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

All right. Good morning, good afternoon to everyone, depending on where you are. Welcome to day 3 of Oppenheimer's 18th Annual Industrial Growth Conference. I'm Noah Kaye, Managing Director in Oppenheimer's sustainable growth and resource optimization practice. We're very happy to welcome back to the conference the management of Rockwell Automation, welcoming in CFO, Nick Gangestad. Nick, thanks so much for being here today.

Pleasure to be here. Thanks for having me, Noah.

There's a lot of great things I want to dive into today. But before we do that, can you just address the Wall Street Journal article that came out today. I think we just want to understand any issues and question, any steps you're taking in response.

Perfect. Yes, Noah, thanks for the opportunity to talk about that. I'm just going to start out and make it very clear that the security of our products is our top priority, and we have -- we believe we have really strong practices and protocols that go towards protecting the integrity of the software that our company develops. Reading the Wall Street Journal article, there's been no report or other indication that these practices or these protocols have been breached in any of our products or have been intentionally compromised. Even the journal article itself says the documents don't suggest any vulnerability with the code. Nor have we been notified by any U.S. agency of any investigation regarding the company's work in China. And as the journal article stated, there may be no action at all. If there is, we, of course, would fully cooperate. And should we receive any kind of notification -- in fact, following the journal inquiry, we reached out to government officials and offered to provide information or answers to any questions they have. And just a couple of comments about our -- what we do, do in China. We have some software development work that's done in China. It's limited, and it's largely in a small number of mature products that have been on the market for a long time and have gone through multiple years of development and testing. Our view of this is we don't expect this matter to have a material impact on our business in China or globally.

That's helpful context. I mean just the obvious follow-up, since this is largely about software, it seems like this is something that you could move if need be. It doesn't sound like you're saying that today, but it's not manufacturing. It's not heavy infrastructure. So this is something you can address if you have to.

It's something that we can -- could and would be addressed. We recognize that the global threat landscape is evolving. And we work closely with the U.S. government, and we will continue to work closely with the U.S. government to monitor that environment. And if needed, if we need to take action, we, of course, will take that action.

Great. I'd like to dive into some of the orders dynamics. Maybe you can characterize for us the orders pipeline that you're seeing right now for the back half of the year. I think you called out expectations for continued strength in North America, for strength in life sciences. So just what verticals would you expect to pace orders growth? And maybe you can speak specifically to the semi vertical where I know some investors have concerns of a slowdown.

Yes. So overall, I'd just characterize it as we have seen broad strength in orders in that we don't see it as being isolated to 1 or 2 or 3 verticals or industries. It is pretty strong. That said, we do continue to point out, here's some places where we see some particular strength going on. As an example, the EV and the battery support, that's a place where we're continuing to see strength in demand as there are some structural changes going on in the entire automotive, electric vehicle space and then the resulting support needed to support battery, the battery manufacturing. And so that's spurring demand for Rockwell products and solutions. In food and beverage, like one of our biggest industries that we serve, we're seeing movement of -- continued movement of taking brownfield facilities and a desire to make them more efficient, more resilient. And we're also seeing an increased amount of investment around cybersecurity and providing ongoing services and monitoring the infrastructure there. I have highlighted e-commerce as a place where we've been seeing some slowing of activity, and I'd say slowing, meaning still seeing a number of projects that want to be pursued. But in some cases, they're being delayed and just as a more metered pace than what we're seeing in the e-commerce. And then finally, semi. When we look at the semiconductor industry, we see lots of opportunity for a company like Rockwell. We were seeing it, and we continue to see it. We will certainly acknowledge that like some of the leading-edge chips that we're seeing a bit of a slowdown of what's going there. But when we talk with our customers in that industry, that's not expected to be a long-lived phenomenon and that there'll be some recovery in that in '24. So we're enthused about semiconductor. We're also enthused about Rockwell's offering. Whereas traditionally, we've offered, what I'll say, more around the building and facility and environment management and more, what we're doing, we have more solutions that are getting into -- more directly into the manufacturing process, things like independent cart being used for wafer transport. Also, more opportunities around cybersecurity, and we're seeing that in some of our greenfield spaces that are being invested in. So that's, Noah, a view of what we're seeing in a number of verticals right now.

That's a great roundup, Nick. On the price side, it's been very strong, right, 8 points organic growth, 1Q; continued mid-single digits here in the last quarter. I think you improved your view of price/cost dynamics for the year. And at the same time, I think we've seen many of the commodity and freight costs that were really pressuring margins last year start to come down. So talk to us about opportunities to sustain price gains and positive price/cost as costs start to abate.

So yes, just -- I want to get some figures out that we're all talking off the same page. So in the first quarter, we had 7 points of growth from price. Second quarter, we had 6 points of price growth. And we upped our guide to for the full year, we expect approximately 5 points of price growth year-over-year. And just to be clear, Noah, that change in price from the first half to the second half really has nothing to do with any kind of deceleration in our pricing growth from first half to second half. It's all about the comps that we were going against in the 2 halves of '22 that we had little price growth in the first half of '22 and then it was ramping up. And we continue to see that price ramping up. Partly from the 5 price increases that we've put in place over the last 18, 20 months. We continue to see that price working its way through our backlog into the shipments we're doing. And that's why we see that with a high degree of confidence, the amount of price growth that we're going to see through '23 into the early parts of 24%. On the input cost side, we started the year expecting input costs to come up, and I'm going to break it down into 2 pieces. We had an expectation that broker for -- not broker for -- semiconductor chips, we'd be seeing some modest increases in what we're paying for semiconductor chips. I would call that playing out very much as we expected. On the logistics front, we also had a plan that, that would go up modestly. And that's turning out much better. We're seeing quite the reverse where we're seeing logistics costs come down. And this slightly better on price plus logistics costs coming down is what's leading us to now say we see the combination of price/input costs being 200 basis points or more accretive to margin year-on-year. Now to the last part of your question about price increases going forward, we do expect continued price increases. We just expect in a lower inflationary period time that our price increases are going to be more modest than what we've had in the last 1.5 years. So -- but we continue to remain confident we'll stay positive on price/cost for several or many quarters to come.

That all makes sense. I want to follow up with that and talk about pricing and price support more conceptually, which is when we look at those pressures that you've called out, remaining tight -- labor shortages, wage inflation, some high-value components and tight supply, those have persisted. And when we think about how that improves your value proposition as an automation provider for customers, that should improve your value proposition. So can you talk about the opportunity to move more towards value-based pricing? I know there are parts of the business that are more competitive in that respect than others. Just how do we think about that?

Yes. Noah, I'd put on the table that largely, we do think about what we do as value-based pricing, that Rockwell, traditionally, is providing some premium value to our customers, and that's resulted in some of the premium price that we're able to enjoy in the market. That said, for the last 1.5 years or so, there's been much more attention in the pricing market driven by inflation. And I will agree that tends to mimic more what you'd expect in a cost-plus type environment where we're seeing costs come up and we're passing that on to our customers through added pricing. But I don't think it actually changes the overall dynamic that we see what we're providing to our customers, providing more value -- high value, premium value to our customers. And the last piece of that dynamic that I'd say, Noah, is -- you alluded to it. It's a competitive environment. We see -- we want to -- while we want to price fairly, we also want to be in a position where we have opportunities to continue to grow our share. And we see those opportunities and we will take advantage of price as an opportunity to grow share. So the value creation that we think we are creating for our customers, we are fairly capturing that in our pricing.

That's helpful. You talked about expectations around cost of components and how that's played out. Can you speak to just the dynamics you saw during the quarter in terms of improved component flow and your visibility into further improvement? I think when we look at the sequential growth implied in guidance, that suggests gradual improvement over the next few quarters. But it does seem like what we saw in the second quarter was more significant.

Yes, yes, yes. That's -- we are seeing improvement. But, Noah, I'm just going to frame it up a little differently. So when we think of what's happening with supply chain and availability of components, there's a couple of different dimensions to think about. One is what's the improvement we're seeing in the amount of chips that our semiconductor suppliers are able to provide to us. And we're seeing improvement in what they're able to promise that they can deliver to us. We're seeing that improve. We're also, importantly, seeing improvements in the reliability of that where if you and I were talking about this a year ago, we would have been very clear of like the reliability is pretty low that we can get calls that say, "Oh, we know you are counting on this many chips coming next week or next month. We can't do it. Something happened, and you're not going to." We still get those calls, but they're just not as frequent as what we were getting a year ago. So by no means am I saying all clear, everything is fine. But we are seeing improvement both in the quantities that are being promised to us and in the say-do ratio, the percentage that are actually delivering to what they said they would do. We do continue to manage it, I'll say, conservatively, that we plan for a certain level of unexpected negative surprises to come. We do that to make sure that we're managing prudently. We're going to continue to do that. And still we see a high degree of certainty in a, I'll say, pre-pandemic level of confidence that what suppliers say they're able to do it, they're actually able to do. So we are seeing that, but I'd say we're also trying to be conservative in how we manage that upward plan.

That's helpful. I think to follow up, the linearity of what you've seen, how has that improved? I mean I don't want to oversimplify it and suggest that suppliers were dumping a bunch of components on a loading dock at the end of a quarter. But just talk to us about how the linearity has improved and how that might translate to better production efficiency.

Yes. So in the case -- if you look at it in aggregate, I would just -- the way we've been talking about, I think, applies. It's gradual improvement. This quarter, we'll see some improvements over the prior quarter in what is able to be provided, and we expect some improvement in the reliability of what will be delivered. As that reliability gets better, we think that will create opportunities to improve our own productivity and efficiency because, Noah, part of the challenge in a world where you can't always count on these products coming in on time, you can be staffing up a shift, ready to start to make this and then find out, oh, these products aren't going to be here and then you've got to redirect it to something else. And that's not the optimal efficiency model to follow. But in some cases, we possibly are -- we are assembling things where we're largely assembling it, but it still needs that 1 or 2 last components. Again, that's not an optimal way to optimize manufacturing productivity. So in the coming quarters, as that gets better and better, it will improve our ability to be getting more products out the door, but it will also be able to help us in our efficiency and productivity in what we manufacture.

And any way to frame for us how far we are off optimal absorption and where that's been? This all makes sense. Just from a numbers perspective.

Yes. in terms of productivity of what we're doing, we're still not at the kind of productivity we had pre-pandemic. I would call '23 has been a stabilization from a productivity standpoint from what we saw in '22 and some modest improvement. But I think more of that productivity improvement is going to come in '24 and '25.

Terrific. The improved flow-through on organic growth you saw during the second quarter, you called that out as enabling the company to up the investment spend for the year. Just give us some color on the types of investments that you are able to spend on now that you're accelerating. And how does that help maybe accelerate some of your growth opportunities or your revenue capacity?