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

Great. Well, thanks, everyone, for being here. It's my pleasure to have up next, Blake Moret, Chairman and CEO of Rockwell Automation. I think Blake will have some initial remarks and then obviously, we can move to other questions. So over to you, Blake, and thank you for being here.

Julian, thanks. It's great to be here, and I appreciate everybody's interest this morning. I'll start with a little bit of a love set on Rockwell Automation. First of all, I've been in the role for about 6.5 years. I'm a lifer with the company. I spent my whole career within Rockwell. And for much of that career, we were known almost exclusively for our Allen-Bradley hardware. We made -- continue to make great hardware components for automation. But in the last few years, we've added more ways to win. We've added additional software that we've built or that we bought. We've added additional high-value services, like cybersecurity assessments and remediation. And so it gives us more ways to add value as a customer proceeds on their journey to digitize their operations, to transform to a more agile organization, and we're very happy with the results that, that yielded. So with that, happy to answer questions.

Thank you, Blake. And if we move sort of to the near term for a second, I think one of your key peer, if you like, in traditional automation, [ Siemens ] had a very positive update fairly recently. I think they talked about good orders. And then on the supply side, component shortages getting better, maybe some of your own lead time data on your website is consistent with that. So maybe just help us understand, are you kind of seeing what they're saying as well on your side?

Sure. So like some of our other competitors in the space, we're seeing a good market for automation. And we're seeing that from a couple of standpoints. First of all, industry specific. So there's lots of objective evidence that electric vehicle manufacturers have historic high levels of spend with the attendant battery manufacturing that's needed as well. The good read for Rockwell, specifically, is that so much of this investment is going into the U.S., where we have the highest market share, the best channel and relationships that go back for decades. You also see high levels of spend in semiconductor, for instance. And then more general, not specific to any one industry, brought on by workforce shortages is a general recognition that advanced technology, advanced manufacturing principles are going to be important to make the most of scarce labor. And so you see cybersecurity assessments even in brownfield operations. You see consulting services to help companies take those first steps towards digitizing their operations that we can provide help with through our Kalypso organization. So we would agree that even apart from the specific effects of supply chain shortages and multi-month or year orders, there are undeniable high levels of investment that would be happening with or without supply chain shortages by important parts of our market. And then the second part of that supply chain shortages are easing. We're not out of the woods yet, but we're definitely seeing a return to pre-pandemic lead times by more and more of our product lines.

That's very helpful, Blake. And maybe on that point on a normalization of supply chain going on for you, gradually, not a step change overnight. Is it a similar picture with how we should think about your own customers' behavior to you? And I guess the easiest way to talk about that is through the lens of sort of backlog development orders progression. How do we think about those things, I guess, moderating, if you like, after an exceptional 2-year period?

Yes. Well -- so if we look at it through the lens of our customers, and I think about the conversations that I'm having with a lot of our customers, first of all, they want their stuff now. I'm not having conversations where customers are negotiating to delay existing orders. They want their stuff now. If you're a European machine builder, and we have a lot of those who are our customers, they have backlog that they're trying to ship out. And in many cases, we're on that critical path for them to be able to ship out that machine. Now that's tough because we want to improve those levels of customer service, but it's also encouraging, in that, we are so important to their fundamental business. And so we're having a lot of those conversations at the highest level. When you look at the end user side, the Fords of the world, the Hyundais of the world, Intel, who is at once a supplier and a customer, then it's very important for them to understand and to coordinate with us so that we can help them get their projects and their new capacity online because a lot of these projects are at a higher level than you and I have seen maybe ever, the number of greenfields is really a large percentage of the activity that's going on versus MRO or brownfield revitalization projects.

That's good to hear. And there's a lot of companies here. They have a different margin profile, maybe of brownfield and greenfield or aftermarket versus OE. Does that matter much for Rockwell on mix? Or it just depends more on the customer industry region, those kinds of factors and you're fairly agnostic profit-wise around green or brownfield?

Yes. I think it depends most directly on the type of application that we're addressing. So if we're doing a highly engineered system in a mine, for instance, that involves a lot of our engineering content or in an oil field, then the margins are going to be lower because it's a more people-intensive business. In an automobile and EV application, the majority of what we're providing is still in the form of product because the engineering is being done by an EPC or an integrator or by the end user themselves. And so it shouldn't have a big impact on Rockwell's overall margin profile. I know you would otherwise think a big project that's going to be pressure on margins, but it's really more a factor whether it's an engineered system or whether it's product supply as part of that product -- the project, and EV projects are product supply versus engineered systems for us.

Got it. That's very helpful. And -- yes, you mentioned orders cancellations, it sounds like a very low rate still in your backlog...

Low single digit.

Low single digit. And have you seen any change in behavior since that product cancellation charge was put in?

No. A short answer is no. So we implemented a cancellation policy for orders, and I characterize that on the past earnings call is more hygiene. We didn't expect that to have a big impact on orders coming in or existing backlog, and that's played down as we expected. We do see some advance ordering every time that we announce a price increase. We had a price increase in December. And as expected, we saw some increase in orders just ahead of that. But that's normal behavior, that's not something that's changed during the last -- in the last year or 2.

That's helpful. And operationally, there are things that Rockwell will do differently in the future, say, to manage supply-demand balances better in terms of changing the way you source chips, maybe carrying more inventory in general? Or do you think not really like the last couple of years are exceptional, no reason why you should be carrying more working capital indefinitely?

We definitely learned some things over the last couple of years that are going to make us a more resilient company going forward. For starters, every product that we have currently or that is currently under development, will be run through a resiliency index to be able to assess are we at higher risk than we should be of sole source components, for instance? And what are we going to do to remediate that? That doesn't automatically mean we're going to carry more inventory, and it's going to be an eternal pressure on working capital. In some cases, we'll have additional inventory for certain components. But in a lot of cases, it's going to mean that we're going to do the upfront work to make sure that we have alternate suppliers that we talk with the supplier to make sure that what we're asking of them is going to be on their important products for a long time. It's going to be an important part of their business model going forward. And that assessment probably wasn't conducted with the same rigor that it will be going forward. So I don't look at this as a negative read going forward for working capital or engineering spend, but there are going to be some things that we do to be more resilient going forward, and we just plug that into the overall business model as a reality and not as something that was won and done. That happened for the last couple of years, but that we don't have to worry about again. We'll always pay more attention to certain of these items based on the events and the reality of the last couple of years.

That makes sense. And let me look at some of your customers' behavior, let's say, by geography. I think Rockwell has been very judicious at talking about reshoring as a concept rather than onshoring. And I think it's a very valid distinction. I thought the good thing for you as we look ahead is if we look today or the last couple of years, your North America revenue growth rate is pretty similar to other regions. So we haven't yet seen the reshoring in your numbers. I guess when you look at orders or backlog do you see it in that yet? Or no, this is a tailwind that actually Rockwell hasn't even begun to see yet, and we'll see it the next X years playing out? And also, I guess, on that point, have your conversations with U.S. customers changed over the course of the last year or 2, as you've seen the legislative backdrop, the IRA and so on get fleshed out?

So shoring is real for us, and I use that term because it's not so much that factories are being shuttered in another part of the world. It's that the U.S. is an outsized beneficiary of new spend. And that comes even ahead of recent legislation, like the IRA. We're definitely seeing that behavior. It's a little bit hard to parse that out in terms of growth rates. And I wouldn't look at the U.S. growing faster than Asia or Europe as the sign to see. What I would look at more is the U.S. growing at a faster rate than it was traditionally because we don't know what's going to happen in Asia. We don't know what's going to happen in Europe. And it's not that this growth in the U.S. is necessarily going to be at the expense of other things in other parts of the world. But I would expect that as we get past the effects of supply chain shortages and larger orders by machine builders and things like that, that you will see faster growth rates in the U.S. than you did previously because of the additional amount of investment that's taking place in some of these critical industries to put manufacturing capacity onshore in the U.S., where Rockwell is in kind of a home field advantage with the largest share, the best channel and the strength of very durable relationships and ecosystem.

That's helpful. And you mentioned at the beginning, sort of EV chain investments. Chips, I think got a lot of headlines as well. Beyond those 2 industries, kind of how is that discussion with customers around U.S. in investment kind of playing out?

So think about one success story that we have highlighted the last couple of Investor Days with First Solar, building photovoltaic cell panels, and they have greenfields going on in the U.S. as well as in India. And they built previously plants that we've been involved with in Vietnam and other places around the world. I think some of the most recent investment has been encouraged at a minimum by the IRA. And as we look at the number of EV plants that are being built in the U.S., that is influenced at least in some part by tax credits associated with electric vehicles that have -- that meet the requirements for U.S. content in the vehicle and in the battery. So those are all positive for us. Beyond that, you look at what companies are doing to accelerate their energy transition, those are good projects for us. So when you look at a carbon capture and sequestration project, those typically involve big pumps and fans, moving air or water or what have you, and variable speed drives are a necessary part of those projects, and we have great share in those technologies and good relationships with those customers.

That's helpful. And I guess in Europe, people have kept waiting for automation spend to come down with PMIs and so on. Doesn't seem to have happened somehow yet. So any kind of perspectives on that? And then in China, you've got some very good positions in the automotive sector there. How do you see that pace of investment or sort of business confidence coming back in China now?

Well, those remain good applications for us in China, in Korea, where you have a lot of the battery producers. So companies like CATL and BYD are certainly good customers of ours, not exclusively, but we participate heavily in those projects there as well because of the strength of our solutions. In Europe, I think some of the resilience of the spend is probably due to a better-than-feared outcome with respect to natural gas and having a mild winter came at an opportune time, right, for Europe -- for Europe that was concerned about possibly not being able to heat their homes, and it's been better than feared, and I think that's contributed. But some of the same issues, workforce shortages, the recognition that automation can give, the workers that you do have superpowers, if you will, I think, has held the market up there as well.

And then I think when you look sort of structurally at the company, as you said, it's been about 6.5 years as Chief Executive, so far. A big push all time has been get more top line growth. I think it's fair to say organic and inorganic, that's been a big priority for you. We can see in the growth rates this year and the guidance, it's playing out. Maybe help us understand kind of how satisfied you are with some of the broader initiatives around Information Solutions, Connected Services, getting that software content in aggregate, higher. Something else -- people used to point out you versus some of your other Western peers was too small in emerging markets in China. Some of those broader elements kind of where you more or less satisfied across those bigger drivers?

Sure. Well, when we introduced the framework for describing what you, as investors, could expect from us back in 2019, we headlined it as accelerating profitable growth. So to be sure, it was about growing faster, but it was about doing it profitably and within a well-understood framework for margins and capital deployment. And I am very happy with the progress there. As we talked about in the most recent Investor Day in November in Chicago, there were 3 main tiers of that program. It was to grow faster than traditionally in our core as a multiple of industrial production, and we've done that. It was to grow double-digit growth in areas of new value like Information Solutions, which is largely about software, and Connected Services, things like cybersecurity services, and we have grown reliably double digits in that area to the extent that it's now over $800 million of our business with a high element of annual recurring revenue. And then it was about using our balance sheet to help us grow faster in areas where it didn't make sense for us to try to build something on our own, and we've grown reliably at over 1 point a year from inorganic acquisitions. We remain fundamentally on organic growth story because that contributes to high margins and less risk. But there are times when making an acquisition make sense, like a Kalypso, like a Plex and so on. We also had, as guide rails to that growth, being able to convert incremental revenue at between 30% and 35% on incremental revenue. And this year, we're going to test the upper end of that. And we remain keenly aware of the commitments for profitability. And we fully expect that as we get past the unusual effects of supply chain shortages as we get past the onetime integration expenses of some of the big recent acquisitions, but that's going to give -- those are going to be positive tailwinds going forward for our margins, which we continue to look closely at.

And is it fair to assume that as the business evolves more software, more information solutions, more ARR, that -- the pressure on the operating leverage should be higher over time? Or not necessarily like if you get higher gross margin, you want it going into more R&D, let's say, to keep that churning?

Yes, we're not going to automatically spend away the additional margin. So no question that we like not only the additional value that recurring software brings to customers, Software as a Service, we like the financial dynamics of that as well. We're not seeking to become a software company. We want to be the company that's best known for producing positive outcomes for customers. And that's going to be through a combination of our traditional hardware, high-margin hardware that continues to make up the majority of the company the software that continues to grow as a percentage of what we do and is often the differentiator, including a growing component of cloud-native multi-tenant software applications and then high-value services, again, like cybersecurity services, like digital consulting coming from the Kalypso organization. All of that together, we think produces a very favorable margin mix going forward.

And then on the sort of capital deployment front, in some of your industrial traditional peers, they have adopted different approaches to software M&A. Even the same management of the same company has sort of changed its mind in some cases, depending on the day of the week. But when you look at your approach to software, PTC, there was a partnership and a stake, Plex wholly owned. How do you think about the preferred route for Rockwell, if there is one, or no you're agnostic and you take each company in partnership and transaction on its own merits?

I don't think there's a one-size-fits-all approach. You have to determine when you go out and build or buy, should you be -- are you the best owner for that particular technology? Can you sustain differentiation? Software is never done. And I think it's silly to think that one company can, at any point in time, own all the software that might be important in a production environment. And that's why we talk a lot about ecosystem and with strong partners, like Microsoft, working closely with the PTC. But then in other cases, making decisions that we do need to own and have the skills in certain technologies. That's why we undertook a significant project to develop internally cloud-native programming software for our flagship Logix product. So the configuration software for our Logix programmable controller is now available in the cloud as well as on-premise. That's a big deal. It's a big deal for the industry. And we're going to build on that, and we felt we needed to do that ourselves with Plex having a cloud version of MES and other critical business processes to complement our existing FactoryTalk Production Center, MES software, we felt we needed to own that rather than through a partnership. And so I think you have to consider each of these in relation to the strategic direction of the company and also the financial implications of it. And when you bring that together, you're going to come up with different decisions about whether buy, build or partner for these different areas. The opportunity for synergy and a special value accretion is the ability to have these different applications working together, to be able to do things efficiently in the database, to be able to take input from the real-time program or control from other software applications and to have to do useful things. And so that's what we're spending a lot of time thinking about now is how to get these all working together, come and look and feel for customers, and that's when you're going to start seeing efficiencies for the customer, that's also going to flush out in terms of value for investors.

That's helpful. And I suppose on that point on Plex and MES, MES is one of the areas in software, Rockwell has a very good position. My understanding is that market is still largely sort of on-prem done by customers one by one. So maybe, I guess, give us a broad update on where you sit in MES, your sort of market position, what kind of growth you're seeing? And also how is the Plex acquisition specifically? It's been a while now since it got brought in, how is that -- how is the integration playing out at Plex?

Yes. MES has seen increasingly as a need to have versus a luxury or a discretionary by more industries. So the new EV facilities, almost all have some form of MES for vehicle scheduling. In regulated industries, FactoryTalk production center is somewhat of a standard for many of the biggest pharmaceutical companies in the world. And then when you look at adding Plex, we've been very happy with the performance of Plex. We're about 15 or 16 months post close. And when we made the acquisition, because it's the biggest one Rockwell had ever done, we disclosed an unusual amount of information about our financial expectations in year 1 and year 2 and so on. And we're happy to say that as we're in the second full year of the acquisition, we're hitting the financial targets that we had set forth. So we're happy about the strategic fit as well as the financial performance, which swings to accretion this year and is only going to grow from there.

Yes. And what sort of -- to the extent it is a stand-alone business still, what kind of organic growth are you seeing? Or what should people expect at Plex?

Yes. We haven't broken out the specific growth targets for that portion of Information Solutions & Connected Services, but we have said that, that's double digit as is the ARR growth and Plex business is practically all annual recurring revenue, and we see that as good double-digit growth this year.

That's helpful. Thank you very much, Blake. And we'll now switch to the audience response survey. So if we could get the first question up around you currently on the stock. Mostly no or overweight? It's pretty polarized. The next question, what's your general bias towards it today, positive, negative or neutral? So fairly balanced. Thirdly, it's around the through cycle earnings growth. And again, peers here is, I think, a broad kind of U.S. industrial or U.S. multi-industry is probably the best peer set to think about. And should be generally above the peer set. The next question is around capital deployment, usage of excess cash. So here, people want acquisitions, bolt-on one, which I think speaks to the success of things, like Plex and Kalypso in recent years. The next question is around the valuation. Clearly, again, this question may read rather stale, but for the sake of consistency over time, that's what sets the valuation ranges inside it. Yes. So basically, sort of 20x -- 20x to 30x PE. The next question is around, why do you not own Rockwell? Or why do you own less of it, instead of more of it? What's the biggest sort of issue or a barrier to ownership? It's a cold growth, surprising in a way. And then lastly, does ESG play an active role in your investment decision relating to the company? We definitely don't have to say, yes if it's not the case. So generally, no, 60%, 70% no, which is consistent with some of the others. Great. Well, thanks, everyone, for the responses. Thank you, Blake.

Thank you.

Thank you so much for discussion.