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

Good morning, everyone. This is Markus Mittermaier. I'm the UBS electrical equipment and multi-industry analyst, and I'd like to welcome everybody to the session at our Virtual Global Industrials and Transportation Conference. I'm very pleased to welcome Rockwell Automation this morning. On the phone with us are Patrick Goris, SVP and CFO; Jessica Kourakos, Head of Investor Relations; and [ Ilana Zener ], Director of Investor Relations. Welcome, and thank you very much for taking the time to be with us in this busy and difficult time here. Before I hand it over to Patrick for some opening remarks, just in a short presentation that he's prepared, just a quick reminder for the audience that you can send me your questions. There's a little chat window on your left-hand side of the screen. So feel free to ping me any questions, and I'll forward those to Patrick and the team here. And with that, let me hand it over to you, Patrick. Thank you very much.

Okay. Good morning, everyone, and Markus, thank you for having us. I'll cover a few slides, and I'll start on Slide #3. Rockwell Automation at a glance. Rockwell Automation is a company. We're exclusively focused on making manufacturers and producers more productive and sustainable. We deliver value to customers through differentiated technology and domain expertise. Our business model is an asset-light business model. And this asset-light business model, combined with our differentiation, translates into high margins, attractive return on invested capital and a very strong free cash flow profile. We're focused on winning the right way. And by that, we mean that we have a very strong culture of ethics and inclusion. The next slide, Slide 4. As you can see on this page, we have taken actions recently to protect our employees, to help our customers and to align our costs to the current environment. Our balance sheet and liquidity remain very healthy. And we see an opportunity in the current environment to work even closer with our customers to deliver value. And case in point, while overall, our cost structure is coming down, we actually have selectively increased investments to increase differentiation to provide more value to customers. Slide 5 provides the outlook for fiscal '20 as of April 28. As you can see, we expect a particularly difficult third quarter with organic sales down about 20%, followed by sequential improvement starting in the fourth quarter. Slide 6 provides some additional color by vertical. What you'll note here is that we expect the Automotive and Oil & Gas segments to be the weakest verticals for us this fiscal year, with particularly weak third quarters. And then those verticals that we expect to perform better than the company average include Semiconductor, Life Sciences and Food & Beverage. Slide 7 provides a little bit more color or comments about our strong balance sheet and liquidity. We, as a company, are in a position to make continued investments in organic, to drive organic growth; those are mostly P&L investments, not capital expenditure investments. We are in a position to continue to look for inorganic opportunities while at the same time continuing to return capital to shareowners. And so clearly, we have a strong financial position and we intend to maintain it. The next Slide 8 provides our framework for long-term revenue growth, and the current environment does not change our focus on long-term revenue growth. It starts with targeting share gains in our core platforms. The core platforms represent the foundation of our control platform. On top of that, we target double-digit growth in Information Solutions & Connected Services. Informations and connected services include new revenue streams as a result of the IT/OT convergence or the connected enterprise. We like these revenue streams, these newer revenue streams because it's a faster area of growth. About half of those revenues are recurring in nature. And from a margin viewpoint, they're neutral to slightly accretive. The third element of our framework for long-term revenue growth is inorganic investments. We target a point or more of acquisitions each year. And the priorities for acquisitions, as you can see here, are Information Solutions, Connected Services to enhancing our capabilities there, increasing our domain expertise in some process industries and then finally, enhancing our market access in Europe and in Asia. On Slide 9, you see our most recently announced acquisitions. Those 2 acquisitions completely align or align perfectly with the strategy we have laid out and the priorities for M&A that I just covered with you. Both acquisitions closed April 30, and we're focused on integrating them and creating value for customers and shareowners. So with that, Markus, I'll turn it over to you to start the Q&A part of that session.

Great. Thank you very much. So with these opening remarks, let me -- before we get to the trading update, let me actually refer back to Slide #8 here that you show because I think it triggers an interesting question. How do you think about hardware and software longer term? I mean if I look at your core, for instance, I think on the Logix platforms, you kind of saw growth in Q2 at 8%. At the same time, obviously, you kind of highlight Information Solutions & Connected Services. I think that's a $400 million business for you at the moment. How do you see the core of Rockwell develop? And where could that Information Solutions business really be in 3 to 5 years?

Yes. So if you look at Slide 8, if you look at our core platforms, that includes both hardware and software, and we see continued opportunities for attractive growth in our core business. And this goes beyond Logix. We see opportunities in our visualization capabilities, motion and power control. Core is actually still the area where most of our R&D dollars go to. And so in addition to making organic investments, it is also an area where we continue to see opportunities to make inorganic investments. More recently, we -- I just covered the ASEM acquisitions, that is enhancing our capabilities in our core platforms, but also other acquisitions we've made over the last couple of years, whether it's independent Cart Technology, our simulation capabilities in software are all enhancing our core. So I'd say our core platforms remain very important to us. It is a combination of hardware and software. More often than not, it's the software that's the key differentiator there. And we make continued investments in organic and inorganic ways to enhance our differentiation and growth there. If you look at the Information Solutions & Connected Services area, it is really complementary to what we do in the core. We provide additional value to customers where those are existing customers or new customers. As we've said in the past, about half of our wins with FactoryTalk Innovation Suite, which is an Information Solutions & Connected Services, about half of our wins are in areas where we're not the provider of the control platform. And so it's a new way to win for us. Information Solutions & Connected Services is a faster-growing space, and it also increases our recurring revenue streams. We still target Information Solutions & Connected Services to reach about $400 million this year and to reach $600 million by fiscal '22. If -- another way or an additional comment I'll make here is that both the core and our Information Solutions & Connected Services offerings are expected to benefit from more demand for flexibility, visibility and resilience at our customers. You need both in order to drive your most efficient operations. So you need -- and the control platform and all the software that goes with it and some of that additional and new value that you can add on top of that. And so we see both of them as highly complementary, and Information Solution & Connected Services clearly has a higher growth driver from a percent point of view, not necessarily short term from a dollar growth point of view.

Great. Excellent. Thanks for that context. I'll come back to sort of like that more strategic angle of the business in a little while. Let me maybe start with kind of trading update and the impact that you see, obviously, from the current sort of pandemic. How was May or how is May kind of shaping up as you kind of look through the numbers here versus April? Should we think about that trajectory kind of continuing? Or are project delays been an issue, getting into plants or final acceptances? How is that month looking and the trajectory that you're seeing going forward?

Yes. I'm not going to make specific comments about May. But if I look what -- I'll describe what we're doing, we're watching very closely what the order intake is not just in China and Italy, the 2 countries that went through this before some of the other geographies, but also, of course, North America, our largest market. We're watching closely the, call it, the industrial activity and the number of plants in certain industries that are opening back up, for example, in automotive. As we see that level of activity at some of our customers and in some of those verticals pick up, obviously, that is a good leading indicator for us. Because it means that our engineers and our solutions and services folks that work at those customer locations are likely to be called back in and, obviously, will be in a position to add value to customers and generate revenue for us. So I'd say that the third quarter -- we expect the third quarter to be the quarter in which we trough. And we've seen, call it, starting the middle of May, particularly in Automotive, more facilities open up. And I'd say that, generally speaking, that it's a good indicator for us. Even though they may not open at 100%, we expect it to drive increased sales for MRO but also related to our embedded engineers and some of the projects that may be back on, and that we're on hold status.

Great. No, that's helpful on the MRO side. And actually, a great segue maybe into the next question around sort of CapEx and maybe the slightly longer-cycle exposure that you had in your portfolio as we look into certainly the second half, but particularly the budgeting cycle in your clients for 2021. Any insight sort of like how your customers are thinking about 2021 CapEx at the moment? I mean obviously, we hear anecdotally that there's a lot of cuts as people kind of adjust to COVID. But I realize that in earnest, sort of like that 2021 cycle probably starts in the third calendar quarter, in fourth quarter, any sort of like early clues around that and maybe the longer-cycle execution here?

Yes. I'll provide some comments about what we've seen in our solutions and services businesses starting in the second quarter. You can think of our solutions and services businesses being about 1/3 of our overall revenue. And they represent our longer-cycle businesses. And on average, we have about 6 months' worth of backlog there. Starting in the second quarter, our second quarter, we saw project delays affecting our solutions and services businesses. And I'd say much more delays than cancellations. And so there might have been a cancellation here or there, but clearly, it was much more cancellations, much more delays, I should say. Even with that, our solutions and services book-to-bill in the second quarter was 1.1. And our backlog in our solutions and services businesses were up year-over-year and sequentially. Now that being said, we do expect those businesses to be weaker from a year-over-year point of view in the third quarter with some improvement in the fourth quarter, just consistent with what we expect for the overall company. As to fiscal 2021, I think it's really early at this point to say what to expect. I think it is fair to say that it will vary greatly, we expect, by industry, obviously, and maybe more obvious than anything else. Oil & Gas might be an area where CapEx might be somewhat subdued for a longer period of time. But there may be other verticals and then I'd be thinking about Semiconductor, I'm thinking about Life Sciences, home and personal care, even Food & Beverage, where we think the capital expenditures plans may be less impacted by COVID-19. And in some cases, we may actually see some level of increase in some of those verticals. As I said, it's somewhat early, but I think it's fair to say that it will be quite different across different verticals.

Markus, if I can just add. It's Jessica here.

Yes. Go ahead.

I think I would just add to that, that even -- if you look at even for us for this year in terms of what we're doing with our own CapEx, while we might be tightening our belts relative to what we thought we would spend this year even, and we're not a big CapEx spender to begin with. But even the reductions that we made relative to our original expectations, we're still increasing investment in certain areas that we think are going to add to our own resiliency. So I think while you might see reductions in CapEx or going forward for whether it's for us or for other customers that we have, I think the concept of prioritizing investments that improve resiliency will still likely happen, and that's certainly happening, I think, for us. We're still looking at, obviously, not only funding kind of our growth investments like in software and other parts of our core automation offering, but we're also certainly making specific investments on improving that resiliency. So I think in some cases, it's just a reprioritization, too, that I think is important to just note here. It's not that everything gets cut. It's that also things are going to get reprioritized to what's most important.

Right. Thanks for clarifying that because it would have been my follow-up actually, but obviously, the CapEx budget and then there is how you spend that, right? And obviously, Automation, people may look at that differently than other parts. But I think it's certainly interesting to kind of keep monitoring that as we get into maybe the second half of the year on those '21 numbers. But I think that's super helpful for context. And then maybe similarly, from a sort of regional or end market perspective, you've highlighted already Italy, Southern Europe and China in recent weeks after the reopening and the MRO there. To what extent do you think is that sort of like a kind of, in a way, restocking demand that you see versus things returning to normal? And how would you think about sort of the rest of the world kind of following suit here?

Yes. I think it's still early to tell Markus whether the slope of the recovery that we've seen in China, and through the date of our earnings release, we shared our -- the slope of the recovery in China, which was very much reshaped, but that is something that is sustainable or a temporary jump back. And so obviously, that's why we're watching very closely the performance in the different geographies. And Italy, the improvement there was different. Clearly, there was a sequential improvement, not as sharp of a recovery as in China. And we use those 2 end markets to estimate or to provide 1 input to estimate what the performance of our overall company will be. But I think it's still too early to tell how sustainable this is and whether there's any restocking element involved with us.

Yes. No. Understood. And maybe also following up on the earlier conferences made that obviously different parts of your business will probably react differently. I mean as I think in broad terms, you're 25% or thereabout discrete, you're 40% hybrid, 35% process in past sort of downturns and recoveries, and I understand this time is obviously different for many reasons. How would you expect sort of the shape of recovery to look like in these various businesses? I mean Automotive, as you said earlier, on different trends than SMB, than Oil & Gas. So how would you kind of think about those 3 broad buckets in our customer activities at the moment in terms of what you might be seeing as coming through?

Yes. So maybe the way I'll answer this question is from an overall company perspective, we expect organic growth to be down 20%, about 20% in Q3 followed by sequential improvements with a fourth quarter up sequentially but still down a little bit more than 10% year-over-year. We would expect the verticals that are weaker than this to be Automotive and Oil & Gas. So they'll be down, we expect more than 20% in Q3 and down more than 10-or-so percent in Q4. Those verticals that we expect to do better than the company average would be Semiconductor, Life Sciences, Food & Beverage and Home & Personal Care. And we would expect that trend to play out broadly consistently across different geographies.

Great. That's very helpful. And then maybe switching to the cost out that you announced in April. Can you just help us sort of like how long you think that the organization can sustain the level of SG&A that you laid out in April? And obviously, there's a strong focus on discretionary costs so far. So how are you thinking about sort of decision points in terms of either rolling some of this back or on the other hand, maybe making some of those more structural. What are kind of the signposts that you're looking for?

Yes. So we implemented significant cost-reduction actions that provide a quick impact or a quick cost out with no cash cost to implement. And that's mostly discretionary spend. We did implement some pay cuts, 401(k) suspension and -- as well as the bonus elimination. While our overall cost structure is down, we selectively increased investments to increase our differentiation and increase customer value. And so the net is down. But at the same time, we actually increased some investments where we believe we see an opportunity to drive differentiation. As to how long we can or will sustain these cost actions, it really depends on the depth and the duration of the revenue contraction. We have identified more structural cost actions to implement if business conditions require, and that goes back to the depth and the duration of the revenue contraction or, frankly, we may decide to implement some more structural cost actions anyway, if we did see an opportunity to reallocate resources to higher priority areas. So I'd say, in short, our cost actions are focused on a quick cost out while protecting our ability to play offense in the current environment. We've identified more structural cost actions that we can implement if needed, if business conditions require or if we decide to reallocate resources.

Great. Excellent. Can I maybe switch to a kind of theme that is coming up here, potentially more long term or midterm, however you want to look at it, around reshoring. I mean one might say it's sort of like emerging again. Do you see evidence of this like hard evidence in your customer conversation that this is actually happening or about to happen, right? And in which end markets would you expect that? And is it sort of like a real tangible upside, I think, for Rockwell setup here going forward?

Yes, you're right. This is certainly a current topic. I'd say that some companies have publicly communicated that they will be taking some reshoring or near-shoring actions that does not -- that includes not just Stanley Black & Decker, but also everyone has seen the announcement of Taiwan Semiconductor. That is not a reshoring, but clearly, they're investing in a large facility in the U.S. We would say, and this is also based on feedback we hear from our North America sales leader, that conversations, particularly in North America, have certainly increased in the last few months with respect to reshoring and near-shoring. We expect in the current environment that customers have an increased need for visibility and flexibility in their supply chain and their operations. And frankly, we think it's not a surprise that, at the same time, customer conversations on digitizing their operations have also increased recently. That's not only about the use of augmented reality, but anything that we can do to help customers enhance remote support for their operations, provide better visibility in their operations supply chain, but also to implement automation to shift work processes to enable social distancing in the plants. We have, from a commercial point of view, we are providing together with our partner, PTC, some free trials of augmented reality. In essence, we're somewhat seeding the market, and we expect that as customers see the benefit of that, they'll be willing to pay for this once the free trial runs out. I would also say that I look at what we do ourselves internally. We are reevaluating some aspects of our global supply chain and our operations footprint to increase our resiliency. I'm very confident that we will be making investments in some of our existing facilities, including in the U.S., to increase our resiliency and that some of our partners and vendors will be doing the same. The interesting thing is that we are a manufacturer and producer. We have about 20 plants. Our operations leader is hearing the same thing from his peers at other companies. So we know that other companies are also looking at ways to increase the resiliency of their supply chain and their manufacturing footprint. And so I would say that it is not just the potential about reshoring or near-shoring, but it's also about an acceleration potentially of digital transformation. And I would say the third element is companies may look at increased investments in automation to address the inefficiencies caused in their plants by changing workflows related to social distancing. The social distancing requirements have disrupted workflows that were optimized in manufacturing facilities. When supply chains are, call it, redesigned and maybe some manufacturing moves from one location to another, we expect that, that is an opportunity for incremental automation investment to offset, call it, nonoptimal workflows in manufacturing facilities. The other part of your question -- I think the other part of your question was the end markets. I'd say that every end market can benefit from digital transformation. Any manufacturer or producer that has employees, probably one way or the other, got impacted by social distancing and maybe inefficient workflows that can be addressed. In terms of reshoring and near-shoring, it's probably -- I think it's fair to say that it's most likely or more prevalent for discrete and some hybrid verticals where we could see some level of reshoring or near-shoring. Think of life sciences, medical devices, semiconductor, as I mentioned earlier, but then also critical components for other discrete industries. I'm just looking at, for example, at what Rockwell Automation does. We -- in essence, we produce differentiated electrical equipment and we will be making some changes to our supply chain to drive some resiliency, which will include some investments in our U.S. manufacturing footprint.

That's interesting. Thanks a lot for elaborating here. And I think it's certainly something to watch out here over the next months and quarters. So thanks for the detail. And I have a question here from the audience around your investment in ASEM. How does that fit into the company's long-term plan going forward? And I'll have a follow-up after that, if you don't mind as well.

Yes. The way you can think of ASEM, it checks the box on our acquisition priorities. It checks several of these boxes. If I go back on Page 9 of the presentation, clearly, it is something that can -- that helps us with our market access in Europe and in Asia. It enhances our capabilities in Information Solutions & Connected Services as well. We have the opportunity with ASEM to increase our capability or offering in industrial computers. Those are differentiated pieces of equipment. They're very different than just normal computers. That is a part of our portfolio that we significantly strengthen. It's actually a fast-growing area in the market as well. In addition to that, ASEM also enhances some of our software capabilities. And so think of ASEM as enhancing our core, providing complementary technology in an area that is attractive from a growth and a margin point of view and also enhances our footprint in EMEA. The other benefit of ASEM for us is ASEM has very limited sales today outside of its home market and outside of Europe. And with our footprint outside of EMEA, particularly then in North America, we think there is a significant opportunity for us to increase sales of ASEM products and technology in North America and other parts of the world. And I'd say that the feedback we got from our channel partners also in North America has been very positive with our acquisition of this company.

Interesting. That's actually a great segue here into my next question where I can think about the more strategic setup of Rockwell versus some of your competitors out there, where one could argue, historically at least, that some of your peers, especially in Europe, has kind of started to integrate software into their captive offering sooner. So how do you think about coming back to kind of what we discussed at the very beginning, that hardware-software interplay in the role here of organic versus inorganic versus sort of like a JV-type approach. How do you see that evolve at Rockwell?

Yes. What I would say is we think that no company will be in a position to offer best-in-class technologies across the entire technology stack. And even if you own every single piece of the technology stack, it doesn't mean that it's highly integrated and it works well together. Even companies like Microsoft don't believe that they need to own every single piece of the technology second. That's why they partner, including with companies like Rockwell Automation. So we think it's important for us to provide the customers with the flexibility to pick technologies that the customers believe are best-in-class and doesn't require them to rip out their existing investments and assets. And so our approach, therefore, is we don't have to own everything, but there is a core capability that is really important for us to own, control and parts of information. We continue to drive differentiation in this offering. And then we partner with best-in-class companies with, call it, complementary technologies. And I think PTC is a prime example of that. PTC has a really good capability with respect to their IoT offering, their ThingWorx capability, their augmented reality capability, their connectivity capabilities, very complementary to what we do. And as I mentioned earlier, in about half the instances where we win with our combined offering is in areas where we're not the provider of control. I think another area where we partner rather than decide to own ourselves is with respect to networks and network switch technology. We partnered with Cisco, the leader in this space. We codevelop it with Cisco. And we then buy the products from Cisco and sell it to the customer. And so I think it's important, and it's a difference in approach for Rockwell Automation. We don't believe we need to own every single piece of the technology stack. It's -- what's really important is to provide the customers the flexibility to pick and choose. And then for our offering to be really differentiated and easy to integrate with the different offerings that customers have in their installed base.

That's great. And if you look at it from your CFO hat sort of like on the value capture side of things, are you happy sort of like with where that model kind of plays out? Or how should we think because some might say, well, you may want to own everything to kind of capture the value and then the counter argument as you lay out is like I don't need to own everything. I just want to have best-of-breed across the board. But -- so just checking in on sort of like CFO perspective around value capture at the end of the day of the high-margin-type business.

So I would provide 2 comments here. One, some of our competitors, who might have a much broader technology stack, do not necessarily have higher operating margins or higher return on invested capital than we do. That's one. Two, what I would say is even on those parts of our technology and what we sell to customers where we do use partners and PTC as one, our incremental margins are still attractive with no invested capital. For example, if we include some of our -- some of PTC's capabilities in what we sell and deliver to customers, we still deliver 30% to 35% earnings conversion on that part of our offering. And that fits in with our overall financial framework. And as I said, with very little invested capital. It doesn't mean that, that is all we're doing are -- the vast majority of what we sell is, of course, our own technology, our own products, our own IP, but the partnership model certainly works. And I do not believe that it automatically means that our margins or return on invested capital will be, as a result, lower than some of our peers because it's not today.

That's great. I know we're coming sort of towards the end here already, but there's another question here that I want to make sure I ask from the audience here. What are the areas of software where you feel you need to invest in, right, to kind of tie in to what we just discussed?

Yes, the areas -- the primary area would be Information Solutions, any software that can help us collect data and also analyze data and provide run predictive analytics. And so our offering there, combined with PTC, FactoryTalk Innovation Suite, there is opportunity there to continue to enhance our offering. So anything related to Information Solutions, think collection and analyzing of data generated on the plant floor is an important area for us. A second area is anything related to cybersecurity. And that would be most likely a combination of software, but also of some domain expertise. In addition to that, some recent acquisitions in the software space have included simulation. There continue to be opportunities in that space as well. And one of our acquisitions in the last few years within the visualization space as well. So on the software side, I think anything related to Information Solutions, cybersecurity, visualization, simulation would be high on the list.

Great. So we talked M&A priorities. We've talked CapEx a bit sort of on capital allocation, obviously, buybacks sort of suspended. Similar questions, like what do you need to see to kind of maybe update your view here? Is that just time? And how is it of like the next few weeks and months develop? How are you thinking about that buyback versus cash preservation at this point?

Yes. What we've said on the day of the earnings release is that the level of repurchases will be dependent on what we see in terms of business conditions that will determine our repurchase level. The assumption we have in our current guidance is 160 million shares outstanding for the year. In terms of capital deployment more broadly, we have the financial position and the strength to invest not only organically, but also inorganically. And even though we've deployed $500 million plus so far this year on acquisitions, we continue to look for opportunities to deploy capital and acquisitions. And as I would say, consistent with the priorities I just laid out earlier, Information Solutions, Connected Services, expertise in process industries and enhancing our market access in Asia and EMEA. So we continue to look there, and we have a robust funnel.

Fantastic. Great. So Patrick, Jessica, [ Ilana ], thank you very, very much. Do you want to maybe leave us with sort of final thoughts at the end of the call here before we wrap up and thank you?

I'll just say, Markus, I'll thank everyone for joining the call, and thank you for setting this up, and we are focused on delivering value for customers and shareowners over the longer term.

Great. Thanks so much, and good luck.

Thank you.