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

All right. Looks like we are ready to go with our virtual session. Blake Moret, Chairman and CEO of Rockwell Automation is with us here to kick us off today. Blake, thanks so much for being with us today. Great to see you. Hope to see you in person sometime soon.

Yes, me too. Good to see you, Joe.

So Blake, why don't we just get right into it? Supply chain, super top of mind for investors post the quarter. Just maybe just talk us through some of the supply chain issues that you're experiencing, and we'll go from there.

Sure. Well, really, the vast majority of the shortages that we're seeing are in semiconductors. And as we talked about on the call, pushouts and decommits in the quarter caused us to have a lower result in Q2. We expect an improving condition through the balance of the year, and we saw that begin to play out through the balance of the quarter. And then as we talked about April, so the first month in our Q3, is tracking well to the forecast.

Okay. That's good to hear, Blake. I guess like, look, I'm sure that you had some discussions post the quarter with your executive team on trying to assess the situation. I'm just curious like, when you think about it, I know you described it mostly as being a chip situation. But like how much of this was outside of your control? What could you have maybe done differently as a management team? Just any thoughts around that would be very helpful.

Yes. Well, as you said, I mean, not just post the quarter, but for the last several quarters, we've been meeting daily on all the aspects of the shortages that we're seeing, both trying to mitigate those shortages, but then also making sure that we're dealing with it, where we can't get out of the way of shortages, where we're getting the price and we're making sure that we're substituting to maximize customer service. I talked about on the call that the changes that we're making for faster realization of price to deal with the inflation side of things. I wish we would have had some of those things in place a year ago. We have a system that has served us well and allowed us to realize price over a long period of time. But improving the speed of seeing those prices realized through the system, including through distribution, is something that we're putting in place more broadly now and that's going to serve us well through the rest of the current situation but also having that ready in the future as things come up where we have to react more quickly than ever before.

Yes. And it's so interesting, I do want to get to the pricing comment. That's an interesting point. I guess you guys had talked about some improvement as we progress through the year. I'm just curious like, on your visibility, like how much visibility do you have to your chip supply as we progress through the rest of your fiscal year?

What we look at, first of all, we start with the baseline of what have we been receiving from the various suppliers. And it's a broad assortment of suppliers and different chip technologies throughout our product families, but we look at what we have been receiving, what is the expectation that suppliers have given us for increased supply in the existing sources. And then what we're doing as we engineer around the most critical bottlenecks to make sure that we're getting those new sources online through the balance of the year. And we talked on the call about one example of that with our operator panels. And by releasing a new series, we were able to get to sources of chips that were a little less constrained, and we've seen that bear out in the increased shipment in that product family. And we'll have other stories like that through the year as well. So we're managing through this. We do expect a gradually -- gradual recovery through the balance of the year and into next year. It's not going to be over soon. There's additional uncertainty as we and all our peers have talked about in China. And a lot of that for us is in the secondary and tertiary suppliers. We're not as exposed in terms of our manufacturing footprint in China as some of our peers. But for all of us, we have a supply chain that includes China, to some extent. And so we're watching that. We are a critical supplier, so we're on the so-called white list in China. Our plants are up, but not necessarily at full capacity.

Yes. Have you -- since you mentioned China, I'm just curious, have you seen any kind of change? I know it hasn't been too long since you reported, but the environment is incredibly fluid. And I think a lot of companies had talked about mid-May kind of starting to get back to normal. I'm just curious whether things have kind of changed on the margin for you in China.

Yes. We haven't -- I'll say this about China and other things, we don't give intra-quarter guidance, but nothing to cause us to change what we talked about on the call.

Okay. And then going back to the supply chain discussion. So I'm just curious, like when you talk through kind of like the level of decommits that you saw throughout the quarter, I guess from a supplier availability standpoint, I know that you don't give -- no changes to quantitative guidance. But like I'm just -- more kind of qualitative, like are you seeing just -- are you seeing any improvement in availability?

Yes. We saw some improvement through the quarter. And you'll remember that there's a lag time from the time that we have a notification of a supplier about an increase or a decrease. It takes a while for those chips to get to us and then to be added to the product and, of course, for it to be shipped down and show up in revenue. In some cases, we've prebuilt subassemblies so that we can decrease that turnaround. But during the quarter, we saw a sequential improvement. And then, again, in April, we saw we were tracking well. And it's not about demand. We have amazing demand across geographies, across industries and across our product offering, it's about the chips.

Yes. No, that makes a lot of sense. And so I am curious, you have really kind of focused it mostly, it's a component, it's a chip issue, hasn't been a demand issue. Some other companies that don't compete with you have also run into like a labor installation issue. I'm just wondering like, is that also at all part of the equation for you guys as well? Because I think more of around like your solutions business or the Lifecycle Services business and whether there is extra cost potentially that you are also burdened with because backlog isn't converting at a rate that it had historically.

Yes. Certainly, there's some inefficiencies when you have your full labor complement, but you don't have all the chips that you need to maximize production. In terms of being able to get the labor, whether it's in our product assembly or in our Lifecycle services, that part has been fine. We've hired to the extent that we need to. But in the case that you don't have all the components, you do see some inefficiencies there, which put pressure on the cost side of things.

Yes, that makes sense. And then I guess just in terms of the backlog and the demand outlook, things have -- at the end of last year, I think you were at $2.9 billion. I'm assuming your backlog has continued to increase since then. Maybe just provide a little bit of color around like the confidence you have in the margins in that backlog. Is that something that is clearly top of mind for folks?

Sure. So backlog is well over $4 billion. It's around $4.5 billion. And it's composed more heavily of product than Lifecycle Services backlog, which would be the normal preponderance of backlog in, let's say, more normal times. The backlog of the product specifically is going to be composed of different tranches of products that were entered with one or more of our recent price increases in force. So there's a certain amount of backlog that has that original price increase of 4% back in June, others that have that plus the 4% in November and then increasingly backlog that has all of that plus the 9% that went in force in March. And so you'll see that continue to have an increasing benefit through the balance of this year as well as into fiscal '23.

That's good to hear. I want to ask you about guidance. I know you've just made a comment about not having -- not making any intra-quarter updates to your guidance. Clearly, the environments are fluid, right, for a variety of different reasons. I'm just curious, like in times like these, there's -- the question we've got from investors is like, well, you had a lot of opportunities to maybe update the guidance on this past quarter, public conferences that you went to. I guess I'm just curious, why wait until earnings when the market right now seems to be starving for information because of the volatility in the market?

Yes. So as you said, it's volatile from week to week and month to month. We called down additional risk in our Q1 release and guide in that we had strong overperformance with roughly 17% growth in Q1, and we did not flow that through the balance of the year because we said there was heightening volatility, and we're managing through that. So we don't give those updates in that respect. We thought it was also important to be able to provide the quarter's results as well as the impact on the full year together, and that's, of course, what we did on last week's call.

Got it. Okay. And then I guess just from a visibility perspective, I know I kind of keep harping on the margins and the backlog, but also on the conversion, right? So I mean, they're all tied together. And the second half of the year kind of bakes in still mid-teens, really good growth, right, in the back half of the year again. Just maybe provide a little bit of context on your confidence in the visibility that you have on the backlog conversion in 2H.

Yes. So detailed product-by-product review of the chips that make up those products gives us confidence. We have a certain level of risk already built in to that recognizing additional volatility. We know that we're going to get additional surprises going forward. What it does not bake in is a material worsening of the situation in China beyond what we're currently seeing. And of course, the widening of the war in Ukraine is something that we haven't been able to quantify and built in as well. But we have good visibility to what we can build, the results of our engineering efforts to engineer around the most critical bottlenecks, daily conversations with our key suppliers about what they're seeing, making sure that they have good visibility into what our needs are. And then there is some impact on price as this continues to ramp up. Then we see roughly about 1/4 of our top line increase, that's going to be attributable to price as well.

Yes. So that brings me to my next point. So the pricing dynamic appears to be getting better. If you do have the visibility in your backlog converting, then the question is really around drop-through, where you expect to see it in your segment. So either qualitatively or quantitatively, if you can maybe just provide some color around the margin progression across the segments. I think that would be helpful.

Yes. So good sequential improvement really in all 3 of our business segments: Intelligent Devices, Software & Control and Lifecycle Services. All of Intelligent Devices was impacted by the price increases. And so you'll see the biggest increase is due to that as well as the leverage on increased volume. Software & Control is a mix of the hardware that's affected by those price increases going through distribution in many cases because we can price software, to some extent, dynamically. It's obviously not directly affected by broker buys and constrained freight lanes. And then Lifecycle Services, those can be priced on a project-by-project basis. And so those aren't really affected as much by the price increases that we described earlier. So it's really going to be most pronounced in Intelligent Devices, but sequential improvement throughout all of those areas. Lifecycle Services is implementing increased price, but it manifests itself in a project-by-project basis.

Yes, that makes a lot of sense. I mean obviously, like there was acute margin pressure in Intelligent Devices this quarter. The margins were like mid-teens, right? And we're so used to seeing low 20s, right? It sounds to me like you're fairly confident that we're going to get back there in the second half of this year.

Yes. We expect improvement in Intelligent Devices in the first quarter, remember, where we had something like 17% growth, then we saw very good margin performance from Intelligent Devices.

Yes. No, the growth was insane in the first quarter. It was actually north of 20% and it was something that we weren't anticipating. But yes, it's been a good part of the story for you guys. You announced pricing increases this year. like roughly $400 million. I think that you've got potentially $200 million, I think, hoping to come through throughout -- as the year progresses. So maybe talk to me about the confidence in those price increases, and we've talked about it to some degree already. And then also, I'm curious that some of those pricing increases really don't take hold until 2023. Is that because of the Lifecycle Services dynamic that you just discussed?

No, the pricing, we're going to continue to see a strong ramp in Q3 and Q4 of those price increases. But because of some of the annual renewal dates of our customers' contracts with us, then we'll continue to see added input from those added benefit from those customers and what they're buying from us into next year. So we'll continue to see that. There's not really a strong calendarization effect. So think about it each month, more contracts renew. They renew at those higher prices, and that falls into the mix of a generally improving margin backdrop.

Can you talk about the contract structure a little bit more? I mean I think this is something that maybe I -- it was maybe my own fault. I typically have thought of like your Lifecycle Services business as being the part of your business that is mostly under contract. But maybe in a more holistic level, talk us through about your entire portfolio. How much of your portfolio is under contract? And typically, how long are those contracts?

Right. So these are annual pricing agreements that affect the majority of our product business. So we have these agreements for product supply across Software & Control as well as Intelligent Devices. These are typically annual agreements. And not all our customers are on it, but a large portion of them are. And so those price increases will go into impact, into effect when their contracts renew. And we're doing some things to decrease that gap. It's already in place with a number of customers, and we're expanding the use of that to be able to get more rapid reaction in periods of hyperinflation like this. And our Lifecycle Services business, well under half of that business is under contract. And in fact, that's not just pricing. Those are agreements for buying at a certain level and they do contribute to annual recurring revenue. So think about our technical support, our tech support, remote support services, remote monitoring contracts, think about some of our parts management contracts, where there's an expectation that there's going to be a certain amount of recurring business, but that's well under half of the Lifecycle Services total business. So the vast majority of Lifecycle Services can be priced dynamically. We don't have to wait for annual agreements to renew.

Got it. No, that's super helpful. And in this period where you're having to go out to the broker market and, for lack of a better term, probably getting price gouged by your brokers for chip supply, I guess -- so is the right way to think about it that right now, I mean, like you're having to eat a lot of that cost and as your annual contracts are renewing, you're then putting in the escalators that are associated with your increased costs? Is that a fair statement?

Yes. Well, I mean, broker buys are nothing new, and so that's been factored into the amount of the price increases that started going into effect almost a year ago. And we'll continue to see the positive effect as more of that price is realized, going from negative price cost to positive price cost in the coming quarters. I think we're about breakeven near term, but then by the end of the year, we're starting to see strong positive price cost.

Yes. And I guess the question is really more around like if you fast forward it 12 months and you're using the broker market less in 12 months than you are today, arguably, that should result in a really good drop-through to your margins, if that were the case.

Yes. We talked about improving conversion of incrementals, seeing it at the top end or a little beyond the typical guidance through the cycle of conversion on incremental margin in the second half of our year, and it should be positive for next year given those factors, as you said. I would also say just a little bit more on price is that we have factored in some additional inflation into our already announced price increases that have not yet been seen in terms of cost that we anticipated but we haven't seen yet. And certainly, we have the capability and expect to be able to realize additional price as appropriate going forward. So all of our competitors have raised price. We continue to have a differentiated product and go to market. And so we're confident that we're getting the realization that we expected.

Makes sense. Too early to hold you to an incremental margin number for next year, although it sounds, to us, like things should improve materially and you should be maybe above normal is probably the right way to think about it for 2023, assuming there isn't a lot of cost inflation from here.

Yes. Joe, just on that. I'll say the last few years, we've talked about a financial framework on that path to $9 billion and beyond. And through the cycle, we remain committed to those parameters in that framework.

So Blake, the demand environment has been really good, right? And it was interesting this quarter, and I know sometimes it's like law of large numbers, you did see a deceleration in growth across many of your end markets. That said, your backlog is up, right, and it has been up sequentially. So I guess, the deceleration that you saw, should we attribute a lot of that at this point to just orders and backlog not converting because of the supply chain issues? Is that a fair statement?

Yes. As we talked about on the call, it's really not as important as in, let's say, more normal times to talk about the sequential ups and downs of individual end markets because it is based on the supply, which of those end markets are more product intensive versus services and software intensive. And to kind of give the examples there, we talked about automotive, which is a more product-intensive market. The vast majority of what we sell into automotive is in the form of products. Contrast that with oil and gas, for instance, whether it's -- especially through our Sensia joint venture or life sciences where only about 1/3 of the business in life sciences is actually due to products directly. It has a larger portion of services and solutions and software. And so those are really the dynamics that played out in the quarter. We're not seeing a deceleration in demand in any of these. And as for market share, first half of the year, up about 9% in markets, and we feel very good about our position, as demonstrated by the continuing very strong order demand.

I'm going to get to a market share in a second. I did want to ask you about e-commerce. I know that it's only mid-single-digit type percentage of your business, but it's a business that has been on fire for many companies that sell into it. I think it was up 50% for you guys in the first quarter. It was down in your second quarter. And it's real -- the real question -- the real reason I want to ask is because Amazon made some comments about overbuilding fulfillment centers. And I'm just curious what you're hearing -- you don't have to talk about them specifically, but what you're hearing from your e-commerce customers and what that environment looks like over the course of the next 12 to 24 months.

It's been very strong. It's certainly direct purchases from the e-com players as well as their large ecosystems of companies, the Intelligrateds and Dematics and Vanderlandes and so on. But then there's also a lot of integrators who are in that business looking for new and efficient ways to handle packages. And it's not just about what they're providing to the e-commerce providers. It's also the big box retailers are looking for automating their warehouses and consumer packaged goods company, taking a look at the additional efficiencies there. So think of the Walmarts of the world, there's a ton of opportunity to automate the way that they're receiving material and the ways that the CPG providers are getting materials out, being able to customize that each step of the way. And we've got some great solutions there as well.

Yes. And then maybe we can talk about the R word. It's getting thrown out a lot these days. And if I just listen to my companies that I cover, the demand environment seems great, right? And the markets are expecting clearly something else in the way that the stocks are reacting. But I'd love to hear kind of your view on not just the rest of this year, but really the next 12 to 24 months. And then specifically, clearly, it's -- you seem well positioned for the semi fab investment cycle that seems to be on its way in the coming years. So any thoughts around that would be helpful.

Yes. As we're looking at the convergence of the macro with the current demand picture, I look at it in 3 ways. So start with the secular trends. We've got historic levels of CapEx going into semi, as you said, but also EV and battery. E-commerce spending is still strong, warehouse automation, life sciences. I mean you can look objectively at each of these areas and see announced projects that I don't think are going to be changed based on inflation rates or chip shortages. So the semiconductor fabs are not likely to tone down their spend on creating new capacity to deal with chip shortages and -- based on inflation because the world needs more of what they're providing, and that's a big part of the inflationary pressure that we're seeing. So in addition to those CapEx demands that are going to take multi-years -- multiple years to complete these projects, you've also got a higher automation and digital transformation intensity in those projects, but also in general. So even when you look at food and beverage providers that may not have the same profile on CapEx, a lot of their projects have a higher intensity of what we sell. So we think those are good from a secular standpoint. From a cyclical standpoint, there's no question that inflation is negative pressure, and chip shortages are negative pressure. But we do see that the multiyear aspect of some of this CapEx will continue despite that. And so that dynamic plus the huge backlog that would be unusual when you compare, let's say, this time period to, call it, 2007 or 2008, it's just different due to the historic high levels of backlog. And so I think that that's a dynamic to it as well. It's a little bit more mixed picture to be sure on the cycle, but we do see some positive and negative forces there. And then you look at our position, an outsized amount of the investment is in North America, where we're strongest. So that's good news for us. And it's not so much a matter of reshoring as -- I've talked about the term shoring in the past and that people aren't necessarily shutting down capacity in other parts of the world. But as they look at bringing up new lines of business and increasing redundancy and getting closer to their end consumer markets, North America is faring fairly well there, and we're well positioned for that.

That's helpful. I noticed that you didn't mention anything on the oil and gas markets and LNG has been incredibly topical. I know that the today process is still an important part of your business as well. How do you guys participate in a potential LNG cycle over the next decade?

Yes. Well, thanks for bringing up oil and gas. We saw strong double-digit growth from Sensia, which is probably at the very center of what we do for oil and gas. Process in general is showing some increases. We've talked about mining the last couple of quarters, particularly in Latin America. But in oil and gas, most of our work is concentrated in upstream and midstream. We do participate in downstream, in refineries. It's about balance of plant, safety systems and things like that. Even more specifically about LNG, we have a strong play, particularly around the terminals. Sensia has some predefined solutions that are holding up very well in the market around the various applications in LNG terminals. And that's a big part of the debottlenecking, if you will, of the supply and the ability to move around more particularly in the face of the geopolitical tensions, war in Ukraine that's putting additional demand on where are the sources of LNG and where can they be rerouted to other parts of the world. So it's good business and it contributes to the strong orders and shipments that we're seeing within Sensia.

Got it. And when you refer to terminals, I'm assuming you're talking about regas terminals that are potentially going to get built in Europe?

Well, it's there, but it's also the retrofitting of some of the existing capacity as well.

Got it. Blake, before we went live, you mentioned that you had just come from PTC Board meeting. So would love to get an update on that relationship. And then also specifically, as it relates to your pure software business, I know that there's an ambition to get to $1 billion. So help us kind of provide like what's the path and time horizon for getting there.

Sure. So PTC Board meeting went well. We have a great relationship. And as we've talked about for the last few years, the focus is on selling more in the market together, and it's the commercial relationship within ThingWorx. We highlighted, as Jim did on his call, digital performance management, which is a packaged application, if you will, around debottlenecking based on the ThingWorx software. We had some good wins in the quarter, and we continue to work well together. Our Kalypso, recent acquisition within Lifecycle Services, was a very strong partner to PTC as well, and we like that connection point. So that's going well. In terms of our software, I'm very happy with the growth and we see it outperforming peers. And it's a mix of the software that's a fundamental part of our automation business as well as on the operations management side, which is where Plex and Fiix live as well as our on-prem MES software. So not constrained by chips, growing strong double digits, and we see that path. We'll update progress on the path to $1 billion or whatever typically at Investor Day. But we have talked about the combination of information solutions and connected services, which is not strictly software as seeing around $800 million in revenue this year. So these are meaningful figures, and I'm happy with the way that they've grown over the last few years. And the way that we're increasing our internal infrastructure to be able to handle this business -- recurring business has impact throughout the entire company, and we're continuing to make the investments to have that capability better and better as time goes on. I just want to -- I want to make this comment as well. We're not seeking to become a software company. The hardware that we provide is a really important part of what we do, but it's that convergence of the core automation, the operational technology with the information technology, I think, that sets us apart.

That sounds good. No, really, that's great. And I know you guys have been -- this has been front and center for you guys for a long period of time and clearly, an area of investment. You have made some good progress. I just -- maybe just to kind of conclude. When you think through scaling this business, are there pieces outside of your potential portfolio that you need to acquire in order to scale the business quicker? And then also, I know annual recurring revenue has been an important endeavor for you and you're making some good progress there. Talk us through what's accelerating your ARR as well.

Yes. So double-digit growth in annual recurring revenue. I like the contribution of existing businesses that we've had as well as the contribution of some recent acquisitions, Plex being the biggest of those, but Fiix as well having a strong contribution on the cloud-native asset management side of things. In terms of acquisitions in general, I've been very happy with the way that they've contributed. When we announced our framework a few years ago in Chicago, and we talked about a point or more growth from acquisitions, we'll see a little bit more than 2% growth this year. And it's a meaningful part of our business. We remain a fundamental organic growth story, but acquisitions in certain areas allow us to move faster, bring in new sources of talent. I'm very happy with the capabilities that we've added. We've got a good pipeline. But in this time especially, making sure that it's going to be a strong contributor to Rockwell's overall performance, I think, is an important consideration. So there's nothing that I'm looking at to say we have to have that come hell or high water, and we can take a measured view of opportunities as they come up there. But we established, I think, a pretty well-defined set of priorities, Information Solutions continues to be an area of growth, Connected Services, advanced material handling, additional growth in Europe and Asia. And so we have opportunities in all of those areas many times that will check more than one of those boxes, but we can be disciplined about it.

Makes a lot of sense. Blake, thanks so much for spending time with us today. Really appreciate it. It was great to see you.

Good to see you, too, Joe. Thanks, everyone.

Take care, Blake.

Bye-bye.