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

Welcome to the Vertical Research Rockwell Automation Fireside Chat. I will now turn the call over to Jeff Sprague. Please go ahead.

Thank you, operator. Good day, everyone. It's Jeff Sprague here from Vertical Research. I'm very happy to have joining me today, Blake Moret, CEO of the company; and Patrick Goris, the CFO. We'll be conducting a fireside chat between the 3 of us. Many of you have e-mailed me questions already, but this will be a closed chat with just me moderating with Blake and Patrick. If you haven't sent a question yet and something comes to mind, please feel free to shoot one to me, and I will incorporate that as best as I possibly can into our ongoing discussion. And without any further ado, thanks again, Blake and Patrick, for joining me today. I know it's certainly been a very, very busy time. Blake, I don't know if you had a couple of opening comments you might want to make, but otherwise, we can just jump right into our discussion.

Jeff, just to make a general comment that we're seeing our customers very focused during the current environment on increasing their resilience and their responsiveness, both in their own operations and in their supply chains. And we think Rockwell Automation is well positioned to participate in those needs.

Right. Can we just talk a little bit about customer behavior? And this is not a guidance call or update, obviously. But a lot of questions about how customers are responding, their pace of opening, some of the challenges that they're kind of experiencing here. Could you give us a little bit of just kind of run around the world, what you might be seeing in China versus Europe versus the U.S.?

Sure. I'll make some general comments, and some of this mirrors our own focus areas. I think first and foremost for us and for most of our customers is the safety and the health of employees. And so when we look at our manufacturing employees who have been deemed essential business and have been working throughout the pandemic, ensuring that they're safe as their work is of paramount importance to us. And so a lot of our customers are still refining those efforts. So things were done immediately. And we've learned, we've shared best practices. And of course, as you said, different parts of the world are exiting and entering peak periods of infection. And so they're learning from what has gone before. I think some common themes have been distancing, of course, protecting employees, having strategies in place to be able to clean facilities, remote operations, remote design, remote management of production, remote witness tests. All of those things reduce the number of people that you have to have traveling. People coming in contact with people from other companies is something to be minimized at this point. And so those are some common themes. We talked in the earnings release about the offsets in terms of timing between Asia and Europe and the Americas and so on and shared some of our experience as of late April in that, where we saw that China was coming out in a fairly sharp recovery at the time, different a little bit than what we saw in Italy as we gave some insight, some higher levels of information because we thought that, that's what this sort of situation warranted in terms of month-by-month progression of product orders. And we also indicated in the guidance that we provided, and we did provide guidance, we said that it was not based on a V-shaped recovery.

Great. Let me talk about reshoring a little bit. The topic gets a lot of airtime and makes some sense to a degree. But how do you see things actually playing out? We've dug into the topic quite a bit, and it's -- we were actually surprised. We actually found that reshoring has been going on actually for the better part of the decade now in the background maybe to some degree. But do you see a significant change in behavior around your customers and how they might alter their footprints and reorient them back towards the United States?

Jeff, I think reshoring is part of a larger theme, and it's the one that I opened the conversation with. It's about the overall increase in the resilience and responsiveness of operations and supply chains. And reshoring may be a piece of that. It's going to be a higher priority for certain vertical industries than others, and it's going to move at a different pace based on different industries. But everybody is talking about how they can increase the resilience of their operations, and part of that resilience is based on reducing the number of single points of failure for high-value products. And again, I look at our own experience as a manufacturer, and we're looking at what are the products that we either have components coming from one source so we manufacture only in one place, and how do we reduce the risk of having entire countries or regions or continents shutting down. And so we're going to be putting money into that. Our operations leader tells me that virtually all of his peers are having similar conversations. And so increasing that resilience, I think, is a pretty sure thing. Whether it involves reshoring, again, is going to be based on specific industries, specific footprints. But some of the other contributing themes -- contributing topics to that overall theme include getting closer to important end markets, remote operations that I mentioned before, traceability across complex supply chain spanning multiple geographies and then the ability to have flexible manufacturing to be able to change things like packaging size. And we've seen in food, for instance, companies like Nestlé that have talked publicly about their need to have different packaging where their customer might be watching their wallets even closer and needing a lower-cost packaged product. And so the ability to respond quickly to those and other market needs are going to be something that I think is fairly certain to be more important as time goes on.

I wonder if you could elaborate a little bit more as it relates to your business because maybe that's -- maybe it's not a perfect microcosm, but it is a microcosm. If you thought about what you were doing in your own business to improve resiliency, maybe diversify your footprint, can you size that relative to what your maybe typical CapEx budget would be or however you might measure it?

I don't know that we're in a position yet to give it as a percentage of our CapEx. And remember, we're pretty asset-light organization, right? So a little over 2% by sales of our business goes into CapEx for internal needs. So we're kind of at one end of a spectrum in terms of just the general capital intensiveness of our business, but it'll be important as we look at how we increase that resilience. I don't foresee that being brand-new rooftops. So I do see looking at -- in our case, looking at using the space that we have within our worldwide footprint. But from that standpoint, if you then reflect that back on the opportunity for Rockwell, a small part of our business is based on new building envelopes and new rooftops. It's more about the automation and the technology and the expertise that goes on underneath, either new or existing rooftops.

Interesting enough.

We'll also -- maybe one additional comment. We're already using technology to increase the resilience of some of our internal business processes. One that we've talked a fair bit about is witness test in terms of final acceptance test for some of our more complex engineered solutions and using augmented reality technology, using workflows so that a customer can be satisfied that what they're buying is fit-for-purpose. Typically would require trips from multiple people to the factories that these lineups were being made in and being able to do that remotely using tools like augmented reality is something that's already giving us tremendous benefit. I heard this morning that we've had something like 2 dozen virtual plant tours of our Twinsburg operations for sales situations where customers are looking at how we're doing it there. And that's already resulted in some new business for us as we've been able to keep those pursuits going by remotely taking those customers through our operations so that they can see how the technology is being used.

We -- maybe pivot to a couple end markets. A couple that have gotten a lot of attention on the kind of reshoring and the like where there seems to be real concern from a national security ground standpoint, Semiconductor and Life Science have kind of jumped out. Certainly, this Taiwan Semiconductor announcement has kind of gotten people's attention, maybe captured their imagination. Can you give us a sense of what Rockwell's typical scope would be in a semi plant? We know it's about 5% of your business overall. But just trying to get a sense of kind of the value, the Rockwell proposition, how significant that might be?

Yes. I mean, Jeff, one of the nice things about our business is that we're not dependent on mega orders. A pretty big order for us, $3 million to $5 million is good business for us. So while we take business and we have customer projects that are sometimes in the tens of millions of dollars, we're not dependent on those to be able to grow. In a Semiconductor project, big portions of the content for us are the building management system. So being able to control the temperature and the humidity and the purity of the working environment. Material handling, another area for us. And think about $10 million for a project is not being unusual in a big project like that. Taiwan Semiconductor is talking about spending $12 billion, and whatever percentage you take of that and look at potential Rockwell content, will be a pretty sizable project for us.

But something likely in the tens of millions, not hundreds of millions, I would guess, right?

No. Again, we just -- that's not our business model to have to chase projects that are hundreds of millions of dollars at Rockwell.

Yes. Right, exactly. One question I've also been mulling over, and a couple of people have asked me this, too, is just Rockwell's home field advantage so to speak. And I think the essence of the question is sort of Rockwell -- this initially became more of an international business by following your customers around the world, right? The global accounts used to talk about Procter & Gamble's and the like. We saw last week that Taiwan Semi made a comment that they're hoping their suppliers will follow them into the U.S. It wasn't clear if that was about chemical suppliers or automation suppliers or who that was. But do you see any particular risk to kind of the door being opened with more competition in the U.S.? And how do you protect your home field advantage here?

Yes. We have to earn every dollar of business whether it's in the U.S. or around the world. You could look at that risk in the past with automotive companies coming from Europe into the U.S., and I'd say probably the majority of those are using Allen-Bradley hardware and Rockwell services. And we get impressive share of that because of that home field advantage. We earn it through the technology that we have and the support we provide. Those customers aren't doing it to be nice to us, so they're doing it because we have a superior value proposition. But we have to earn every bit of it. I think when you look at Taiwan Semiconductor, I think they're probably talking more about the tooling suppliers that are coming from wherever, from Japan or other spots, but we have relationship with them. And in that particular case, even without a significant footprint in the U.S. yet, Taiwan Semiconductor is a strong Logix user already. And again, it's because we earned it. The other thing that I would say is you're right, one of the ways that we expanded our international presence is providing support as U.S. multinationals win around the world. It's one of the reasons that the PTC relationship is -- been a really nice story for us because it gives us another way to win. And so we're winning at customers who are not traditional Rockwell users of control that have used our European competitors. But this gives us another way to add value by providing the information software. And as we've mentioned before, about half of those sales are on top of someone else's control system.

I was going to go to PTC, and why don't we segue to that since you brought it up. And you partially answered the question I had, but there's also been some new announcements. Saw this factory insights offering last week with PTC and Microsoft. I think you're also trialing some augmented -- new augmented reality offerings. Can you just elaborate a little bit more on what those opportunities are and how you monetize that?

Sure. Well, it's about ecosystem. And it's about the idea that no one company is going to have all the answers under one roof today and tomorrow because the field of software is moving fast. And so in addition to the partnership that we have with PTC, PTC and Rockwell both have very good relationships with Microsoft, for instance, with ANSYS. And that gives us some interesting opportunities to solve customer problems. Factory insights provide some very good solutions at the edge, being able to use standard offerings that reflect the best from our various companies. Augmented reality, particularly in a time like this when people are looking to empower their workers, including from a distance, there's opportunities. And we made an offering with PTC to give manufacturing companies free access to this to help them through the pandemic, but it's obviously going to give them a sense of what's possible going forward. And we do expect that, that will be able to be monetized going forward. One of the things that Jim Heppelmann demonstrated at PTC's Liveworks event last week, which was virtual for the first time, was our Emulate3D simulation software working with their new Onshape offering, which is a SaaS-based CAD and PLM offering that was very exciting. And I encourage you on the call to take a look. I think that information is still available. But again, it gives you a sense of the possibilities of these partnerships.

And would you see all this rolling up inside the goal of kind of the connected strategy-related revenues moving up into that, I guess, $600 million range kind of in the -- I guess, it's a 2022 time frame? Has that moved from $400 million to $600 million? Does it encompass all of what you just mentioned there? And is it all organic as we think about moving towards that target?

It is. I mean that figure is based on organic growth. But the total figure for Rockwell is expected to be higher because we've done some things inorganically that fit in that bucket of information solutions and connected services. So we talked about those numbers before we acquired Kalypso, for instance. And we were not including at the time the digital software that comes to us through the Sensia joint venture with Schlumberger. So we're not standing still. It's impressive growth on an organic standpoint, but it's going to continue to be augmented by inorganic activity as well.

Maybe we can spend a minute on Sensia also like the -- kind of an interesting environment, obviously, right? Quite a curve ball from an energy standpoint. The productivity play though, I just wonder if you could give us a little color on kind of the natural CapEx pressure that industry must be feeling versus the desire to kind of be more productive and how that kind of plays out over the next 12 months or so?

Yes. Well, within Oil & Gas, we're positioned where we think we should be. It's much more on the OpEx than the CapEx. It's far less on drilling new wells than it is on reducing the breakeven point to produce a barrel of oil. We're not basing our projections or our guidance on some sort of sharp recovery in the price of a barrel of oil. But to be sure, it's put the whole industry under pressure. And you're right, it wasn't in the script, but nothing that's going on from day-to-day now is in the script. And so we think we're where we should be. We think that improving operational efficiency, continuing to pay attention to safety, those are things that oil and gas companies are going to continue to need. The world is still demanding 70 million, 80 million barrels of oil a day. And you might as well do that just as efficiently as possible, and we think we're in a great position to help there.

Maybe just pivot a little bit to bring Patrick into the discussion, if we could. This is a -- first, on the temporary cost actions, Patrick. Are you still -- I would imagine you're kind of evaluating that on an ongoing basis. Really the nature of my question is, is there a move towards some of these actions becoming permanent? Or how do you see that playing out over the balance of the year?

Jeff, you're right. We are watching this situation carefully. At this point, all the temporary actions we shared with you on the earnings call went into effect May 1, and that gets us to the $150-ish million of cost savings for this fiscal year. We're looking at business conditions to determine how long we will keep these in place and to what extent. And frankly, that is the main driver of that. At the same time, and we also shared this on the April call, is we have identified and are continuing to identify more structural cost actions that we can implement in case business conditions do require that, meaning, revenues stay weaker for longer, or frankly, we may decide to implement those more structural cost-reduction actions anyway to redirect resources to higher-growth opportunities for us. And so at this point, all these actions are implemented. We are getting the benefit from that, and we're looking at business conditions to see how long we keep them in place.

And as it relates to your Q3 guide, the -- you guided to maybe a little over $1, I forget the exact words you used, but roughly $1-plus a little bit, it sounded like. To get there based on your revenue forecast, this kind of implies an observed decremental of about 65% by my math. It's a different underlying number, of course. Can we just unpack a little bit why it's in that neighborhood of 65%, given kind of the temporary cost actions that you're taking?

Yes. So what's happening in our third quarter, we have a little bit of a perfect storm of different items happening at the same time. The first one of which is we expect our organic growth in the third quarter to be down about 20%. And so that's the weakest quarter we expect for this fiscal year. Overall, organic sales down 20% -- about 20%, but particularly so in our higher-margin product businesses where you see some of the MRO. And so that is our highest-margin businesses, which we expect to be the weakest in the quarter. On top of that, you referred to the temporary cost actions we've implemented. I just mentioned they went all in place full time the 1st of May. And so we're only getting a partial benefit of those cost reductions in this quarter. Other elements that play in the quarter as we refer to in -- on the call, we refer to inefficiencies in our plants because of workflow disruptions due to social distancing and some same inefficiencies in our solutions and services businesses, which is hurting us. And then bonus incentive compensation expense is actually a headwind this year in the third quarter as we had a large accrual release in the fourth quarter -- in the third quarter of the prior year. So that's from an earnings perspective, the color for the third quarter. From a conversion point of view, we think that the second half of the year, if I exclude currency and acquisitions, conversion is about 40%. And for the third quarter, it will be worse than that. We think it will be a little over 50%. And obviously, we think it will get better in the fourth quarter of the fiscal year as we get the full run rate of the cost savings initiatives and as we expect sales to sequentially improve. The last comment I'll make and all of this is consistent what we said at earnings is, obviously, from a free cash flow point of view, much higher resiliency there than from an earnings point of view, and that is as expected as we continue to manage working capital in this period.

Great. And maybe I'll pick up one there, which maybe is for you, Patrick, or maybe it crosses over into Blake or both of you. The balance sheet is in good shape. Cash flow is good. What is your kind of M&A pipeline looking like currently? You've obviously been more active in the last, I'd say, 24 months or so. Do you see enough in the pipeline to soak up and absorb the excess free cash flow you're going to generate? Or should we expect a resumption of maybe more active share repurchase as we look a little bit further forward?

We've deployed so far this year over $0.5 billion on acquisitions, all very much aligned with our strategy. And I would say that our pipeline continues to be very active in this period, and we're continuing to evaluate opportunities to deploy capital. And of course, test one is how does it align with our strategy and our priorities for inorganic investments. And then two, we look at the financial metrics associated with the acquisition. And so I would say, continue to focus on it and continue the opportunities in the pipeline.

Great. Maybe I could pick up a little -- go ahead.

Yes. Jeff, I was just going to say, talking about the fit with the strategy as we look at some of the things we've done recently. So Information Solutions & Connected Services, you think about MESTECH and Kalypso and Avnet Data Security, process expertise, you think of Sensia, increased access to markets in Asia and Europe, think of awesome with the Industrial PC. So we think we've done -- we've maintained pretty good fidelity to acquisitions that need one or more of those consistent strategic priorities.

Can we pick up a little bit more on kind of customer behavior? I had a couple of questions coming in about CapEx in general, and there are a lot of really interesting and exciting things you're doing with your connected offerings and the like. But I think the overarching concern folks have is just everybody's hitting the brakes on CapEx everywhere you look, kind of including yourselves, even though you're not a CapEx-heavy company. At what point in the year do you start to kind of get a view of what's coming at you for the next year in terms of customer spending plans, how they behave, how they budget? I guess maybe a different way to answer that question, too, is this idea of front log, which, in the past, you've spoken to. I just wonder if you could address that. Maybe it's more of a general question than a specific question, but it certainly is a very kind of unprecedented time right now to try to understand what customers are really going to end up doing.

I think a good place to start is to segment by vertical. We believe that we've picked verticals and even parts of verticals that are selected not only by our readiness to serve, but also their ability to grow over a period of time by being aligned with large demands from their own customers. So you think about electric vehicle within the general auto segment while -- and this will come as a little bit of a surprise to longtime Rockwell watchers. I mean auto's going to be less than 10% of Rockwell's total business this year, but electric vehicle within that is going to continue to grow fast. We have a high readiness to serve in power transmission, actually higher than in traditional internal combustion engines. And with our new motion technology with the dependence on software for scheduling in new electric vehicle lines, that's a good area for us. And all those electric vehicle startups have to bring vehicles to market or they don't get a return on their investment. They don't address that burn rate unless they can bring a vehicle to market, and they're going to have to spend money to automate because you can't competitively sell any sort of vehicle without a fairly high degree of basic automation. So not all those companies going to make it, but all of them are trying to bring a vehicle to market or having to spend money there. Of course, Food & Beverage, particularly given our focus on packaged food, food that goes to grocery stores or direct to home, that's going to continue to be important. People are going to continue to want to eat. And that's our single biggest vertical. And we're seeing some of our biggest customers talk about really high levels of overall demand. Life Sciences is a little bit over 5% of our total business now. It's growing fast. And particularly now with the focus on those companies, we're right in the center of those companies' efforts to produce testing kits at higher quantities than they ever dreamed would be necessary, talking about the potential for having 1 billion doses of a potential vaccine. So it's not a huge part of our current business, but we think it's going to continue to grow faster than the average for a long time to come. And we, with our new software offerings, continue to get a larger share of wallet in those pharma facilities. So you can look across the different industries and find the pieces within that industry that are important for those customers, and that's where we're focusing as opposed to just serving indiscriminately the overall market for automation and electrical controls.

I wanted to dig a little more into Life Sciences, and that was a good segue. Would your exposure in Life Sciences be more towards actual equipment manufacturers who are making instruments and that sort of thing? Or is the play more kind of in the hybrid batch pharmaceutical intermediates in that part of the equation? Can you provide a little bit more color there on what exactly you do, how you play?

Sure. It -- we've always had a strong role in the equipment supplier, certainly the packaging, the building management, the qualified building management systems for Life Sciences. But as the functionality for process control grows within that single Logix platform, we're seeing more of that. And as biologics become a more important part of the offering of those pharma companies, those are really good fits for our offering. The software offering, the MES software, the combination of that with ThingWorx from PTC, that's proven to be really valuable for those customers. So all of those things, the independent car technology for precision packaging, all of those things contribute to put us in a position where we do believe that we're gaining share across the breadth of the pharma applications.

It's interesting to my question on Semi and Life Sciences. The first discipline you mentioned or offering was building management system. I would think that would be the domain of other folks. Do you find you play -- so why do you play so strongly in those end markets? And are there other markets that are important from a BMS standpoint?

Yes. I think, traditionally, we've had some expertise there. Generally, those systems are delivered. The engineering is provided by the supplier of the hardware. A lot of that capability really grew, particularly with Semi, out of our experience in Asia. Air handling, moving air, filtering, these are some, let's say, horizontal processes that, based on our ability to bring together power control, monitoring and real-time control, they're just a good fit for our portfolio.

That's interesting.

We do -- I will say, Jeff, it does sometimes bring us into competition with nontraditional competitors. So you do see folks like Johnson Controls in that area as well. And it's a piece of our offering in each of those verticals.

Just going back to kind of the market conditions. You've always had a pretty tight grip on what's going on in inventory in your channel specifically. Just wonder, though, if you see anything unusual there. One of the things that we heard from a couple of companies through last earning season was there was actually sort of a kind of a prebuy or accelerated buy of MRO-related equipment and products at a fear of not being able to get it. I guess, to some degree, it was kind of the industrial equivalent of the run on toilet paper. Did you experience anything like that? And is there any kind of normalization or inventory liquidation that you think needs to happen, if not directly in your distribution channel, maybe at the customer level?

In our discussions with our sales organization, Jeff, we did not hear comments related to something like that happening. And so if it did happen, we don't think it was material. When we look at our -- the inventory levels at our distributors, as you may know, we -- in essence, we determine the levels of those inventories at our distributors. We have not seen any movements there that are, call it, misaligned with expected volumes in the market. And so those inventories have come down a little bit as expected, obviously, given what has happened in the market. But we have not seen big swings in inventory impacting our business. We've certainly -- not that we have noticed.

Interesting. Blake, you mentioned the need to do business differently a couple times. Can you maybe provide a little color on -- I mean I'm sure there's hidden benefits of not traveling. I wonder if there's hidden costs of the way you've got to reshape your business, whether it's in the office or in the factory. Maybe balance those for us? Is this a net positive or a net negative as we work forward through this from just a Rockwell operational standpoint?

Yes. I think it's a net positive. I mean during a normal run rate, the organization spends a lot of money on travel. And I think we're seeing -- we're all seeing how much less we can still get work done without that. We're not going to stay at virtually 0 travel, but I don't think -- I think it's fair that some things were not going to go back to as they were before. And I'm certainly spending lots and lots of time personally on video conferences that work just fine. And that will carry over once we get back to something that's not being shaped by current infection rates, the number of rooftops that we have, looking at that, and I don't expect us to make any draconian mandates or things like that, but I think it's safe to say that a lot of people are finding that they can get a lot of work done remotely. And then again, trying to find ways that our own technology can help in our own operations. We are a manufacturer. We are an employee of tens of thousands of people. And so the things that have helped our customers, we'll use ourselves. And the things that are needed in our own manufacturing sites, we'll look at ways to monetize that with the credibility of walking the walk ourselves. And so I think that is a silver lining in this, is that it's teaching us what are the things that are truly needed and persistent, and we'll make sure that we're addressing those in our current and our future offering.

One thing that jumps to mind is what about Automation Fair? That's always been such a central event. I don't know if you've made a decision yet, but how do you kind of keep all those touch points active? And maybe if you have made a decision on that, update us on what you're thinking.

No. I mean -- look, I mean, nobody can predict. Nobody is given a single view of extrapolating what infection rates are going to be at 6 months from now, and that's enough time that we know. It won't be exactly what it is today. That's the one sure thing. I think you can count on there being more virtual content available as we saw from Liveworks and ROKLive that were held together last week. There's lots that you can do there with respect to virtual demos and training and so on. But at the end of the day, there is no substitute for a certain amount of personal contact. And we hope to be able to preserve that, but we haven't made decisions at this point because, as I mentioned, nobody has a script for what we're going through right now.

No. That's right. Well, Blake and Patrick, I want to thank you for your time for today. It was a very enlightening discussion and wish you all the best and safe health as we work our way through this. And certainly, if there's any parting words you'd like to leave us with, by all means, feel free to do so.

We're optimistic about the increased value that we can provide as people find new ways to work going forward. And we hope that we're in a position to have science help us out with this a bit, but we're ready to deal with what may come going forward.

Well, great. Thank you for that. And again, best of luck, Blake, Patrick, and everyone on the line. Thanks for joining us today. Stay safe, and hope to talk to you soon. Take care.

Thanks, Jeff.

Bye-bye.

That concludes today's conference call. At this time, you may disconnect. Thank you.