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

Hi, good morning, everyone, and welcome to Morgan Stanley's Life After COVID Conference. I'm Josh Pokrzywinski, the firm's electrical equipment and multi-industry analyst. Joining me this morning from Rockwell Automation are Chairman and CEO, Blake Moret; and SVP of Software and Control, Brian Shepherd. Before we get started, I just need to remind everyone that for important research disclosures, please visit Morgan Stanley's research disclosure website at morganstanley.com/researchdisclosures, and please contact your sales representative with any questions. I'd also note that if you do have any questions during the presentation, we do have a Q&A portal. You should be able to see a box for that, and we'll leave some time at the end to run through some of those questions. Guys, thanks for joining us this morning. Clearly, we're well into the throes of solid recovery in some of your end markets here, I think, indicative with some of the order strength you saw in the quarter.

Blake, just for those on the line who may not be as familiar, can you just spend some time talking with folks about who Rockwell is and what makes you special?

Well, thanks, Josh. It's great to be here. Happy to be joined by Brian this morning. And Rockwell Automation is a pure play. We're devoted exclusively to industrial technology. And we think we're in the best position of anyone to add value right at that convergence of IT and plant floor technology.

That's great. So maybe just to lead off here, I think this recovery right now is a lot more unusual than I think folks have seen for some time, clearly a big and exogenous shock rather than like a macro endogenous one. And big V-shaped recovery that we've all seen. So compared to past recoveries, what do you think is most different this time? And I think within that context, there's maybe a perception out there that Rockwell is made to be more early cycle than mid-cycle. But given the revenue progression, the order progression, it seems like you guys fall into the mid-cycle camp. So what are you seeing out there that would be comparable or not comparable to past recoveries? And how do you think about Rockwell's kind of timing position in that cadence?

Sure. Well, I think 2 broad areas to consider. First is what is happening in the macro and the environment. As you said, very strong V-shaped recovery, springing back. We've talked about that idea of a spring concept. And I think that we have seen that, but we also don't expect it to tail off in that. I think we're in the early stages of a sustained period of investment. Now in terms of Rockwell's evolution, in our positioning for that, the diversification of the industries that we serve continues. When you look -- even comparing us to where we were in 2008, 2009, exposure across more industries, hybrid, the largest single industry segment for us, meaningful things that we have done to improve our exposure in other discrete and process-focused industries, talking about annual recurring revenue. So I think the conscious steps that we've taken to increase our resilience are playing out in this recovery as well as the way that the macro is responding.

That's helpful. And then I guess you mentioned some of these big investments that are coming back and the durability they're in. I think for a lot of folks, their mind immediately goes to nearshoring and some of these big flashy announcements that have played out in that regard or starting to play out that we've seen from the likes of like a TSMC or elsewhere in the semiconductor chain. What's your take on how broad that scope could be? And then how you guys think about your TAM, whether it's the big flashy stuff that we need to be watching the New York Times for? Or is it a lot of stuff that kind of falls below the waterline for most folks who aren't plugged in?

Well, the U.S. was our fastest-growing region in the second quarter. And it is being fueled by, across the spectrum, MRO as well as expansions and greenfields. I like taking an industry vertical-by-vertical view of the whole concept of reshoring or expansions in, let's say, North America. So you start with the discrete verticals and, as you said, a bunch of the big announcements regarding semi investment here. And we're seeing spend from those semiconductor companies, some of that spend is not yet for the U.S. fabs that have been announced. They're in their own home markets because we have existing relationships with some of those companies. EV batteries. We've talked in the past about the value that our independent car technology plays in battery assembly for electric vehicles. When you look at in hybrid, you look at life sciences and the involvement that we have with vaccines being produced, food and beverage, the expansions there, e-commerce, look at the 70-plus percent growth we've seen there. So vertical by vertical, there's no question that additional investment in the U.S. is fueling a big part of the orders growth that we saw in Q2. Now to your second question, how does this change kind of the demographics of what a typical order looks like for Rockwell? We continue to get a tremendous amount of flow business and that great distributor network that we have is -- continues to be that differentiator that it's been for many years for us. But we're also increasing our ability to get the big projects. So we talked about the U.S. Navy project of over $50 million. We talked about a big e-commerce project here more recently. And so with some of our newer offerings, things like cybersecurity services, we're having the ability to throw the long ball a little bit better as well.

Got it. That's helpful. So maybe just to bring in Brian here, I want to spend some time on software. I think out there in the industrial world, probably more wrong than right just because the market is still evolving, there's an assumption that maybe life begins and ends with bigger products like PLM, and these are kind of a one-size-fits-all solution. Obviously, it's not a component of what Rockwell does. But how would you break down your software exposure? And when you guys sell into a customer, what is sort of the lead in? Is it product-centric? Is it solutions-based? What does that go-to-market strategy look like?

Yes. Great, Josh. So I spent a lot of my career in the PLM side of the world. So I understand that fairly well. And the focus of PLM has traditionally been early in the life cycle of product development and product engineering. I think about it as focused almost exclusively on the VP of engineering, of product development in those companies. Rockwell, as Blake was saying, is a pure-play focused on production system, the design, the operation and the maintenance of our customers' production systems and the software required to do that. So that could be control system design, could be system simulation. It's all of the runtime software, manufacturing execution systems, data analytics. It's a broad software portfolio, but all of it focused on that kind of VP of manufacturing or VP of production operations, the people responsible for making things at our customers, not designing products at our customers. So I think there's a relatively bright line between PLM and Rockwell's focus. Of course, there's points of integration, and that's where partnerships come in. Of course, our partnership with PTC is an example of that where we tie that -- pull that digital thread really from engineering all the way into manufacturing and production.

And how would you think about sort of that breakdown within software? Because I think for folks out there that have sort of a distinct name of, "We do these type of software offerings," it's easy to maybe allocate some of the strength or talk about where you're winning. Rockwell seems a bit more homogenous or there's kind of a solutions base there. How do you think about kind of the big silos within your software offering? Or how should investors think about those as the drivers?

Yes. I think that's actually an opportunity for us is that the software landscape inside of manufacturing or production operations is a little bit scattered today. And so there isn't a convenient moniker like PLM to describe the collection of capabilities that we and, of course, others are targeting into this production space. But I think there's a set of kind of key capabilities. The first is in design. We talk about this life cycle, design, operate and maintain. Design, in our case, means tools for designing the production systems, new cells, new lines, even whole new plants. And there's a set of engineering activities there that are required, some of which we offer, some of which we partner to provide our customers. Then in the next stage of the life cycle, it's kind of the operation of the factory, of the plant, of the line. And there's a set of software applications there, some of it quite low level in the stack like operating and controlling the machines themselves, some a bit higher in the stack like quality systems, which we offer, manufacturing execution systems, which we offer. And then in the maintain portion of the life cycle, kind of the third part of the life cycle, there's the MRO kind of maintaining all of those assets that are required for production. Manufacturing is an asset-intensive endeavor for our customers. So when they're thinking about return on investment capital or trying to achieve overall equipment effectiveness, they need a maintenance process that keeps those expensive assets up and running. And we offer the software to do that through our Fiix acquisition that we just closed last December. So I think we have a broad portfolio of software for manufacturing, all under this kind of connected enterprise banner of weaving that all together.

And when you engage with a customer who's maybe not as familiar with Rockwell on the software side or has traditionally been more of a hardware-heavy customer, is there a particular solution or a challenge on their side that they're trying to alleviate? Or is it just taking the entire plant base kind of up to a more connected level?

Yes. We think there are kind of 4 things that our customers are worried about. Production and kind of the productivity of production is the obvious first choice. And sometimes companies are trying to ramp up manufacturing more quickly. Sometimes they're trying to supply into a market where there's plenty of supply. So they really want to work on efficiency. And sometimes, like a lot of our customers today, they're in a market where demand is exceeding supply, and so they're trying to do everything they can to maximize output. So production is one of the key areas, one of the key outcomes that we talk to our customers about. But also kind of asset effectiveness is another whole area of kind of making manufacturing more efficient and more effective. So again, those are things like MRO, maintenance, repair and overhaul of all of the assets required in manufacturing. Our customers also spend a lot of time thinking about compliance and regulations, kind of new green initiatives to manufacture, with less impact on the environment, as an example. And then finally, it's an area of transformation. Our customers are trying to find ways to bring new technologies like augmented reality or machine learning into manufacturing to approve overall effectiveness. So there's kind of 4 buckets of conversations that we have, and different companies are at different levels of maturity as to how we engage, but that's kind of our entry point.

Got it. And then one question that we get from more of the tech side of the world or folks who focus predominantly on software companies is, okay, some of these new entrants, like industrial companies who do software, maybe the -- it's not really software. So can you take maybe a second to talk about how you guys sort of price and engage with the market? I think there's a view that if it's something that's done based on scope or man-hours that maybe that's not the same as sort of a recurring model or something that's more subscription-based. Which way do you guys tend to lean? And kind of more broadly, how do you price in the marketplace?

Well, I mean, the answer to that question is Rockwell has both, a strong services organization engaged with customers and their facilities, like formalizing these solutions for their specific needs. So that's a real strength of ours. We have thousands of people that are technical professionals engaged with manufacturers around the world. A lot of other companies don't have that luxury. At the same time, we have a big kind of core R&D software organization that is creating standard applications. So these aren't bespoke or single-customer solutions. This is -- in the old days, we'd call it packaged software, but it's just productized software that we sell on the market in either a subscription model or in a perpetual license model with maintenance. But there is a strong component of ARR in our software business, but also in that services business, as I talked about.

Yes. Let me just -- Josh, if I can add to that, one of the things that sets us apart is the focus on outcomes at customers. And as Brian said, we have the range. A customer doesn't care whether the value is provided through firmware or through application software or through the deployment of services. That customer cares about getting the outcome and having a supplier that understands their problems and can take a system approach to implementing it. We know, and we've talked about our ability to increase our pure software capacity, but it's the combination of all these things that sets us apart.

Got it. That's helpful. And then maybe thinking about this in a competitive context because a lot of what, I think, Blake, you and Brian are describing is very customer-facing, right? It's not portal-based or you go to some local reseller and click on a few things, there's a lot of engagement that is involved. How much of what you guys do is really a competitive offering versus something maybe the customer didn't know existed and they, to your point, Blake, were looking for an outcome, not a definition of this is what we need?

Yes. I think it's a combination. And also, the market moves. So whereas MES software in many verticals, not too long ago, was a nice to have and a customer didn't necessarily feel like they had to have an offering there, if you look today and you look at the new EV facilities being built, practically all of them recognize that they need to have the scheduling capability, the supervisory function that comes with MES software. And we've got a great one, and that's why we're winning at a very high rate there. So it moves, and I would say it's a combination of both defined market-serving type of capabilities as well as market-making type of capabilities for customers who are looking to test the bounds of what has traditionally been offered in the market as they're looking for their own competitive advantage. And one of the things that I'm very happy about is the consultative services that we've added through the Kalypso acquisition and organic hiring to help customers better define their problems. That's where it all starts, is to help the customer define what it is they're trying to accomplish and then to see what combination of established software packages and custom engineering are going to be required to bring that together to give them the outcome that they're looking for. And that's how we're beating our toughest competitors in this space.

Got it. So maybe talking about what that final solution looks like at the customer level, how would you think about attachment rates between kind of the software and hardware piece of the business? It seems like naturally, they would be fairly high, and maybe there's some hardware that needs upgraded to pull in. But is that a fairly healthy mix? Or are those kind of discrete purchases, no pun intended, when your customers do make those upgrades? That's the only automation joke that I think is possible, by the way.

You found it.

I can take the first shot at that, Josh. So at the lower levels of our stack, kind of very close to the control and automation layer, there's really high attachment between software and our hardware. I mean we're selling solutions at that level. And by solutions or systems maybe, it's the combination of software and hardware that come together that solve a problem. So right there, again, very high attachment. Think about it as almost like your phone kind of thing. It's a combination of hardware and software, and that works together very, very well, and that's what people buy. So that's the way I think about it, the control layer. At higher levels in the stack, when we're talking about MES or analytics capabilities or connected worker solutions, that's our opportunity to kind of grow into that, to make those solutions, those applications logical extensions of this big core base we have of automation customers. So we have decent attach rates, if you want to call it that, or growth capabilities there, but I think we can do even better as we kind of engineer all of these products to work better together.

Yes. The information solutions, the software, the connected services can double the monetization of a relationship with the customer. It doesn't happen in every case, but we've talked about case studies in the last few automation fair investor days about that capability. We also see the pull-through of some of these higher-value services like cybersecurity services, which is over $100 million business for us, just the services side, apart from the hardware and the specific software. And that also helps get us to a new level of decision maker within those customers. Those are CIO decisions that are being taken. And we're a huge resource for them because many times, they lack the familiarity with what's needed on the plant floor. They understand what they need to do reasonably to make their office environment more resilient, but those services to complement the pure software is an extra value that we can provide.

Got it. And I was going to -- it's a good into my next question is, Blake, I think you've talked before that customers don't really want to factory in the box or, in a lot of cases, can't afford it. And the market is a little bit more democratized, I think, as you go up the stack and get closer to that CIO. Is winning in that market really dependent on getting in front of that layer of the organization? And does that plant reference point get you a lot of leverage? Or are you going in a bit more cold on the CIO side?

So nothing scares the CEO more than to be looking at a new technology solution that the plant say will imperil their production. That's what they do. And as a manufacturer, that's the ultimate scary type of situation. And so while the CIO is very often involved in these sorts of discussions because you're implementing MES and it needs to interface with other enterprise applications, you're picking someone for your cybersecurity services on the OT side, on the plant side, starting by being such a great resource in the production environment that Brian talked about is our home field advantage. We understand what they're trying to do. We understand where the data is coming from. We've got all those last mile intelligent devices that not only are controlling the core automation but also where the data that's ultimately used to feed these higher level systems. And so it's starting there, but as we're making, I believe, great strides in moving into the IT side of things, and we're augmenting our capabilities, not only with our product offering, but also with the consultants that we're adding, the partnerships that we formed to have a better, more direct conversation in those decision-making areas as well.

So I want to follow-up on something you mentioned a couple of times here, cybersecurity. I know that's something you guys have pointed out as a recent source of strength. Obviously, extremely topical these days. Watching people fill up plastic bags with gasoline in the Carolinas, I think, is an interesting mental image. What -- is that a potential -- like, is that an example of a potential customer when you look at somebody like Colonial? And how -- I guess, how has that conversation evolved with customers? Even though it's still fresh news, I would imagine everyone who has an at-risk asset just went, "Oh God, I need to do something because the risks are very high if I'm not properly protected."

Absolutely. Just quite simply, absolutely. I mean this has been one of our fastest-growing lines of business, cybersecurity services. We've got hundreds of experts on cybersecurity in the industrial environment. We've made acquisitions to fuel that growth. And I think the interest is going to inflect yet a steeper slope, really.

And is there any way to sort of benchmark for folks, kind of scope or revenue opportunity with customers? So you mentioned bringing in kind of the full capability on the software side can double a relationship. I would imagine cybersecurity is part of that. But is there any way to sort of say how much of that TAM expansion is potentially cyber related?

Yes. I think if you start with the figure in just in the operational side of things of a couple of billion dollars, that would give you the right order of magnitude. And growing fast, we've done some internal studies when we were starting out with our cybersecurity services and looking at what the pull-through multiple was when you have such an engagement with the customer, coming from the kind of decision makers you were engaging and the problems you were solving for them. And it was multiples. It was, in some cases, close to 10x in terms of the pull-through of the other things, the dollar value of what we were selling that customer when we were engaged in a cybersecurity project.

And then I guess just taking a step back, given that there's such a rich list of conversations to be had in the marketplace. Cyber is just one of them. Bottlenecks and supply chains are maybe a completely dissimilar one, not to mention some of this existential growth and things like EVs. Anything from an industry or application perspective that is a particularly high focus for you guys right now? It seems like there's a lot of at bats to be had. I guess where do you really want to take the pitch and put in more resources or feel like maybe you're not putting in enough resources?

I'm going to ask Brian for his early impressions, but I tell you, you put your finger on it, more ways to win. It's more industries that we're a big player in. It's more offerings across the spectrum of our portfolio: hardware like Independent Cart that's helping us win in EV battery; custom applications, like with the U.S. Navy; packaging in food and beverage and so on. It's the software, the way that our MES is winning, our analytics solutions, what we're doing with PTC and the services and the growth of our managed services of high-value expertise. So more ways to win, but ask Brian for some of his impressions about the biggest opportunities that he sees.

Yes. I think the common thread from my standpoint is data, data and manufacturing, data and production operations. So we are the source. Rockwell's products are the source of so much of the data in manufacturing, whether that's sensor data, whether it's control data. We have an opportunity to make sense of that data for our customers to help them extract value from that data, whether that's in dashboards or analytics or special applications, all kinds of solutions taking advantage of that data. So it's more a theme than a special application area or a single application area, Josh, but that theme of the value of data and manufacturing and technology, by data in manufacturing, I think, is a huge opportunity for us.

Got it. That's helpful. So maybe putting it all together and matching that up with some of the near-term progress. Blake, you guys had an awesome order quarter last quarter, $2 billion. I can probably get to a number slightly higher, if I include in some of the services side. I think the $2 billion was product only. Doesn't seem like from anything you've said that cyclically, we're going to lose momentum. I don't think seasonally, there's a lot of factors there as well, but correct me if I'm wrong. What stops us from just cascading into, okay, we're doing $2 billion of orders. And at some point, that's $8 billion of revenue. It seems like that's right on the doorstep, knocking and waiting to be let in. Anything that gets in the way of that from either a conversion perspective or any other kind of lumpiness that we need to think about?

I think we have a clear line of sight to that $9 billion figure that we've talked about at Investor Day for the last couple of years. I do want to clarify that the $2 billion of orders we saw in the second quarter was the total company, it's without the inflection yet of the services and the solutions, but that $2 billion was for the full company. We do see every evidence that the services and solutions picking up will add to the momentum that we've seen with the products. But Josh, the short answer is no. We think that getting to an $8 billion top line figure on the way to $9 billion and beyond, we've picked the right areas to go deep on. We've added the new talent with new perspectives and new energy, and we think we're in the early stages of a very supportive macro.

That seems like a great place to leave it off. Blake, Brian, appreciate you guys taking the time today. Always a pleasure. And thanks to everyone joining us on the line. Please feel free to reach out with questions.

Thank you.

Thanks.