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

I think I'm on here. Yes? Great. Great. Up next, we've got Rockwell and CFO, Nick Gangestad. So Nick is going to talk for a couple of minutes around some slides, and then we'll get right into the Q&A.

Thanks so much, Steve, and thanks, everyone, for being here. I'll just start out by saying that Rockwell we see as a company well positioned in a growing space of manufacturing automation. We go to the market -- the automation market with a combination of several businesses. First of all, we have Intelligent Devices, which are often connected devices on that factory floor. We couple that with our Software & Control solutions that control the automation and the data flowing within the factory floor. And then finally, we add our Lifecycle Services business, which helps our customers through the life cycle of their projects, from the very beginning to the planning, to once it's in place, the ongoing operation of it. And we see power in that business model of combining those things and how we go to market. Last year, we had $7 billion in revenue, almost 60% of that in our North America region where we enjoy our strongest market-leading position. Our go-to-market is with some very strong brands, brands that mean quality, reliability, innovation, ease of use to our customers. Brands like Allen-Bradley and FactoryTalk are a couple of those that we go to market with. And for years, there's been a promise of how technology can really enable manufacturing and new capability. But we really believe we're in a phase now where we are taking manufacturing to the next level. The technology around automation, data, analytics, all of that, we see ourselves at a time that we're taking our customers to a new level for their manufacturing. And part of what we're doing for them is helping them around their added need for resilience and their added need for agility and their increased focus on sustainability. And let me take a moment just to explain what I mean by that. By resilience, in the last couple of years during the pandemic, a lot of our customers have seen vulnerabilities in their operations, where there's points of failure that they need to address in order to have a more streamlined supply chain or manufacturing operation or resilience around cybersecurity. Also, increased need for agility, increased need for packaging that can quickly move from one SKU to another SKU. And then sustainability. Almost every customer we know is working on how to be more efficient, more productive, less yield -- or less waste, higher yields. As well as the focus on sustainability is creating new industries that are looking for automation solutions as well. A couple -- a few years ago, we introduced a slide that laid out a longer-term vision for where we want to take revenue and how we want to do it. And we -- a few years ago, we said we aspire to be moving to $9 billion of revenue. And we laid out then how we would do that: through growing our core part of our business twice the pace of industrial production; growing our information solutions and connected services at a double-digit rate; and adding inorganic growth at a pace of 1% or higher per year. And we have done that at a -- we've been very, very true to what we said there of things -- that aspect progressing exactly what we -- as we said. We also laid out the financial framework and how we will achieve that growth around our -- how we think about core conversion as -- which balances our profitability and our investment, our earnings per share growth and our free cash flow conversion. So those are the things we laid out. And the success that we've seen there is a result of the shift we've had from that vision. And we put even more focus on the execution of that, and we're seeing good progress. That vision is becoming a reality. So much so that we are putting increased focus on the things we need to do to make sure that we are executing at $9 billion or even higher. That includes our partners that we go to market with and our technology partners as our -- as we're seeking to have solutions that are even more comprehensive for our customers. We're investing in our own operations, that we have the capability and capacity to be meeting greater than $9 billion of revenue, and ensuring that we have a culture that is energizing both to our customers and to our employees. So I'm just going to wrap this portion up saying we feel this is an exciting time for Rockwell. There's a high demand for our products, especially in our home market in North America. We do believe we're still in the early stages of economic expansion. And we're seeing high growth across many industries for the very reasons that I talked about earlier. And we're excited about taking our customers' manufacturing to a whole new level. So Steve, thank you. Let's turn it over to Q&A.

Thanks, Nick. Orders have been an important number for you guys, I guess, increasingly over the last year or so, 1.5 years, especially as supply constraints hit a little bit. Can you just talk about kind of the pace and what you've said recently about orders? And when do we kind of migrate to a more normal book-to-bill, if you will? And what is -- what should we think about as kind of a more normal quarterly book-to-bill for the cycle?

Yes. So in the last year, we've been sharing more about orders in an attempt and a desire to be as transparent as we can about what we're seeing in the market. Because traditionally, in our business segments, such -- like Intelligent Device and Software & Control, our book-to-bill there is more traditionally 1. It's a pretty short-cycle business. And what we see for orders traditionally becomes what we see for revenue. Our Lifecycle Services business tends to have some seasonality. And we share that each quarter on the book-to-bill there where it tends to be above 1 the first 3 quarters of the year and below 1 in the fourth quarter of the year. As far as approaching some kind of normalness on that, we project that throughout '22, we're going to continue to see strong orders that outpace our ability to ship based on the supply chain constraints that we're seeing. We do have some increases as we go through the year in our shipments. That's based on what we see as some gradual improvements in our access to semiconductor chips, which is by far our most significant supply chain constraint. But as far as the return to normality, I'm not ready to put a time on that. It's -- I certainly don't see it in '22. It could even be extending past '23 based on what we're seeing right now.

So if we think about that kind of like $2.5 billion run rate, where do we see that, I guess, exiting the second half? Like I think you've given a -- talked about a $9 billion -- some $9 billion figure. Maybe discuss how you kind of derive that. And...

Yes. So we don't normally guide on orders. We normally guide on shipments. But what we did in -- at the end of the first quarter, based on what we were seeing of strong order demand, we shared that we expect orders to remain strong for the full year. And we had $2.5 billion of orders in the first quarter. And that's part of several quarters in a row where we were seeing what we consider strong demand of greater than $2 billion a quarter of demand in the form of orders and an expectation that that will continue. We also said that there's a portion of those orders that we saw in the first quarter, approximately 10%, that we feel is being advanced orders placed given the supply chain constraints that we are seeing.

So is that $9 billion number this year kind of still the right bogey?

Yes. The -- we have no reason to be updating that at this point. We gave that guidance when we had 3 quarter -- 3 months of the first quarter, of course, and then one month of the second quarter under our belt. And at that time, we felt $9 billion plus was a good guide.

Got it. And just one more on that. When -- back at that time when you had that trajectory, was that going to be kind of a smooth trajectory from the $2.5 billion to something that kind of gets you to that $9% billion? Or was that -- was there a more of a thinking of a drop off in the...

No, no. There -- I would say, Steve, there's just not that kind of definition of it. The point was it's going to remain strong for the balance of the year.

Got it. And then pivoting to kind of your ability to fulfill those orders. What are you guys seeing on supply chain? And is -- how much of an impact is that having relative to what you would have thought maybe a month ago?

So we don't normally provide inter-quarter updates on revenue or things we're expecting. I'll go back to what we were saying...

You can do that today if you want. Nothing is normal these days.

But what we saw at the end of January, we were continuing to say it's a dynamic situation. Every week, every month, what we're seeing of access to semiconductor chips. And it's something we're managing to get as much access to semiconductor chips in the short term. But as we go on a longer-term basis, what we're also been investing in is how do we increase our own resiliency by investing in our capability to increase the number of suppliers that can be going into our components. So we've been working on dual sourcing and any kind of product modifications that give us even more resiliency in the medium term.

So is there -- that sounds like there's not improvement? Like you haven't seen improvement? It seems like it's still kind of dynamic.

Our view as of the end of January is that we thought first quarter to second quarter would remain pretty stable between that, with some gradual improvement into the third and fourth quarter. And that remains what we're expecting.

Okay. Got it. What types of chips? And like -- what are you guys buying most of? And what should we be watching to gauge how that supply is coming online?

Yes. There's a variety of chips that we do. Some of them are memory chips. Some of them are ASIC where -- specific application chips. And some of them are, say -- I'll say, more general chips that we buy. But there's a variety. The first 2 I mentioned are the most common that we're buying. And they are from virtually every semiconductor manufacturer that you can think of.

Got it. On the -- somewhat related to supply chain, the price cost dynamics. I know you guys have an improvement baked in for the second half of the year. Maybe just a bit of an update on how you're pushing price and any change in the inflationary environment.

Yes. On the -- I'll talk first on costs, Steve, and then I'll share on the price front. So we're continuing to see rising input costs, we -- even more than what we expected when we first laid out our guidance for '22. When we first laid out the guidance for '22, we had an expectation of a certain amount of input cost inflation, both for semiconductor chips as well as for logistics costs. Those are our 2 biggest places we're seeing input cost inflation. And that has increased as we've gone through the year. Part of our strategy with that is we've -- we will introduce price increases with a strategy of offsetting what we see for cost increases. In the last 6 months, we've had several announced price increases. Some of the dynamics of how Rockwell prices is, there can often be a lag from when we announce a price increase until it's fully realized. Many times, we have customers with annual contracts. So when we announce a price increase, it comes into a play the next time their annual contract is refreshed.

What percentage of your book is that? And is that more on the Lifecycle Services side?

No. That's -- a very high percentage of all of our business is handled that way. A very high percentage.

Like 75% plus?

I would say so. So the dynamics of that is, in the first half of '22, we're expecting it to be margin dilutive to us. And I said on the first quarter earnings call, we expect that to be margin dilutive of approximately 200 basis points. As those price increases gain more hold, as these contracts renew, we expect that to flip to be approximately 100 basis points margin accretive in the second half of the year. And that will still have some tail effect into '23 as well, the increases that we've already announced.

And are those rolling annual contracts?

Yes.

Or are they kind of fiscal year?

They're rolling.

Okay. So there could be some that are January...

There's always some renewing. That's why there's an ongoing phasing of that. If we see inflation -- input cost inflation going even higher than what we've -- than what we're currently estimating, we have the flexibility and agility that we can introduce more price increases.

Now you guys book like 1 -- you guys are booking like 1%-ish from your filings. What is the -- what's the kind of list price -- gross list price that you try and put through typically or at least what you have in the last couple of months? And it doesn't sound like Jan 1 rolls around, you kind of announce a price increase. This sounds like it's kind of constant, if you will?

Yes. We typically have an annual price increase we announce in the summertime. That's our typical model, Steve. In addition to that, we've had a couple of interim adjustments. The most recent was a month or 2 ago, and that was a 8.8% list price increase that we introduced. And there will be yield loss on that. I mean...

Right. Because that's a lot higher obviously than you're guiding in your price assumption for the year.

I haven't updated a number for total price. Right now, I've been up -- saying how we think about price, cost and how they'll net out. And our latest guidance on that is we expect that to be $0.10 accretive to our earnings for the full year.

For the full year. Right. Okay. And embedded in that -- I mean, so far, you're kind of in the 1% to 2% range, low single-digit range year-to-date. So should we think about kind of 2...

That will be growing each quarter in -- throughout '22.

What is the size of that purchased materials for you guys, like that bucket that you gauge inflation off of? Percentage of COGS or whatever, like what is the size for you, guys? I don't think about you guys like an HVAC company, buys a lot of metal, assembles stuff, converts it, there's raw steel and copper. You guys are not quite.

If I look at our total cost of goods sold, these higher inflationary components, such as semiconductor chips and logistics, it wouldn't be over half, but it would be approaching half of our total COGS.

Got it. Got it. Okay. Maybe just a bit of an update on what's happening in Russia and Europe, just the most up to date.

Yes. So Rockwell announced a little over a week ago that we were suspending operations in Russia. We also shared that it's -- accounts for less than half of 1% of our total revenue. We continue to monitor what's happening in the region, working with our customers and how can we best assist our customers in that transition for us. We're also monitoring, does this have any impact on our supply chain? We don't see that yet, but that's something we're watching for, if it has any longer-term implications on the supply -- on our supply chain. We do have a few employees in Russia. And we're working with them to ensure their safety and what's in their best interest. And it's a dynamic situation, but probably not very material to us. And then in terms of a broader European implication, we haven't seen it having an impact on our demand in Europe, but it continues to be one of the things that we are monitoring.

When -- moving to margins. Intelligent Devices margins have been very strong. What's kind of the sustainability there? And is there a potential for improvement moving forward from this level?

The 2 biggest things that are impacting our margin in our Intelligent Device business is volume. This is a business where the more we grow the volume there, that has a positive impact on the margin. The second dynamic is price. The margin you saw in the first quarter was where price cost is a negative impact to margin. And we expect that to be flipping to positive in the second half of the year. So increased volume as well as price, we think, make that margin that you're seeing in the first quarter not only sustainable, but in the coming quarters, not necessarily in '22, but in beyond, that give upside potential on that margin.

So I mean is mid-20s kind of the right rough launch or range for a business like that?

We think, both in '22 and in '23, this is a place for continued margin expansion.

And then kind of on the flip side, Lifecycle Services has been a little bit weaker. Maybe what's the trajectory there? And what's an appropriate kind of longer-term target for that segment?

Yes. So in the first quarter, that business had a margin of 5%. And that's a margin that we see increasing in subsequent quarters. Some of the dynamics impacting margin in our Lifecycle Services business are, first of all, the volume and absorption that we're seeing there, that we see some added growth coming in that business, and that's in itself going to impact positively the margin. Price is another dynamic that impacts our lifecycle margin there. And we think price will continue to have a positive impact on that margin in the coming quarters. And then finally, component availability impacted by semiconductors also has an impact on the mix within that. So as there is increased access to semiconductor chips, that increases that particular segment's product mix of sales, and that in the coming quarters, we think, will be having also a positive impact.

So can that business be a double-digit margin business at some point? I mean is that what we should think about as being able to get back to?

In -- at some point, and I'm not putting a clock on it right now, but getting that to double-digits is part of our vision of where that's going.

And then on the software side, just the margin trajectory there. And how should we think about things there?

Yes. That's traditionally been a business in the high 20s, even sometimes in the low 30s for an operating margin. Right now, in the first quarter, some of these volume and price dynamics that we've talked about, but in addition, with our recent acquisition of Plex and Fiix, those 2 businesses within our Software & Control business, and the integration spend that we're doing, that's had a downward pressure on margin that, as we progress through the year, that will have less and less downward pressure. In '23 and beyond, we actually see the Plex business becoming accretive to that business' margin.

And I guess just to kind of wrap up the guide in financial discussion here, when you talked about embedded in your assumptions, supply chain getting a little bit better, how much impact kind of sequentially or on a year-over-year growth basis is supply chain, right? Because there's a magnitude of things accelerating. I mean, is it a 2% impact? A 5% impact? Like what's the magnitude of that call to kind of see it get a little bit better? How do we frame that?

Yes. I'm not exactly sure how to frame that question. But it's virtually 100% -- all of our growth that we have projected, the sequential growth that we have projected is 100% -- virtually 100% tied to semiconductor, access to semiconductor chips gradually improving. There's not another dynamic of relying on increased demand for our products because the demand in almost every scenario we see far outstrips that ability. So it's -- the gating factor is our access to components in our supply chain. As far as our own capacity, we have that ready, able. In fact, I even talked on the first quarter earnings call about the amount of work in progress that we've done that there are many of our products that are, I'll say, 98% complete, where we've assembled all of it. And we're waiting for just those last 1 or 2 components to have it ready to ship out the door.

So is it fair to say that if supply constraints stay kind of where they are, that your revenue would be kind of sequentially flat in the back half of the year?

If the supply chain constraints don't ease any, then that would have a lessening effect. Probably not a downward impact, but it could lower the slope of the increase.

Kind of like weaker-than-normal seasonality, but not flat?

Yes. Seasonality is almost like a nonissue right now. It's just -- I don't think it's the right dynamic to be looking at right now. It's really about sequential growth and access to inputs.

Could things though be -- I mean, you have all this demand. Could things be flat in the back half of the year if they don't ease or you have some growth?

I really don't see that as a very likely scenario.

Yes. Okay. Got it. Shifting to kind of the longer term and the software side. Just a bit of an update on Plex and how that's going and maybe what's been done there and so far on the results.

Yes. Yes. So we are excited by having Plex and Fiix as part of our portfolio. Both of them provide cloud Software as a Service solutions for our customers. We've been focusing on integrating Plex into our company and also finding synergies between bringing Fiix and Plex together. We've been introducing Plex and Fiix as solutions that our go-to-market channels can be helping us sell more of. We're excited by that opportunity. We've also had some recent expansion of our capability of selling our Plex solution in Europe. But it's also bringing to us increased capability and insights around Software as a Service. We, of course, have been working on our own organic development of software. But as we continue to invest and learn more about the Plex solution, it's having positive impacts on our own capabilities of what we're developing organically for Software as a Service software solutions. And then there's even some diversity in business model that it's bringing to us. So for instance, Plex has a business model of selling software in a more traditional model based on usage and seats of how it's being used. But they have other business models that result in revenues and gain sharing that as our customers do better, Plex is able to build more as a result, too. So there's diversity of business models that we continue to be excited by and what implication does it have on how we go to market on a broader Rockwell scale.

And have you seen your -- how are -- what are the early innings of your customers? You're bringing the product to your existing customers and kind of expanding that share of wallet, if you will, [indiscernible].

Again, it's early. We're still very early in this journey with Plex. But we are already finding success where some of our existing customers that were not buying Plex are now placing orders and becoming Plex customers. And we're excited about continuing to grow that.

Are there more out there of this size? I mean this was, for a software company, a reasonably large deal. Are there more of these types of assets out there on the software side? Or are you kind of digesting this one?

Yes. I think there's both a short-term and a long-term answer or a medium-term answer to that question. So of course, we have an active pipeline on the M&A front. A lot of our focus right now is on how we're integrating Plex and Fiix. We do see capacity for what I would call maybe more traditional of what Rockwell does of tuck-in acquisitions while we continue to focus on Plex. But if I go out a few more quarters, certainly, I see capacity and interest of, is there yet another similar software sized opportunity for us. It's -- we continue to have a pipeline that's looking in that. I just don't think it's very likely in the next 2 or 3 quarters.

How fast is Fiix growing?

Oh, boy. I've been -- we've been seeing order growth in the 30%, 40%, 50% range. It's growing fast.

Got it. And just remind us of where that business plays. Are there other -- some verticals outside of the core industrial facility that [indiscernible] play?

Well, first of all, what Fiix is -- for those that may not be aware of it, it was a little over a year ago that we acquired Fiix. It's in the asset management, maintenance side. So typically, a customer of ours will need to have a solution that is maintaining the assets that they have, a list -- a record of all their assets, where they are and then also the maintenance schedule for them. And traditionally, maintenance has been something that is done based on a time schedule, like it's time to bring this asset down and do preventative maintenance on it. Customers want to have more agility there and more intelligence applied to that. So what Fiix brings is the capability -- as we're connecting to some of what's being sensed within -- with that piece of equipment, it can give an early warning that now is the time to take this down for preventative maintenance versus later. So that's what Fiix does. And it cuts across many industries, industries especially that are capacity constrained and are looking for any edge of how they can use this type of technology to decrease their downtime on assets and increase the output that they're getting.

Any questions out there? In the back and then right up here in front.

Are you seeing any drop in demand or volumes from the contracts in which you are able to pass on prices? Or on the other hand, do your competitors also pass on those prices and you're seeing the volumes more or less flat? My question here being, what is some sort of ballpark figure for elasticity price of demand?

Yes. We have -- we think what we have done from a price increase is not out of line with what we've been seeing our competitors do. And as far as impact on demand, we have not seen it have an impact on demand. Given where we are with supply chain constraints, we've still seen very robust demand for our products. And -- but we're also in a world where there is a lot of projects for capital investment going on. And while I talk about these price increases, Rockwell is also a premium priced solution. And we reserve room to adjust that pricing in order to make sure we are getting the access to these projects. So that's why when Steve asked like, "That's a big increase that you put in place," the yield will be less because there's -- we reserve some space to be aggressive in pricing to make sure we're getting those opportunities that we feel we should be.

Two questions for me. One, for the orders on the guidance, does any of that embed the potential for any cancellations from double ordering? And two, I appreciate the color that you gave on the supply chain within Russia, Ukraine. Curious, any update that you're seeing within China given the surge in cases from COVID, lockdowns coming in?

First, in terms of our order guidance and the impact cancellations is having or could be having on that, to date, we have seen, I'll say, virtually no cancellations. And this aspect of double ordering is something that we're very careful in monitoring. Is there some risk of this not all being real demand? Is it some extra ordering on the part of our customers to be safe to try to make sure they get a fair share of allocation? To both what I'll call qualitative and quantitative measures, we just don't see very much -- we don't see evidence that there is that extra ordering occurring of more than what's expected. However, as quickly as I say that, when we see the ordering pattern now, we have seen a shift of patterns with our customers where customers are placing orders further in advance. And so when we shared our orders of $2.5 billion in the first quarter, we estimated that we think about 10% of those orders were orders that were placed not in the normal period, but were orders that in a normal time would have been coming later in the year probably. And those are -- and we do that based on some quantitative measurements on the request dates that the customers are placing for these products to be shipped to them and also on qualitative measures where we are engaging with our customers and with our distribution channels for what they're seeing of ordering pattern. It's not an exact science, but it's our best estimate of what we're seeing on what could be some advanced orders in that. And then can you remind me of the second part of the question?

[indiscernible]

China update. Yes. I'd say it's a little early for us to have much to say about what we're seeing in China. But China has -- well, it's a focus area for us to continue to grow. It's not a significant percentage of our total revenue in Rockwell. But what we've seen just in the last few weeks and months, we -- up until, I'll say, today, and I'm not saying we're seeing anything right now, but we have not seen anything to take us off the trajectory that we've been expecting in China. We've been seeing strong demand in China. And the strong demand being driven by -- we've changed some of our product offering there to have, I'll say, more solutions in the mid-tier level. We've also expanded some of our sales force. And just as I talked about at the beginning about increase go -- our go-to-market strategy with Lifecycle Services, we've been expanding our capability in China to have a support system that can be helping our customers not just with procuring products or software, but solutions that can help them and expertise that can help them -- our customers on their whole digital transformation. But in terms of what I'm seeing in the here and now in China, have not seen anything yet that would take us off the track that we're projecting there.

Was that pivot a bit of a pivot in China? I mean, you guys weren't doing that before. I mean is that -- were there extra resources you had to add to kind of reinforce that? Or...

Some is -- had been in the works. Some is more recent. So for instance, the addition of products that we think are even more applicable for the China market, those were development actions that we put in place a couple of years ago in order to have those solutions in place now. In terms of expanding our go-to-market model with the people and the right types of solutions, that has been a more recent thing that we've done in the last year or so.

Got it. Over here.

Just around cybersecurity, what kind of solutions does Rockwell have to help their customer base against that threat?

Yes. Rockwell does a couple -- at least a couple of different things in the cybersecurity space. So historically, there's been so much focus in companies on, I'll say, cybersecurity threats in an IT perspective, so computer service and what's their vulnerability. And in some cases, the vulnerabilities on the factory floor where there's a lot of nodes there that create risk. So part of the solutions that Rockwell provides is, on a consulting basis, helping customers assess what the vulnerability is and what can be done about it. So there's an aspect of what we do in cybersecurity on the initial assessment. There's also a part of our cybersecurity business is, as solutions are being put in place to protect, we will be involved in the ongoing monitoring of that. And we partner with other cybersecurity partners in providing solutions there. So there's an assessment phase and then an ongoing monitoring phase that we're involved in.

One more for you on PTC. What's the update there with your relationship and status going forward?

Yes. We're pleased with the relationship. So there's -- for several years now, there's been 2 aspects of the relationship: a commercial agreement where we partner with PTC and selling some of the PTC products to bring, I'll say, an even more complete solution to our customers. Very pleased with how that's going, both for us and for PTC. There's also been an ownership stake where when we first started this, we acquired 9 -- approximately 9% of the outstanding shares of PTC. We announced several months ago in a filing that we may, at the right price and the right opportunity, start to liquidate some of that holding in PTC. And in a -- and there's been a little bit of activity on that front there. We have an agreement that as long as we maintain ownership greater than 5%, our CEO, Blake Moret, will remain on the Board of PTC. We're pleased with that arrangement. But we also see some flexibility that we can flex down some of our ownership, partly based on the strength we see in that commercial relationship that we have with them.

Got it. All right. Great. Thanks, Nick.

Thanks, Steve.