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

Good morning, everyone, and welcome to the Goldman Sachs' Second Annual combined Industrials and Materials Conference. This is our first one doing it virtually and hopefully our last. Just some rules of the road for investors that would like to ask questions. If you're logged in to our web link you can either ask a question via the participant view or you can send me an email to [email protected]. Now before we get started, I want to read certain disclosures, I'm required to read certain disclosures. So we're required to read certain disclosures and public appearances about Goldman Sachs' relationships with companies that we discuss. The disclosures relates to investment, banking relationships, compensation received or 1-or-more percent ownership. We're prepared to read out loud disclosures for any issuer upon request. However, these disclosures are available in our most recent reports available to you, as clients, on our firm portals. Also the views stated by non-Goldman Sachs personnel do not necessarily reflect the views of Goldman Sachs. Okay. With that, very excited to kick off this virtual conference with Rockwell Automation. Excited to have both Blake Moret, the Chairman and CEO of Rockwell; and also Patrick Goris, CFO, here with me today. Blake is going to kick it off with a few minutes of prepared comments, and there are also slides on the webcast. So with that, Blake, why don't you take the mic?

Joe, appreciate it, and I want to thank everybody who's listening in today. I appreciate your interest and looking forward to the discussion. As you're following along with the slides, turn to the Rockwell Automation at a glance slide. Rockwell Automation is an industrial technology company. We're focused on productivity. We go to market in 2 business segments, serving a common customer base worldwide, and we're serving customers in discrete, in hybrid and process applications across the industrial span. We win the right way. We're all about creating long-term value for our customers and other stakeholders. If you turn to the next slide, how we're navigating the current environment, a lot of our current energy is being spent in keeping our employees safe. We have reworked our manufacturing environments, practicing social distancing and all the things that you would expect as we continue to operate as an essential business. We're doing that because we're really playing a critical role helping to provide essential products like masks and medicines and food during the crisis. So it's a long list of stories. We talked about some of them in the earnings release about how we're helping our customers keep things running during the crisis. If you move to the next slide, full year outlook highlights. We did provide guidance after a good second quarter. We do expect the current quarter, our fiscal quarter 3, to have the sharpest decline but throughout this, we're preserving strong free cash flow. If you look at the organic industry segment outlook, the next slide, we're continuing to provide value really across the entire customer base. In quarter 2, you might recall, our automotive, semiconductor and food and beverage were actually up year-over-year in that quarter. You see the outlook for the full year. And there's more specific split in the appendix, I think, that shows the contribution from each of the individual vertical segments. Moving to strong balance sheet and liquidity. We do -- we have a strong financial position, and we have the ability to continue to invest in the creation of new value organically, but also with the continued robust pipeline of potential inorganic investment opportunities. In November -- on the next slide, accelerating long-term revenue growth. In November, we refined our framework for growth, and it has 3 main parts to it. First is the continued share gains in our core platforms. And we've got some exciting new products, things like independent cart technology, the continued performance of Logix as the centerpiece of our control architecture, but also with new capabilities in process applications and a stronger push into Europe and in Asia, so increasing share in other parts of the world. We continue to be very encouraged by the development of our business and information solutions and in connected services. You see some of the specific offerings there, things like cybersecurity, consulting and remediation, remote monitoring, MES software. Of course, the FactoryTalk Innovation Suite with PTC. All of those things continue to win in places where we're providing new value and many times on top of our competitors' core control platforms. And then finally, adding a point or more from inorganic investments. Our reported sales in Q2 were actually up driven largely by the additional contribution of inorganic investments of recent acquisitions and the Sensia joint venture. Turning to the next slide, inorganic investment highlights. Earlier in the year, we launched Sensia. We closed the acquisition of Avnet, cybersecurity services. In the STEC, softer delivery and more recently, ASEM in Italy, a manufacturer of industrial PCs along with some very interesting software for human machine interface, and we're monitoring. The current customer base is primarily machine builders in Europe, in Italy and in Germany. We think there's going to be a great opportunity to introduce their products to our North American distributor base. Kalypso is a solutions provider and consulting firm, specializing in digital threat applications. And I can tell you they are already fully engaged in some of the most important projects that we have and adding a whole new dimension of value to our existing services and solutions offerings. And then finally, I want to make a comment about the future. I talked a little bit about this in our earnings release, but we do believe that some of the trends that are coming to light as people learn to navigate in the new environment are good fit with the offering that we have, things like creating resilient supply chains, reducing single points of failure in those supply chains and localizing some of those supply chains, remote engineering, remote design, remote monitoring, being able to project expertise where you can't have people on-site in some mission-critical applications and that's something that we have a lot of expertise in, and we're seeing considerable increased interest as we look at the uptake in augmented reality, the Vuforia chalk offering that we have with PTC. And then product traceability. Being able to look how a product was made, where it was being made to ensure the quality to be able to trace back the supply chain that's something that we learned how to do within the Life Sciences industry, I think it's going to be more important, both in Life Sciences and in other manufacturing around the world. It's a good fit with our strengths. And so with that, happy to open it up for questions.

Appreciate the prepared comments. And I want to -- you ended up ending a good segue, right? The resilient supply chains and localizing those supply chains. But clearly, restoring has been a theme that's been getting a lot of attention. And I guess the question that I get most from investors is why now. So maybe you can touch a little bit about what you're hearing from your customers, specifically around realigning their supply chain and how you feel reshoring, what kind of impact that could potentially have over the next several years?

Yes. So we have definitely been brought into specific conversations by some of our customers about increasing the locations that they're manufacturing some of their high-value products. We're looking at some of those things ourselves. I've mentioned Stanley Black & Decker is one. And then there are a number of Life Sciences' customers that aren't ready to go public with their plans yet. But we do believe that it's a hot topic at customers in multiple applications. I think I would characterize some of the impetus and the why now this way. Over the last, say, 10 or 15 years, some of the locations that people offshore their manufacturing to, have a rising wage rate. So you think about areas in Asia, for instance, that were low cost. People were moving there for wage arbitrage. Initially, they're not that low cost anymore. And so that was -- let's say, a negative, but a little bit of a headwind, but not enough to make people -- make wholesale changes. Then you had the trade conflicts. And again, with the addition of tariffs, the uncertainty there, it caused even more uncertainty around those offshore manufacturing locations. And finally, with the COVID-19 crisis, and the prospect of having countries shut down, I think it's finally prompted people to look at increasing the number of places that they're manufacturing so that their highest value, highest margin products can't be cut off if a country gets shut down for reasons of what we're going through currently or any sorts of future events that destabilize the supply chain. So that's the way we're thinking about it, and I think that's the way a lot of our customers are thinking about it.

No, that seems to make a lot of sense, especially that last point, just around diversifying your manufacturing base for your high-value products. I guess the flip side of that is that we're in this downturn right now, and a lot of companies are trying to conserve cash. So as you think about kind of like the timing of when you can really see this really start to take hold, is this something where we kind of need to get through the current backdrop? Or do you think that customers are going to be more front-footed and make those decisions today?

Yes. I think it has a lot to do with the specific vertical that you're in. So if your demand is through the roof and you're making personal protective equipment, you're making masks or ventilators, you're trying to ramp up the production of test kits or potential vaccines then you're on it right now. And so I think in those sorts of industries, you're probably already starting. If you're in other industries where consumer demand is not so high, you're probably going to be a little further out before you make those sorts of moves and you start releasing capital.

Got it. That makes sense. And maybe kind of switching gears a little bit. I know that you guys just reported a couple of weeks ago, and gave us some trends as of April 24. You guys were assuming like roughly a 20% decline in fiscal 3Q. Is anything notable that you call out either from an end-market or regional perspective based on what you were just seeing a few weeks ago?

No. I think that's the best information that we're providing at this point. We certainly expect industries like oil and gas to take longer to recover. We're not counting on prices of oil to recover dramatically. And so I think we have a realistic view there. The automotives, the Detroit area plants look set to reopen beginning next week. We're getting called in to help them get prepared to return to production in those cases. And obviously, the types of customers that we talked about in the earnings release that have been going strong throughout this. The prepared food providers, the mask makers, people making ventilators and so on, the business continues to be strong, and we're providing both products as well as support.

Okay. Great. I guess maybe one part of your business, the solutions piece of your business. You did reference some project delays in your inability to get into the factory floor to do some final acceptance. Has that started to ease at all? And where are you getting affected most today?

Yes. I think -- we are expected to see through the month some easing of the ability to get into plants. I think we'll continue to see a tentative view with respect to our customers and coming to our facilities for things like final acceptance test. We're using remote technology wherever we can to move forward with those. And again, as we said on the call, we see push outs, but we're not seeing broad cancellations of projects.

Got it. Okay. So my next question, you mentioned that there were a number of important strategic wins that you had. You referred to a bunch of different end markets where that occurred where you weren't the incumbent control platform. I'm actually getting a question from the audience that fits in very good with this. So can you give us maybe an example or just elaborate on just your competitive advantage, specifically on your PLC products?

Well, our PLCs continue to be really valued because of their ability to solve Logix -- logic across a wide variety of applications with a single platform. So you have one Logix platform that can solve, process or hybrid applications in one part of the plant. And then at the other end of the plant where you're packaging up what you make, being able to use that same control platform for discrete is really valuable for the very clear reason that you only have to train your maintenance people on one technology. They only have to understand one software configuration tool, and they can work in the so-called wet end of the plant, where something is getting mixed up and blended to the packaging side of the plant where it's getting put in boxes or tubes and shipped out the door. So it's a benefit to our customers. It's a benefit to us because it's less costly to maintain and to keep current one technology platform. We can put all our effort into that, and that contributes to some extent to our high margins.

Got it. And is there -- I mean, do you have any advantage at all from -- is there anything around like your -- whether it's open architecture that you have? Is that considered an advantage that you have relative to some of your other competitors?

Absolutely. I mean we made a decision a long time ago to use Ethernet as the standard communications and do not try to continue to hold on to a proprietary network. So that's a good element of openness that the market has chosen, moving more to that endorsing OPC UA as a standard that adds an additional degree of openness. Those sorts of things are all priced by customers, and we think are going to be more important as time goes on.

That makes sense. Blake, maybe just going around the regions. China, specifically, you called out this past quarter and really kind of looking like a V-shaped recovery there, at least through April. That was pretty encouraging to see. I mean can you maybe just touch on some of the end markets that have been leading the recovery? Are these the same end markets for you that were down a lot in the January time frame?

Yes. So first of all, geographically, we talked about a strong recovery in China and maybe better-than-expected results in Asia. We're not choosing that as the model that we based our outlook on around the world. You also look at other markets like Italy that we're seeing some sequential improvements in, but not at the same rate that China did. And so our guidance looks at those 2 examples as important data points and charts, of course, that fits a little bit in the middle of that. In terms of the vertical end markets, we saw growth. We saw strong growth in automotive in Q2, driven largely off of our continued wins in electric vehicle. We had a great win in Asia for a battery manufacturer. And then the continued successful competition for traditional projects for vehicles with internal combustion engines, that we've been tracking for a while that came to fruition in the quarter. We don't expect automotive to continue to have strong year-over-year growth for the balance of the year. We saw food and beverage with growth in Q2, and that's positive. I think it speaks to the strength of what we're offering. But again, we're not expecting continued growth in food and beverage for the balance of the year. Life Sciences is an interesting one. You might have expected that to be up in Q2. While we're seeing a lot of business in Life Sciences, I think one reality is that now those customers are focusing 100% on getting what they're making today out the door in greater quantities than they ever have before. And so some of the longer-term projects that might have diverted resources are being pushed a little bit and so while we're getting a lot of orders to increase and to scale up existing production, some of the other projects were deferred, not because they're not important, but just because it's every able hand on deck to get what they're currently making out the door.

Got it. No, that's helpful. And maybe just following up on those auto comments, really interesting to see how much it was up year-over-year and even sequentially. Can you maybe help size like how big -- within auto, how big the EV business is? And you referenced that battery making equipment win as well. Just trying to get a sense for how much those pieces of the business could potentially help dampen some of the cyclicality that you would see with legacy internal combustion engine spending?

Yes. So we've talked about automotive in total as around 10% of our business. This year, it will actually be a little bit less, which for long time Rockwell watchers, that may be a little bit of a surprising statistic because we really have diversified. Within that, think about electric vehicle and powertrain, powertrain, both for electric vehicles as well as the powertrain business we're doing for traditional internal combustion engines. If you take that together, EV plus powertrain, around $100 million of that business and growing faster than the rest. Powertrain, because a lot of our customers are producing powertrain or drivetrain for both types of vehicles, it's very hard to tease apart, which is for what. So we bring that together. And then when you look at the additional activity in electric vehicle, we have talked in the past about some of the customers like Rivian that we're doing work for, it involves the other standard parts of putting a vehicle together. So you still have a paint shop. You still have stamping. You still have the final and the trim parts of the operation. And all that together is about $100 million. Battery manufacturers, I'd say, is a specific bright spot for us with the independent cart technology, that's the precision motion control using linear motion controlled technology we really have a very differentiated offering there. A lot of our traditional competitors just don't have it. And it's really a good fit for those applications. And so that's why we continue to win at a high rate in battery assembly.

Okay. That's great color. And maybe one more question just on end markets before I get to Patrick on the cost actions that you guys announced. Just on the oil and gas business, also kind of interesting to see how good the backlog is today and that it's been holding up relatively better. But I guess when I think of process, I think the refineries and right now, production is down a lot. So can you maybe just elaborate a little bit more on why it's been so strong of late? And how you're thinking about kind of the trajectory on the go forward?

Yes. So just for background, we've got 2 broad pieces of our business in oil and gas. You've got the traditional product business that continues to flow through our distributors, products that are sold to VARs and other -- and directly to users. And then we've got the new Sensia joint venture that we formed with Schlumberger focused more on the solutions, where we're working directly with those end customers, primarily upstream oil and gas operators, and heavily weighted towards OpEx, not drilling new holes in the ground. It's more about reducing the cost to produce a barrel of oil from an existing asset. So it should be less affected by the stopping of CapEx spend within oil and gas. That being said, when people are shutting in wells, it's going to put pressure everywhere in oil and gas. No question about that. But we do believe that the waiting for its OpEx as well as some of the critical applications that we address, such as process safety. We're a leader in process safety, and people are going to still pay attention to that even during a time like this. It's going to allow us to continue to deliver value in this vertical. And again, I just want to reiterate, we're not expecting some big recovery in the price of oil. So our outlook, our forecasts are based on what I believe is a realistic view of the price of oil.

And how does -- maybe just one follow-up there. How does that kind of change your -- in what's been happening with oil sitting at $20 to $30 a barrel? Like how does that change your expectations at all for the Sensia relationship?

Yes. So we're still positive about the value that it can bring, domain expertise and understanding our customers' problems, the focus on OpEx and long-term productivity, the world, even in the depths of this crisis is still consuming over 60 million barrels of oil a day, and we expect that, that will inch up as people get back on the road and eventually in planes, so energy production and doing it efficiently is still important, and I'm optimistic about the prospects for Sensia to help us grow share in that area.

Okay. Great. And maybe just transitioning now over to Patrick. And Patrick, you guys outlined about $150 million in 2020 cost savings. I just want to make sure I have all the moving pieces, right? So there's about $40 million of incentive comp that reversed in fiscal second quarter, about $35 million in incentive comp to decline in the fiscal second half. And then lower investment spending of $65 million to $75 million. Is that ballpark-ish, kind of how you guys are thinking about it?

Yes. The way you can think about it, Joe, is for the full year on a year-over-year basis, think of it as being a little over $150 million of savings. Of the $150 million, $80 million relates to lower incentive compensation expense. Of that $80 million of incentive compensation expense, we saw about $40 million in the second quarter. And we expect to see about $20 million for the balance of the year. For the third quarter, we actually expect a headwind of incentive comp of about $10 million. And fourth quarter, we expect a tailwind of about $30 million. So that's with respect to the $80 million of incentive comp, and that leaves you with about $60 million, $70 million of overall lower spending, and that really includes some of the benefits we get of the temporary actions we implemented, but also offset by some of the incremental investments that we've decided to make more recently.

Okay. Super, super helpful. And then I guess, as you're thinking about some of these temporary measures, is it fair to assume that a lot of these measures kind of reverse themselves in fiscal '21 as demand normalizes? Or do you think that there will be a portion that you'll essentially get to keep?

I think that the answer to that is it all depends on the slope and the curve of the recovery, and that will be the main driver for our decision-making as to what temporary actions do we undo. I would also add to that, that as I mentioned on the earnings call that we have identified additional more structural items that may decide to implement the business conditions require or just for us to reallocate resources to highest -- or higher priority investment opportunities.

Got it. No, that's helpful. So I guess maybe just following up on that point. As you kind of think about what -- what levers you could pull from a structural perspective, what would make you essentially have to take additional actions. Can you maybe just provide a little bit more detail or color on what you could do and what would the emphasis would be?

I think in terms of triggers, it is the slope of the recovery. Is there no recovery at all? Do we think this is a longer-term event? That is not our current view, but that would be a potential trigger. But another figure, as I mentioned, would be is, and we are constantly looking to see how we can reallocate resources to our highest priority. We may decide to pull some of these -- or to trigger some of these items just to reallocate resources and increase our investments in targeted areas.

Okay. Okay. Great. And then Blake mentioned earlier, you guys were one of the few companies actually that gave detailed guidance this quarter, which was definitely appreciated. I know that you threw out a fiscal 3Q EPS number of a little bit more than $1 per share. Historically, you've been fairly conservative in the way that you've given guidance. And honestly, I had a hard time kind of getting to the dollar number. So how should I kind of be thinking about the decremental margins? Or should I be kind of chalking this up to conservatism?

No, the way you can think about it, Joe, is that in the third quarter, we expect we -- our current guidance assumes that our third quarter is, call it, the trough, with organic sales down about 20%. And our organic sales particularly down in our higher-margin product businesses. So the fall-through there is pretty high. At the same time, as I mentioned on the call, we're seeing some inefficiencies in our plants, our supply chain and our solutions and services businesses, given the current environment. And we're not getting the full run rate benefits of the cost actions that we've implemented until May 1. And so we're not getting the full benefit of that in the quarter. And then finally, as I -- as we just talked about incentive comp in the third quarter, incentive comp is actually a headwind, not a tailwind. And so that gets us to -- again, and the main driver there is obviously the levels of organic revenue performance. But that gets us to an earnings conversion, excluding currency and acquisitions, of about 50% in the third quarter.

Okay. Great. No, that was very clear. And maybe just kind of -- I think we've got a couple of minutes left. Shifting it back to Blake for a second. At the -- at your Investor Day in November, you kind of outlined your long-term vision for Rockwell. There are several key priorities that you talked about regarding bringing the connected enterprise to life, above-market revenue growth, superior returns. I'm just -- I guess I'm just wondering in the backdrop that we're in today, has anything really materially changed? Or have any of your priorities shifted, just given the experience that we've been through in the last few months?

No. I think the strategy is working. We saw a strong contribution from our core automation in the second quarter. So Logix was up 8% in the quarter, which speaks to the intrinsic value of that core automation. Information Solutions & Connected Services didn't have as strong a quarter, mainly due to a tough year-over-year comp, but we built backlog, and we're still expecting that to be $400 million worth of our business growing fast. And the things that we're offering there, the consulting to help customers better define their business problems, the remediation in areas like safety and in networks, remote monitoring, additional productivity through information software and analytics, all those things, I think, are going to be at least as important going forward as they were. And then as I mentioned before, helping ourselves with acquisitions that fit our strategic priorities. We've done more recently, and we continue to have a strong pipeline.

That's great to hear. Guys, with that, we're bumping up on time. I really appreciate you both attending our virtual conference today. It was great speaking to you, and wish you all the best throughout the rest of the week.

Yes. Same to you, Joe, and thanks to everybody for listening in.

Great. Thanks, Joe.