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

Good morning, everybody. We're excited to have our second presenters here today with Rockwell Automation, we have Chairman and CEO; Blake Moret, who's been with the company for over 35 years and newly minted CFO, but not new to us, Nick Gangestad, who just joined the company in March. Thank you, Blake, and Nick, for joining us today. We're excited to dive into the conversation. But I know, Blake, you had some prepared comments that you wanted to go through first, and then we'll dig into Q&A.

Thanks, Joe. It's great to be here this morning. And I do have a few comments just to frame up the upcoming discussion. Rockwell Automation is a pure-play industrial technology company. We integrate control and information across the enterprise to help industrial companies and their people be more productive and sustainable. And we're really taking manufacturing to a whole new level. [ Aijana. ] We just -- we announced recently our second quarter results. And I would say that the headlines were really continued very strong order growth across almost all of the industrial end markets that we serve. And that was across our portfolio, the intelligent devices, the controllers, and importantly, software and associated services all saw very strong growth. The orders for the last year, we've given more information about the development of our orders from a quarter-to-quarter and even a monthly basis. And you can see here what our orders have done, even taken out a couple of very large orders that we've seen in the last few quarters. We believe that we're entering a period of sustained economic expansion, and we're very well positioned to participate in that expansion. The framework that we introduced a couple of years ago, getting us to $9 billion in revenue, still remains vibrant. And again, across the different elements of this growth platform as well as the profitability guidelines, if you will, we're very happy with our progress. We offer value across the customer's investment life cycle from their design of their systems, the operation of those systems, the maintenance and then the upgrade cycle. We think that we differentiate by meeting a customer where they are on their automation and digital transformation journey and recognize their installed base, what they're trying to accomplish and working with them in an open way to implement our technology as well as our expertise. We've recently reorganized into 3 easy-to-understand business segments. Intelligent Devices, that's the last mile devices that are a big part of the core control system. But importantly, it's also where the data is born. Our Software & Control segment, which is our highest margin, fastest-growing business segment. And Lifecycle Services, when combined with the technology helps ensure the positive business outcomes that customers investing in, in the first place. We updated and increased our guidance 7% at the midpoint, organic growth and with continued good contribution from recent acquisitions and good profitability. Across the end markets, we are expecting growth in almost all of the industry end markets that we serve. Oil and gas is lagging, but we do see signs via sequential growth and discussions with customers, but that's picking up as it usually does a couple of quarters after the discrete and the hybrid segments. And so with that, Joe, I'll turn it back to you.

Yes. Thanks, Blake. I appreciate that overview to kick off. Where I'd like to start. I'm sure we'll get into the end markets and the trends because I know investors want to discuss that. But maybe we'll just kick off. Back in 2020, you guys put together a slide in your investor deck that showed like where you were investing from an R&D perspective and the progress that you had made, where you were going, what you expect to do achieve longer term. Can you maybe just update us on that and what progress you have made on the investments across your portfolio?

Sure. And maybe I'll organize my answer across our -- by segment. So when you think about the Intelligent Devices, we continue to fill out our line of high-performance drives. So we've always had a very strong offering of general purpose, variable frequency drives that control the speed of a motor and also importantly, save energy. They're a big part of our efforts to help customers be more sustainable. We've added high-performance drives for precision motion control used in process applications and high-performance pumping applications and so on. And we have an offering now that's second to none. So we'll continue to invest there and to fill out that line. We've also added a couple of new product lines of lower cost motion control. And this is particularly important, as we've talked about taking a more aggressive posture in emerging markets or lower cost, more price-sensitive markets like China. I don't think we can call China emerging anymore. But when we look at lower cost motion control for packaging applications for use by machine builders, we've been very happy with the early reception to those new product introductions. In the last couple of months, I'm aware of several major orders where we beat the usual suspects to win in China with these new motion offerings. If we move to Software & Control, late last year, we launched the P controller, which is a process focused version of the Logix controller, and the reception across our regions has been very strong. I'm proud, first of all, of our team for getting a product to market right in the heart of the pandemic, to be able to do a lot more work remotely than we ever thought possible in terms of taking that product, the final steps to introduction. And it's an important step in our long-term stated goal of having a stronger offering and to take share in process. We're also working on IO to go along with that control, focused on process, and that will be released within the next year. So good progress there. We launched from a software standpoint, an important SaaS offering, cloud-based design tools that are part of our Factorytalk Design Hub. And then within our Lifecycle Services offering, we continue to strengthen our cybersecurity services offering. That business is over $100 million for us today, and we have great expertise, great offerings on our own, but we also combine that with what I think is the best ecosystem in the business.

That was really great and helpful, Blake. We've talked about this in the past, and I'm sure you've heard this from investors as well, but there's this feeling amongst the investor base that you're behind in some of your software offerings relative to your peers. So maybe I'll just leave it at that and how do you respond? Like how do you feel your offerings are stacked versus the likes of the Siemens of the world and the investments that you've made?

Joe, we're beating Siemens and other competitors every day with our software offering, with our combined solutions. Tough competitors. But I'm very happy with the progress that we're making with our software, with the associated connected services and the way that, that integrates with our core automation. One of the things that we've talked about is our open approach. And for our information software, half of that software is going on top of someone else's control system. So not only are we beating that incumbent in their own house in terms of an installed base, but our software seemed to be valuable enough to provide that benefit, taking data from someone else's control system. So I'm happy with that. And we're working with the continued sense of urgency, both inorganically as well as organically to continue to strengthen that offering. Software is never done, and you never get to this plateau where you can just sit back and harvest the results. You've always got to be moving in that respect and we've moved much more assertively from an acquisition standpoint, with acquisitions like Fiix, which is a full SaaS offering in the asset management space, Emulate3D, which is winning every day at new customers, by the way, with the simulation capabilities to model and debottleneck production systems. And then our own internal work to bring in new automation software platform to market. So it continues to be a high priority. It's difficult. We've added new people to help us with those perspectives, but I'm happy with our progress.

Yes. No, that's good to hear. I guess, Blake, you mentioned M&A, so I may as well go down this cap. You have made some acquisitions. Just talk about the types of acquisitions that you're interested in prospectively, you've also been very active in your partnerships as well. And so how does -- how do you think about the -- when you're thinking about entering into a partnership, whether it's PTC or others, how do you think about the partnership path versus the M&A path? And what are you looking to build out from an M&A perspective?

Well, first of all, the purpose of acquisitions or partnerships is to create more ways to win, more ways to add value for customers. And it also allows us to move at the pace of the market. As it and so-called OT converge, plant floor operational technology, the pace of change is picking up. And no one company has all the answers under just their own roof. I think it's arrogant to think that's the case. And so by acquiring and by partnering, you can move at the pace that customers are expecting and we're going to do both. One of the criteria for acquisitions is, first of all, strategic fit. And we've talked for a few years now about information solutions, software, connected services, process expertise and expanding our markets in Europe and Asia as the broad rubric, if you will. Within Information Solutions software, there are certain areas that are interesting to us that have an important fit with the real-time data. So when we bought fix, for instance, one of the things that was most attractive to me is that we had a good asset management system but they also had the ability to take real-time data from our control systems. And I'm very happy that just recently, they added another $1 million-plus annual recurring revenue customer in the area of sustainable packaging. So that was good. And very importantly, I was delighted to hear that it's taking our real-time data. And that's a differentiator. In that case, asset management software is not a brand-new field, but we differentiate from our older, more established competitors there by understanding very well the way that real-time data can be fed into these systems to combine the worlds of transactional, keystroke-entered data with real-time data. And so I'm looking for those edges. I'm looking for, in this case, software that can solve real-world problems, but can do it in a way that is Rockwell's unique opportunity to differentiate. When it comes to partnering, partners like PTC, like Microsoft, like ANSYS, these are opportunities to work with the best in the business in areas that we needed to move quicker in and that in certain aspects of their offering, we didn't feel like we necessarily needed to own. And so each one is different, but we consider it from a customer end viewpoint, and I've been happy with the way that we've been able to pull together what I think is a very powerful ecosystem.

Yes. No, that's super helpful. You mentioned annual recurring revenue. I know that, that's something that is super important for you guys moving forward, ambition to get to north of 10%, and now it's part of -- love that it's now part of your incentive plan. You mentioned Fiix and what you're seeing there. Maybe just give us some more examples on like how you're developing this more recurring revenue stream? And how important is M&A going to be in terms of getting there?

Well, it certainly helps a potential target to get through the hurdles, if it has a significant amount of annual recurring revenue. Annual recurring revenue is good for customers because it can help convert CapEx requirements into OpEx and give them cost certainty as they're acquiring services or software or hardware or bundles of all of those. And obviously, it's financially attractive to us so that you're not starting each year at 0. And so in addition to Fiix, taking some of our traditional software, like our MES offering and converting it to subscription, that's an important way to grow and to give you the benefits of that compounding effect of having bundled software and the related services. The new offerings that we're releasing from a software standpoint are almost all to be sold on a subscription basis, such as the automation software platform under development. And then adding -- making it just as easy as possible to add services to be sold to that project to give you a reason for being in that customer after the initial project is commissioned. So remote technical support is an area that I'm particularly proud of because we've been able to provide a range of offerings from just basic, call a smart person when you need them, all the way to continuous remote monitoring of critical networks and production, such as we're doing with Kraft Heinz.

Got it. That's super helpful, Blake. Maybe transitioning the conversation. In your prepared comments, you said sustained economic expansion. And it seems like you are starting to see some green shoots across your business. So maybe just a broad question, just talk to us what you're seeing across your enterprise and what gives you the confidence that you're going to see pretty some strong inflection here?

Well, we've seen very strong orders growth year-over-year, strong double digits. We've seen that continue, as I showed in the graphic, across several quarters now. And the breadth across different end markets as well as regions, makes us feel very confident that, one, we're entering that period of economic expansion. And two, we're very well positioned to participate in that. So in discrete, we saw over 70% growth in e-commerce. That's pretty strong. And while it's traditionally been a smaller business for us, it doesn't take too many quarters of compounding at those kind of growth rates to put it on the radar in a big way. Semiconductor. You've all heard about the number of fabs that have been announced, including those in the U.S. We had existing relationships with most of these companies. So it's not just opportunity to leverage our superior support in the U.S. We know these customers, and we're looking at ways of expanding the set of applications that we can cover beyond our traditional facilities management. We look at electric vehicle within automotive. We're taking a very aggressive posture with respect to electric vehicles, and that's where the capital is being spent within the automotive industry. When you move to the hybrid industry segment, life sciences. We're involved with virtually all of the vaccine producers. Food and beverage, has picked up tremendously, led by the food packaging OEMS. And we saw good double-digit growth in the last quarter there. And so across those industries and even within Process, activity within mining has picked up. We're seeing sequential improvement in oil and gas. But as I mentioned, that, as expected, is going to lag the discrete in the hybrid segments. And then chemical, we're seeing some activity there as well, particularly in our sweet spot of specialty chemical.

Got it. No, that's great color. I think maybe just going back to your comment on the existing relationships that you have with the semi fabs. Have you started to see orders come through for the new fabs that are going to be built in the U.S.? And -- or is that -- do you expect that to be on the come from this point?

I think that's going forward. I know we had a nice order from one of the major fab producers that is going to be producing in the U.S. We had a nice order last quarter, but it was for their Asian operations, actually. And so everything hasn't been put on hold elsewhere, and we continue to work in some of these other facilities as well.

Got it. And Blake, as you kind of think about maybe a little bit longer term, like the next 5 to 10 years, right? And you mentioned in the discrete space, EVs and your placement there, specifically, what you're seeing with e-commerce, small piece of your business today, but growing very quickly. And you compare that to some of the process end markets and how they're a little bit slower to recover here? And I think that, that's a broad comment across the board for the companies that we cover. Does the mix of your business change? Do you see the mix of your business being much different 5 years from now than it is today?

Well, we've seen significant diversification, let's say, in the last 5 years, ourself, when you think about automotive, reducing as a overall part of our business from -- when I started all those years ago, it was over 1/3 of our business, maybe closer to half of Rockwell's business back in the '80s. Now we're seeing automotive is somewhere around 8%, despite the growth of electric vehicles, that's not because we're losing share in automotive. It's because we're penetrating these other end markets. And I like that diversification. It's a part of our resilience strategy. So when we see life sciences, which has become more meaningful, I think we're going to continue to see strong growth there. E-commerce is going to become a bigger part of our overall business. And even in the process industries, in oil and gas with the joint venture with Sensia, I'm still very happy with the way that we're positioned there. We're focused on efficiency, not as much drilling new holes in the ground.

Got it. Okay. That's helpful. I guess -- and maybe since you guys did highlight the $2 billion in orders that are -- I think it was even north of that in orders that came through this quarter. Anything around like the -- is there a difference to -- we talked a little bit about the composition, but is there a difference in like the size of orders that are coming through? Just any other color that you could provide there.

Well, 2 aspects of that. First of all, we are seeing the size of projects, the larger projects, which traditionally for us, say, over $5 million. We're seeing the frequency of those coming back for the first time in a while since before the pandemic really set in. And so there's that normal recovery. But then in terms of secular trends, are we playing a bigger role in our customers' digital transformation? The answer is yes. When we look at some of the engagements we're seeing with areas like cybersecurity services, these are some very large projects across multiple facilities at our customers, and they rival and exceed, in some cases, the big projects of the past, which might have been a new paper machine or something like that. We're seeing that combination, the more ways to win that I talked about, between the hardware, the software, the services, the engineering design, you're bringing that together, I don't think it's moved significantly the average order size. We still sell a lot of product through distribution, and that's not going to change. But it gives us, again, another way to win.

Yes. That's great. And so as I asked that question, I actually got a question from the audience, relating specifically to the semi conversation that we were having. So typically, like how much would like a semi facility be to Rockwell in terms of like dollar revenue? Is there a way to help us size that?

I think it obviously is going to depend on the size of the facility and so on and how much software is a part of it versus engineering design and the basic control. But typically, it's going to be single-digit millions of dollars, depending on the size of the facility. And then there's going to be an opportunity for ongoing work in those facilities as well. So there's an add-on piece that gives you an annuity as well.

Okay. Got it. Nick, I promise, we're going to get to margins in the second, but I want to finish along with this growth conversation that we're having with Blake. And so we've talked about the semi component. We've talked about life sciences to some degree. Reshoring was a very big theme a year ago, right? And there was a lot of exuberance over it. I -- kind of didn't pan out over the last 12 months the way that we kind of hoped. How does the next 12 months differ? And maybe that's -- maybe it's a function of stimulus funding. But are you starting to feel more confident about what could potentially be a bigger boost from restoring in the U.S.?

I think whether it's reshoring or it's expanding an existing U.S. operations. I don't think it's a coincidence that we're seeing such strong orders as a really strong supplier into the discrete and hybrid end markets in the U.S. I don't think you can look at those as just a coincidence. Reshoring activity and increased manufacturing in the U.S. is going to come primarily from discrete and hybrid industry segments because in Process, with rare exceptions, you're kind of tied to where the resource is, where the crude is or the bitumen is or the ore is. But the industries that I talked about is contributing to our strong orders growth are the ones that we're seeing investment in the U.S., semiconductor. E-commerce isn't really reshoring. It's just an expansion of a really successful business model, and we're seeing great growth there. EV, you hear about the battery plants that are being put into the U.S. to be close to the end market. In hybrid, life sciences. It's well-known that people are looking to try to shorten supply chains for critical medicines, protective equipment, mass, things like that. And we've definitely benefited from that and even food and beverage. We've seen a number of now public, but also nonpublic plant builds and capacity expansion. So it's not a coincidence that this is where we're seeing some of our strongest growth, and I'm very happy that as the strongest supplier to those industries in North America, we're positioned very well for that.

Yes. Those all good points. Nick, transitioning over to you. So we talked a little bit about just clarifying some things on investment spending for this year. Just to make sure that we've got it correct, you're expecting a $90 million to $100 million increase in investment spending increase in the second half. So it ends up being like roughly, like, call it, a $50 million to $55 million headwind, I think, in 2H. Is that the right way to think about it? Or I'm sorry, year-over-year headwind for the full year, $90 million to $100 million headwind in 2H. Is that the right way to think about it? Did we get that right?

Yes, Joe, in the first half of the year, we -- our spending went down from the first half of 2020 by about $50 million. And now in the second half, we're seeing our spending year-on-year go up approximately $100 million. That brings the full year to -- we think our spending will be up about $50 million for the full year. So some of that is some timing things. Some of it's that incremental investments that we talked about on the prior quarter call. And just in terms of these -- the year-over-year increase, some of it has to do from a comp standpoint of how the spending was timing last year as the pandemic was unfolding.

So as you think about that spending, can you maybe just elaborate a little bit more around where you're spending the additional dollars? And then also, as we think about 2022, how do we think about 2022? Is there going to be an incremental amount of spending in '22 as well? Or does that just start to normalize?

So Joe, we -- when we talk about our spending this year, we're continuing to focus on our highest priority areas, and that includes software development, process functionality and enterprise digitization. Now this accelerated spend in software this year, that's going for specific development that we're doing to pull forward some of our SaaS offerings, and we're doing that to benefit our recurring revenue in '22 and beyond. And then the broader picture of core conversion and margins, we've said for quite some time that we expect core conversion for our incremental margins to be in a 30% to 35% range. And that's typically aligned with years where we see our growth in mid-single digit. And this year is -- '21 is no exception to that, that we see our core conversion in that range. Now going forward into '22, there's a lot of factors in play, and we're really focused more right now on '21 and delivering on that and ensuring we're executing and getting the return on the investments that we're putting in place. Now -- but as we go to '22, we continue to think that 30% to 35% is a good place to start. I wouldn't say it's a barrier that we never will go over 35 or never under 30. So a lot of it would look at what are the investment opportunities. It's really early for us to say, but that type of range, we think is the right range. Of course, as your growth goes above mid-single digits, it gets a little easier to be at the high end of that range or a little over that.

Got it. That's helpful. And so if Blake is right on sustained economic expansion, we're looking at an incremental margin at the high end, perhaps higher than 35%? Or like, will you manage -- I guess the question is, will you manage to a 30% to 35%? Or will you -- if we wait for high single-digit growth, could we see something much stronger?

No, we're not going to just spend for the sake of spending to keep the margin, the core conversion down to 35%. It's going to be based on the quality of the investment opportunities we have. And if we have the right opportunities, we will be spending on them. If we feel they're not the right opportunities at that time, there could be some upward pressure. If we are in a period of sustained economic growth and where we're seeing our organic growth beyond our -- what we've laid out is the mid-single-digit when we describe that 30% to 35% core conversion.

Yes. And if I can just jump in. We outlined this as part of that slide that I touched on at the beginning on the path to $9 billion. That's one of the really important financial guidelines, striking the balance between growth and performance, but it's all with the idea of accelerating profitable growth. We think that 30% to 35% commitment is something that has served us well. And as Nick said, we're going to consider the quality of the individual investment options going forward. But we're happy with where we are in terms of our spend. And one of the reasons that we brought forward some of that incremental spend that Nick mentioned was because we expect that we're entering a period of sustained economic expansion. And so we want to participate just as fully as possible by bringing products out earlier if we can.

Yes. No. And maybe following up on both of those points, right, around like the investments that you're making in SaaS and getting to that $9 billion number. Today, your software business is roughly -- your pure software business is roughly $500 million business. How are you thinking about the ability to make that $1 billion business over time? And how quickly can we get there?

Well, we spent a lot of time in that in our recent strategy refresh. And with some new eyes on it. I think the clarity, the detail and also the realism of how do we get to that kind of number. In the end, the single most important factor is bringing software out that customers find very valuable in helping them be more competitive. That's what the name of the game is, is to be able to bring the positive business outcomes to those customers, and that's why, in addition to the software, having a really strong offering of the services to help them define their business problems, implement it to get the results that they were looking for in the first place, that's going to help catalyze the growth of the pure software portion of that. And so it's all these pieces working in concert. But I am very excited about the prospects as we convert some of our existing software streams to subscription, the market is more and more looking for that, and in some cases, even demanding it. The new offerings that we're working on organically. The acquisitions that we've already made in making sure that we're getting the benefit from those. And then acquisitions yet to come that are going to enter into that mix as well. So there's lots of ways to win.

Well, maybe on that note, since we're bumping up on time, Blake and Nick, thank you for spending the time with us today. Always great to see you, and have a great rest of your week.

You too, Joe. Thanks for having us.

Thanks, Joe. Take care.