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

Ladies and gentlemen, welcome to the JPMorgan 2020 Industrial Conference fireside chat session with Rockwell Automation. Joining us today are Blake Moret, Chairman and CEO; and Patrick Goris, Chief Financial Officer; as well as JPMorgan analyst, Steve Tusa, the host of this call. I would now like to turn the call over to Steve. Please go ahead.

Great. Thanks, operator. Everyone, thanks for joining us once again here. We have now -- very pleased to have Blake, Patrick as well as Jessica from Rockwell. I think we're going to turn it over to Blake for a few opening comments, and I'm going to go through the Q&A. If you have any questions, as always, feel free to e-mail them to me, and we will go from there. With that, I'll turn it over to Blake.

Thanks, Steve, and thanks for everybody who's participating virtually this morning. I am going to begin with a few slides and then move to questions. Starting with what you should see is Rockwell Automation at a Glance. We are an industrial technology company, and our strategy is geared towards productivity and sustainability. Everything we do is about helping industrial companies and their people be more efficient to reduce energy consumption, to improve worker safety. And we feel very good about being well positioned in the business for what comes in the future. If we go to the next slide, we know that these are volatile times, and we do feel like our strategy and our framework is well positioned, whatever comes our way. We talked about this strategy in November, and we continue our resolve to invest in initiatives that not only can accelerate our long-term profitable growth, but also allow us to build even greater resiliency in our business. The execution plan that we laid out is still very much on track, beginning with growth in our core, in excess of industrial production rates; double-digit growth continuing in Information Solutions and Connected Services; and adding a point or more of inorganic growth each year, on average, strictly in line with our strategic priorities. We also show the financial framework that ensures that as we accelerate profitable growth, we stay with the same levels of performance that we've talked to you in the past about. If we look at some of the recent inorganic investments that we've made. Again, they're well positioned with one or more of the inorganic priorities, Information Solutions and Connected Services, adding process expertise and increasing share in Europe and Asia. PTC continues to perform well for us. We use the double-digit growth of Information Solutions and Connected Services as a bit of a proxy to show the growth in that area, not only growing the software that we have as a result of the relationship with PTC, but we're also seeing increased win rates in our own software. It makes us more important to customers, and we are well on pace for Information Solutions and Connected Services to exceed $600 million in revenue in fiscal '22. Sensia targeted at productivity in the oilfield had a good start as they opened for business on October 1. We believe that the relatively high exposure to OpEx versus CapEx in oil and gas positions us well as suppliers, now more than ever, are looking to reduce the cost it takes to produce a barrel of oil. MESTech is already helping us win business in Information Solutions. This is the systems delivery company that we have been partnered with for many years, headquartered in Pune, India, and as we grow the sales of our software of Information Solutions, MESTech is a great lower-cost resource to help ensure that customers get the outcomes that they paid for in the first place. And Avnet Data Security is a cybersecurity company based in Israel. It will establish a center of excellence for cybersecurity in Europe. Cyber is one of the fastest parts of Information Solutions and Connected Services, and this adds to our resources, our best practices and our consulting and services coverage throughout the world. We move to the next slide. The 2 most recent acquisitions that we made were ASEM and Kalypso. ASEM has best-of-breed industrial PC technology. It also increases our access in Europe to an important class of customers as most of ASEM's customer base are German and Italian machinery builders. So we're excited about the prospects of ASEM to increase our reach in the technology as well as in the market. And Kalypso is a solution provider focused on helping customers who are going through a digital transformation create their digital threads. They're technology-agnostic when it comes to design tools, like CAD and PLM, but they have strong expertise in bringing together these various software applications to reduce the time to design, and they're already getting engaged in some important projects at some of our large customers. So we're very happy about the existing expertise that they bring to us. If we move to the business resilience slide. We've talked a lot about the things that we're doing in multiple dimensions of resiliency. This is about clipping the spike in traditional cyclicality without giving up any of the growth prospects going forward, in fact, increasing those. And we talk about, on the revenue side, increasing our exposure to process industries as an offset to the traditional cyclicality of discrete industries. We talk about increasing our software subscriptions. Our recurring revenue, for example, is around $400 million, growing double digits, and we expect that trend to continue with our own organic efforts as well as the acquisitions that we're making. And then finally, the increased focus on life cycle services. It gives us a reason for being in these customers after the initial project and an ability to monetize over a very long period of time the services and the recurring revenue that should come to us as a result of delivering those initial projects. From a cost standpoint, we continue to have the discipline that you know us for in terms of being able to strip out costs when the times require it as well as redirecting investments to the areas of greatest need. We have a dynamic process and we continue to work that actively. From a balance sheet standpoint, we have an asset-light business model that, again, allows us to trade on our core intellectual property value. Another aspect of business resilience is our free cash flow, gives us a great example, as you look at this graphic of increasing cash flow, a strong percentage of total revenue and, again, looking at our CapEx for our internal operations to remain in the 2% to 2.25% range going forward. So we continue to trade on an intellectual property as opposed to high-cost fixed assets. The increased resiliency that we talked about a minute ago will contribute, we believe, to even stronger and more predictable free cash flow streams going forward. And then finally, the guidance that we provided in November. And again, in January, during the earnings call. And as we get a better handle on when our 2 most recent acquisitions of ASEM and Kalypso will close, we'll be able to give you a better information on the impact on fiscal year '20. Remember, we did mention previously that we expect those 2 acquisitions to contribute over a point of annualized growth going forward with profitable, incremental and accretive free cash flow and adjusted earnings per share. So with that, I'll turn it over to you, Steve, for questions.

Great. Blake, I know things are kind of perhaps changing week-by-week here. But maybe if you could just give us an update. You were in Florida kind of mid-February, talked a bit about an incremental impact from coronavirus, possibly, but that North American products were maybe doing a little bit better than expected, at least that's how I interpreted those comments. Maybe you could just give us an update a month later, kind of what you're seeing out there. Most companies are understandably not giving a full picture, but maybe just some context for us to be able to kind of make our own assumptions and analyze what could happen here in the next few months or even quarters.

Sure. Well, Steve, let me use the same framework that I used with a little bit of additional information and additional color based on what I talked about a few weeks ago and what a difference a few weeks makes. But we talked about our own plants in China. We talked about the supply chain, order intake in China and then a little bit on the rest of world. And so I'm going to use that same construct as I go through some additional remarks. In China, we have plants in Harbin which is way up in the Northeast, and as well as in Shanghai. People are back to work, and our production in our plants is keeping pace with current demand. From a supply chain standpoint, we mentioned before that some of the supply chain actions that we took to mitigate tariff impact are actually benefiting us now, based on the current environment. It's still a very fluid situation. And we are working with suppliers in all regions to mitigate any potential disruption or lead time increases, and we're selectively increasing our inventory levels of some components and products to protect the supply for our distributors and our customers. And I should mention that all our distributors in China are back to work. In terms of China order intake, for reference, China is about 6% of our total sales, there's a clear impact, as you would suspect, of coronavirus in China, particularly in February. But in the end of February and into early March, we did see some weekly sequential improvement in order intake. We expect China to be down versus expectations and year-over-year in Quarter 2, but it's too early to determine the fiscal '20 impact as we assess what sales were lost versus delayed. From a rest of world standpoint, North American product sales through last week were encouraging, but obviously, March will be key with respect to our worldwide Q2 performance. So that's a little bit of a rundown with some additional information, Steve.

That's great color. Appreciate that. The kind of magnitude of the February declines, we obviously saw the ISM come out for China. Not sure how reliable that can be, but certainly, a pretty weak number. I mean are we talking kind of solid double-digit declines out of China? I think most of the guys that sell into air traffic, which was a bit of a delay, but certainly a pretty dramatic drop off, have talked about that in the first quarter and then March being down solid double digits, obviously. Just trying to kind of put the pieces together. How should we think about the magnitude of what you're seeing in China?

Yes. I think double digit, particularly on the product part of China sales. And again, China is about 6% of our total business. China has a little higher percentage of solutions and services than the company average. So the impact was greatest on the product portion of the China sales.

Got it. Got it. Okay. That makes sense. When you think about the breakout of the business in China, can you just give us a rough update on what the pie chart looks like there when it comes to verticals?

Yes. So, recently, as we looked in Q1, I'll start with some of the areas of strength, China actually saw oil and gas and water treatment as 2 of these strengths. Automotive in China was down, whereas auto for Asia was actually up based on some performance in other countries. The mix of verticals in China is similar to the corporate average, probably a little bit lighter on oil and gas than the average as well as a little lower -- a little higher, I'm sorry, a little higher oil and gas than the average and a little lower food and beverage than the average. But in general, with those 2 modification, similar to the corporate profile. And I'll just mention, the corporate profile, as you look at discrete, hybrid and process, discrete's about 25% of our sales with auto and semi as 2 of the main areas there. Hybrid, with food and beverage and life sciences, ecoindustrial is about 40% of our sales corporately. And then process is about 35% with oil and gas, mining, metals, chemicals and so on.

And when you think about the oil and gas exposure now, what is the -- what's kind of the split between up, mid and down these days? I know last cycle in '14 and '15, you had a pretty heavy upstream exposure, if I recall, perhaps in some of the acquisitions and refocusing. And it's ex Sensia, of course, unless you want to throw Sensia in there as well. What is the kind of breakout now? And how might things be different this time around for that oil and gas business?

Yes. About 60% upstream, both onshore and offshore. Sensia is focused fairly heavily on the upstream side, although they have solutions extending into midstream and even to the refinery with respect to process. Sensia, however, has a greater weighting to OpEx versus CapEx. So again, relatively small amount of Sensia is geared towards exploration of drilling new holes in the ground versus increasing the efficiency of existing wells and extending its life. So it's all about production, not drilling, and reducing the cost it takes to produce a barrel of oil. That's more important now than ever. But I want to be clear, at the oil prices that we currently see, that's going to put pressure on oil companies. And we do think that it's possible even likely that there'll be some consolidation in the industry, and so the survivors are going to be the ones that do invest in innovation and technology to reduce their cost to produce. And so that's what we're geared towards. We like the positioning of Sensia. But there's no question that the current environment is putting extreme pressure on those operators.

What is the -- just remind us of what type of revenue you expect from Sensia? The type of revenue that's going to run through your P&L this year?

Yes. So Patrick?

Yes. Steve, for the full year, we expect the incremental revenue from Sensia to be a little bit over $200 million. So we contributed a little less than $200 million. Schlumberger contributed a little bit more than $200 million. And overall, Sensia revenue will therefore be a little over $400 million.

Okay. Got it. Got it. That's very helpful. Do you think we should use kind of the '14, '15 construct as the right one for what could happen here in the intermediate term, over the next 18 months as this oil price kind of filters into CapEx budgets? Or are there any major differences in your view?

No. I think that was the last time that we saw a rapid decline in oil prices, of course, from something over $100 a barrel to much less, right, down $40 or so. We saw declines in our oil and gas business at that time, significant double digits. We've only seen about half of that recover so far. So I would say if you're looking purely at the numbers, then there's not as far to fall from our business. And again, with Sensia, in particular, we've taken steps to increase the exposure to OpEx versus CapEx there. So I think those are some differences in what we're looking at from that time. And then, in general, and this is more broad than oil and gas, we remain -- we still have the same levers. And I think we've learned some additional things in terms of being able to strip costs down as necessary going forward, while still making sure that we're going after the pockets of continuing growth. I want to make that point. We haven't made a carte blanche shift from growth to cost. And I think that's dangerous to talk about a company moving from one mode to the other so starkly. While we are keenly aware of the current situation and are prepared, as we have done in the past to take cost down as necessary, there's still areas that are growing. There are areas that are growing even within oil and gas on the production side. There are areas with life sciences, electric vehicles, and we're going to continue to pursue those growth opportunities.

Right. So when you talk about the kind of IS and CS business, can you maybe just talk a bit about what's in there? And then where are kind of the most kind of the highest growth pieces of that? I know you guys haven't broken that out. You guys have broken down the path, but it kind of has evolved over time. I'm not looking for any kind of straight numbers on that, just which parts of that are meaningful and are kind of the most exciting to you?

Yes. So when we first started talking about this bucket of Information Solutions and Connected Services, or ISCS, that was about fiscal year '18 and we introduced it with a total revenue of about $300 million, growing double digits. It's well north of that now. As I mentioned, we do expect that we're on track to exceed $600 million in that business in fiscal year '22. And that was based on what we had at the time. So that included the PTC investment, but it did not include some of the newer investments in things like Kalypso, which would be a part of that now as well. So we're happy with the way that it's growing, both organically and through acquisitions. We've been able to put a number of quarters together with strong double-digit growth. And if you look at what's in those, Information Solutions has our traditional MES offering. It has our FactoryTalk Analytics. It has ThingWorx from PTC, Kepware, Vuforia, augmented reality, which continues to be a really exciting and even game-changing part of that offering. That's on the software side. On the Connected Services, as things like cybersecurity, consulting and remediation, Avnet Data Security, again, is a part of that now. Remote monitoring, something that we've done for many years and now have literally hundreds of customers that we're providing remote monitoring and surveillance for as well as enabling machine builders to spin up their own lines of business using our infrastructure. Network design and implementation and then the software delivery services, and Kalypso would be an example of a new entry to that area.

Steve, it might be helpful to recall why we're excited and focused on ISCS. Those are our new revenue streams, and we see some of these new revenue streams on top of other control platforms, not ours. About 50% of that revenue is recurring in nature. And the third element this is from a margin point of view, it's neutral to slightly accretive. And that is why there is also a lot of focus on increasing the ISCS revenue streams.

Right. And how big is that again? Sorry, I might have missed that in the beginning. How big is that business now, that bucket of revenue?

It's about $400 million, growing double digits. And as Blake mentioned, we are on pace to reach or exceed $600 million in '22, which implies a mid-teen-ish CAGR.

And you would expect, I guess, if we do go into a bit of an industrial production pullback, I guess, that we should think about 50% of that continue to pace and then 50% of that probably kind of trends in line with the economy, but not as bad as the economy. So it holds up, it just doesn't go down as much as the economy does? Is that kind of the way we should think about that revenue bucket?

Yes. I think -- directionally, I think that's right. I'll give an example. Going back to 2009, and this is an area that I didn't mention as part of the portfolio of services, but remote technical support, we had back in 2009. And when the rest of the company went down double digits, we actually saw an increase in remote tech support up about 2% during that period of time. And it's an inexpensive form of insurance for access to technical experts. And I think there are other parts of that ISCS business that may follow that kind of path. And since then, by the way, remote tech support has probably doubled in size from what it was at that time.

Right, right. Can you talk about where you've seen the most success with PTC? And, I guess, how you have leveraged that relationship? And then maybe contrast that with what it would have taken to kind of home grow something like that within Rockwell. Always curious as to the decision of make versus partnership or buy. Maybe just give us some context on now that you've had a couple of years under the hood here, how convinced are you about how good that decision was relative to just going it alone?

Yes. Well, first of all, the decision feels good here a couple of years on. We've talked a lot about the convergence of IT and OT, the information technology and then factory floor or operational technology. And it's not only the technology that's coming down from IT into our space, but it's the pace of change as well. Things are moving faster and PTC and our Information Solutions business, in general, is on the front lines of that. So speed is important. And when you look at technologies like augmented reality, it would have taken us several years to have started from almost scratch, really, and build up an offering there. And I'm not sure how differentiated it would have been at the time. But now, augmented reality through the relationship with PTC, is a part of around 1/3 of the sales of our FactoryTalk innovation suite. And we were able to start selling it within a month or 2 after the agreement in 2018. And so today, we've built up. We've seen expansions of some of those initial pilots. And so that's a great example of how that investment allowed us to move at a faster speed than we could purely on our own. I think we probably move faster even than we could have if we have made an acquisition. So that's an example. When you go back to where we're seeing some other successes, it's across all industries. It's across all regions. Food and beverage has been a great area for it as these companies are looking to do things like benchmarking across their fleet of similar lines. Look at OEE, for instance, their efficiencies, and identify why one line is running more efficiently than the other and then moving to address that. We see it with the Kepware offering that allows connectivity to a lot of different smart end devices, not just Rockwell, and we've talked before about how a lot of that software is going on top of competitive control platforms. Kepware, specifically, gives the ability to pull data out of many of our competitors end devices as well as ours. And so it gives us another way to win at these customers that, for whatever reason, didn't have our installed base of Logix processors.

How big is this kind of FactoryTalk innovation suite you're talking about? And would that be -- that's a subset of the ISCS portfolio?

That's exactly right. FactoryTalk Innovation Suite is the part that's most related to the investment in PTC. It includes the ThingWorx software from PTC, Vuforia augmented reality, Kepware, as well as our FactoryTalk Analytics offering and some of our MES as well. We haven't broken out the specific dollar value, but it's a fast-growing part of that overall ISCS bucket.

You think it's like -- is it as big as 1/3 of that?

It's big. And importantly, it's almost entirely subscription-based.

Got it. I'll stop that line of questioning there. Can you -- but I had to ask, sorry, I was trying to look for the revenue breakdowns. When it comes to the margins, if we do end up seeing a bit of a revenue pullback in the automation economy, wouldn't be unique to you guys. You talked about the 30% to 35% incremental kind of on the way up. How should we think about kind of the decremental leverage if we had, call it, a 2% to 3% type of revenue decline? How do you -- what kind of levers do you guys have to protect margins? I would assume that the product business goes down more than your stable business, which could maybe be flat or up a little bit. What -- how do you -- what are the levers to protect margin? How should we think about the decremental leverage if things slow down and decline a little bit? What's different this cycle than -- versus last cycle, perhaps, on the margin side?

Yes. I'll make a couple of comments, and then I know Patrick will have some additional ones. We talk about the 30% to 35% incrementals on growth in the mid-single digits of growth. So we like to think that the decrementals are less than that mid-single digits, then we can hold it to less than that kind of conversion. We do have some levers to pull that we've used in the past, probably -- with probably some additional ones. Our incentive comp, for instance, is one that we have used before that can be implemented. We don't do it lightly, but it can be implemented without a lot of additional charge. And then some of the things that we've done before, aimed at the growth side that are meaningfully different than even in '15 and '16, and certainly, from 2008, 2009. Patrick maybe some of the additional cost levers?

Yes, Steve, maybe a couple of comments. One, the decrementals will, of course, depend on how deep any revenue reduction would be and the pace of that. Now, of course, we're running scenarios, we still run at levels of contract labor today that are higher than they were, say, 10 years ago. So that's a lever that we can use. We do have, as we normally do, restructuring items and actions that are ready to go in case we need it. Also, within our current guidance and Blake referred to that implicitly, we still have incentive compensation in there of about $70 million. And as you know, our incentive compensation is very variable and is very closely related to how we perform financially. And then finally, of course, we have a playbook from prior downturns on other levers we can pull temporarily in case we need to.

And one final comment is, different even than '15 and '16, we have increased the low-cost profile of our development resources. So that was a deliberate strategy to have an appropriate balance between high-cost and low-cost development resources.

Got it. The -- speaking of resources, the balance sheet and the cash remains pretty strong here. You guys have definitely made a bit more noise about doing acquisitions. And you've certainly continued the pace of bolt-ons. Is this something that we should think about kind of every year adding maybe a point or 2 of growth on acquisitions? And should we continue to think about these, focused on the ISCS and also perhaps incremental technology bolt-ons, like this industrial PC one you just did, and not kind of in the direction of more, I'll call them, electromechanical devices like field devices and things like that?

Yes. It's -- it continues to follow our inorganic priorities. Continue to follow the framework that we talked about of Information Solutions and Connected Services, process expertise, and examples of that would have included MAVERICK as well as Sensia and then increasing share in Europe and in Asia and ASEM, the industrial PC company, in addition to having some really strong technology increase in our access, in particular, in Europe. Per our framework that we introduced a little while back, over time, adding a point or more of growth a year is what we're expecting, but it will be lumpy because we're going to start first with the properties that have the best strategic fit. And some of that is a function of availability, affordability and so on, but we're going to start first with the strategic fit and then make sure that it hits our financial criteria based on free cash flow yield in excess of our WACC plus a risk premium. So we have done a little bit more here recently. I'm very happy to welcome these new capabilities. And I think the final comment I would make is that you should expect future things that we do in this space to be more of the traditional acquisitions. So we made an investment in PTC. We executed the joint venture to form Sensia. But going forward, you should expect these to be more traditional complete acquisitions when we do them.

Right. And, I guess, this should -- should we think about it as kind of a more steady diet? I never really -- you guys have bought back stock and the acquisitions were out there, but it wasn't a real kind of topic of conversation. It feels like we're talking about these things more and more, and it makes sense because you guys have such a great installed base, such a great channel globally. And that's really when these bolt-ons can accrete akin to kind of a bit of a flywheel as one of our other companies refers to it. Should we think about this as something that we should see every year now?

This is another way to win. And we have a strong pipeline and we're going to continue to work potential targets through that pipeline. It's a mix. I like the diversity in terms of the size, in terms of the fit with those different priorities. And I think you should see this as a regular part of our ability to grow in value. I'll also say, I am encouraged by the performance of some that we've done over the last 3 or 4 years that are working well for us. So when we look at the customer value as well as the financial performance, some of the things that we've done over the last 3 or 4 years, where we now have a little bit of a track record, look good. And I think it's a capability that the whole company, not just the core dev function, which we did build, but within the businesses and sales, they recognize that this is another way to win. And to use our strong balance sheet to do these things and, of course, share buybacks and dividends are still part of the mix of capital deployment, in addition to this newer muscle that we're exercising with respect to acquisitions.

Got it. And I just have one follow-up from e-mail in the last minute here. I guess just a little bit more clarity on the potential decremental margin. You guys definitely talked about some levers you could pull. In the end, do you think you can hold that 30% to 35% in a low single-digit revenue decline type of environment? Just wanted to kind of get a marker on that. It sounded like there are levers you can pull to do that. But historically, obviously, the decremental has been a little bit worse than that, sometimes way worse than that in '08, '09, given how dramatic that decline was, of course. Just a little more precision around that. If you're not comfortable giving it, no big deal, but we had a follow-up around that item.

Steve, Patrick here. In an environment where we would see low-single digits of organic revenue decline, clearly, that would be our objective to stay within that 30% to 35% on the decremental and not being worse than that.

Got it. Perfect. Okay. I'm going to leave it there. We're out of time. I really appreciate you guys being flexible and managing to spend 40 minutes with us in a day with people in virtual one-on-ones, much appreciated. Best of luck, stay healthy, and we'll talk on the first quarter call.

Sounds good, Steve. Thank you.

Thank you, Steve.

Thanks, Steve.

Thank you, guys.