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

Hi. Good morning, and welcome to Morgan Stanley's Ninth Annual Laguna Conference. I'm Josh Pokrzywinski, the firm's electrical equipment and multi-industry analyst. Joining me for the next presentation is Chairman and CEO of Rockwell Automation, Blake Moret. Blake, thanks for joining us this morning. Before we get started here, I know you have some opening remarks and some slides. I do need to read a quick disclaimer. And then for those of you who have questions about our disclosures to please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And then for all other questions, please reach out to your Morgan Stanley salesperson. So with that, again, Blake, welcome. Like I've heard a few times today, and I think for the rest of the week people were lamenting the loss of Southern California. So fingers crossed that I can actually say with confidence for next year. But thanks for making the time all the same.

Yes. Josh, thanks for having me, and I appreciate everybody who's interested in Rockwell this morning. As Josh said, a few opening comments to ground those of you who might not be as familiar with the name. You can follow along with the slides at your own pace. But as we look at Rockwell at a glance, we've always been focused on the productivity of industrial companies with our core automation products. But the events of the last 1.5 years with the pandemic is everyone is looking to be more resilient and agile and sustainable, along with our rapidly expanding portfolio as we become an industrial technology company really give us more value to add to these customers than ever before. And if you move to the accelerating profitable growth slide, that $9 billion figure that we talked about moving to profitable growth that brings us to and beyond $9 billion, when we introduced that a few years ago, that was a strategic vision. And that's really moved into an operating objective as we make sure that we've got the capacity and the plans to serve customer needs at that level. And we think the financial framework that we described here is serving us well. It is about profitable growth, and it's about acquisitions that are a great strategic fit and that contribute just as soon as possible to that path up into the right. We talk about growing our core, which remains the biggest part of our offering with profitable products, new disruptive technologies, double-digit growth in Information Solutions & Connected Services, which continues to be a more and more meaningful, large part of our overall business. And then obviously, the acquisitions contributing 1 point or more of growth a year. If we look in particular at software and even more specifically at our expanding SaaS offering, accelerating FactoryTalk as a service, we've got, I think, a great plan aided by the recent acquisitions we've made to be the predominant, preeminent supplier in this space, providing software that simplifies and gives more productivity to the customers who are in the business of making things. And they look at it as their design process, their operations process and their maintenance processes. Plex is a great fit in the operations hub of our FactoryTalk offering, fixed with its asset management software, a great fit within the maintenance hub. And then we have significant internal development underway to bring SaaS offerings to the design phases of our customers' processes. When we look at -- on the next slide of our organic industry segment outlook, I'm very proud of the way that Rockwell has diversified across a broad spectrum of growing high-value vertical segments. So within discrete, automotive and electric vehicle remains very important to us. But e-commerce, fast growing. I think we talked about 60% growth in the last quarter. And it didn't take long to compound those kind of growth rates before it becomes a larger and larger part of our total business, and we have very differentiated solutions there. Semiconductor, I don't have to tell you about the amount of activity in semiconductor. Food and beverage, life sciences, chemical and helping oil and gas providers be more efficient than ever. So across discrete, hybrid and process industry segments, I'm happy with the position that we have in terms of our products and the secular tailwinds in each of those verticals. And then, finally, I don't think there's anybody better positioned to add more productivity to customers at that convergence of IT and operational technology, or OT. And so with that, Josh, ready to answer some questions.

Excellent. And I think everyone on the line can appreciate as can you that supply chain is sort of the word of the day with everything becoming harder to source, a few other industrial companies out there saying that in addition to inflation, some things, at any price, have been impossible to get. You guys have talked about availability being a bottleneck at other points in the year. Where do you stand on that today? And then when you see those bottlenecks maybe ultimately letting up just based on your current visibility?

Sure. Well, typically, when we get asked about supply chain, it's about our own internal ability to ship as well as what that might do to customer demand. And taking the customer demand piece first, we're not seeing it crimp or put downward pressure on the demand that we're seeing. And as we've talked about, we've seen extraordinarily high orders and customer demand, particularly in discrete and hybrid vertical segments. Where we are seeing the situation not get any better is within the ability to receive the chips and other components but primarily chips and to be able to ship, and it is pushing shipments to the right. So we talked in Q3 about the continuing supply chain constraints, the fact that it's a very dynamic situation. Since then, coronavirus spikes in Southeast Asia, for instance, have added further pressure to that. And we will see shipments that will move into fiscal '22. We believe that we're doing a very good job with what we can control. And one of the other constraints that have been talked about with respect to supply chain is labor. And in our own factories, I think we're doing quite a good job of getting the staffing that we need, putting measures into effect, first, to keep our people safe but also to retain our skilled workforce. And so that part feels good. Price cost, we continue to be confident of our ability to mitigate inflation with respect to component price increases, labor inflation. So that's not the biggest issue. It's being able to get the components and to be able to complete the assembly of products and ship.

Got it. And that sounds an awful lot like some of the messaging you had in prior quarters. Now with one more quarter to go in your fiscal year, and I guess, at this point, a handful of days, I guess some opposing forces there. First, you talked about demand being healthy. And at some level, things like labor shortages should only further create more demand for automation. Does that put the fourth quarter at risk because more slips into next year? Or does it all sort of wash out as stronger demand leaks more into the out-quarters versus something you can deliver today?

Yes. Well, we don't provide updated guidance in the middle of the quarter. And I think the time constant of the 2 kind of opposing forces that you talk about needs to be considered in that short-term constraints on components are not happening at the same frequency and we believe are temporary. We're going to move through these as an economy and look at participating in what we continue to believe is a sustained period of economic expansion, further aided by the longer-term tailwinds, if you will, of increased demand for automation because what we have heard from customers in a variety of industries is that many of the short-term issues but also their plans to release new products being more resilient and so on are positive for the types of products and services that Rockwell is providing.

So within the timing of the year, I mean, one thing that's nice, I think, about when Laguna falls on the calendar is that we're sort of at the early end of a CapEx planning cycle as people start to square up next year. So presumably, customers are having conversations around what they want to do in '22. And if I think a year ago, maybe no one had the confidence or visibility to really know what that looked like. We said words like near-shoring, but I don't know if anyone put pen to paper. Have you seen that evolution take place where '21 was kind of more about like let's get back on our feet and '22 is when the real projects happen? Or have you been seeing that project activity that would be more of this step-function change be part of the narrative this year as well?

I think it's useful when we talk about reshoring or near-shoring or just shoring to take it on a vertical-by-vertical approach. So starting with some of the discrete vertical sector. No question that in the automobile industry with electric vehicles and battery that we are seeing more investment, and we're seeing a large portion of that investment in the U.S. So you can read every day about what's happening with respect to new plans with respect to battery production and electric vehicles and related activities there. We're even seeing a little bit in terms of increased mining activity in the U.S. regarding minerals that might be valuable in new forms of batteries and so on. So I think, unquestionably, we're seeing heightened investment that includes CapEx there. In e-commerce, new fulfillment centers and distribution centers and not just with the big e-commerce players but as the big box retailers are looking to be more efficient in the way that they receive and distribute material to keep their shelves stocked. And we provide some great solutions, Independent Cart, as it does with battery assembly and automotive in the warehousing and e-commerce areas. Independent Cart is a real differentiator there with some of the big providers whose names you all know. Semiconductor. Again, it's fact that the semiconductor providers have big capacity expansion plans, many of which include the U.S. And the current administration is trying to work hard to figure out what they can do to help create or recreate a semiconductor industry here. And as the market share leader, I think that's a pretty good read for Rockwell. Food and beverage. We're seeing activity with additional capacity, creating more flexibility in those lines as those companies are looking to be more agile than ever. And pharmaceuticals. I mean if we're moving into a new normal where the world is going to be looking for 7 billion or 8 billion booster shots a year, that's a lot of capacity that needs to be built with the pharmaceutical companies. And we're a strong player both with respect to the core automation as well as the software in those shops.

So on the near-shoring part, and you and I were talking before we started here, the shoring has lost all meaning as a word. I've heard it too many times now. But going back the 12, 18 months since we started talking about this stuff, what has surprised you most about that discussion, positive or negative, an end market that sort of rose or fell based on customer interest? But kind of putting it all together on that topic of localized supply chain and near-shoring, what stands out to you as kind of the biggest revelation?

Well, the strength of the recovery. I mean as we saw the inflection point, as we were in the depths of the pandemic and coming out of the lockdowns and so on, we all expected that there was going to be some recovery. But the strength and the way that it's sustained, I think that, that has surprised us with the string of $2 billion-plus order quarters. Now that's not just people replenishing their tool cribs to support existing manufacturing. That's people doing just what we're doing, looking at how can we come out of this stronger and with more differentiation than we ever had before. Companies are all placing that bet because they have to or they're going to fall behind.

So I think the context that maybe folks who are asking about kind of that shoring up the tool crib -- see, I'm saying shoring now, has lost all definition for me, versus the more project-oriented stuff sort of gets to the heart of, I think, a big debate on Rockwell that if you look back over the last 10 years, growth in automation, not just Rockwell, sort of had a harder time outgrowing IP. But that was a different environment on inflation and China-based supply chains and trade relations, and technology has come a long way. All those things probably play into the higher entitlement for growth today. But are there 1 or 2 that you think became kind of the tipping point there that say this is why now is different?

Yes, I think so. And I'm talking specifically about Rockwell. A higher percentage of annual recurring revenue, you can do the math and look at what that can do as it gets to 10% and beyond of our total revenue, as you look at greater diversification in end vertical markets. Automotive is around 8% of our total business, and it was a lot more than that not too long ago. Automotive remains important to us. But I'm very proud of the way that life sciences has increased as chemical has increased, e-commerce, semiconductor. I think that's very healthy for us to be able to support a number of high-growth verticals with good secular trends. And then the way that we've added new innovation into our offering, from our core products with things like Independent Cart Technology; new functionality in Logix; the rapid growth of Information Solutions & Connected Services, which was not something that we had as great a focus on in years gone by; and then bringing in acquisitions where we're the best owner and we have an opportunity to make synergy a reality. So all of those things, I think, are a more positive read for Rockwell going beyond its traditional reputation of a good manager of our business and a strong outperformer earlier in the cycle. But I think we're adding new muscle and new ways to win.

So one of the big issues here, I think, at the societal level, not even limited to industrial companies, is labor availability. So automation kind of fits hand in glove with that conversation. Is what Rockwell is deploying today or what customers are asking about taking labor out of the equation? Or is it something else? Because for some of what you're talking about -- I mean, auto is a good example. It's not like we're building cars by hand. Certainly, we're not doing chemical processing by hand, I hope, for the sake of employee health and safety. So how do you kind of square up the labor tightness with what customers are ordering? Do those match up? Or is it a different definition of productivity they're looking at?

It's helping customers make the most effective use of their people resource. So as you said, a lot of the industries we serve, there's not a lot of, let's say, low-hanging fruit or places where there's lots of people doing jobs that can very easily immediately be replaced by basic automation like it was, I would say, when I started in this business a long time ago. What we're seeing now, though, is freeing people up to make the best use of what people do great, and that's the innovation. It's the ability to have multiple skills to be able to work in different parts of the line. A trained workforce is critical to be able to interact with the advanced technology but it's more about that than it is a pure cost takeout of labor. It's also about the realities that have been imposed on us by COVID, more spacing. It's harder to get people from around the world come together physically shoulder to shoulder to start up a line. And so virtual commissioning is much more of a reality, and we saw rapid advances there over the last 1.5 years. And I think a lot of those changes are here to stay as well. So it's about both. It's about a trained, engaged workforce interacting most efficiently with advanced technology.

Got it. So putting everything we just talked about together and why this is a different cycle and all these pulls on CapEx, you guys have outlined your order intake, which has been really healthy now for the past several quarters. But I think as a newer statistic, this $2 billion or $2 billion-plus is sort of hard to anchor to pass cycles or past environments. Anything that you can break down within that, whether it's the complexion of that -- of large versus small project or MRO or anything around book-to-bill that would give folks confidence that this is sort of a unique moment in time the way it's captured in the order book relative to the past?

Well, there's a large component of the products that make up that backlog as opposed to what you might see if, say, the process verticals like oil and gas and mining were contributing huge projects into that backlog where there might be multi-month or multiyear shipment schedules for some of those. But that's the part of our business that has actually lagged behind some of the more recovering discrete and hybrid businesses. So it's about elongated lead time brought on by the supply chain constraints as opposed to just a spate of large long-term long lead-time projects. That's not what is composing our backlog. The industries that we outlined in Q3 that are contributing so much to that: automotive, e-commerce, semiconductor, food and beverage, life sciences. Again, these are industries that have good secular tailwinds. It's hard to argue or bet against any of those not being in demand. And then finally, we get asked about the, let's say, the transactional nature of that backlog. Do we see widespread evidence of double ordering? And while you can find anecdotes to indicate where OEMs may have ordered ahead, we did a pretty deep dive in Q3 to look at that, talking directly with distributors. And when we talk about that on the earnings call, we stated that it appears to be very reflective of underlying demand and not people just ordering ahead where you would see that tail-off going forward as we serve that demand. And similarly, with cancellations, we're not seeing a high rate of cancellations of these orders. These customers need these products.

Given the size and complexity of what some of these customers are ordering, I'm thinking of like big semiconductor fab, those things don't exactly go up overnight. I mean is '22 still like a brownfield type of year where you have to have the infrastructure in place because everything is just taking so long to get and implement that you couldn't build a new facility if you wanted to? I mean I guess like flipping the calendar doesn't really change that supply chains are sort of stretched. And despite all the demand in the world, like we probably need a starting point rather than a plotted there.

I think -- I mean, brownfields have traditionally been a larger part of our business and brand-new greenfields. But it's also going to be a backlog here, right, with the kind of backlog that we go into fiscal year '22 on, that's a big input that we typically as Rockwell have not talked about as we prepare to move over into a new fiscal year. But I would say that there are some greenfields that I'm thinking of that will start to contribute next year. So maybe not as much the marquee semiconductor fabs, but there have been some others that were kind of announced ahead of the big discussions by TSMC and Samsung and so on that are contributing revenue to us already. But again, Rockwell continues to look at -- a pretty big order for us is, say, $3 million to $5 million. And while lately, we've seen a number bigger than that, we're still not dependent on those big orders to feed the machine. And so we're less dependent on those giant greenfield capital projects. We still participate in them but that's not the largest part of our business.

Got it. And then just diving more into kind of the specific product side. I mean you closed Plex recently. It seems like this opportunity for an MES product that's sort of outside of the traditional on-prem gets to that more small and midsized customer that could benefit. How would you size up what portion of your customer base may be a candidate for Plex but scale or price or some other reason wouldn't be a good candidate for on-prem historically prior to that?

Well, I think you said it right. It is particularly tuned towards the needs of small- and medium-sized companies because of the ease of installation. These companies don't typically have large IT departments that can handle the amount of requirements of maintaining a lot of on-prem computing hardware. I know when I've talked to customers even before we bought Plex about why they liked cloud offerings like this when they were tier suppliers for an automotive, for instance, it's just easy to get that kind of functionality. But also in the software industry, a lot of the functionality that starts in small- and medium-sized companies works its way up based on cost advantages and that same ease of maintenance across fleet of plants for the big multinationals that might span hundreds of plants and dozens of countries. There's some advantages there, too. So we're very happy to have an on-prem and a cloud-based offering, specifically for MES. And that's going to continue in both cases to be valuable to different customers, but they're looking for cloud options increasingly. And over years, I think we will see those road maps converge, but we're meeting customers where they are on their journey rather than saying, okay, flip the switch, time to change. You go into one of the big pharmas trying to meet demand for vaccines. I don't think they're going to give you much time if you tell them that you need to change their regulated processes on a different schedule. They just can't do it. On the other hand, a small, medium-sized company looking to be more agile, a tier supplier in automotive, a bakery, those are great opportunities to get a level of productivity from MES software that they could never afford before. And they might not have trusted the suppliers like they trust a Rockwell where our Allen-Bradley hardware has been in those facilities for decades, and they know us and know our distributor really well.

I guess sticking with the product side. Where you interface with PTC and that partnership, has that product mix evolved over time? And the customer relationship amongst PTC, Rockwell and the customer, has that evolved as their needs have changed? Or is it still kind of the same thing you would have envisioned a couple of years ago?

Well, we're happy with the relationship. First and foremost, I was at the PTC Board meeting last week, and we continue to look with optimism over the coming quarters and years working together. PTC [indiscernible] last earnings call, we think, are complementary. And the focus of the PTC relationship for Rockwell remains the IoT and the augmented reality. So ThingWorx, Vuforia Kepware, that remains the focus of the relationship. We have access to their PLM and CAD software. And our fairly recent acquisition, Kalypso, is a big integrator for PTC. In fact, they got integrator of the year last year for PTC, and they get involved in those projects. But that's not the focus of the relationship between our companies, and it's still valuable. And in fact, it's expanded the way that we play in the earlier, broader part in our customers' digital transformation. Very happy with that aspect of it.

Got it. Just shifting away from, I guess, what is -- it seems like a pretty clear strong demand environment and technology that goes into that more on Rockwell's business. Incremental margins have been pretty topical this year. I think among most industrial companies, you guys haven't had the price cost challenges that others have in just nature of the business. But things like investment and incentive comp seem like bigger swing factors. Should those sort of normalize from here? Do we get back to normal or maybe slightly above normal? I think you had some over -- some extra investment this year that leaks out. Is that profile kind of set to normalize from here?

Yes. I think those are some factors that point towards, as you called it, more of a normalization. We had some onetime investments with respect to development that come out, not to say that our base spend in development isn't going to increase, but it's at a controlled rate. And then some of -- as you said, the swing back in terms of incentive comp going from 0 in 2020 to good performance this year, that normalizes going forward. And so I think that helps. And then, obviously, the volume -- and as we've talked about, nothing helps margins like accelerating profitable top line growth.

Excellent. Well, I see we're out of time. Thanks for the update here, Blake. Good to see you as always, and thanks for everyone for joining on the line and submitting your questions. Again, hope to do this all in person next -- soon and for your own analyst meeting coming up here in a couple of months.

In person in November in Houston. So looking forward to seeing you there.

Yes, we'll see you there. Thanks, Blake.

Bye-bye.