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

Good morning, and welcome to Wolfe Research Global Transportation and Industrials Conference. This is the Rockwell Automation Fireside Chat hosted by Wolfe Senior Analyst, Nigel Coe. [Operator Instructions] And now I hand the call over to Nigel.

Thanks, Ruth. I'm not sure how new I am, but very pleased to be hosting Blake Moret, Chairman, CEO and President of Rockwell Automation. Blake, I think this is the first time we've done a fireside since you became CEO, so we're very grateful for the time today. The format of the session will be Q&A. I'll direct the questions, but I will pause towards the end to see if any questions from the audience. You can ask a question via the text box of your browser or e-mail [ [email protected] ]. And I'll take a couple of questions in the order in which they are locked. So Blake, I know you have some slides and prepared remarks. So over to you.

Great. Well, Nigel, happy to be with you and with everybody who is tuned in this morning. I'm going to make a few remarks beginning with the slides on Page 3. So if we could advance to that. So a little bit of a primer on Rockwell Automation. We're an industrial technology company and we're focused exclusively on productivity for our customers and their people. We have 2 business segments that we go to market with, but we serve a common customer base and we're serving customers across discrete industries like Automotive and Semiconductor, hybrid industries like Food and Beverage and Life Sciences, and process industries like Oil & Gas and chemical and mining. We focus on winning the right way by delivering long-term value and expanding human possibility. If you turn to the next slide. A lot of our current energy is focused on keeping our people safe throughout our worldwide operations. We are an essential business because our products enable customers who are producing masks and medicines and test kits and potential vaccines because you simply can't produce those things at scale without a high degree of automation. Next slide. So we did provide guidance. So we felt that it was important to share with investors the information that we thought was going to be most important in charting the course going forward. Off of a relatively strong Q2, we guided that quarter 3 was going to be what we believe the trough of declines in terms of revenue with some sequential improvement in quarter 4. We also noted that inorganic investments was going to play a reasonably prominent role in our results. And in fact, during quarter 2, our reported sales actually registered growth paced by our inorganic investments in their early contribution. Next. We talk a lot about our performance by vertical industries and we introduced what we think is a simplified way to view our performance in verticals, again, across discrete, hybrid and process, and you can see our outlook for the year with the assumptions within that. And we'll certainly talk a little bit more about this as we go to questions. Next. Throughout this, we maintain a strong balance sheet and the liquidity to be strong through this crisis, but also to continue to invest in areas that we think are going to be the highest opportunity going forward. So as customers invest in the resilience and the responsiveness of their supply chains and their internal manufacturing operations, we believe that we already have a very strong offering to help customers in this area. But if we see new opportunities, organically or inorganically, we have the strength to be able to move towards those as well. Next. As we introduced in November, we talked about the ways that we're going to grow. It begins with our core, adding new value in our core, such as Independent Cart Motion technology, Logix as the center of the automation architecture. And in quarter 2, we saw 8% growth in Logix, which speaks, I think, to the intrinsic value of those products. We talk about continued strong growth in Information Solutions & Connected Services, where we expect, even with the current crisis, to achieve $400 million worth of sales in the current fiscal year and then creating more value and more ways to win through the contribution of inorganic investments, which we expect on average to contribute 1 point or more of growth each year. We're seeing that in fiscal '20, and we certainly expect that in fiscal '21 as well. Next. The next slide, please. Yes. Just speaking to the contribution of some of our recent acquisitions, we launched Sensia, the joint venture with Schlumberger, earlier this fiscal year. We also began operation with Avnet Cybersecurity as a Rockwell company and MESTECH, a software delivery integrator based out of India. They're already having a very positive contribution. And more recently, ASEM, an industrial PC manufacturer and also the producer of HMI Software; and Kalypso, which provides consulting and delivery services for customers who are embarking on their digital transformation journey. And in the case of Kalypso, we're already seeing a material impact on some important projects with some of our biggest customers. Next. And so with that, I'm pleased where we're positioned as we go forward to weather the current crisis and to provide even more value to customers, again, as they look for creating more resilient supply chains in the future. So with that, I'll turn it to you, Nigel.

Thanks, Blake. That was a great way to set the stage. I guess the most obvious question would be that the messages you gave there were very consistent with what we heard on your 2Q call. But at the margin, are you seeing any changes, any change in the sea by end markets or by geography compared to where you were at this time last month?

So we've talked at our earnings release about what we were seeing in terms of the development of end markets. We saw, on the one hand, with strong growth in the second quarter from Automotive based on some electric vehicle wins as well as some line of sight to some traditional projects that came to fruition. But we don't expect Automotive to continue through the second half of the year with growth. Semiconductor was another bright spot, and we do think that longer term, the trend towards things like data centers and 5G are going to spur investment. We saw the news that Taiwan Semiconductor was looking at potentially putting a big operation into Arizona, which was positive news. Food and Beverage, which had some growth in the second quarter, although we do expect that to moderate in the second half of the year. And Life Sciences which, on a tough comp, was down a bit. But if you're engaged in the race to scale up test kits or to find a vaccine then you're certainly extremely busy in that part of your operation, and we're playing a critical role in a lot of those customers' efforts. Oil & Gas is the one that is going to be the longest to recover. We're not counting on any big rebound in oil prices. But we like where we're positioned there, which is more heavily on the OpEx side rather than a new CapEx because lowering the breakeven point by which operators can produce a barrel of oil is what is absolutely the central goal, and that's where we're focused on, particularly with our Sensia joint venture.

Great. That's a great summary. Some companies have talked about May being substantially better than April. Have you seen any evidence of that at this point, Blake?

Yes. We haven't talked about the continued development of orders, but I can tell you, we watch product orders on a daily basis as an early indicator and particularly looking at the different countries that may have entered into the depth of the crisis at different times. So we continue to look at recovery in China. We look at the development in Italy. And then, of course, as in our big market in North America, looking at what's happening here as well.

Okay. Great. You mentioned Taiwan Semi's announcement to build a big, I think, $12 billion fab. What sort of content could that provide to Rockwell? Assuming you won the bulk of your addressable markets in that kind of fab. What sort of revenue content could that be for Rockwell?

Yes. I mean, a project like that, I think they talked about the overall investment of $13 billion. So whatever percentage you take of that, it's a big number. And it's a big project for Rockwell. There's different parts to that. There's the primary process equipment, there's material handling. There's the facilities management control system. These are all areas of opportunity. And that particular customer certainly has an installed base with Rockwell, but we'll look at that and other projects and aggressively pursue them.

I mean, I think you found -- wouldn't that kind of be in your [ toolset ], I don't think, Blake? But what kind of end markets would -- if you do see a reshoring activity, be it pharma or food, et cetera, what would be the typically rich verticals for Rockwell?

Well, as we've talked about, we're very happy with the diversification that Rockwell has had over recent years, in particular, with moving with a real nice balance between discrete and hybrid and process verticals. So we've mentioned here recently that we expect Automotive to account for less than 10% of our total business in fiscal year '20. And for a long time, Rockwell watchers, including myself, we remember a time when Automotive was far, far more of our total business. So I like that diversification and so if industries are moving -- and it doesn't necessarily mean new rooftops, right? It could be putting additional capabilities into existing facilities, and that's fine for us. But I think it's positive, particularly if they're coming to the Americas where we have relatively high share. Industries like Life Sciences, that might have an urgent need to decrease, let's say, single points of failure and to be able to produce their high-value products in more than one place, getting closer to their markets. That's certainly a great spot for us. We think Life Sciences has crept up to a little more than 5% of our business. So it's not a huge percentage, but it's rapidly growing. And we have a particularly good offering between the products as well as the software for Life Sciences companies that might be moving their operations and their supply chain around. Food and Beverage is a very strong vertical for us. And we've already seen publicly some of the Food and Beverage companies' desires to be especially responsive to the current needs of their customer base during this crisis. So we hear about Nestlé creating smaller, more affordable packaging sizes for people who are buying more groceries than ever, but who may be out of work and are especially cost conscious. And that flexibility is one of our strengths with those sorts of customers to be able to react very quickly to new packaging sizes and to be able to double down in geographies where there's particularly high demand. And so that's a positive trend for us as well. So those would be a couple of the industries that I think are particularly interesting, where they may have an urgent need to move their manufacturing base and capacity around based on unexpected high demand.

So I think it was 2011 or 2012 where we had the last U.S. manufacturing renaissance thesis. And do you think this is kind of different? Are we starting to see temporal signs that this trend is actually underway?

I think there's a cumulative effect of things that have happened over a long period of time that are causing people to put plans together with a little more urgency than they may have in the past. Years ago, 10, 15, 20 years ago was people were offshoring manufacturing. The business case was based on a labor rate in some of these countries that's a lot higher now than it was then. And so those business cases wouldn't look quite the same. That in itself wasn't causing people as it was kind of an insidious thing as those rates increase. Some people move to places like Vietnam and so on. But we didn't see evidence that there was this now wholesale disenchantment and reshoring based on that. But then you had the tariffs and the trade conflict, which added additional costs in some of these places that people had moved the manufacturing to. And certainly, people did move some of their supply chain and some of their manufacturing around. We certainly had that as a part of our tariff mitigation efforts that allowed us not to incur additional cost. And now we're seeing, when entire countries can get shut down quickly, then I think that's finally putting a larger amount of the supply base on wheels, so to speak. And I know we're going to make some investments in reducing single points of failure but that doesn't necessarily mean building new factories, but moving some manufacturing capacity so that we mitigate that risk because being the lowest cost producer in a location that gets shut down doesn't help you, right? Because it's 0 margin dollars if you can't get anything out the door. And so we're looking at it. Our operations leader tells me that all of his peers are having those conversations. And I do expect that there's going to be some resulting investment not necessarily all coming back to the U.S., but moving and increasing the resilience of these systems.

Great. Thanks, Blake. You mentioned very strong backlog growth in our is IS -- Information Solutions & Connected software. Revenues were down a little bit, I think, because of a tough comp. Are customers continuing to invest in software and taking services to connect software during this time frame? And do you think that with the down 3% that you laid out for 3Q, do you think that IP's CF can actually grow through that quarter?

Yes. So I'm not going to predict the specific growth quarter-to-quarter, but I can tell you that the value remains strong. And in certain areas, we've seen skyrocketing interest. So when you think about augmented reality and the role that it can play with enabling remote operations and being able to project expertise across the mile so that you don't have to have the expert on site at the machine, that's important now. That's going to be important in the future, I believe, and the downloads of the Vuforia Chalk that we offer with PTC is huge. We've seen increased interest in the promotional programs as well as the revenue. Still a small base, but customers are starting to vote with their wallets that, that technology is going to be useful in the future. So we see that as a continuing trend, as customers look at how they're going to be able to run their operations again, and it's part of that resilience theme, right, when they can't get all the people that they might want right in the plant or at the equipment.

And what's a good reason for this slide in the business? I know it's not exactly segmented, but the Information Solutions software, 5 years down the line, could this be a $1 billion business through organic growth but also inorganic? Do you see that?

I think it's going to be a combination of our continued organic development for our MES offering, for FactoryTalk Analytics, for other software that has come up through Rockwell for some period of time, the relationship with PTC and the potential for other inorganic activity. Because it's important to be able to maximize the productivity from our overall solution. This is not instead of the core automation that comes from Logix programmable controllers and drives and so on. It works together. So it provides a new level of productivity on top of that core automation. And that's where the data is born. So we think we have a natural home field advantage because those sensors and those variable speed drives, all of that equipment on the floor, is sending the data, and we produce a lot of those products. And a lot of that is already in the installed base. So we understand it. We understand how to put that data into context.

Great. Just a quick reminder for those of you logged in, if you have a question, please log on. I'll take a couple more and then see if there's any in the queue. Maybe talk about some of the cost actions you announced in April. Heavy emphasis on discretionary cost control at this point in time. Can you maybe just discuss how long can the organization sustain that level of SG&A management? And what would be the tipping point for more structural restructuring actions?

Yes. Well, you can't go to that while continuously or for too long because then you start to -- it just -- it's not adequate and you start having engagement issues. And so we watch closely the depth and the duration of the crisis and we have other plans that would be more structural in nature that we'll implement as appropriate. This was a way with the temporary reductions, the formula reducing incentive comp as well as the salary actions, that could get a lot of cost down quickly, which we thought was appropriate for an event-driven decline like this. But if something structurally starts overlaying, then we're ready with structural cost reductions to make sure that we're protecting our profit through this time and also to manage it through the recovery. We're in control of how we layer that back and so it's a balancing act between protecting the profit, being able to redirect spend to the areas of highest opportunity, but also making sure that our employees are engaged and motivated and that we're keeping our best talent.

Obviously, when you think about structural actions, you both take some judgment call on the duration of the downturn, duration of the shape of the recovery. Maybe -- and I know you probably don't have to stick your neck out too much here, but any thoughts on what you're planning for at this point?

I'm sorry, what -- on what...

What are you planning for? What type of recovery are you planning for?

Yes. It's as we guided to, so a trough in the third quarter, down year-over-year in the neighborhood of 20% with sequential improvement but not growth in the fourth quarter and then a continued recovery after that. But these next few months are going to be critical in pacing that and allowing us to extrapolate as things get back to previous run rates.

Great. There's not a lot or too many questions at this point, so I'll carry on with my questions. Capital allocation, I think one of the hallmarks of your tenure as CEO has been a bit more of an aggressive M&A focus, Blake. Maybe you can talk about that, I mean, obviously, right now, there's not a whole lot of focus on M&A. It's much more about cash conservation. But what are your ambitions towards M&A? Are you maintaining an active pipeline right now? What are the white spaces you want to fill the next 3 years? And how do you view a large deal over $1 billion? And I know there's 4 questions there, but just wondering what's on your mind right now?

Sure. Well, I've been very happy with the development of our corporate development as we use all of our strengths to create more ways to win. And -- but we've done it in a disciplined fashion by looking at the strategic fit, and those priorities continue to include Information Solutions & Connected Services process expertise and then expanded reach into Europe and Asia. And the rubric, if you will, of the recent acquisitions we've made, I think, fits very well into 1 or 2 or 3 of those different areas. So I've been happy with that. We continue to work a robust funnel and while, overall, at a macro level, M&A has been muted here recently, we continue to look for opportunities that may come up that fit that strategic framework. And we've said that over a period of time, we do expect acquisitions to contribute a point or more of growth to the core in the Information Solutions & Connected Services. So it's all those things working together to create that growth, but then also to bring in the new ideas and the fresh talent that are so important as the pace of change picks up in the industrial automation landscape. As IT and OT come together, it's not just the technology, but it's the pace of change. And bringing in that new talent through acquisitions, moving faster, as we did with PTC to get augmented reality capabilities and other things, I think that's what it's going to take because all the good ideas aren't going to come from any one company.

Great. And we're getting close to the end of the line here, but -- and this is probably more a question for Patrick. But do you think the buyback can get completed this year? Or are we still going to be in -- managing kind of liquidity moats at this point?

Yes. So in terms of the buyback, we indicated that at the earnings release the criteria that we're in the market, but we're watching closely the situation, and that's still our posture as we look at repurchases.

Okay. Great. Well, Blake, thanks for your time. This has been helpful. Any closing remarks to leave us with?

Yes. We're focusing our attention on keeping our people safe and then also being able to work with the customers who are providing critical products and medicines and potential vaccines during this time. And we think we're very well positioned as the world recovers and looks at new ways to work. We think we have a lot of the value that's going to be even more on demand going forward.

Great. Well, thanks, Blake. That was a great way to finish it off. Good luck and stay safe.

Yes. Thank you very much, Nigel.

Thanks.