its distribution grid, preparing for increased demand driven by the growing population in Texas.
Oncor will gain operational efficiencies and enhanced grid management capabilities by leveraging a purpose-built OT platform for both transmission and distribution systems. Next, Emerson was chosen by NextDecade for the Train 4 and 5 expansion to the Rio Grande LNG facility, which will add 12 million tons per annum in capacity. Emerson will supply instruments, valves and analytical systems and was selected based upon our strong operational performance in LNG applications and our local presence and support.
Third, a major pharmaceutical manufacturer based in Indiana, chose Emerson to support their 3-site production program for oral GLP-1s. Ramping production quickly to meet substantial demand is critical for this project and Emerson will provide our leading DeltaV Control Systems & Software as well as our ability to execute complex projects. Lastly, Emerson will provide NI software and modular hardware to a leading aerospace company headquartered in South Texas for the production of their next-generation communications satellite.
Emerson was chosen for its ability to provide improved test speed and measurement accuracy within a small footprint. Please turn to Slide 6. We have a $1.2 billion business in the Middle East, representing 7% of sales.
Emerson has an $8.5 billion installed base in the region and over 1,400 employees across manufacturing, field service and sales administration. The conflict presented a significant disruption in the quarter, causing a 1 point impact to underlying sales. First and foremost, the safety of our employees and customers is our ultimate priority and we took actions such as shutting down manufacturing for a period to protect our people.
In March, our field service engineers also operated at less than 50% of pre-conflict levels. Emerson maintains a strong regionalized manufacturing strategy in the Middle East but components for instruments and valves are imported into the region. Additionally, the closure of the Strait of Hormuz caused significant disruptions to ocean, air and ground logistics, which restricted our ability to import necessary components for instruments and valves.
Our customers experienced a varying degree of impact with 47 customer sites identified as having been damaged in some capacity. We saw a slowdown of MRO and project activity in the quarter as some facilities restricted personnel but we saw an improvement in activity in April. We are encouraged by the efforts of our employees and customers to drive business continuity.
The situation remains challenging and we expect it to impact the full year 2026 underlying sales by 1 point. Customer sites were largely operational by mid-April, although running at around 75% capacity due to their inability to move product out of the Strait of Hormuz. Emerson's manufacturing facilities are both operational and our field service engineers are now operating at 80% of pre-conflict levels.
The dedication and service levels of our employees is deepening customer relationships and we are working proactively with our customers to ensure we can meet their needs as they begin to work to repair damaged infrastructure. We have already seen rehabilitation activity and we expect to have additional opportunities as customers continue to assess their facilities. Overall, we estimate a future rebuild and restart opportunity of approximately $100 million, which will play out over several quarters.
Although the Strait of Hormuz remains effectively closed, our teams are implementing alternative routes and expect to see logistics continue to improve. While we are seeing increased freight expenses in the region, the cost impact to Emerson is manageable. Importantly, on-site project execution work is now progressing well at several key sites and the outlook for projects remains strong.
I want to reiterate how proud I am of our employees for their resiliency and we continue to stand with our customers during this challenging situation. With that, I will now turn the call over to Mike Baughman to discuss our financial results and guidance in more detail.
Thanks, Lal. Please turn to Slide 7 for a more in-depth look at our Q2 financial results. As a reminder, our first half financial results are adversely affected by a software contract renewal dynamic that impacted Q2 sales growth by approximately 2 percentage points, adjusted segment EBITDA margin expansion by 90 basis points and earnings per share growth by $0.09.
Our Q2 results were also adversely affected by the Middle East conflict by approximately 1 point. Excluding these headwinds, Q2 underlying sales growth was approximately 3%. We continue to see strong growth at Test & Measurement, up 12% in the quarter and Control Systems & Software, which was up 4%, excluding the software renewal dynamic.
I will provide more details on geographic and group performance on the next 2 slides. Price contributed 3.5 points to growth as expected and MRO was 65% of sales. Backlog ended the quarter at $8.2 billion, up 9% year-over-year and our book-to-bill was 1.07.
Adjusted segment EBITDA margin of 27.6% exceeded expectations and benefited from favorable segment and geographic mix. Price/cost and cost reductions more than offset inflation. Excluding the 90 basis point impact from the software contract renewal dynamic, adjusted segment EBITDA margin was up 50 basis points.
Adjusted earnings per share was $1.54, a 4% increase year-over-year, while Q2 cash flow came in at $694 million with a margin of 15%. We are on track for full year cash flow growth of approximately 10% at greater than 18% margin. Q2 was a difficult quarter due to the conflict in the Middle East and I am proud of the operational performance we delivered.
Please turn to Slide 8 for details on Q2 underlying sales by region. The Americas were up 5%, with the U.S. up 9%. The pace of business in North America remains strong with significant activity across our growth verticals and resilient spend in MRO.
As expected, Europe was soft, declining 4%. The Middle East and Africa was down 5%, driven by the conflict in the region as customers were forced to curtail operations. As Lal mentioned in his comments, we have modeled the conflict in the Middle East as a 1-point headwind to consolidated... [Technical Difficulty]
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Okay. Sorry about that. We had some technical difficulties.
We are going to resume on Slide 9 (sic) [ Slide 8 ], where we will talk about underlying sales by region. The Americas were up 5% with the U.S. up 9%. The pace of business in North America remained strong with significant activity across our growth verticals and resilient spend in MRO.
As expected, Europe was soft, declining 4%. The Middle East and Africa was down 5%, driven by the conflict in the region as customers were forced to curtail operations. As Lal mentioned in his comments, we have modeled the conflict in the Middle East as a 1-point headwind to consolidated Emerson sales growth in 2026.
During the first half of our fiscal year, we have seen better-than-expected growth in the U.S. We expect the strength in the U.S. to continue and we now expect the U.S. to grow high single digits for the year. This incremental growth is offset by a slower-than-expected China, which we now expect to be down mid-single digits for the year. Globally, we are seeing significant activity sustained in our growth verticals, which were up 22% in the quarter.
Power was up 23% and we saw healthy investment in plant modernizations, lifetime extensions and behind-the-meter generation for data centers. We also saw robust performance across the other growth verticals, including -- particularly in aerospace and defense and life sciences. Please turn to Slide 9 for details on the sales and margin performance for our 3 business groups.
Software & Systems faced a 4.5% sales headwind from the software contract renewal dynamic and reported underlying sales growth of 1%. The growth was led by broad-based strength in Test & Measurement, which was up 12%. We saw significant Software & Systems growth in power, life sciences, semiconductor and aerospace and defense.
Software & Systems margin of 29.2% decreased 250 basis points year-over-year, driven by the software contract renewal dynamic, which was a 300 basis point drag. Intelligent Devices underlying sales were down 1%. The conflict in the Middle East impacted this growth by 2 points, offsetting strength in power and LNG.
Intelligent Devices margin of 27.9% increased 80 basis points year-over-year from strong price/cost and cost reductions. Safety & Productivity was up 2% underlying, driven by electrical products and stable project activity in North America, while European markets remained soft. Safety & Productivity's margin of 21.7% was down 10 basis points year-over-year, driven by lower volume, offset by benefits from price and cost reduction.
Please turn to Slide 10, where I will bridge Q2 adjusted EPS from the prior year. Excluding the $0.09 impact of software renewals, operations delivered $0.08 of incremental EPS in Q2. Of this, Software & Systems contributed $0.05, Intelligent Devices added $0.02 and Safety & Productivity contributed $0.01.
Nonoperating items added $0.07, primarily from FX benefits. Overall, adjusted EPS grew 4% year-on-year to $1.54. Please turn to Slide 11 for our 2026 underlying sales guidance by business group.
We are adjusting our full year guidance for sales to reflect the Middle East conflict and now expect full year underlying sales growth of approximately 3%. We expect Software & Systems to be up approximately 8% in Q3 and are increasing our full year expectations to up 5% based on the strength of our growth verticals in this business and strength in the U.S. Test & Measurement is planned to grow mid-teens in Q3 and low teens in the full year, up from our prior expectations of high single-digit growth in 2026. The Control Systems & Software segment is expected to grow mid-single digits in Q3 and low single digits in the full year.
We continue to see robust adoption of our software and still expect ACV growth of 10% plus in 2026. Intelligent Devices is projected to grow 4% in Q3 and we are lowering our full year expectations to approximately 2%, driven by the conflict in the Middle East. Second half growth in Intelligent Devices is supported by backlog phasing and the timing of product shipments with strength in the U.S. and growth verticals offsetting a slower-than-expected China.
Safety & Productivity is expected to grow 1% in Q3 and 2% for the full year. The North America market continues to recover and we are seeing sustained strength in electric utilities. However, automotive and European markets remain weak.
Overall, Emerson expects to grow approximately 5% in Q3 and 3% for the full year. Excluding the impact of software contract renewals, Emerson's growth rate is expected to be 4% for the full year. Please turn to Slide 12 for details on our Q3 and full year 2026 guidance.
Before going through the details, I would like to highlight a few important assumptions embedded in our guidance. Our guidance considers a gradual resumption of activity in the Middle East and assumes the impact of the conflict remains in the region. Additionally, we expect a net neutral impact from the removal of IEEPA tariffs as this benefit is offset by increases in Section 122 and 232 tariffs as well as freight costs.
Finally, our earnings and cash flow guidance excludes any benefit of potential tariff refunds. For the full year, we expect FX to be a tailwind to sales of approximately 1.5% and GAAP sales to increase approximately 4.5%. We still expect adjusted segment EBITDA margin of approximately 28% and free cash flow of $3.5 billion to $3.6 billion.
We are raising the bottom and midpoint of our 2026 adjusted EPS guide and now expect $6.45 to $6.55. We still expect to return approximately $2.2 billion to shareholders through $1.2 billion in dividends and $1 billion of share repurchase, of which we completed $542 million in the first half. Moving to the third quarter.
Sales growth is expected to be approximately 5.5% with underlying sales growth of approximately 5%. We expect adjusted segment EBITDA margin of approximately 28% and adjusted EPS of $1.65 to $1.70. With that, I would like to turn the call back to the operator for Q&A.
[Operator Instructions] Our first question is from Scott Davis with Melius Research.
Couple just points to clarify. I thought the detail you gave on the call was pretty thorough. But -- so we lost about 1 point in the Middle East and it sounds like you expect to get about half of that point back.
Is that correct? Is the rest lost revenues? Or is there still optionality or potential to get -- to regain those -- the remainder of those revenues?
No, I think, Scott, we've seen the disruption in the Middle East. And as we mentioned, I think, on the call, there was about $50 million in the quarter. So as we look out, we're expecting about another $100 million of disruption.
What we see is encouraging with the supply chain improving but it's still a very uncertain situation and we've got 6 months left here for the year and capacity right now is running at about 75%. So we mentioned that there is some opportunity out there for rebuild and restart and that has started. But that's going to take, we think, 6 quarters to unfold here and we'll see how that goes.
But I would say I don't think there are revenues that are lost. And in fact, over the longer term, there should be opportunity. But in this next 6 months, based on what we saw in the quarter, based on what we see on the ground today, we felt it was prudent to bake that in and take the full year guide down by 1 point at the top line.
Okay. That's helpful. And then I don't think you mentioned why China was weak in the prepared remarks but down 9%, was pretty material.
Is that chemical related? Or are there other dynamics?
Surendralal Karsanbhai
CEO & President
Yes, Scott, this is Lal. Yes, I think you hit the nail on the head. Our exposure to the chemical industry in China, an industry that continues to be overcapacitized and very weak in terms of spend.
And we've been adversely impacted now for a few quarters and that continued through the second quarter of the year, which then led us to assess the China for the year more in the negative mid-single digits versus the low single digits as we had originally thought 3 months ago.
Our next question is from Andrew Obin with Bank of America.
Yes. Just a follow-up on the rebuild question. Was I correct that the value of the rebuild is $100 million?
Surendralal Karsanbhai
CEO & President
That's what we've assessed to date. That's based on pace of quotations and orders that we've received already. Now obviously, that's based on the 47 sites that have been impacted across the region.
That number could change over time. And that's also based on what we assess a restart procedures will entail for MRO activity. So that's all we have today, Andrew.
I guess the question I have is, I'm just sort of thinking about damage to Ras Laffan and your content, just that gets me a much higher number. So what's wrong with that kind of analysis? And then clearly, you guys are on the ground, you know what's happening.
But it's just -- it seems the number should be order of magnitude higher given the amount of damage that we've been reading about.
So Andrew, I think the way -- the $100 million we've estimated is on the damage created to the installed base on the 47 sites impacted. Now if you're talking about the 17% LNG capacity that came online to be rebuilt, that's a much bigger opportunity. We haven't really scoped that.
What we're scoping for you is the near-term disruptions we've seen in customers and as they try to restart operations, what we call our life cycle services businesses, we've quantified that over the next quarters to be in the tune of $100 million. But to your point, the capacity that was taken offline as that comes online, that's a much bigger number but we're not in a position to quantify it at this point.
Okay. That makes perfect sense. And then just another question, sort of more fundamental question.
Has dialogue changed post Middle East as to where downstream CapEx goes or chemical CapEx goes, right? Because I think a lot of capacity was reliant on Middle East feedstocks, huge capital costs, low cost of capital. But I guess, just as we've learned during COVID that maybe efficiency versus reliability, not necessarily the same things.
Has thinking changed about where facilities go going forward and where this capacity will be domiciled going forward? I'm just thinking, right, because I don't think chemicals are particularly competitive in North America. But any glimmer of hope of any of that capacity coming to North America?
Sorry for a long question.
Surendralal Karsanbhai
CEO & President
No, no, it's a good question, Andrew. And I think it's certainly worth thinking about the future balancing of capacity in the chemical industry. As you know, at least on the bulk chemical side, that's been largely dominated by China with Germany and in the United States having smaller components as you move towards the more specialized chemicals, the Europeans and the Americans have had more of a position.
That's going to take some time. Right now, I'd say the first step is going to be to find alternatives in the Middle East for the Strait of Hormuz. There's a lot of pipeline quotation activity ongoing across Saudi Arabia and a few of the other countries to bypass what likely will be a concerning pinch point from here on forward.
And so that activity has started. But certainly, I think as things start to settle, producers will eventually balance out capacity needs across the world and regionalize their production.
Our next question is from Andy Kaplowitz with Citigroup.
Well, maybe just a little more color on the near-term demand environment and orders moving forward. I know, obviously, you have difficult -- more difficult order comparisons from here. But as you said, you're getting good support from your growth verticals, particularly in power and Test & Measurement.
So can you sustain that mid-single-digit order growth rate in this environment? Did you see any difference in order cadence between January and April as a couple of your industrial peers called out a weak start to the calendar year outside of the Middle East?
Surendralal Karsanbhai
CEO & President
Yes. No, we felt very -- it was a very strong quarter outside of the Middle East. It was driven for us, as we remarked on the -- in the written comments, by the United States and by India, which led.
And we saw broad growth across all of the growth verticals with the lowest one being probably semiconductors in the mid-teens and all of them in terms of orders grew above that. So feel really good in terms of that resiliency. Of course, the Middle East was much softer than expected in the quarter.
We expect that to rebound. We have already seen in April that was encouraging in the Middle East, particularly as it relates to MRO activity and we'll see how the projects ultimately pan out. But no, look, I think mid-single-digit orders are sustainable for us as we navigate through the remainder of 2026.
At this point in time, we feel very confident that with our backlog support, we've got the second half well sized. And then with this momentum in orders, really setting us up for the first half of 2027.
Helpful, Lal. And as you said, your expectations for margins, really margin incrementals have been drifting up a bit given the lower sales forecast. And that's despite, I think, you're absorbing more inflation with price.
So maybe talk about what you're doing to offset the inflation. Are you baking in more, for instance, memory chip inflation and confidence level that can continue to offset inflation headwinds even on lower growth?
Yes. I mean I think, obviously, our pricing has been very, very disciplined. Our cost reductions and frankly, favorable mix in some of the sales we've executed has helped but ongoing productivity actions and supply chain mitigation actions to offset the inflation is really what's driving the margins.
Our next question is from Julian Mitchell with Barclays.
Just wanted to understand quickly sort of how you've thought about the high-level guidance moving parts. So you've taken a little bit off the revenue line. The EPS dollar guide low end though has moved up with an unchanged kind of segment margin guide.
So is really what's happening is, I think, $10 million narrower corporate cost and then perhaps some rounding in the margins. Is that what's helping? And on the mix front, you've mentioned it a couple of times.
Help us understand perhaps how you see that mix impact playing out over the balance of the year, please?
Yes, Julian, so from a margin perspective, you're correct when you say is it in the roundings. I mean it's not fundamentally changed. And if you think about it, our view other than the $100 million, the $50 million and the approximate $100 million in the back half of the year in a region that really has lower margins, our full year view hasn't changed.
The mix will improve a little. But as we've said, a lot of this growth in the second half is in backlog, it's projects. So there will be a volume uptick with some project and some mix going forward and it all nets out where we feel very comfortable holding the 28% for the year.
That's helpful. And then just as we're looking at the balance of the year, so I think you've got in Q3 and Q4, a mid-single-digit sequential revenue increase dialed in and kind of high 30s operating leverage. Is that a fair sort of placeholder for both quarters?
Anything we should bear in mind in one versus the other? And on the ACV front, I think you're embedding an acceleration in the back half. Anything to call out there?
I think from a leverage perspective, we're -- the numbers are affected by that software contract renewal dynamic and the FX there. But if you take that out, we'll be over 40% leverage on the year -- full year. And certainly, that means some acceleration in the back half.
From an ACV perspective, yes, we continue to reiterate the 10% plus for the full year. We had a good quarter and we continue to think that the ACV growth of 10% plus is the right number for us.
Yes. And I think you said sequential growth mid-single digits, that's correct. And also year-over-year growth is mid-single digits.
So I think that's an important addition to your statement. So I think you're spot on. It's sequential growth, mid-single digit, which is consistent with what we've executed year-over-year mid-single digit.
And if you do the math, the leverage will be a tad better than the 30s you stated for the second half.
Our next question is from Jeff Sprague with Vertical Research.
I just wanted to get maybe a broader sense of just the total global ramifications of this. The nature of my question, right, is the comment of the war stays contained in the Middle East but the economic impacts aren't contained, right? So we've got Europe becoming less competitive from an energy cost standpoint, maybe China not having the cheaper feedstocks it needs for its chemical industry.
So when you're kind of framing this and I know none of us have a crystal ball, like how are you thinking about those second order impacts? Or are you trying to dial those in, in any way?
Surendralal Karsanbhai
CEO & President
It's a very good question. And certainly, Jeff, we have to create a framework in which to set expectations for the second half and performance for the second half of our fiscal year, of course, within a time frame of just 6 months that we have to work with them to mitigate potential impact. That framework that we built has a very important assumption, as you stated, that this conflict essentially gets -- is constrained to the Arabian Peninsula, the Arabian Sea, the Persian Gulf area.
There are certainly economic downstream impacts that are already being felt, certainly feedstock pricing and supply. We have electricity curtailments in parts of Southeast Asia. We've accounted for as much of that, that we know today.
But very honestly, we have not assumed a significant deterioration in economic conditions or growth, for example, in India or any of the countries in Southeast Asia that in a much broader, deeper conflict could significantly be impacted.
Right. No, understood. And then maybe just a little -- I think if we didn't have this war going on, there probably would have been a lot more Test & Measurement questions.
Maybe just come back to Test & Measurement, the raw numbers you shared with us, growth rates sound quite encouraging. Anything beneath the surface on verticals, the distribution channel that you can share with us that sheds a little light on the demand profile here?
Yes. I mean I think the momentum in Test & Measurement is clearly led by semis and aerospace and defense. Both end markets are doing very, very well for us.
And frankly, I think we expect continued momentum across both those sectors, whether it's new space, defense spending and then certainly on the semi side, the RF and mixed-signal investments that are happening, data center investments. So I think there's no surprise there. Now we -- obviously, the weakest segment we have within our Test & Measurement business is the transportation segment or the automotive segment, though we believe we've kind of hit bottom and that will start growing low single digits.
Again, most of that business is in Europe. And our portfolio business has been resilient. Obviously, we had a nice run as we came through the recovery mode but that has stabilized in the mid-single-digit type growth rate.
So on a cumulative fashion, the double-digit for T&M is sustainable for the next couple of quarters and we expect that to continue into 2027.
Our next question is from Deane Dray with RBC Capital Markets.
Would love to do a similar run through on power, bigger number there. I think you said up 23%. But could you just talk about the visibility?
You called out plant modernization but also behind the meter. Where does that stand and the outlook for the balance of the year?
Well, I think from a power perspective, I think the momentum in terms of the project funnel, which is a pretty big funnel and that's made up of both modernizations as well as greenfield and we're starting to see a greenfield. There was some greenfield in Q2. We expect a bigger greenfield activity in the second half.
And a similar comment on behind the meter. We saw some behind-the-meter opportunities in Q2 but we expect more to happen in the second half and into 2027. So broad spread for the Ovation business.
Obviously, that flows through to our valves and instruments business, which is doing very well. And also, we called out our digital grid management business and the transmission and distribution side, a lot of investment happening in the T&D space. So broad-based strength in power, certainly led by North America, which is our strongest market but we are seeing momentum in Latin America, particularly Mexico, good activity in China, rest of Asia and some activity in Europe.
All good to hear there. And then if we just spotlight MRO for a moment and you called out it was 65% of your mix. In previous oil spikes, when you get $100 oil, you'll often see the refiners just turn on the cash register, run 24/7 and defer as much MRO project activity as possible, like right up until regulatory limits.
Have you seen any delays there? Do you expect anything like that this time?
Surendralal Karsanbhai
CEO & President
No, Deane. As a matter of fact, we tend to see when you run things that hard, the opportunities for MRO to actually increase for us, particularly in stringent applications of high pressure, high temperatures. And so -- but to date, we have not seen any change in trends that would alarm us to negativity on MRO anywhere in the globe other than, of course, what we highlighted related to sites in the Middle East.
Our next question is from Andrew Buscaglia with BNP Paribas.
So obviously, very topical throughout the quarter and throughout the year this year has been on AI -- has been on software. And it sounds like you guys kind of -- you have these new products out, Nigel, you talked about quite a bit. It sounds like adoption is going well.
But can you give us an update on anything you've learned intra-quarter on that front? And then I'm curious on the outlook, like how impactful do you see these products contributing to growth going forward as soon as this year? Maybe you can comment on that, please.
Yes. I mean I think a lot of customer interest, not only on Nigel on the NI side but certainly the capabilities we've launched on Ovation, DeltaV as well as AspenTech. I think it will be a very interesting users group event where you're going to see a lot more customer input as it relates to pace of adoption for both NI and AspenTech.
So we'll get to learn that in a couple of weeks. I would say, frankly, we do believe that it is a differentiator for us and we are seeing a lot of activity, particularly in the Ovation business in terms of customer dialogue and a lot of quotes around AI. I would say it's a little early for it to translate into meaningful revenue opportunities.
I mean we've been very thoughtful on pricing and making sure that we can extract value and tiering the product suites where we can capture the value with tiering on the higher tier products, which will have the AI functionality. I think time will tell. I think there's certainly a lot of customer interest but we don't have meaningful impact on revenue as we sit here today.
But I think as we progress into 2027 and beyond, I think it will be a huge differentiator for us.
Okay. Fair enough. And sticking with software, wanted to check on your margin cadence through the back half of the year.
There's a little bit of noise starting the first half versus second half. But yes, can you comment on what's behind the implied guidance for the back half of the year for that segment and the puts and takes there?
This is control -- Systems & Software or Control Systems & Software, just to clarify?
Yes. So yes, software -- yes, your Software & Systems.
Yes. It should be up a little bit in the second half versus where it was in the first half but pretty consistent through the year. There's some project execution there that plays against some of the mix favorability that we'll see in the -- in just the business mix that comes through.
Our next question is from Joe O'Dea with Wells Fargo.
You made a comment about seeing significant capital deployed in projects and would imagine that some of this is a continuation of what you've seen in growth verticals when you talk about power and LNG and life sciences. But I'm curious if you're seeing an acceleration as well as a broadening out at all. And I'm asking because I think a lot of what we've heard in terms of industrial end market activity is companies seeing a continuation of spend on areas like productivity but not so much a broadening out on the capital project side.
And so just anything there if you're seeing some broadening out or acceleration of this?
Surendralal Karsanbhai
CEO & President
No, I'll go and Ram, you can add a few comments. But no, we continue to see consistency in the funnel. And as you know, Joe, we look at that on a 2-year, 2.5-year out basis, 2- to 3-year basis.
It grew to $11.2 billion. And the growth has come entirely from -- inside of our growth verticals. Power really drove the growth in the funnel but the win rate and the project activities continue to be consistent within the growth verticals that we identified.
We haven't seen tremendous broadening beyond that. It continues to be those 5 core verticals that are driving not just the activity but also the feeding of the funnel.
Yes, you said it. I mean I think the new capital formation in our 5 growth vectors of power, LNG, life sciences, semiconductors and ADG continues to accelerate. I think every meeting we have with our businesses points to more opportunities in the funnel being added across these 5 verticals.
Now obviously, the core markets in energy, refining and petrochem depends on the geography there. It is stable or muted activity. But I think as it relates to the growth verticals, no slowing down.
In fact, we see accelerating additions of opportunities to the funnel.
And then just touching on the margin strength in Intelligent Devices in the quarter. We saw it in both Sensors and Final Control. If you can unpack that impact a little bit more with respect to mix cost actions during the quarter.
You do expect a step-up in the growth rate in the back half. Curious the degree to which volume then helps those margins sequentially and how mix is expected to play out as you move forward in the year?
Yes. As we talked about, it was the strong price cost and cost reductions. I will say we got a little bit of benefit in the quarter from not having the IEEPA tariffs.
And obviously, as we move forward, that will, as we talked about, that benefit will be offset by other tariffs and some freight cost pressure. I think as we move into the second half, the margins will kind of have, as you suspected, offsetting factors of volume being beneficial with some mix pressure as projects get delivered. So I expect to see that group improve margins year-over-year as they have been doing and continue to perform very well.
But yes, there'll be some pressures that should offset net-net but year-over-year, we'll see improvement in the operating margins there.
Our next question is from Alexander Virgo with Evercore ISI.
I wondered if you could just touch on a couple of things for me. Free cash flow came in a little light of where I thought it might end up being. So I wonder if you could just talk a little bit about that, how we might think about the phasing through the back half of the year?
And then secondly, just on ID, I think even ex the Middle East, the business came in a little light of your guide. So is the primary driver of that weakness in China and Europe? Or if you could unpick that a little bit for us, that would be really helpful.
Sure, Alex. In terms of cash flow, yes, the first half was certainly affected by the interest from the Aspen buy-in that was primarily in the back half of last year. And so we'll lap that out as we move forward.
And we also had some tax payment timing that was a negative in the first half. And I would say we also had a buildup of some working capital as we get ready for the second half of the year. If you're looking at prior year, our cash flow that year was far more ratable than it historically has been.
So this year will look a little more like we have looked in the 2 years prior to last year. In terms of what...
Surendralal Karsanbhai
CEO & President
Intelligent Devices.
Oh, intelligent -- sorry, I lost the point here. Oh, sure. Yes.
The Intelligent Devices, this period versus the expectation, yes, it was some softness in China and Europe, as you suspected.
Thank you. This concludes today's conference. We thank you again for your participation.
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