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

All right. Rolling along here with Rockwell. Very happy to have CFO, Nick Gangestad. Nick is going to open up with a few comments, and then we'll go right to Q&A. Nick?

Great. Thanks, Steve. And I will just take a few minutes to give an overview of Rockwell Automation and share a few of the things that may set the stage for part of the conversation, Steve and I will be having and you in a few minutes. First of all, Rockwell Automation, a company with a -- Steve, can you help me go backwards.

No.

Yes, you can. Thank you, Steve. So Rockwell Automation, a company that we are dedicated to taking manufacturing to a whole new level. Part of our focus has been in today's world, our customers are wanting to figure out how to become more resilient, more agile, more sustainable. And we believe what we are bringing to the table for our customers helps in that regard. We're a company that's been around for over 120 years. We are -- predominantly, our biggest share is in North America. About 60% of our total revenue is in North America. I'll say a little bit on the next slide about the different industries we serve. There's different ways we service our customers. We show them as segments, it would be wrong to think about them as distinct businesses within Rockwell because they're all facets of the value we deliver to the same customer. We have an intelligent device business, which is much of the hardware that we bring to our customers. Most of it, smart chip-enabled devices that talk to one another, it's close to half of our total revenue. We have a software and control business. It's little over 25% of our total. It is software that we provide as well as the controller, programmable logic control that is often the orchestration of what's going on, on a factory floor. And then a number of our customers like Rockwell to help them from a service perspective, sometimes helping them upfront with a project, the way certain piece of equipment is -- or factory is being implemented and designed, all the way to after it's operating the way we can monitor what's going on and be helping optimize the performance. And that's part of our life cycle services businesses. All of them, they don't operate independently. They're all part of one face that we provide to our customers. Different industries that we compete in. Part of the strength of Rockwell has historically been in discrete automation, of automation that involves doing something one at a time. On the opposite end of the spectrum is a process automation, often where there's a flow going on, sometimes involving bigger, more complex control systems. And then there's hybrid in between that is always a combination of both discrete and process. A good example of that would be food and beverage industry, where there's a flow occurring at 1 part of the manufacturing process and then later discrete items that are packaged. Part of what Rockwell does is works to have the same architecture across all of the industries that it serves. And that's what we consider unique to Rockwell, whereas other people competing in this space will have different types of controllers that are involved in process versus discrete. Rockwell's architecture is the same across the board, and that creates some advantages of simplification for our customer. Our technology stack, what do we do and how are we growing this technology stack? I'm just going to start in the middle. Rockwell has a strong product platform of some of the products and software that we deliver to our customers. We are taking that and building that with our digital platform. We have an integrated architecture. We have an open architecture as part of our approach to how we approach automation. And we see in the future of the world, there will be expanding need for working in a hybrid space, where years ago, many things were just on-prem in the factory with OT systems just in that factory. More and more our customers are interested in the edge or what can be done in the cloud. And that's part of what we're building in our digital platform and some of the new offerings we have. And then finally, taking those product platforms and building industry-specific solutions. We compete in a wide range of industries, as I talked about a little on the previous page. And we're increasingly putting our focus on how to have solutions that are customized specific to a particular industry to deliver a particular outcome. We're trying to accelerate the way we're going to market to accelerate our pace of growth. Part of that is included what we're acquiring, new technologies we're acquiring, new consulting services we're acquiring. We recently acquired Knowledge Lens to complement the success we're seeing with our Kalypso consulting acquisition of a few years ago. Two more significant software acquisitions, both in cloud native software-as-a-service with Plex and Fiix. We also have a strong partner network. I'd say that is when we feel 1 of the hallmarks of our company of our strong partnership, whether they be technology partners or channel partners that we rely on our partnerships for part of our success. And then part of it is our talent ourselves, the way we go to market with increasingly capable talent to be accelerating our paths for growth. We have done a number of acquisitions in the past 6 years. There are 3 places we focus on acquisitions. One is information solutions and connected services. So some of that consulting and some of the software acquisitions that we've talked about. We also are interested in acquisitions that improve our market access in Europe or Asia. And then finally, acquisitions that improve our capability around advanced material handling. It's a place that we feel is important, it's a place we feel we have some competitive edge, and we want to continue to build on that competitive edge. Our current outlook for the full year, we're expecting between 11% and 15% organic growth. We do expect currency to hold that back by a couple of points for all-in sales growth of 10% to 14%. We expect our margins to be approximately 21%, which is a little over 100 basis points higher than what it was in fiscal year '22 and EPS ranging from $10.70 to $11.50 and a free cash flow conversion of 95%. We did update that. That is an update from how we started the year with our guidance. We -- based on the strength we saw in the first quarter, we raised our full year organic growth guidance, both the top and bottom of the range by a couple of points. We also raised our margin expectation by 50 basis points, and that's led to the guidance that I just shared there. And then -- so the way we see it, we have been systematically adding more ways for Rockwell to win. We believe we're set up to continue this -- our pathway for accelerated profitable growth. And we believe we have the right technologies, the right people, the right ecosystem to help our customers take manufacturing to a whole new level. So Steve, let's get into our question and answers.

I'm going to start with a highly unique question, but highly, yes, highly unique. I thought about this one a lot. Can you just talk about the various range of outcomes on backlog and orders as we move through the year? And where you expect to be at year-end? You guys have made some comments on that. And just to kind of level set the conversation on those trends, given that you don't update intra-quarter?

Steve, I'm not sure if I'd call that a highly unique question. I'm just challenging that premise a little bit. In our last earnings call, we -- one of the things we said is that we expect that our backlog at the end of this year to be substantially above the normal level that we operate. We typically operate pre-pandemic with backlog levels south of $2 billion. We ended last year with backlog -- total backlog of just over $5 billion. And so we expect it to be substantially higher. There's a number of scenarios we think about and plan about. And the short answer is we don't actually know the pace at which this is going to happen. For example, if our lead times improve noticeably in the coming quarters, we expect that can have some impact on the timing at which customers place orders that they could rather than placing them several months in advance, we placing them more real time. That would create a negative impact in the short term on orders and have a negative impact on backlog. At the same time, we could be seeing continued -- some of the continued strength that we're seeing in places like North America, where we're seeing customer interest in resiliency and in some cases, redundancy in their supply chain and some of the investments, some of the things that the government has done with the CHIPS Act or IRA to stimulate even more investment in North America. So we could see orders continuing at a pretty robust pace. So I think the short and most honest answer is we don't know exactly where that could end up, we think it will be quite elevated from where it was pre-pandemic. Whether it's equal to the $5 billion that we were at, at the beginning of the year or slightly lower than that. We just don't know how to call that yet.

Right? And it could be a combination of lead times getting better. And then like you said, as lead times get better, not only are you liquidating backlog, but guys will feel more comfortable placing their orders later. So it could be that kind of compounding situation, but that would kind of get you to a more normalized trend line?

But even in that type of world, we still see ourselves exiting '23 with a noticeably higher...

Substantially better than where you were...

Substantially higher backlog than what we were at before. And so much so, Steve, I'd go so far as to say as we think about our revenue projections in the second, third and fourth quarter for us, they still are very heavily driven by our view of what happens with supply chain versus what happens with demand. Now that will start to flip with some parts of our portfolio. But for the next 3 quarters, it's still going to largely be driven by what happens supply chain.

Like is there a scenario where this plays out and you -- supply chain loosens and you have some nice backlog liquidation and the second half is significantly better than expected, but then you're getting back to this more hand-to-mouth type of business model. I mean, there's no really way to manage that right? Is that hard to manage?

If part of the question is, if we actually get even better access, would we hold back on some of our orders and not ship them to customers, heck, no. We would be -- we have customers that really want their product and we will be shipping them out to them. That's the part we don't know. It's going to be driven by the pace of what happens with supply chain.

And is there any update on how much of the orders or backlog or preorders or have you done any kind of additional scrapping after the new policy was put in place, maybe take another look at the backlog and try and figure that out. There are some companies that have said it's 10%. Most companies say they don't really know. Nobody thinks it's real double order.

I think the policy you're talking about is, in January, we instituted a policy that for orders that are placed for some of our normally make-to-stock type products that -- an order for that is canceled, and we are doing our part of fulfilling our promise that we hold the right to assess a cancellation fee. That's the policy I believe you're talking about. And to the best of our understanding and engagement with channel partners, engagement with end customers, we really are not seeing that as a very significant influence on our customers' order pattern. We really instituted that. I think Blake said that back in November, we really see it as good hygiene that we just wanted to make sure that we're not inadvertently creating incentives for people to place more orders than they should be because there's no consequence because -- and part of our rationale is we are placing orders with some of our suppliers that are firm orders that were being held accountable to, and we want to make sure that we have a good integrity in what we see as what we will have as a orders will be shipping to our customer. We want to make sure there's high integrity there. So in terms of what we see in that -- in our backlog, I don't think there's anything new to add. There is a portion of it. And I don't know how to tell you what portion of it is where customers are doing what they should be doing. When we have a longer lead time on something, we expect them to place something further in advance to ensure they're proper place in the queue that's been going there. And I will echo what I think you'd said, other people are saying, we really see little or no evidence of double ordering of -- ordering twice as much or duplicating what they really want.

If you take a look back at the first quarter and that the order rate that you put up in the first quarter, was that roughly what you would have expected? Was it holding up better than you would have expected in, let's say, end of October, what's end of September? What -- it's more -- again, more of a backward looking?

I don't know if I've said it this way before, but I will say it since you directly asked the question. The first quarter orders were slightly better than what we had in our original projections as we looked at orders by the -- by quarter.

Got it. It looks like the lead times are starting to come down a bit on the website that you guys provide some of that info around. Most companies at this conference are saying, it's getting better, but it's slow and still choppy and certainly not accelerating. Maybe it's just kind of a steady progression. How would you characterize the supply environment?

I think the words we've been using, I think, for 6 months now, we expect gradual improvement, I think, is still the best way to describe it that we don't see a fast acceleration that all of a sudden, many of the constraints are going to be gone. But we do -- from month-to-month, quarter-to-quarter, see a gradual improvement in our supply chain. That said, we certainly still -- every week, we'll deal with bad news type calls, where a supplier will call us and say, do you know what you were planning on next month and the month after that, we're not going to be able to ship all of that to you. Why I say gradual improvement is the proportion of those types of calls have been going down over time. They're still there, but they're not going away.

And that's mostly still on chips and boards and things like that? Or is there any other...

Other electronic components that is the majority of the constraints that we're talking about.

So does that suggest that things that are a little bit more I guess -- well, I mean, everything you do have some degree of electronics in it. So it's pretty much across the board. There's not anything that really wouldn't have that constrained. Are there any products that were more severe than others?

Not more severe, but what I'll say is we have some places where it's getting closer back to normal. So in our industrial components part of our business where a classic example is a push button. Many of our SKUs in our industrial components are getting much closer back to normal than, I'll say, the more sophisticated parts of our portfolio. But even those industrial components as I said earlier, many of them are smart or enabled with chips in them as well. It's not like they're dumb push buttons that have no logic in them.

Right. Well, the actual push button itself is probably the...

But it's connected to some smarts. I don't think that's a technical term, by the way. .

In terms of the backlog normalizing, do you think that at this pace, we will be normalized by, I don't know, middle of next year? .

Yes. We haven't put a time frame on it. We feel pretty confident it won't be in '23. And to say, middle of '24. I certainly could see a scenario like that. I could see a scenario where it's later than that.

Right. Okay. Thinking about the verticals a little bit. Obviously, everybody talks about EVs and semis. I think that's pretty well vetted. There's a lot of activity going on there, at least long term. Some of the more nuanced areas like consumer and packaging, I mean, Emerson was in here, they are definitely a more marginal supplier to the packaging machine tool guys. You guys have such an incredible franchise there. They talked about a little bit of weakness in Europe on that front. Anything you guys are seeing on the -- just starting with kind of the packaging vertical on the OEM side that -- any signs of weakness there or slowing or anything like that?

Nothing -- I really don't have any kind of material -- any kind of direction of industry by industry of something turning what we would call slightly or more significantly moderately negative. We still are seeing pretty strong growth across all of our verticals. I think the one that I called out, we've called out multiple times is in the e-commerce warehousing space. That is a place where we have been and continue to see slowdown in orders or requests from our customers to be pushing out orders.

You guys have talked about that reaccelerating or something in the second half, I thought in your guidance.

In our view as we see that changing in the second half of the year in our guidance around revenue. I don't think we've made a comment about it from an order perspective turning.

Got it.

Again, that -- Steve, that is a little bit of the dynamics of I think it's very helpful what Rockwell shares every quarter, not just to understand what we're seeing but also to give a glimpse of what we're seeing by industry. I think that's a helpful thing for multiple reasons. I would just caution people right now what that's seen is not a representation of demand, it's a representation of what we're seeing with our shipments out. And so there can be nuances where demand might be really, really quite strong in a particular industry. But because of the components that we need for that industry, you might see an unique growth. It doesn't -- just means our backlog has grown bigger in that particular industry.

Right. It's interesting that when you mentioned warehouse and you see weakness in the revenue side, given what others are seeing out there and the way Amazon is talking, obviously, to say that it's -- the demand is still strong. That's definitely a disconnect relative to others that play in that industry, whether it's Honeywell or [indiscernible] or some of their customers. That's why that one is interesting to kind of dig into a little bit. On the oil and gas side, what -- or just process in general, what are you guys seeing there? Where are you winning on that front? And is that an important part of the demand growth and the order growth that you're seeing out there? .

So in the oil and gas business, part of how we go to market in oil and gas is through our joint venture with Schlumberger SLB. We have been seeing pretty healthy -- nice, healthy growth there from an order perspective. That is growing nicely. But that joint venture has the same type of supply chain constraints that we're seeing in our core Rockwell business. And that's -- so we see a growing backlog. I'd say proportionately, maybe even just a little more severe than what we have in Rockwell as a whole. So we're seeing growth in our Sensia business, but even more significant growing backlog in our Sensia oil and gas business. Process in general, we're continuing to see it's doing well from a growth perspective. I'd say the orders that we're seeing are also keeping pace with what we expected.

And is that like the traditional process stuff? Is there some new metals and mining growth that's coming on the back of electrification or anything like that? I mean what's -- what are the key drivers outside of the Sensia JV?

So part of what we've been doing and some of you maybe saw it in November in our at Automation Fair at Investor Day, there was quite a bit of new product launches that we've been developing specific for the process industry. And those feel what we felt were some of the gaps in our process portfolio that we think create an even more competitive process line. And I'm sure -- I know there are other things, but that is 1 of the things that we think is behind some of the success we're seeing in '23 in our process industries.

And who do you think -- what types of other suppliers do you think you're taking share from? Is that mostly the control systems guys? Is it on the product side? Like where would you...

I would only be speculating if I said that, I just assume not to try to speculate where we think we're taking share there. .

But I guess can you remind us where the new products are, like what types of products...

Those would be within our software and control business, where a number of those were...

Got it. Shifting over to the discrete side and auto, both growing -- obviously, ICE is less the future, but there's still activity going on there. Just talk about your exposure to starting with EVs? And where you have kind of the richest content there? And then what you're seeing on the ICE side of the house?

So we publish to the nearest 5%, is what we see as our industry exposure by industry. Automotive right now rounds up to 10%. And of that total of rounding up to 10%, about 1/3 of that is what we would call directly aligned with EV. And by EV, we also include battery as part of that as part of the ecosystem servicing EV. So we still have 2/3 on the other side serving the internal combustion side of it, some of it MRO, some of the CapEx on that side. The EV part is the faster-growing part. We see that strong growth there, continuing of the orders we're taking -- some of the things that we see as some of our differentiators, if I just go for a moment to the battery side, technologies like Independent Cart, we see as a pretty significant competitive advantage to us that it helps solve some problems in the assembly of that battery cell. And that, coupled with our ControlLogix platform. And even as we get down into the tiers, software that we've acquired, such as Plex, that's 1 of the places where Plex has a good penetration into the automotive tiers that solves a lot of the problems, and it's useful and that has some specific solutions for that industry. That's another part of where we're seeing wins there. And I'll go further like sometimes some of these greenfield EV battery, places that are being set up. They just want to do the whole thing right. And so even at the very beginning, we're getting involved in some cybersecurity services where from day 1, they want to make sure their factory is as hardened as it can be from cyber attacks. So those are some of the things where we're seeing wins on the EV side.

And then how should we think about the ICE exposure? I mean, is that 10% of the company going to move up because EV is growing?

I think there's going to be some kind of displacement between the EV side and the ICE side. Our view, you've heard me say this before, but I'll repeat it for everyone here, our exposure into ICE, we see as less of a negative than our upside on EV. And one of the reasons I say it is we have very little we do today on the ICE side around the engine itself. That's often a CNC machining where we just don't have a lot that we do there. So as that part of the drivetrain is being replaced with battery. We feel that's a net win trade for us.

Got it. And then -- so EV, 1/3 of the 10%. And then on the semi side, how big is your exposure there? And how do we think about that globally? And what's going on out there now, which is a bit of a pullback perhaps in global spending, but then obviously, a lot of investment here in the U.S.?

Yes. So I think there's a couple of dynamics to keep in mind for our semiconductor exposure. If you and I were sitting here a few years ago talking about it, I would have told you, most of our semiconductor exposure is in Asia, and it's primarily around the way we manage the building environment. We would have little -- very little content involved in the actual manufacturing process in the fab. It would be -- we're managing the climate and other parts of what happens in the facility. Now as there's more diversity in semiconductor fab manufacturing and right here in the United States that in itself is creating some upside for us where it's going into the United States where we have naturally a higher share penetration in, for instance, a PLC, and a programmable logic controller environment. But we've also been working on diversifying the capability, expanding the capabilities of what we have available. As an example, I talked earlier in batteries around Independent Cart technology. It's also -- we're also finding a relevance there where that is helpful in some of the semiconductor new fabs going up as part of the -- how the wafer is moved through the facility and that our independent cart technology helps solve some problems there. Just as I said earlier, about cyber security. Cyber security is something that we are seeing more penetration in semiconductor space. So all in, even if the global CapEx has come down from what was earlier, we see it as better positioned playing to where Rockwell's strengths are.

And that when you list is around 5% of sales for semis, I think. Is that -- does that round either way? Or is that...

I don't actually know if that 1 is rounding up or down, Steve. You got me on that one. .

Got it. Got it. All right. It only took 30 minutes to get you on one. So when thinking about the margins, should we think about this 35% incremental is you'll -- you kind of manage to that in any given year? And is there any kind of -- you've listed the bridge pretty well? Any kind of mix dynamics there that we have to keep in mind?

No. Well, first of all, I wouldn't say that we per se manage year-to-year to a 30% to 35% core conversion. That's -- I think of that as over time. Now certainly, even in a year period, it's something we look at and think about, but I'm going to put some perspective on it. We are not going to -- in years where it looks like we're overshooting the 35% like, "oh, let's find some more spending to bring it down to 35%, or conversely, if we have some good investments that we know are going to create good value, oh, it will move us short of the 30%, let's not do it. We're not -- we don't manage that way. But over time, we see it as the right framework to think about where we're going in terms of our margin and in terms of the discipline we have about how we'll grow too. And then in terms of our bridge for this particular year, with a 11% to 15% organic growth, that would normally -- in normal circumstances, they'd be saying, oh, you're -- I would expect your core conversion to be at the high end or higher than your 30% to 35%. I think the only 2 things I'd point out is 2 more significant things. We have currency with a stronger U.S. dollar. Now I'm not taking into account any moves in the dollar in the last 2 days when I say that. But the stronger U.S. dollar because enough of our spending base and cost base is U.S. dollar denominated. For instance, almost all electronic components wherever you buy them in the world or U.S. dollar denominated in what you pay. There's enough of a U.S. dollar base that the stronger U.S. dollar is versus last year is hurting our margin. And then the second is variable comp. Rockwell company has a pretty noticeable amount of variable compensation, meaning last year, where we were falling short of our expectations, we were paying far less variable compensation. And this year, based on our latest guidance, we'll be paying more for variable compensation. That also is having a pretty noticeable effect year-on-year in our margin expansion.

And then how should we think about the investments and going forward, would that be managed in the realm of sales growth?

Total investment spend there's different places of what we're spending in. First of all, some of our support functions, it's part of our DNA to manage that for productivity. So just year after year, what are we doing productive? Our investment spend that we see is most directly tied to growth, what we're investing in development of new products, what we're investing in accelerating our go-to-market, our sales. Those could -- this year, they're actually -- they're growing -- they're not growing as fast as sales. But the year before, they grew faster than our revenue. And where we see opportunities, those could grow as fast as sales, if not faster, if we have enough productivity. I'll also point out in our supply chain as in the next year or 2, as we hope there will be more predictability on continuity of supply, we think that will also be enabling some productivity enhancements in our manufacturing supply chain itself. It's difficult to run a manufacturing operation when you have to very quickly adjust this planned shipment didn't come in, I now got to regroup this and start assembling this instead. So as it gets more predictable, that will, in addition to revenue benefit, will also help our productivity in our factories.

Got it. Any questions out there. Yes, right here.

Well, [indiscernible].

So again, when we raised our guidance that has almost nothing to do with demand. Yes. So our guidance for revenue is, I'm going to say, is 99% of function of what our view is of what supply chain is going to deliver. And it's largely driven by that starting the year with that just over $5 billion of backlog versus something that's south of $2 billion. So that's -- I'm just trying to explain the raise in our guidance in that regard. In terms of what another [indiscernible] seen. It could be some geographic differences though I'm not sure why I would see a geographic difference there. It's just not something we are seeing.

Go over here?

You've had 1 thing to your business right now that would make it even better, what would it be? .

The 3 things that I listed from an acquisition targeting standpoint, as an example, something that increases our market access in Europe and Asia, that would be something I would do, if I could do it on a cost-effective basis. That would be the one I'd very quickly point out. .

I mean what would that be Kalypso type of thing? Or...

It doesn't have to be. I mean, I think a good example on a smaller basis is the acquisition we did a few months ago of CUBIC in Denmark. It's -- we had some products in space where our biggest share is for things that are designed for the North American market. And we had a similar version designed for the European and Asia market. We just were not seeing as much market penetration as we felt we should be getting by acquiring CUBIC and their capabilities. We felt it was the right product, a better product for us to be going to market with for the standards in Europe, plus it gave us market access in Europe that we just didn't have organically. So that -- I'd call that a small example of what I'm talking about there. .

Can you maybe just talk about your current most up-to-date thoughts on PTC and your relationship there?

PTC, I'm very pleased with the relationship there. And I believe PTC is very pleased, too. We've been an important partner where we've been actively selling part of their portfolio, and that's helped our selling process as well because we have a bigger, more integrated set of solutions that we can go to our customers with. So on a commercial regard, we see that as a positive and are pleased with that relationship. At the same time, we created a commercial agreement a few years ago, we also created an ownership agreement. And at the time we did that, we owned 9% of their outstanding shares. Over the last year to 1.5 years, we have been moving down that stake slightly. I believe we're at the end of the last quarter, we were somewhere between 6% and 7% ownership of their total outstanding shares. We've been liquidating some of that partly to help fund the acquisition we did of Plex as part of our commitment to delever over the next 2 years and get our debt to equity leverage levels back to with a more traditional 2x debt to EBITDA.

Is there some sort of floor to your ownership there? I mean, like Blake wants to stay on for that, I would assume?

There's no floor. But if you read the agreement as long as we own 5% or more, we are entitled to one Board seat of which Blake currently is sitting.

Right. Okay. Any other questions? Great. Nick, thanks a lot. Really appreciate it.

Thank you so much, Steve.