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

All right. Good morning, everybody. I'm Josh Pokrzywinski, Morgan Stanley's electrical equipment and multi-industry analyst. Just to echo what some of the folks have already been on stage have said a few times here, just thanks for coming back. Thanks for joining us this week. It's been 3 years too long, so it should be an exciting week. We got a lot of great folks up here to talk to you. And I think to Adam Jonas' point, like this is a generational moment for a lot of these companies. And I think it's fitting that within that, we start with a company that touches a lot of what we just talked about in terms of supply chains and energy independence and productivity. So I'm happy to kick off the conference this morning with Rockwell Automation's Chairman and CEO, Blake Moret, not Black Moret as the screen says there. So just before we get into things, I do need to quickly remind folks and you'll get sick of this over 3 days that if you have any questions about our research disclosures, please visit the research disclosure website or reach out to your salesperson.

With that, Blake, thanks for joining us. And maybe just to kick things off, talk a little bit about what you're seeing out there. I mean it's a dynamic environment. I think everyone is sort of kind of looking for that canary in the coal mine based on some of those macro comments. Companies don't really seem to be sort of living in that reality. What are you guys seeing at Rockwell?

Sure. Well, let me start by saying, I really appreciate the interest in the company, looking forward to sharing some thoughts with you over the next few minutes. For those of you who are new the story, Rockwell Automation has long been a provider of core automation, hardware and systems that power industry across verticals. Recently, we've added more ways to win by increasing the software content and the value-add capabilities to be able to provide more complete solutions to be earlier, deeper partner for industry in their digital transformation journeys. So we think we have a pretty good vantage point to answer Josh's question about what we're seeing out there. And to be sure, there are headwinds that we're all looking at and dealing with the most critical, which for us and for many of our customers are the semiconductor shortages. That's clear and present danger to hitting shipments to being able to maintain cash flows. And I think the whole world is finding just how pervasive the dependence on semiconductor technology is. It was one of the things that at once was a source of stress for us, but it was also a source of some comfort to recognize just how integral we are to keeping the world running. You can't make vaccine without automation. You can't package food without automation and with our products. You can't build electric vehicles and the batteries that power them without automation. You can't do these things manually anymore. So what we see out there is, while that pressure continues with chip shortages and obviously, with high inflation, both offsetting and what is different from previous cycles is the enormous backlogs that we and many others in the space have, over $5 billion of backlog for us, which represents over 2 quarters worth of shipments. So even if orders went down a lot and they're not going down a lot, then we see this as a little bit different than in previous cycles. Unemployment remains low, and so labor continues to be tight. Again, with a positive read for automation as people are looking for that ideal combination of making the most of scarce human resource and complementing it with the technology that we provide.

So it's a good starting point because I think the breadth of what you guys have seen doesn't necessarily map to like I think some of the hot button sectors that people are talking about. So like near shoring or EVs or what you talked about with pharma, like those are certainly parts of the business that are benefiting. But I think there's this rising tide that's kind of lifting the whole business. How do you see that? Is this sort of kind of all at once awareness that, hey, we need to invest in our supply chain. We need to invest in productivity versus just, hey, we're in a scarce environment, I'm going to go out and order everything I need.

I think during the pandemic -- and we look at our own behavior as a manufacturer in our own right, what are the things that our CFO and I and the business leaders are thinking about as we're sitting in lockdowns during the pandemic. We're thinking about how we're going to catch up to the projects that were deferred because of the shutdowns and how are we going to maximize our differentiation to come out stronger than ever, launch new lines of business, add capacity, localized to take share. That's what all of us were thinking about as we were dealing with playing defense, but how do we come roaring out of this with the opportunity to get ahead going forward. And I think you see that across a wide variety of industries, not just the headline ones that Josh mentioned, the EV and battery, semiconductor. Those are important industries for us, but one of the things I'm proudest about over the last 6 years is the way that we've increased that tail of 5%-ish vertical industries that we serve that weren't really on the -- in the conversation for Rockwell previously. Now let's start with the biggest one, and it's not -- it's the head of the line of food and beverage. Over 20% of Rockwell's business is food and beverage. Last I checked, people are still interested, needing and drinking, and they're looking to do that with more choice in what they have. Obviously, being able to transport things around the world means efficient effective packaging is important, which is one of the strongest applications that we're in. So it's those sorts of applications. Medicine. People want to live longer, healthier lives. These are secular trends, I think, that are hard to bet against that complements some of the ones that are grabbing a lot of the headlines today.

As you look at the order book and those sort of became like an overnight KPI, I think, externally, not really something that you guys talked about maybe 2 years plus ago. Anything about the order book whether it's average size or what projects look like that feels different? I mean, obviously, everything is going up, but is automation playing some bigger role? Are customers ordering twice as much? Like what sort of context can we have for -- from kind of before and after here?

Well, orders over 40% above pre-pandemic levels. So let's set the context there. Even in Europe, orders over 30% pre-pandemic levels. I think it's the contribution of the industries that are in historic all the terms that were used during the kickoff here, never before seen going to continue for a while, building out EV fleets and the batteries to power those vehicles, semiconductor and then the stable elements of medicine and food, things like that. So it's the percentage of greenfields, the number of greenfields, particularly in EV battery, semiconductor, those are powering a lot of the backlog. But then it's the increased automation intensity and all these other places whether it's due to tight labor, whether it's due to the increasing confidence that you are going to get a return on your automation investment as we make it easier to integrate these projects as we reduce commissioning time as we have a higher hit rate in terms of projects that deliver what customers expected in the first place. I think all of that is increasing the order book for us. And it's -- and the other thing that's I think notable is the diversity of that order book. It's across industries, it's across geographies, and it's across our offering. We can't point to 1 or 2 areas that are just stratospheric and everything else more normal. It's all at elevated levels.

And when you think about some of the bigger drivers and all the industries you mentioned, including kind of the food and beverage side being a bigger market for Rockwell, they're pretty automated already, right? Like we're not cranking out cars by hand or barrels of oil or loaves of bread. Is that something where the automation density is getting higher or they're saying, look, everything we have is 30 years old and what's on the market is just so much better right now. Like I guess it comes down to, is this sort of an internal acknowledgment that they underspent? Or did the technology reach some threshold where now like the layups are up? It's like an obvious payback layup.

I think it's a combination of several of those things as well as a desire to create more redundancy in terms of localization. I talk about shoring, not reshoring. It's not about moving lines that were sitting in China or Southeast Asia to the U.S., but the U.S. is an outsized beneficiary of new money coming in. And by the way, that CapEx spend was suppressed. It never really rebounded like people expected it might after 2008, 2009. So some of that is what's driving this spend. I think also some of the higher-level automation and information management technologies that were looked at as nice to have in the past are seen more as a requirement to have a first-class manufacturing facility. So I'll give an example. In an automobile factory and the ICE, Internal Combustion Engine plants, MES software for scheduling was once seen as kind of a nice to have. A lot of companies would try to have it as a homegrown extension of their internal information management systems. And over time, they found one, the benefits were real of being able to scheduled jobs on the fly as seamlessly as possible. And second, they recognize they weren't really in the business of creating and maintaining bespoke software system. So you see in the EV plants coming in, MES being purchased from Rockwell or one of our competitors is seen as more of a requirement. And that increases the amount of spend in these new facilities because typically, they're also looking for us or an integrator to be able to do the integration as well, and those are multimillion dollar projects. So I think there's a few things like that where certain elements of automation that we're seeing as bleeding edge, we're going to be first to do this are starting to come a bit into the mainstream now.

Is automation today solve -- like do you guys solve like this labor shortage that we have? Like if you look at the manufacturing labor data, we sort of had this kind of job opening run rate that held in for decades and now between the number of people we need and how much they cost. Like we kind of ended up with a bit of a problem overnight, but are we actually pulling people out of the system when we automate? Or are we filling some other need?

We look at it as making the best use of the labor that our customers have been able to have people doing what their highest and best purpose is. A lot of the labor substitution of having people move a heavy object from one place to another has been automated out, and I think that's okay. But on the other hand, don't expect there to be a rapid increase in the number of light sound factories where there are no people. There's still a lot of people in the vast majority of plants. The trick is to be able to have them comfortable interacting with the technology to have them cross-trained so that they have the capability of doing multiple jobs to level the load and for them to be able to utilize decision-making capabilities that are still not something that is readily automated. There's still a lot of room for people in factories, and we talk sometimes about Rockwell being at the human heart of automation because the people are very much a fundamental part of our message, and it's working together. And I think that's an important concept. So it's not just about raw labor substitution.

I want to shift over for a second to supply chain. Obviously, this is something that everyone in the room has kind of dealt with. You guys more than most. What's your sense of how the market is sort of evolving today? And when we might be in a better spot for some of these chip deliveries for like the industrial kind of legacy nodes that folks like Rockwell would purchase?

So gradual recovery. That's kind of the headline. We are seeing some stabilization, but there are still volatile elements of it. And the important concept is that in the vast majority of our products, you have bills of material that require a host of components. So you have the more advanced technologies, the microcontrollers, the ASICs and so on. And those are, of course, important to run the product and it creates a lot of differentiation, but you have capacitors and resistor networks and signal converters and all the other passes that you need to ship a product and have it do what you want it to do. And the shortages that we're seeing are very broad-based across that spectrum. So until those chips show up on your dock, you're not 100% sure. Now I think a lot of the semiconductor companies have gotten their legs under them a little bit more, so to speak, and they have their own processes a little bit more stable. We've entered into long-term supply agreements with a number of them so that they have an idea of what the needs are from their biggest and best customers going forward. Some of them to be sure are adding capacity, while the majority of the CapEx spend is in the leading-edge process nodes, 4 or 5-nanometer and so on that industry doesn't use as much of. There is some investment in the legacy process nodes that we and our competitors and our customers and the automobile manufacturers are largely dependent on. So it's a combination of their additional capacity, making sure that we're doing everything we can to maximize our allocation. It's the redesigns that we're doing to be able to qualify additional sources of supply, redesigning products so we can move away from the most severely constrained components. From a revenue growth standpoint, it's obviously, it's price entering into the mix in a greater way. And it's also that additional content that we have that's not as dependent on hardware, the software part of our business, the services and so on. So all that together creates an outlook that does include growth.

So if I'm understanding that right, it sounds like if we were to look over the next kind of maybe 12, 18 months that revenue is really going to be more governed by supply than demand, just where you're in backlog today. You mentioned orders are still kind of in these elevated levels. Is that the way you see it? And does that sort of eliminate normal seasonality because you're just getting ideally more chips every month than the prior?

I'm not ready to say for the next 12 to 18 months. That will be the only consideration, but for the foreseeable future, and I think through the majority at least of '23, it is going to be based, given our very large backlog, given the continuing strong orders, I think it is on that gradually improving supply. And I think it does mute -- not moot, but mute seasonality a bit that is more a function of cyclical demand.

And even though you guys don't have what I would call sort of like raw material, heavy or highly inflationary inputs maybe outside of things like semiconductors, which aren't a big category, you are taking price that's starting to flow through the system. But I think what you guys have sort of signed up for is kind of in that mid-single digits kind of realized range relative to what you've put out there, I think, in the teens. Is there a reason why price should have kind of that negotiation wiggle room? It seems like a lot of folks out there sort of getting what they're asking for a little bit more readily, especially in some of these consolidated markets.

Yes. So to give a few figures that we've talked about in the past with this, in 12 months, we raised prices, a combined total of about 17%. And that was for our products. We're also raising price on our engineered to order and our fully engineered systems. We don't track it in the same way. We don't publish those numbers because it's on a little bit more of a per project basis, but we're taking price across there as well. So the 17% that we talk about, which has quite high realization -- it's for the products only, so you can't take the denominator of our total shipments to look at that realization. I feel very good about the magnitude of what we published and our ability to realize that price in terms of the impact on Rockwell's financials, we expect about $200 million of price realization in fiscal year '22, which ends in a couple of weeks here. We have an October 1 start to the new fiscal year, and then another additional $200 million plus next year through fiscal year '23. And we're confident that this plus the likelihood of additional price increases will more than cover the cost increases that we've already seen as well as some additional cost increases in certain parts of our inputs.

If I just look at what you have in backlog today and try to pair that up with what you talked about in terms of what customers are doing and kind of this regime change and how they're approaching automation and productivity. I think a lot of the excess backlog throughout the history is in intelligent devices. As a fully admitted kind of non-engineer here, and I think there's a lot of people in the room have heard me say this before, including you. The -- I guess, when I think of automation, like software and control seems to be more of kind of like the category that my mind goes to. Like what is having all this in intelligent devices tell you about what customers are doing? Or is that just sort of a different way of saying, well, there's a lot of chips, and we need more chips so that's where the backlog is.

Yes. I mean the majority of the SKUs are in intelligent devices. The average cost per unit of an intelligent device is going to be less than a programmable controller, a Logix controller, for instance. So there's a lot of those devices that are out there. And to be sure, it includes some of the lower end, let's say, of the automation market, it's the electromechanicals. There's still a lot of push buttons out there, motor contactors, relays, switches that things that made the Allen-Bradley brand that became part of Rockwell years ago. But there's also some very advanced products in intelligent devices. So variable frequency drives that control tension on process lines that are a fundamental part of saving energy by varying the speed of an electric motor, the motion control, the servos, the independent cart. These are highly differentiated products where Rockwell has high market share, particularly in the U.S. and Canada and to a lesser extent, into the other parts of the Americas. And quite frankly, those were some that were hit by some of the more severe decommits early in the process. In the last few weeks and in the coming weeks, several of the major engineering redesign programs that we embarked on months ago to engineer around these most severe constraints are coming online. Those products are coming out of test with the new bills of material, and we are seeing increases at the end of this quarter and then certainly, for the full fiscal year '23 in some of those products, particularly some of the higher value end of the intelligent device product portfolio that we're expecting significantly increased flow that will start to get at some of that backlog.

And just shifting over to Europe, which I think will be very topical this week as a whole, but your business in Europe is maybe a little bit different than the core, and it's a little less in factory, a little bit more machine builders who are then shipping globally. What are you seeing in Europe? And are you surprised personally that like with all these headlines that I think at most points in time over the last decade would have been cycle killers like full stop that things are going forward? Like, I guess, what are you seeing that kind of gives you confidence that that's not coming down the road? Or what's changed in your mind?

Well, what we're seeing is, those machinery builders have enormous backlogs themselves that they're trying to ship out, and they want the prospects from us to be able to ship those machines. So I'm having frequent conversations with our customers. And I can tell you, the European OEMs are well represented there who have been strong Rockwell customers. They're shipping their machines all over the world, including into other parts of Europe, and they want their stuff now. Nobody is coming back and saying, hey, given the worsening environment, can you hold off? They need those products to ship their machines to keep their cash flow going and to preserve relationships with their end user customers, many of which, of course, are big end users that are buying directly from Rockwell and their own rights. So we're not seeing any wavering on people's desire to get that backlog shipped to them just as quickly as possible.

Is there any unusual sense of urgency about, hey, maybe we might not have energy come winter or so, we need to get through all this now.

I think given that the lead times are already quite a bit longer than they had originally experienced, there's already urgency. I haven't seen a new level of urgency because of the potential energy crunch in Europe. They just want their stuff now so that they can ship out that equipment because their end users are asking for to be able to create new lines and new locations, new lines of business for the reasons I mentioned at the beginning.

And anything they order today probably wouldn't get there by the end of the year anyway at this point, right?

Well, it wouldn't get there by the end of our fiscal year. Some of our product lines, you would be able to get it by the end of the calendar line, and I think that's an important point to make. As we go through fiscal year '23, some of the product lines are going to be recovering faster than others. We do expect some of our product lines to get back to normal lead times where demand is going to be more of the gating item versus supply in '23. We're not talking about what percentage and so on of that. You'll hear more about that at November earnings and in our Investor Day, but it's not going to be a one speed recovery within our portfolio.

And then what are you guys kind of focused on? It could be external M&A or internal investment on sort of what are the applications or products that you need to be better represented in? I know if we went back sort of 5, 6 years ago, software was sort of the buzzword for everything. Everything would be software, but as Adam said, it was half an hour ago, like can have metal without metal. Does that change your approach or kind of making you more satisfied with what you have? Sort of how do you view that environment?

We're really happy with the progress that we've made over the last 6 years. When I came into this role, I said, we were going to use our balance sheet to give us more ways to win to help us move faster to complement a fundamentally organic growth story. And we've done just that with acquisitions in software, in hardware, outside of the U.S., in high-level consulting and digital transformation expertise. So I think the hand we have is more powerful than any time in our history, and I think that's partly reflected in our order book. I don't think it's just explained by macroeconomic or secular trends, it's also our position in this business. We still have a robust funnel of acquisitions, but our first priority is to make sure we get the return on what we bought for customers and for you. And so we're spending a lot of time making sure that we're getting the promise, we're realizing the promise of what caused us to buy these companies in the first place. And I'm very happy with our progress there. Again, in November at our Automation Fair in Chicago, we're going to be showing more major product releases in terms of hardware and software than we may have ever had, at least since the '90s when we released Logix, which unlocked years of growth. But new programming software for Logix, that's cloud native, that's going to be an industry first. New I/O targeted at the process industry. Additional intelligent devices for on-machine control that are going to be highly differentiated and on and on as well as the advancements that we've made in recent acquisitions of Plex and Fiix and knitting those into the overall company. That's one of the things we trade on as being a tightly integrated company focused on a single set of customers.

And then maybe last question here on the margins. Within a couple of businesses, software and control and life cycle services been a bit more volatility there as of late. I think software and control has gone from like low 20s to low 30s within the same year. Life cycle services, a few points below where you guys have been. Do you expect those to start to be a little bit more consistent or kind of tighten that band? Or is that just sort of a different reflection of what we see in supply chain for the near term?

No. I think the margins are reflected the supply chain and the volatility. And obviously, if you go back to 2020, shutdowns put enormous shocks into the system that did all sorts of things to top line and margin. But as we saw in Q3 and as we talked about in the earnings call, there's a lot of positive tailwinds for margin going forward. There's volatility, and I hope I've gotten that message across, but the increased volume, the growth that we're seeing, some stabilization in terms of our input costs, the strong realization of price and continued focus on productivity, even in a growth environment, even in an environment where hundreds of our engineers are involved with redesign projects to get around chip shortages, saving money in the organization remains a really important part of a healthy business even during times of growth. You don't turn that on and off. It's got to be something that's really a part of our culture to continue to look for ways to most effectively deploy a given dollar of spend. And so nothing is safe. I don't want anything to be able to hide in a run rate without looking and saying, is the reasons for spending in this area, whether it's in product development, sales resources, SG&A, whatever it is to make sure that we're evaluating is that the best way, is that the best talent that we have deployed for our mission as it stands today.

Excellent. Well, Blake, I see we're out of time. Thanks for kicking us off here for Laguna, and we appreciate you coming.

Yes. Thanks, everyone.