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

Well, thank you very much. I think this is -- personally for me today, it's the final session of the day. But we have Rockwell Automation with us, and we have Blake Moret, the company's Chairman, President and CEO. Also I think it's my first opportunity to welcome Nick Gangestad and his new capability as Senior VP and CFO of Rockwell Automation. So really, really look forward to working with Nick in his new capacity. And I think the plan is for Blake to make short introductory remarks. I have some questions prepared. I think what we've done. People definitely have an opportunity to ask questions via IB or through Veracast. And with that, I'll turn it over to Blake. Blake, first of all, thank you so much for making time for us and participating in our event. And take it away.

Well, Andrew, it's a pleasure to be here. And thank you for all of you who are tuning in. For those of you who might be a little bit newer to the name, Rockwell Automation is a pure-play, devoted to industrial technology and digital transformation. We're bringing the connected enterprise to life for customers across discrete and hybrid and process industry segments, really taking manufacturing to a whole new level and helping them to be more resilient and agile and sustainable. We're organized in 3 segments that are based on the type of offering that's coming out of each, but united by a single selling force that's very familiar with the specific needs of the industries that we serve. And so with that, I'll turn it back to you, Andrew.

Thank you so much. So look, I'm going to start sort of with the obvious question. Maybe we can talk about but macro environment, sort of trends in key end markets such as oil and gas, automotive, consumer and geographies, U.S., Canada, LATAM. How do you see recovery on the global basis? And whatever color you're willing to provide, I'll take.

Sure. Yes, I think you can approach this, as you said, in a variety of dimensions. Maybe starting with the geographic dimension. Asia was the first in and the first out, I would say, of the recession caused by the pandemic, we saw that in our results in Q2 of last year, where -- because our exposure was relatively less than that of our peers in Asia, we overperformed in Q2 of last year. Conversely because North America was maybe last in to the effects of the recession. We're seeing North America come out a little bit lighter. But we did see good signs with the sharp uptick in orders, particularly for products that we saw in November and December and continuing into January, led by North America. From a vertical industry, if we take some examples across the discrete and hybrid and process industry segments. In discrete, automotive led by electric vehicles and the rise of that technology is certainly giving a sign of optimism going forward, and around the world, in China, Korea, Europe and certainly in the U.S., we saw multiple examples of EV wins in the first quarter that we expect to continue contributing to good growth in automotive across the current fiscal year. Semiconductor, we saw growth in the first quarter and the need for additional capacity in semiconductors, I think, is well known by everyone on this call. The rise of 5G as a communication technology. All those point to secular demand for semiconductor going forward. And then also in the discrete segment, e-commerce, we grew 40% in e-commerce in Q1. We have a great readiness to serve those fulfillment centers with their requirements for package handling and sortation, and we do expect that trend to continue. In terms of hybrid industry segments, the verticals of life sciences, we saw good growth in the first quarter. We expect double-digit growth across the fiscal year as the life sciences companies of the world build on long-term secular trends, but also the short-term acute demand for vaccines and treatments. And again, between our hardware and software and services like cybersecurity services for these companies. We have a strong readiness to serve, and we expect that will be one of our strongest industries this year. Food and beverage, and particularly the packaging machinery builders, which is usually a leading indicator in the recovery of that vertical. Packaging OEMs were good growth for us in the first quarter, and we expect the rest of food and beverage to continue to recover, and we expect mid- single-digit growth for food and beverage for the year. And then in process, while oil and gas is the slowest to recover based on our current outlook, our focus on efficiency versus additional capacity is the right bet. And we do expect an improving picture. We've already seen some positive development in orders. I talked about that in our earnings release with good order intake at the very end of the last calendar year in our Sensia joint venture with Schlumberger. And then mining, the rising prices of commodities are supportive of a renewed investment cycle in mining in areas like copper. So with that, Andrew, hopefully, that gives you some picture of what we see as the pacing items in the recovery.

Yes. So a couple of questions. I think Eaton brought up the fact that they actually are seeing difference in onshore as rigs are coming back. I think oil and gas was a particularly big headwind last quarter, and I think you did highlight recovery. So maybe we can talk a little bit about that, just what are you seeing at oil and gas relative to expectations, if you could? The other question, the big pushback we get on Rockwell is whenever we sort of bring up reshoring and you did highlight semiconductors. Folks do bring up that your competitor, your blue competitor has a very, very nice franchise in semiconductors, and there is a bit of a question mark in your ability to participate in this semiconductor CapEx onshoring in the U.S. So a, any comments on sort of developments in energy; and b, we've talked a lot about semiconductor, pretty obvious that you are getting your fair share. But just maybe talk a little bit more about your key relationships on the semi side, if you could?

Sure. So in oil and gas, again, our focus is on increased efficiency. Our business is biased more towards upstream, about 60% of that business for us in oil and gas is upstream and about 30% midstream. So relatively small amount on the downstream or refining side. A little bit heavier on the onshore versus offshore side. And so I think we're positioned quite well for helping companies reduce the breakeven point to produce a barrel of oil as opposed to worrying as much about rig count. Some of that business is going to be correlated to rate cap, but not the majority of it. It's more about efficiency from existing wells. It's also about working with these producers as they move into new energy. That's an important area. And so as they look at geothermal, as they look at wind, as they look at hydrogen, we're well positioned in those areas to work with them there as well. On the subject of reshoring, let me start with a general comment that reshoring is going to take place at different rates by different vertical segment. And so if we look at discrete verticals, semiconductor is certainly a piece of that. We had a semiconductor positive growth in the first quarter. Our building management systems, our material handling systems are very strong. Facilities management, where you're controlling the temperature and the humidity and the cleanliness of the air. We compete with the competitor you were referring to all the time and we come out on top plenty. So I'm very proud of our offerings there. And with new technologies like Independent Cart, we have opportunities to expand our share of wallet in semiconductor. And some of the companies that have already announced new production in the U.S. are existing customers of ours. We don't necessarily get everything that they do, but the fact that we have unmatched support in the U.S. adds to our value proposition there. Other industries that we're seeing reshoring EV battery production. And again, with differentiated capabilities and Independent Cart in our software, our MES software, we have things that give us calls for optimism as those companies establish new manufacturing footprint in the U.S. Life sciences, the companies, and we've talked about them in past investor days who are involved with the vaccines are increasing capacity in the U.S., and we expect that to have a good influence on our business in '21 and beyond. So across that spectrum, I think there's multiple opportunities. I like looking at reshoring as part of a larger picture of manufacturing resilience, along with things like decreasing single points of failure. Remote operations. We're getting a bunch of people together from different companies all in the same place may not be an option. Those are all things that we have a strong readiness to serve.

All right. Got you. This is great. Can we just talk about just outgrown global IP. How do you think about your target about growing IP by 2x relative to cyclical recovery? I know that there's reshoring, there's growing software mix thrown into that. And how does the potential for structurally high CapEx growth this upcoming decade impact your business outlook and long-term targets?

I'm optimistic about where we're positioned and where we are in the cycle. We have 3 main parts of our growth equation. It starts with the majority of our business in -- that's where we talk about increasing the multiple, which we outgrow industrial production. Historically, that's been about 1.8x. And and we think, with some of the investments and the positioning that we have, we can increase that to 2x in our core. Some of the factors contributing to that are new products, like the Independent Cart Technology, new process functionality within our Logix controllers, a more assertive posture with respect to growth in Europe and in Asia. So that's the first part and probably the largest part of the overall growth equation. But along with that, it's the double-digit growth in Information Solutions & Connected Services, which will be about $500 million worth of organic revenue for us this year. Those are areas of new value that include the information software, the high-value connected services like cybersecurity services that we offer. There's some amount of the Information Solutions that comes from the relationship with PTC. But I want to clarify that the vast majority of that software is our own software. And then the final piece of the growth equation is 1 point or more of growth from acquisitions in accordance with the priorities that we've talked about over the last few years for inorganic growth.

Like as long as we started talking about sort of outgrowing global IP, I know that software is a big internal focus, maybe underappreciated -- the nature of which is maybe underappreciated by The Street. Can you just talk about your goal of reaching sort of ARR greater than 10% of revenues by 2025? Question from the audience. And what obstacles or what tailwinds do you see to achieving this goal?

Sure. So when we talk about our Information Solutions & Connected Services. Today, you can think of annual recurring revenue as a pretty large subset of that area of new value. It's about 5% of our revenue today growing double digits this year and beyond, and the target is to get to about 10% by 2025. We obviously won't put down our pencils and say we're done then. We'll continue to look for making that a foundational part of our growth equation. But it's really an all hands on deck approach to this. It's not just in developing and acquiring new software that sold and supported in a recurring way. But it's also about the sales of it. It's about the internal digital infrastructure to be able to provide a great customer experience to be able to reduce churn rates. And what gives me excitement about this makes me optimistic. It's a way that, that message has been heard not only by our internal employees, but by our partners as well as our customers who see a change in the company in the way that we can provide value to them as we meet them on their digital transformation journey.

Got you. And just generally, another way of asking this question about software, are you being not aggressive enough? Because if you look at the mix of your customer spending over the past 20 years, particularly in the U.S., the mix has really gone to software and software has been growing, almost you can argue at the expense of hardware. So how do you face the sort of structural change where the customer base is spending more on software relative to hardware as an overall mix? And it actually has been material change in shift over the past 20 years. And do you think this cycle, do you think we're going to add more fixed capacity over the next decade, right, because we've probably underinvested a bit over the past 20 years? Or do you think the shift to software will continue? And this is not like next 12 months, this is like 5, 10 years question.

I really -- what we're seeing and what we're hearing from customers is that it's more about the addition of software to the value that we can provide as opposed to a zero-sum game of dollar spent in software taking away from what they spend in hardware. Because the hardware and the core automation is where the data is coming from, and so there's still a need to have strong architectures that can communicate that data securely and at the right speed and in context up to the software. We see this with customers where we might have been selling a couple of million dollars of our traditional hardware to a mature plant on an annual basis. But then by adding the software like our MES software solutions, our -- and analytics software, we can double the participation in the share of wallet at that customer as they find ways to get even more productive with software complementing the base core automation. Now in terms of our recognition of the increasing importance of software and a total solution, we've increased our development internally because we still remain fundamentally an organic growth story. We have increased the amount of acquisition that we've done. We have the relationship with PTC. We're making investments within our IT infrastructure, again, to ensure that great customer experience. And you've seen some of the leadership moves we've made so that we can be assured of having that perspective of people who have grown up in a software world running our sales and running our Software and Control business segment, complementing that deep domain expertise for people like me who spent our entire careers in operational technology environments.

And maybe you sort of talk about process outlook, and I'll try to tie it into software automation as well. You definitely sort of highlighted the fact that your clients are thinking differently about what they are spending on, right? It's sort of efficiency versus production. So how does this impact your strategy, right? And what does it do to your mix? Because I think some of your sort of downstream peers, right, for them, the message is, hey, we like upgrades more than new stuff. It's a clear sort of margin mix -- up mix for us. How does it work for a company like Rockwell because you are more focused on upstream and midstream? Just -- once again, we can probably spend an hour talking about it.

Well, I think upstream and midstream, there's still a big opportunity for infrastructure to be able to be put in, particularly in oil and gas. And in many cases, as advanced as the oil and gas exploration and production companies are in terms of their use of technology there's been relatively little of that applied to the actual production side. And so there's a profound opportunity to increase that efficiency and whether it goes in as CapEx or as OpEx's in terms of subscription based services, we think we've got some great opportunities to grow double digits in that area. We've never been a company that's based on really big projects. So maybe a little bit in contrast to some of our competitors who -- they like the ongoing services because it's a more profitable business for them. But to be able to hit revenue goals, there's a certain amount of that, let's say, KOB 1 business or new capacity that they require. A big project for us is $3 million, $5 million. We don't rely on the big tens of millions or hundreds of millions of dollars projects in terms of our normal run rate for volume.

Well, we did analysis interestingly enough and we compare sort of automation intensity for industrial CapEx versus oil and gas CapEx. And I think like on software alone, industrial companies spend like 10x on software than oil and gas guys do. So it's actually staggering how little is spent on automation in oil and gas. But I guess for you, like what I'm gathering, you look at it as more of an expanding market opportunity is just so big rather than software over hardware, what they spend on is just the total spending could actually go up as they focus on efficiency. Is that right way to read your answer?

Yes. It's a big opportunity. And I think you're supporting the point that to apply the digital oilfield with software, including SaaS-based offerings that have a lower cost to implement. There's a profound opportunity for these operators to get more efficient because they haven't used these technologies in these applications when you think of the LACT process, the custody transfer process. Still in a lot of places, it's being addressed by somebody driving around in a pickup truck with a click board to be able to look at that vital part of transferring ownership from crew to the next custodian. And so I think there's a big opportunity for us to apply these concepts and grow in that particular industry there.

No, the top-down numbers are just staggering. It's fascinating. Anyway, moving on to operating leverage through the cycle. What is the right operating leverage to model for each of your new business segments? And if we have maybe more growth near term, what's the implication on incremental margin? Does the incremental margin stay the same? Or are we sort of capped into how high the operating margins can go and maybe more growth, but less incremental margin?

Yes. Well, I don't think there's any absolute cap on where margins can go. That being said, the best place to look is some of the framework for accelerating profitable growth that we provided over the last couple of years. In terms of 30% to 35% conversion on incremental revenue in that mid- single-digit range of incremental revenue. But if you look at the segments, and then Nick may have some additional comment here, Software and Control in the new segments that we have, Software and Control is our highest margin segment. It's where all of our software lives as well as our Logix and CompactLogix programmable controllers. It's our fastest growing, highest margin segment, and that's a pretty nice combination to have. And you've got the intelligent devices, which is about half of the company's revenue and continues to be a good source of growth for us. The products are differentiated, and they fit well into a coordinated system and they're in the middle when it comes to margins. And then you have the Lifecycle Services, which are the lowest margin because of the people intensity, but absolutely essential to give the customer outcomes of high uptime and fast commissioning and great support. The customers are making the investment in all these areas in the first place to get a return on. So we think those 3 segments segmented by the type of offering that they have with different earnings profiles, but brought together by a common sales force to meet customer problems and challenges in those target industries. In terms of leverage and the way that we can influence that, Andrew, the single biggest impact that we can have on margins is to accelerate profitable growth. Based on that framework of 30% to 35% conversion on incremental revenue, our margins will respond the most visibly to increase growth there. And that's why we've taken the deliberate strategy of working to accelerate profitable growth.

Yes, Andrew, I don't really have anything to add to that. Blake really summarized that very well.

Excellent. So maybe your go-to-market strategy. You do have this very unique setup. Your partnerships brings together players with strong relationship with customers, engineers, and strong corporate relations on the IT side of the organization. Can you talk about how your go-to-market strategy have evolved to weave together those digital threat of offerings? What is the marketing objective? And I know that you have sort of made moves internally to improve your own channel, particularly on the software side, maybe you can talk about that? And what are the implications of that, right, as cloud advanced analytics is becoming more important? And then in the end, it is interesting, some of the guys you partnered up with, they are -- and I'm talking maybe IT players, they have their own agenda as well, right, because all of a sudden, this industrial software market used to be a great place to sell cloud capacity. But all of a sudden, given the growth, it's a very, very attractive TAM by itself. So how do you manage this balance with some of your most valuable partners, but who, at the same time, could potentially be competitors?

Sure. Well, a couple of things. Let's start with the evolving go to market. So with the go to market, we and our partners continue to evolve to make sure that we're maximizing the value for what customers need today. And that starts with our salespeople who are very first in operational technology and within industry specialization because a fundamental part of our ability to bring the connected enterprise to life is to be able to describe our value and the language of particular industries, the way that an electric vehicle manufacturer talks about what they need. It's somewhat different than what you talk about if you're making vaccine or your mining. And so that's an important part of our approach. Looking at the outcomes that we can bring for these customers, including software, has been a strong focus of the leadership that we've hired and the way that we've shifted the capabilities of our own sales force as evidenced by our new Chief Revenue Officer with a strong software background. When you look at the impact on our electrical distributors, we've been very transparent in working together with our distributors over the last few years as we talk about how they need to evolve with us. Working together to increase our digital presence, being able to establish clearer accountability for who is doing what in an account, which frees us up, to some extent, to be able to make new investments in our own people without doing negative things to our cost to serve. Being able to support our distributors as they offer new services themselves, which was something that we used to take a negative view of, but I believe that by asking our distributors, to involve and to create new capabilities in their own offering, then it increases their level of expertise. And then finally, when we do go direct, having a defined way in which the distributor can participate in the life cycle because this is a huge opportunity for us to be able to launch new offerings, both regular software as well as -- or traditional software as well as software as a service, and bring a whole new level of value to customers that we've been serving in the past with our hardware or new customers where we're providing that software that sits on top of someone else's control system. Now in terms of our partnerships, we think we do a very good job of vetting our partners to make sure that we're getting something of value from them and that they're getting something of value from us. And that's a living thing that we have to continue to nurture. But in terms of differences between what's provided on-premise or at the edge or in the cloud. We believe that manufacturing customers are looking for a scalable approach. Everything is not going to move to the cloud. Any more than everything is going to stay on-premise. And so being able to provide a range of solutions there is important.

And just another question, AWS, it's very interesting is sort of introducing all of a sudden hardwares. If I think about the automation pyramid, right, it's just interesting that AWS is sort of moving perhaps the level 0, level 1 was their hardware and software offerings. What have you heard from the customers? And what do you think about that move? And just leave it at that.

I don't take a competitor like AWS lightly for a minute. Very great platform developer. I think our differentiation lies in our ability to understand the customers' needs and to be able to take a platform the last mile, so to speak, with understanding what data is needed to feed a platform, the volume and the variety of the data that needs to be ingested with security is something that an OT provider like us, I think, has a somewhat unique ability to understand because manufacturing is different than up your IT world, but then also with the delivery services, and the application software to meet specific needs, sometimes built on top of a cloud operating system. But so far, that combination of the technology as well as that domain expertise and the understanding of what it takes to bring that together into a solution has allowed us to fare quite well in these opportunities. But the field is going to continue to evolve, and we have to make sure that we remain unafraid to compare ourselves with all the other choices that a customer has. We're not just looking for incremental improvements on what we're doing. We're looking at all the other choices they have to make sure that we're doing the disrupting rather than being disruptive.

Can we just go -- I think one of the things you started doing when you became the CEO is this deeper focus on key industry verticals. What are the key focus areas today? And how is the strategy different from what you guys have been doing before? And what -- I think you sort of talked about it, but just structurally, what can you do? What are the verticals where you can change your behavior the most was the biggest impact?

Well, I think it has to do with an understanding within the company of what are the applications within different industries that we have to be great in and that no one product can do -- can meet the needs in that application by itself. So products need to have certain features to be able to do battery assembly. And there needs to be a certain amount of engineering expertise and software to manage those processes. So it's all those areas working in concert that come from our different business segments, but then with one account manager, one sales force, who understands those applications, who can represent the outcomes of combining that various technology together. That's how you really bring the connected enterprise to life. It's not just talking about the features of our Logix controller or the flexibility of our MES software, it's bringing that together to describe to a brand owner, trying to get an electric vehicle to market how we can help that person do their job. And similarly, in life sciences and validated industry that's very important because the demands there are quite different. Change has to be controlled much more highly, adherence to good manufacturing practices important in that industry, and so it is with other industries like oil and gas and mining. So that's inside the company, and that's the way that we represent it in our sales force. But I think as a pure-play company, we have the ability because it's all we do to be able to move a little faster to pivot to that industry approach. The final thing I would say with that is think of those industries as a bit of a proxy for customer centricity. When you're looking at the applications that we have to be great in, in a particular vertical, it naturally brings you and all the employees in your company closer to what that customer is experiencing and what they need as opposed to getting into the track of looking at just incremental improvements of your own products. You're thinking about it through an outside-in perspective.

Got you. And the last question, and maybe I'll combine the 2 questions that I had because I think they are combinable. So your software strategy, right? How do you think longer-term about make versus buy, right? And versus partnering up to achieve digital transformation goals. The second thing, I do find it very interesting as the industry is transitioning to SaaS and cloud, and this transition has been accelerated. You do have a lot of European competitors that have these big huge legacy software businesses, where my personal view actually is about to get disrupted, and that's going to be very, very interesting to watch. And from that perspective, because interestingly enough, you don't -- you ended up not having -- because of your nature of partnerships, you do not have this big legacy software business with this on-prem focus. How do you think about your M&A strategy going forward? Because to me, all these 3 things are actually interconnected, but I'll let you answer it.

I think we can move pretty fast. I think that when you look at make versus buy decisions, we have a strong and growing organic development capacity for software, our biggest development project in our history is ongoing to provide a new automation software platform that gives really unmatched flexibility to customers that they're going to start seeing this year and for the coming years. So we have that ability to offer that in parallel with what's been offered in the past. And then in certain areas and think of, say, augmented reality, we work with partner -- partners, where we don't think we necessarily need to own that technology. But there is a need that customers have for that to complement a solution, and we continue to look for innovative opportunities for acquisitions, and I would say that Emulate3D software for simulation, that we bought in a few years ago out of the U.K. as an example of that. Looking at the fixed asset management software that we just bought a few months ago. These are great well architected solutions that we're going to be able to build from, and that leads to your other question about can we be a disruptor? Absolutely here. Again, our focus on outcomes, our singular focus on this market allows us to weave together these solutions often sold as cloud-native and as a service and to be able to move faster to be able to provide new value to these companies, whether they're using our hardware or not. And so it gives us more ways to win.

Well, we're up on the hour. We're out of time. I am very, very curious and excited to see what you guys are going to do. I'm very curious to see what Nick is going to do. He looks very relaxed. I'm looking at this thing. And of all the management teams, you can tell the guy who was like taking time off. And I can expect that this may change. But congratulations on a great hire and I can't wait to see what you guys are going to do. Thank you so much.

Yes. Thank you, Andrew. Thanks for the time.