Rockwell Automation, Inc. (ROK) Earnings Call Transcript & Summary

Yes, I think we're good. So welcome to day 2 of the Citigroup Global Industrials Conference. Again, I know most of you, Andy Kaplowitz, I cover multi-industry and E&C. We are very excited to have Rockwell Automation with us, with Chairman and CEO, Blake Moret. Blake has been with the company since 1985, many leadership roles during your tenure, and we're really happy to have you here. I know you have some prepared comments you want to make. So I'll switch places with you, and we'll go from there. Great.

Thanks, Andy. Good morning, everyone. Happy to be here with a brief respite from the Milwaukee winter. So I'm going to spend about 10 minutes with some remarks, touch on some current events, and then we'll go into Q&A. So for those of you who are new to Rockwell Automation, factory automation, electrical controls, software, services. Our core business is automating basic processes in a wide variety of industrial applications, everything from discrete applications like automotive; hybrid applications like food and beverage and life sciences; and then pure process applications like oil and gas, chemical, pulp and paper, all over the world, and we pride ourselves on providing long-term value. We win the right way. We do it with integrity and in a spirit of inclusion around the world. At the Investor Day in November at our Annual Automation Fair, we gave a framework. We put together a framework to kind of summarize our main areas of emphasis for top line growth and the guidelines for doing that profitably. The theme of that Investor Day was accelerating profitable growth. And you see the main areas that we expect to grow faster than the market. It's growing our core at a multiple of roughly 2x industrial production. It's growing the new value of the Connected Enterprise, Information Solutions and Connected Services, double digits, and I'm happy to say that over the last 3 years we've done just that organically, but also now adding to that some recent acquisitions that contribute to that additional value to customers. And then finally, using all of our strengths to win. We have a strong balance sheet. And adding a point or more of acquisitions that fit first with our strategic framework, but also with a rigorous financial criteria. And then you also see on this, some of the financial guidelines that we look at; high conversion on incremental sales, discipline around capital allocation and a high ROIC. We've made more acquisitions over the last few years than we have in the past. We do that because the pace of technology in the industrial automation world has picked up, and it's also a great way to bring new talent and new ideas into the business. So PTC is the largest investment that we've made, not an acquisition, but through the PTC investment, we've dramatically expanded our presence in information software. About half of those wins -- with the FactoryTalk innovation suite that includes PTC and Rockwell software, about half of those are on top of competitive control platform. So it's another way to win at accounts where we don't have the basic control. And we've seen that play out over and over across a variety of industries. Sensia is the joint venture with Schlumberger. It opened for business on October 1. We had a good first quarter, double-digit growth as we provide the digital oilfield technology and services, mainly in upstream oil and gas, but with value throughout the oil and gas industry. And we talked about that at length at Investor Day, and then we updated the financials at our earnings release in January. MESTECH delivery services for software, already enabling more business in that area, not only in their local market, but also around the world based on their cost base and their knowledge. We've won some projects that we probably would not have won without them. And then Avnet Data Security, which is cybersecurity services out of Israel. It will help us establish a center of excellence in the EMEA region for cybersecurity. That is one of the fastest-growing businesses for us, cybersecurity assessments and remediation on the factory floor, and this will supercharge that. Yesterday, we announced 2 additional acquisitions. ASEM is an Italian industrial PC manufacturer. They also have software for human-machine interface and enabling remote monitoring. We're very excited about this, first, for the products that they provide us, and second, for the access in Europe. Their primary customer base are Italian and German machinery builders. So that's a prized market. And this puts us on offense in that area. Kalypso is a consulting services company as well as software delivery integrator based out of the U.S. with offices in Cleveland and Portland. Primary industries: consumer and life sciences. And they enable customers to create a digital thread for their product-focused businesses. So we're thrilled to have this new addition of talent to the team that can help customers bring together disparate software applications to create a digital thread and to accelerate their digital transformation. And they're already engaged in some of our biggest customers, and we expect to see an immediate benefit. The combination of the 2 increases our revenue by over 1 point in the first full year and is expected to be accretive to EPS and free cash flow in the first year. We'll update our guidance in April when we have a better idea of when those acquisitions will close, and we'll update that inorganic growth. What I'm showing you here is the guidance as of late January, when we released earnings for the first quarter. So we'll update that -- the impact of the recent inorganic investments. I want to also make a couple of comments about the quarter that we're in so far. Coronavirus is having an impact. You've heard a lot about that. For us, we're watching and seeking to mitigate the impact in 3 primary areas. It's in our plants, it's in our supply chain, and it's with order intake. I'll talk a little bit more about that in the Q&A, I'm sure. I will say that we have had some benefit from some of the mitigation actions that we took when we were seeking to limit the impact of tariffs over the last year or 2. We had some supply chain moves that actually have helped us here because it moved down some of our supply chain manufacturing footprint from some of the areas that are in the heart of the affected coronavirus area. And I also want to say that while coronavirus is having an impact, on the other hand, we have seen encouraging sales from North American products so far in the quarter. It's early in the quarter, but I think it's important that you have a somewhat holistic view of what we're seeing at this point in the quarter. Still early, these situations are very dynamic, but we want to get that out there. And so with that, we'll go into Q&A.

So it's probably the right time then to just ask you follow-ups about what you just said. And let me ask you in couple of different ways. First of all, as you know, North America was sort of weakening for you guys over a couple of quarters. So it's very interesting comments you made about if this is sort of an inflection in the North American business at all, and we can talk about that. And the other question I'd have for you is on sort of supply chain in coronavirus. Most of the companies have said, "Well, we've been able to sort of get our factories running, but we're running at substandard level." Is that kind of where you guys are, too? And then how concerned are you about sort of the global supply chain that the issues there could sort of bleed into fiscal Q3 and beyond?

Right. Okay. So North America and impacts of coronavirus. So you're right. North America, particularly around Q3 of last year, we talked about the uncertainty with respect to trade at that time that was causing our customers to delay some purchases. And we've been talking about uncertainty for at least a year. And in Q3, we said it is having an impact. And then we had in Q4, where -- while we continued to see some weakening in certain industries, particularly on the process side, a little bit with food and beverage, we actually saw some better-than-expected performance in automotive, for instance in Q4, and then in Q1, we actually had some growth in automotive. I think it's still a mixed picture. We have not characterized the optimism about the start to this quarter in terms of which industries are doing better than others. We typically do that deep dive at the end of the quarter to prepare for the actual earnings release. And so while we're not updating guidance, we don't update guidance in the middle of the quarter, we thought because coronavirus is definitely having an impact, it was important for you to have a view of other potentially material factors.

Got it. And then on the supply chain and...

Right. So I mentioned 3 main areas when we look at the effects of coronavirus and our efforts to mitigate those effects. The first is our plants. We've got 2 plants in China, in Shanghai as well as in Harbin. Harbin is medium-voltage equipment. Shanghai is engineered-to-order as well as we do push buttons and some components there, split between serving the Chinese market as well as exporting to rest of world. And you're exactly right. We're watching closely the return to work of our employees. While we're not talking about the specific percentages from hour-to-hour or day-to-day, there's nothing to indicate to us that we're doing something particularly better or worse than the typical curve of people coming back to full production. There's some variability in different cities, different situations, depending on where you are in China, but we think that we're faring somewhere in the middle in terms of that return to work and productivity. The supply chain is one that like tariffs, the impacts kind of ricochet around, and it's really hard to predict exactly where you're going to have the issues. So we're certainly in constant contact with our biggest suppliers that have manufacturing footprint or have their own suppliers, kind of a tertiary effect, their own suppliers sitting in China. And in addition to looking at what they're doing, we're also looking at the impact on freight. And you're seeing a little bit about that in the news where because planes are canceling flights -- freight companies are canceling flights into China, it disrupts the pattern that they would normally go into Asia and then from there into Europe. And so you see some knock-on effects there. Again, we had some help because some of our suppliers moved the manufacturing that they're doing for us out of Mainland China. And so that's helping some. But that's probably the biggest area in terms of what we're watching. And then finally is order intake in -- at Chinese customers. And China is about 6% of our business. So it's not a huge amount of our business, but it's, obviously, an important market. And a question that we'll be looking at through the quarter is whether we're seeing orders that are down that aren't coming back or whether we'll see that spring back and obviously, it's too soon to say when we're on a recovery curve and can extrapolate to full business as usual.

Got it. That's very helpful, Blake. So one of the things when we look at your presentation is, again, all the activity, the inorganic activity is striking, right? And so you go to the Automation Fair. And you just see like all your partners there, and -- it just is very, very striking in that respect. So my question really is, since you've started, you've really ramped up the partnerships. You really ramped up the M&A. It does seem to be leading to outperformance on a market share basis. So maybe you can talk about the ability for you guys to take market share because frankly, this has been kind of a downturn for the industrial world, and it really hasn't been that bad for you.

Yes. So when I came into the role, which is to my astonishment, it's been almost 4 years, so really, there were a few things that I wanted to do. I wanted to be able to use all of our strengths to win, which included using a strong balance sheet to move a little bit more deliberately with respect to inorganic investments. And it was also finding more ways to win at a customer. And so while we're -- I don't like saying, "Hey, we're becoming a software company" because it implies we're not playing our own game. We still are an industrial technology company that's focused on productivity for our customers, but software and services are playing a larger role in ensuring that customers get the outcomes that they invested in. And so we do that by making investments organically. We're still spending hundreds of millions of dollars on important internal developments to grow our intellectual property. And obviously, that's one of the safest, most profitable ways to grow our financial performance. And we're doing that around software configuration tools for the design and the operation and the maintenance of our connected systems. We're also doing it through acquisitions and inorganic investment. We've talked often about the strategic framework for considering those acquisitions. It's Information Solutions and Connected Services. It's process expertise, and it's expanding our reach and our share in Europe and in Asia. So we've been deliberate about that. When you look at the presentation I just went through, we say -- we look at our acquisitions and determine which of those priorities, usually multiple priorities, does it hit and then we look at the financials and the return there.

So one of the, I guess, feedback that I get is, "Well, Rockwell's become a lot more diversified." So that sort of helps on the downside, but does it also cap some of the upside? And it's striking also that you see that the end markets like process and hybrid are now bigger than discrete for you guys. So maybe you can talk about the ability to outgrow now that you are so diversified?

Yes. Well, again, it's about more ways to win. And so we're trying to accomplish 2 things. One is, as you said, to increase our resilience to clip the trough of those downward parts of the cycle. We're doing that through process growth because that serves as a little bit of a natural hedge versus the early cycle discrete businesses like automotive and semi. Then you have a growth in subscription-based software and then an increase in life cycle services. There's no reason that those things can't help our resilience, but also help with our top line growth as well. So increasing our penetration in the process should help us grow as we move closer to a market share for process control like we enjoy with discrete control. Subscription-based software isn't a panacea, but starting each year, not from 0, but with a base business that approaches 10% of recurring revenue, which is kind of a near-term goal, that's going to help with top line growth as well. So we're not cannibalizing anything by doing this. Do we miss the kind of surge in business, if we were 50% automotive when the SAAR count comes back and so on? Maybe, but that's not what we're seeking to do.

Blake, how does it help with visibility of the franchise? Like, so you talked on the quarterly call about backlog being up sequentially, right? But like, when I think of Rockwell, I think of you -- historically, 6 weeks of visibility, and that's it. So maybe you could talk about the transformation or if there is such a thing, and your visibility toward the business now versus when you started as CEO.

Yes. I think as we increase process, because that -- those types of businesses involve more projects that you have the engineering as well as the product content, there's a higher project versus component content in process. And so we will see backlog becoming a more important metric as we go forward. As you said, I mean, Rockwell, today, our average backlog is probably weeks or maybe a month or 2. It's not very much. It's a lot different than when I started with the company, when we had Rockwell International, and you had B-1 bomber backlog and things like that, right? It's -- we're not going back to that point where we have a huge amount of backlog. But it will increase. And more importantly, the subscription-based software and as-a-service business models will increase that base of contractually bound business that repeats year after year. And that's what we're going for, that truly recurring business. So leave aside the MRO business that typically gets bought, but there's no contract that says, a customer has to buy, but the truly recurring subscription-based software, technical support contracts that go over multiple years, it's a little over $400 million, growing double digits, and we expect that to continue to grow much faster than the company average.

So Blake, it's my opinion that people still are confused about your auto exposure in the sense that they look at it and they say, "Okay, it's just global builds and we follow that." But you, obviously, in the last couple of quarters, you said that you outperformed sort of up mid-single digits. And over the last couple of years, you've talked about EV penetration. You've got some stuff going on in Southeast Asia. So maybe you can like talk about why you're outperforming now? Should we -- EV was small for you guys, but it seems like it's becoming more important every quarter. So maybe talk about what 2020 brings in terms of outperformance?

So the 2 things I would point to for our outperformance, I want to be careful about talking and claiming big share gains because it takes more than a quarter or even 2 to say, we're growing share in an industry. This is a long-term game. That being said, we think we are winning more than our traditional share of powertrain in EV -- actually in internal combustion engine powertrain for that matter, but especially in electric vehicles, where our readiness to serve is higher than it is in traditional internal combustion engine power transmission. When you make a gasoline-powered engine, there's a lot of subtractive manufacturing. You need CNC to bore cylinders and to grind and all those metal working activities that you don't have in electric vehicles. And so that's more of a traditional assembly and fabrication process that we have a really good portfolio to serve. That's the first area. The second is the increasing attachment of software for scheduling that sits on top of the core automation system. So MES software, and there's very high attachment with electric vehicles, but even in traditional internal combustion engine, fabrication, people are recognizing that putting that software on top of the basic control, whether it's our basic control or it's our competitors control, we're seeing that, and we have a very good software offering there with many, many references that are up and working and providing value in the industry today. And so we're winning there as well. I think those 2 factors, the electric vehicle rise and the software attachment, are contributing to some of the pleasant surprises we've seen in auto over the last couple of quarters.

So I want to open up to the audience in a second, but let me ask you a follow-up there. So again, when you went to the Automation Fair, you saw a lot of MES. You saw a lot of augmented reality. So it seems like you guys are kind of ahead in sort of the next big things, like AR seems like a big thing. It might just be cool, but like maybe it's a little more than cool. So maybe talk about how these things are starting to drive the business?

Automation Fair, just for those of you who don't know, is our annual Rockwell and our friends show, training session, seminar week really. It was in Chicago. We had almost 20,000 people there, and it will be in November in Anaheim. This is an opportunity for us to show our technology working in integrated solutions for different industries and with our partners. And we were very proud this year of showcasing some of the new, especially software, but not only augmented reality figured prominently; simulation tools, our own and those of our new partner, ANSYS, figured prominently in the show. And what I was so encouraged by is just what you said, that it showed up in many different parts of the show because our people, as they were planning what they were going to exhibit, saw these things as being really helpful. And so there was pull. It wasn't just all right, we are going to put this package here and here and this other place, it was our team saying, "Augmented reality is real now." Customers are starting to vote with their wallets that is providing them value in terms of knowledge transfer, in terms of error proofing. We're piloting it in some of our plants. We're using it in our field service activities to be able to project the expertise from remote locations, the people who can help newer field service members in the field, and we're seeing augmented reality present in about 1/3 of the FactoryTalk innovation suite orders that we've had over the last 1.5 years with PTC. Simulation is a similar one. We bought an English company, Emulate3D, last year. And to be able to simulate the operation of your automation system without actually having to run boxes through your packaging machinery or whatever and running a lot of product, saves you a ton of cost and time. That's one that has absolutely captured the imagination of our people and our customers.

Any questions from the audience? Vlad?

You talked about adding a point or more of growth kind of with M&A, so you're still assuming that? How do we think about the potential for doing bigger M&A? Or the opportunity even to further invest in some of the partners or investments that you already saw that would make sense for more PTC investments.

Right. Let me just repeat the question. So just what's the potential to do bigger M&A and potentially invest in some of the partnerships that you already have?

Yes. So we think it's important to maintain a diverse funnel of potential acquisition activities. And while we have said what we did with PTC and Sensia is nontraditional, and you should not expect more of those minority investments or joint ventures, then we do have that diversity in our pipeline of acquisition opportunities, both diverse in terms of looking at those priorities, Information Solutions, Connected Services, process expertise, market access, Europe and Asia, and also in terms of size, in terms of some that are almost too small dimension. And then others that are over $1 billion in terms of valuation, specifically with respect to PTC. The focus of that relationship has always been on the IoT and the augmented reality. It is interesting that they have PLM and CAD, and we're learning about the interaction of the different applications. But we're very happy with the progress that we're making. And I think Jim would say the same thing from a PTC standpoint, in terms of the development of the relationship, the impact on customers, the speed with which we were able to bring solutions to market, like augmented reality that have had an impact, the ability to penetrate from Rockwell standpoint, competitively held accounts. All those things are very satisfying. As we get to the end of the first 3-year period, we'll look at ways to strengthen that relationship in accordance with our mutual strategic interest, but I'm happy with the way that it's going at this point.