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

Good morning, and thanks for joining us. We're kicking off day 3 of the Wolfe Research Industrials and Transports Conference. My name is Nigel Coe, and I cover the multi-industrial sector for Wolfe Research. We have 8 fireside chats on the investment track today, and we're starting off with Rockwell Automation. Very pleased to welcome to the virtual stage, Blake Moret, Chairman and CEO of Rockwell. Blake, thanks for being here. And Nick Gangestad, I want to say CFO of 3M, but of course, now he is CFO of Rockwell Automation. So Nick, it's great to see you again, and thanks for being here as well.

Thanks, Nigel.

Right. So folks, any questions you have, I think you know the drill by now, just punch them into the text box or IM me, email us and we will try and get through to those questions if we can. But Blake, I thought it'd be a good start to maybe just give us an update on what you're seeing out there. We're planning to turn back deposit growth in third quarter fiscal. Any thoughts on that?

Yes, strong positive growth in fiscal Q3. And maybe just to circle the verticals, going through the -- by industry segment. So starting with the discrete industry segment, you're seeing a lot of very strong activity there. We talked about e-commerce for us of over 70% growth in the second quarter. We've got a great offering when it comes to the intelligent conveyance and sortation applications in e-commerce applications. And I should mention, it's not just the pure e-commerce companies. It's also the back-of-the-store type of automation activities at some of the big boxes that are increasingly turning to our sorts of automation, where we have a really strong offering. Independent car, for instance, is a great capability there. Elsewhere in discrete, EV. People have to bring vehicles to market to get a return on all those investments that are being made. And particularly when it comes to battery assembly, we've got some real differentiation there. And then we look at semiconductor, and there've been some very well-publicized enormous numbers for investments already being made, particularly in the U.S. When we look at hybrid industry verticals, life sciences continues to be very strong for us. We talked about growth over the last few quarters, and we really see the continued contribution of life sciences throughout the front end, the active pharma ingredient process control through the packaging, the serialization. Cybersecurity is, of course, critically important in that industry, and we've got strong offerings there. Food and beverage is our single largest vertical, and we see good growth there, particularly led by packaging as people are looking for more flexibility, being able to minimize change over time in their applications, going from one packaging format to another really with low to no change over time. Our motion control technology, again, independent card is playing a role, is a strong differentiator there, and we're winning around the world there. The laggard, as we've talked about, is oil and gas. We think that we're well positioned there. But that's, as it usually is, lagging discrete or hybrid-type processes and a return to growth. We do see sequential growth as we go towards the end of the year in our fiscal year in oil and gas. And we do see activity in other areas, process mining. Obviously, commodity prices are at very high prices. Copper is an area that's particularly important to us. And while we haven't seen the spend turn loose there, we are seeing increasing activity in terms of updating quotations and so on by the copper producers. And then there's activity that we're seeing in chemical, which is another large vertical within process.

Okay. That was great. And so the heavy industries process still lagging fleet average in 2Q. Do you think oil and gas breaks back to positive growth in second quarter against that easy comp?

I think in the second half, it -- we start to see positive growth in oil and gas. I do.

You mentioned -- I just want to pick up on some of the points you mentioned there. You mentioned packaging. And I think a trend that we're seeing is a trend towards renewable packaging. Is that a major trend that you're seeing? And could that be a mass driver of your business?

It absolutely could be. We're very engaged with not only the users who are selling directly to consumers who are intensely focused on reducing their carbon footprint and making sure that they can participate fully in the circular economy, but it's also the machinery builders that are serving them as they're looking at how they can create renewable packaging or recyclable packaging. It's a difficult challenge because the same things that you're protecting against with the packaging traditionally with heat and humidity and so on are the things that make traditional packaging more impervious towards natural degradation and the ability to recycle it. But we're working with them on some exciting areas, and we're seeing some early results. Our new Fiix acquisition, which has -- brings a SaaS asset management software to the market just notched their second million-dollar recurring revenue customer. And it is with a company that provides renewable packaging or recyclable packaging. And so that's an interesting area because it will give us an opportunity, of course, to sell all of the core automation components, but we led with the new Fiix software, and that's an exciting development for us.

That's great. So it sounds like that's a trend. And auto, auto was another lagging end market in the second quarter fiscal. You mentioned EV. But in totality, do you expect auto to be back to growth? And again, kind of comparable to your [ t ] of fee average in third quarter?

Yes. We haven't talked specifically in the third quarter, but for the full year, we are expecting auto to get to around 10% growth for the year.

Okay. And how does this -- I know you get a lot of questions around this, but how does the content for -- in the EV plant compared to ice plant for Rockwell?

We think it's a net positive to us. We don't have to worry about the cannibalization of traditional subtractive manufacturing processes in drivetrain that some of our competitors do. We have been in CNC in those applications, which is used when you're boring cylinders and finishing metal surfaces and things like that. The battery assembly, which is part of the drivetrain or the motive force within an EV vehicle, that's an application that with our Independent Cart Technology, we have a very high readiness to serve. And so you have all the other traditional parts of making a vehicle. You have to stamp the metal and paint and assemble it. There's final test at the end of the line. You're tracking it with MES and so on. But on top of that, you've got our increased readiness to serve in the drivetrain side with our own technology. And I would also say, software, MES software, while it's present in those internal combustion engine plants, it was seen as a nice to have maybe. Maybe the brand owner had their own homegrown system. But increasingly, with these EV start-ups and even the traditional brand owners that are bringing electric vehicles to market, they're seeing as MES and the ability to schedule through those applications as a need to have. It's something that you really can't do competitively without a higher degree of software.

Okay. That's perfect. Do you think, though, that an EV plant would be -- you mentioned this in some sort of new opportunities for Rockwell. But do you think an EV plant is less PRC-intensive than ice plants or [indiscernible].

No. You still got the core automation. And with all the discussion of the new software, you're still not closing a very precise millisecond loop with -- in the cloud or without the Intelligent Devices and that without the physical controller. So you definitely see the same intensity of that core automation in an EV plant compared to an internal combustion engine plant.

Okay, great. Touched on another sort of big debate for Rockwell is the whole theme about reshoring. I imagine it's still a little bit too early to call a trend here, but certainly, semi is an area where we're seeing a lot of announcements and ambitions. I know semi is a relatively small end market for Rockwell, but what sort of content do you think you could target within each fab that's being built?

Well, multimillion-dollar projects for the facilities management systems in these fabs is a not unusual size for us. And we saw a little bit of that last quarter in some of the Asian facilities for some of the same companies that are announcing big U.S. investments. So that bodes well. We had a nice win in a U.S. facility, a little lesser-known fab a couple of quarters ago actually. And while we've been providing the facilities management, what we're seeing is the ability to expand the scope, including things like cybersecurity services, building out from the core control of the temperature and the humidity and the cleanliness of the air in a plant. I think more broadly, when we talk about reshoring or, as I say, in some cases, shoring, it's not where they're coming back, they're just growing within the U.S. I mean, the U.S. was a very strong growing country for us. It was our fastest-growing region in orders in Q2, and that's not all MRO. That's expansion of existing facilities. There is some greenfields in there. And as I circle through the verticals at the beginning of this discussion, some of those clearly are targeting higher investments close to their consumer markets in the U.S.

Okay. Is it fair to say that we're now past the deshoring phase, if that's even a word, but the kind of the offshoring is probably a better way to put it, but the whole offshoring phase is now behind us. Is that fair to say?

Well, I think people are looking to create more resilient supply chains around the world. And fundamentally, that's about reducing single points of failure, whether it's a single source of a particular metal or it's a component that's critical to something that the world needs, being -- relying on just one place for protective equipment at the beginning of the pandemic, it was all about masks only coming from one place and the need to diversify that. It's about substances, chemicals needed in medicines, in vaccines and making sure that there's a more resilient supply there. Obviously, the chip supply is something that's been talked a lot about. So I would hesitate to say that nothing is going to go to low-cost labor parts of the world. But it is clearly not a panacea, and it brings challenges and risks of its own. And some of the risks that we were looking at as a manufacturer ourselves but didn't get to the level of funding over the last decade or so are probably getting to the level of funding right now as people are seeing that those black swan events as well as just the general risk brought on by a rapid return to growth and shortages. So as some people are saying, "I don't want to be dealing with these issues ever again. How do I make my operations and my supply chain more resilient?" And I look -- I talk frequently with our own operations leader because we ourselves are a good-sized manufacturer. And so we know the issues that we're facing are common to our biggest customers as well.

Sure. Well, black swan events start with a black swan events [indiscernible] or they seem to happen a bit more frequently than black swan events. But you mentioned the supply chain, Blake. And I'm curious, we've heard a multitude of companies talking about tight supply chains but working through it. I mean, how would you characterize the way of Rockwell, what are you seeing? You do buy a lot of chips and microprocessors for your PLCs and other devices, but also your customers. Are you seeing any constraints in your customer supply chains?

We're not -- we're certainly seeing our customers dealing with those constraints. The woes of the automotive industry and the way that it's crimping production is well publicized. We haven't seen it have a big impact in their demand on our products and software and solutions. Of course, we had a $2 billion orders quarter the last quarter, our first. And so we do see continued very strong demand that began the beginning of last calendar year. In terms of our internal operations, supply chain constraints are top of mind, and we're working those issues every day. There were a number of events that exacerbated the rapid recovery in demand. I think we're doing a great job of managing through that. The risk is reflected in the guidance that we provided in Q2. But it's a day-by-day situation between chips and resins as the North Texas facilities are recovering from their weather events. Freight. Freight lanes are still constrained and so on. So we're working multiple issues, but I think we're doing a good job of maximizing output and keeping our customers informed of what they can expect as well.

So you touched on the $2 billion of orders you booked in the last quarter. I think the implied guidance suggests about $1.8 billion of revenues in the back half of the year, quarterly revenues that would be. Why wouldn't those orders imply a higher run rate for revenues in the back half of the year?

Yes. I think we continue to take a measured approach to looking at our ability to convert. We know that lead times for some of our products are further out than we would like them to be. But those orders ultimately are going to turn into shipments, and that is reflected in the very high-growth rates that we've talked about beginning in Q3 as comps ease, and we do convert those orders into shipments.

Okay. Great. I do want to turn to software and digital in a moment. But Nick, I did want to touch on investment spending, another hot topic on the last quarterly call. You mentioned, I think, $90 million to $100 million of investment spend headwinds in the second half of this year. Are we still on track for that? It's not easy to ramp up investment spending, but are we on track to meet those commitments?

Yes, Nigel, we're right on track with the spending levels that we suggested. And that $90 million I talked about, that was a sequential first half to second half as we were ramping up some of that spending. And that's all right on track as well as that included in that is what we had talked about in our first quarter earnings call of $30 million onetime investment we were doing to accelerate some of our software SaaS offerings and some spending on some environmental projects that we think are exciting opportunities for us. So that's inclusive of that, and those are on track as well.

Great. And I think you qualified the sort of the temporary component of that is about $30 million, if I'm not mistaken.

That's correct.

That rolls off in 2022, but would you still expect investment spending to be higher in '22 versus '21? I know you're not giving guidance for '22, but normally, I think your investment spend will be up $40 million to $50 million year-over-year. Are we still on that sort of cadence?

I think the best way to think about it, Nigel, because we're -- I mean, we're still in the process of how are we going to be building our plans for '22 and actually probably even more focused on how we're exiting -- executing on '21. But our guidance that we've given in the past of targeting a core conversion of 30% to 35% with growth in the mid-single-digit range, that type of guidance, I think, is the best gauge of how we think about investments. It's not that we necessarily will spend to that level, but that's, over time, how we see investments lining up.

So you basically moderate investment spending or accelerate investment spending depending on the volume environment to maintain that sort of...

That's [indiscernible]. We're also driven by what's the opportunities that we see. But in times where we're growing mid-single digits, that's usually the range we're in. When we grow higher, we don't necessarily ratchet the spending up. It will depend on what the opportunities are.

Right. So Blake, it seems that the world has accelerated towards software, digital. There's probably [indiscernible] by 3 to 5 years post pandemic versus the run rates. You've partnered with PTC. You're buying an increasing level of capability with some of the small technology acquisitions like Kalypso, Fiix, et cetera. How would you gauge today where you are and where you want to be versus some your competitors have spent billions of dollars on software acquisitions? Where do you think you are competitively versus your competition?

Well, in the end, it's all about the outcomes that you can provide to that customer. So looking at just the raw number of how much you pay for software companies or the like. That ultimately is not going to be the measure of competitiveness or effectiveness. It's going to be the outcomes and the way that your customers say, "Yes, I got the return on my investment through the combination of the hardware and the software and the expertise and so on to be able to get my product, whatever it is, faster to market or to be able to maximize the use of my manufacturing assets or decrease the risk in my supply chain and so on." And that's what we're focused on. That being said, software is an increasing part of the way that we differentiate. We talk about it through the customers' investment life cycle, through design and operate and maintain. And I'm very excited about the way that we are clarifying our focus there that we're bringing new capabilities through organic development as well as acquisition as well as the partnership with PTC to bear on a customer's problem. In design, we're working on some exciting new design tools. We just released some in the last couple of months in a SaaS format to be able to help customers design their automation projects, and you're going to see a lot more in this space. It's a big focus for us in our own organic spending. But we've also done some acquisitions to complement that. And Emulate3D is one that's particularly comes to mind, still a relatively small part of our business, but the ability to simulate a customer's automation project, particularly to be able to do it remotely without having to be at the physical location, is something that the importance of which was underscored during the pandemic. And we continue to see strong demand for that kind of offering. And the operate space of the customers' life cycle, we have a very strong MES offering that continues to grow and is a big part of that Information Solutions & Connected Services bucket that we talk about each quarter. That continues to be an important part of a customers' overall spend as they're looking to modernize and make their operations more productive, and we have a very strong offering there. There are other opportunities to add to our software capabilities in the operate phase. So when you look at the linkages between production and supply chain, quality management and so on. So there's multiple vectors back in -- take to add more value. And then on the maintain phase, and Fiix is probably the single best example from a software standpoint that we've provided. And then tying a lot of those things together is the investment with PTC as we use ThingWorx to be able to get data from these multiple sources and kind of create mash ups to have very effective dashboarding. We use it in our own facilities.

And you recently expanded your relationship with PTC, and you wrapped in PLM and SaaS offerings into the bundle, if you will. What drove that expansion? Is it a case of customers are demanding more end-to-end solutions, and therefore, having a bigger wall garden is better? Is that what drove that?

The focus of the relationship with PTC continues to be on the IoT and augmented reality side. So the original applications remain the focus, ThingWorx, Vuforia, their Kepware communication tools and so on. With the acquisition of Kalypso, we felt it would be useful to have even less friction in our ability to source PTC's Windchill and Creo, Onshape is an exciting SaaS-based CAD tool and so on and then Arena, which came more recently for them. But we continue to see customers looking for suppliers that respect an open approach. And so we don't see increased customer demand for having the same supplier of their automation products and software saying, "We need our PLM to come from the same place." We just don't see it, being able to take the data and to integrate data that's coming from other design tools like PLM is important. And we do that really well, and Kalypso helps -- helped us accelerate that. But we don't see customers saying, "You got to have it all from one supplier" because just having it from one supplier doesn't mean that it's going to work great together because those suppliers typically acquire, they built those applications at different times. They're on different technology stacks. And that's not just us talking. That's what we're hearing from our customers.

Yes. So partnership remains the way forward. How...

As a part of the overall, but having considerable organic capabilities and when we do think that we need to own a technology, making those acquisitions. It's all those things in concert.

Well, that's what I want to go next was really what capabilities do you really want to -- not necessarily you lack, but where do you really want to strengthen muscle outside of your existing capabilities? So -- and there's a pretty sort of -- they all debate about acquisition strategy going forward. So I'm just curious, what are the broad areas where you really feel you need to mass up?

So we've been talking about acquisition priorities fairly consistently for the last couple of years, and it starts with Information Solutions & Connected Services. That's a broad area. Within Information Solutions, I mentioned a couple of interest to us within the kind of the operate phase of a customer's life cycle then we have a great MES offering, but there's also opportunities in linkages with supply chain to be able to see past the 4 walls of the customer's own enterprise and to be able to look upstream to their suppliers. And again, the pandemic has thrown those needs into sharp focus. We're doing some of that today, but I think there's additional opportunities. Quality. Quality management remains very important. Track and trace serialization is moving beyond just regulated verticals like life sciences into other areas to help customers manage complex supply chains or supply chains that are changing, that are very dynamic. So those are a few of the potential areas. Having analytic tools that can be applied in a consistent way throughout that life cycle to be able to bolt in and to create composable solutions to applications across design, operate and maintain, I think there's some opportunity there. We've got to make sure that they truly differentiate because there's lots of analytic tools out there, and I don't want to necessarily acquire one just to have it when it's not differentiated. So we're being selective there. In Connected Services, cybersecurity. We made a couple of acquisitions with Oylo and Avnet that are off to a great start to complement what is a base business of over $100 million just in those network and cybersecurity services. So those are priorities. Expertise. We've talked about process expertise. I think we've done a good job of addressing that with MAVERICK going back a few years and then, of course, the Sensia joint venture with Schlumberger. But there's other areas of expertise such as in digital thread consulting. Kalypso has been so successful with customers and capturing the imagination of our sales force. There may be opportunities in other parts of the world. And then the final area is specifically doing some things that increase our penetration into Europe and Asia.

Okay. Great. I do have a question from the audience here, and this is a genuine audience question. Just the question is, can you explain recent unperformance versus your large German competitor?

Yes. So it's -- we've talked before about having a different mix from a regional standpoint. Starting with Q2 of last year, where we outperformed I suspect the competitors that the listener is referring to, we have a lower penetration into China. China was first in and first out of the pandemic, and that's driving some of these performances. Conversely, being very well positioned in the U.S. We talked about the U.S. being our fastest-growing quarter -- fastest-growing region for orders in the last quarter. That's going to come out. That's going to flush out in shipments. And I suspect that's going to be favorable for Rockwell. So there's other factors in it, but we are not -- while we always are vigilant for areas of relative performance and share, we do not believe that we're losing share. And we're seeing examples every day of where we're converting customers from some of those other competitors to Rockwell. So I'm very happy about the way that we're positioned.

Okay. I appreciate that question and answer. Maybe moving to Nick on the margin front. And you talked about [ 30%, 35% ] as the planning range. For those of us with gray hair covering Rockwell a long time, that range used to be 35% through time. So just curious, is the mix moving a bit more kind of mixing down on -- and the reason that -- where I'm coming from with this question is, when I think about Emerson, and they're a bigger process player than you are, but their process control revenues are lower margin than fleet average. And I'm just curious, as you're mixing towards hybrid and process, is the margin slightly dilutive to where you've started being?

Nigel, I think you have to go way back to when we were talking about a 35%. This has been many years that we've been targeting this 30% to 35%. And when I look at what mix has done to our margins in recent years and also just a forward-looking view of how much do we think mix will be playing into our margin story in the coming years, I just don't see more mix having a very material impact on our margin. We clearly have some things helping it and some things holding it back. But in aggregate, I don't think mix is a very material story for us in our margin in the coming years. I do, however, see growth, organic growth as being -- has been and will continue to be one of our bigger drivers of, of margin expansion, putting us at the higher end of that 30% to 35% range, moving us to higher margins and sustainably high margins.

Look, I mean, if I could just add to that, nothing impacts our margin conversion like growth, and that's why we're focused on accelerating profitable growth. Also the focus on annual recurring revenue driven by software, that's very high margin, and it's sticky. And with the support as part of that, that can definitely do positive things for our conversion.

Well, that's what really was driving towards. If ARR is moving to 10% by 2025 and software, just in general, is mixing up, why wouldn't that be mix positive? And why wouldn't incremental margins go higher over time?

Well, as Nick said earlier, we're not going to do things artificially to constrain that conversion. And so it can. We've given a range that we feel confident in, but we're doing things to give us opportunities for very strong performance in terms of margin conversion. And that focus on ARR is one of them.

Great. And then look, we're getting close to the end here, but I did want to get one more question in. You've been largely an organic growth company for the last 20 years since the breakup. You've done some smaller bolt-on acquisitions. But do you think you're now in a position whereas you seek to retransform Rockwell that you could do contemplate $1 billion-plus acquisitions?

Yes.

Yes. That was pretty clear. Okay. Well, Blake, we got the end of the conversation. Thanks for the time as always. Thanks for supporting us, and we look forward to catching up very soon. Thanks, Blake. Thanks, Nick.

Great talking with you. Thank you.

Thanks, Nigel.