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

Thank you, everybody, for joining. I'm very excited today to have Nick Gangestad, CFO of Rockwell with us today. Nick is going to start off by going through some slides, giving a little overview of the business before we get into the fireside.

Great. Thanks, Chris. Good morning, everyone. Thanks for your interest in Rockwell. At Rockwell, we say we are taking manufacturing to a whole new level. And we're doing this at a time where our customers are needing more resiliency, more agility and more sustainability. And we're doing that through the product and service offering that we provide. Our business is made up of almost 50% of it around intelligent devices, those smart devices on the factory floor, being controlled and used and leveraged through the software and control that we provide. And then we provide life cycle services for our customers from the beginning of projects to their completion and then the sustaining of their operations after their automation is in place. In fiscal year '22, we had approximately $7.8 billion of revenue, 61% of that in North America. We take our technologies and our products, and we leverage them across virtually all industries. We often break it down between discrete industries, hybrid industries that use both discrete and process and then process. And we have a good balance of revenue across all of those industries and all 3 of those categorizations we often use. Part of how we go to market in terms of our technology stack, we have a number of products that we have, things like Logix, our PLC controller, those products. We couple that with a digital platform where we have an integrated architecture, integrated communication services. And we continue to expand that in a world that's moving into a hybrid world of the Edge and the Cloud. And part of our approach is also through industry solutions, where we focus on our customers, what outcome they want and then what can we do from providing a combination of hardware, software and services to help them provide get the outcome that they're looking for. In our go-to market, talent is part of what we do. We have been investing in our talent in how we go to market for our customers. That includes investing in software capable sales organization. We've also been acquiring often when we're acquiring, we are acquiring products and technologies. But with that also comes go-to-market capability that we're bringing into our company and making us an even stronger go-to-market organization. And then we've historically had, and we continue to build on a strong set of partners. And we see them as an extension of the talent that we have, technology partners that may be a technology, we don't want to reinvent ourselves. We'll partner with another technology. Machine builders. And 3M has -- or excuse me, Rockwell has a strong set of distributors that we partner with in how we go to market. We have been acquiring -- I show our acquisitions over the last 7 years. We've been acquiring in particular, in 3 spaces: Information Solutions and Connected Services, market access in Asia and Europe and then things that increase our capability around advanced material handling. We're very pleased with the results we're getting from what we've acquired. And one metric that I'll share with you, after we acquire a company and bring it in and measure the growth we are getting from that they are growing at double the pace of the rest of our company. So I'm going to turn it over for the Q&A and just let me summarize that we see ourselves as having even more ways to win. In a short time, some of the focus areas we've laid out, such as software, digital services, cybersecurity, these are places we're growing fast, growing double digits. And we're also a company that's more resilient. Just as we're helping our customers become more resilient. We ourselves are becoming more resilient through our own supply chain agility, through expansion into new industries into industries that are growing even faster. And then changing our revenue mix as more of our revenue is coming from annual recurring revenue. So I'll start -- I'll end where I started with we have the technology, the people and the ecosystem to take manufacturing to a whole new level. Thank you.

Thank you for that, Nick. Maybe starting off kind of high level. Obviously, there's always been secular tailwinds for automation. I mean always kind of outgrowing the global economy. A lot of those secular drivers have accelerated over the past couple of years. And now when we think about demand, sometimes revenue and orders, there's a lot going on in there. I guess my first question to you is when you guys are talking to customers and looking at the market, is demand deteriorating at all?

Chris, I would say we were really not seeing demand deteriorating. And I will agree, there's a lot of noise with supply chain challenges and disruptions in the last couple of years, a growing order book and what our extended lead times have been doing to orders, that's created some very large orders and a growing backlog for us. And we -- at the last earnings call, we said we ended the second quarter with greater than $5.5 billion in our backlog. So there is noise there. But when we strip it down to what we're seeing with our customers, that demand is remaining strong. And there are a number of secular things that are part of that, that we're not blind to what's -- what kinds of risks there are from a cyclical prospective but there is a very strong secular set of activities going on, some of them around the industries themselves places like EV or semiconductor, where there's investment occurring just because of the large shift that's going on in an industry like automotive. Also, the concept of shoring often called reshoring we more, call it shoring of a secular trend of many companies working on their own resiliency and from a supply chain perspective, wanting to have capacity, their manufacturing capacity lining up even better with where their end customers are. That's created some added shoring or investments in manufacturing in North America. And then concepts like a tight labor market and high wages. Part of a secular trend there that's more so than cyclical that causing customers to say, "I need to be investing and upgrading my automation technology to make my own operations more resilient." In a labor market that I think is going to be tight that many of our customers say they think it's going to be tight for years to come.

And then kind of taking that, I guess, what gives you kind of confidence that these secular drivers will remain in place on a multiyear basis? Because if you go back historically, automation always kind of outperformed the cycle, but there was cyclicality. At the end of the day, it's a CapEx investment. What are you guys think that gives you confidence this is not just a demand pull forward in response to supply chain disruption, inflation and in all of the secular tailwinds like, why do you believe it's here to stay?

Some of that, I've already said, Chris, that much of what we're seeing for demand in an industry like automotive is not being driven by normal cyclical factors that we've often seen in the past with automotive. This is a structural change occurring and it's happening over years of the investments that are going on that is not nearly as closely tied in the past to what is expected to happen in the economy. Also a shift in where the world is wanting to be locating semiconductor manufacturing. That's -- and having more dispersion there as that's continuing going on. There is continue to be some cyclicality, but it's a longer-term trend that is occurring. One I didn't mention earlier, energy transition. We still see ourselves in the very early phases of what's happening with energy transition and the way automation is a necessary component to make some of these alternative sources of energy capable. So part of it is these are long-term trends that occurred, not just based on what's happening with the economy this quarter or this year.

Yes. I appreciate that. And then maybe turning to shoring, as you call it, reshoring has been a big topic for us, but I do like the phrase shoring because I think sometimes reshoring is misleading. It's not necessarily that someone is closing a factory in China and opening in the U.S., it's just that the U.S. is attracting more capital -- global capital. It's really quite that simple. Can you just kind of talk about what that means for the company? Why the company does so well in North America? And I think almost everyone I would imagine have seen the numbers of the mega projects, and they're pretty astounding. Any way to kind of think about bring that back to what it means for Rockwell?

Yes. So first of all, in my opening comments I talked about our own makeup of where we sell around the world and 61% of our revenue coming in the United States. So from a market share perspective, North America or the U.S. is where we have noticeably higher market share than the rest of the world. So when this concept of shoring is going on, there is a natural tailwind that it's moving more CapEx and more manufacturing investments into what I would call our home turf. Some of the reasons that that's an advantage to Rockwell. First of all, we have a strong ecosystem set up in North America. With our own sales organization, our distributor network, the partners that we have, that in itself creates some strength and ability to capture a good share of the shoring activity going on. Also, the marketplace. It is -- there is much more -- many more people in the United States that are knowledgeable and familiar with using Rockwell technology that creates some natural advantage as well as manufacturing is coming into North America. And then just from a shoring perspective, some of the places where this is occurring, like, for instance, I mentioned it before, electric vehicles as more of it is coming into North America, it's also coming into a place where Rockwell technologies are especially relevant. So there's a number of factors that is causing us to feel we have an outsized advantage as this is coming in more into the United States and North America.

Yes. I appreciate that and maybe following up on kind of the company's moat. I think every industrial company would love to be more involved in factory automation for obvious reasons. Some have spent a lot of capital trying to do so. But it's proven pretty difficult for new entrants to break in, in a meaningful way. Can you just talk about the moat the company has and why that's the case?

The moat that you're referring to -- some of it is some of the things I was just mentioning, that strong ecosystem. And the fact that the established labor force in the U.S. has a familiarity with Rockwell products, Rockwell Technology. But I'd also go further and say, what we see as a differentiation in the way Rockwell develops its products is we work to have an open architecture and scalable technology, which means that our customers have the ability to take the parts of our portfolio offering that make the most sense for them are the most fit for purpose. But if they have something else from another provider, we've designed it in a way that it works together. And that's a desired trait that creates some differentiation. We've also created our technologies such that it's the same technology that's being used across the industry. So in my opening comments, I talked about process, hybrid and discrete. Rockwell's approach is when we have a PLC controller that's being used, we've designed it that it's the same way to operate across all of those. That's a differentiator that creates simplification for our customers in how they can go about using our technology. And we see that as an important moat today, but we think it's a moat that's going to keep growing because the need and demand for simplifying factory automation, we think is growing. And we think we have the upper hand there.

I appreciate that. So it sounds like demand trends are holding pretty steady. The company's orders the last couple of quarters have been pretty steady. But the company is talking to a decline into the back half of the fiscal -- September fiscal year, I think [ $4.8 billion to $4.2 billion ] has been the communication. It seems like the high majority, if not all of that, is driven by kind of lead time compression. So can you just kind of talk about kind of how you guys come to that number and that guide? And then also, where are we in this kind of like lead time compression innings?

Okay. That's a lot of questions. I got to -- what I'm going to address their yields keep me honest if I'm missing something. First of all, -- in terms of our orders, I'll just lay out like a little longer scenario. If I go back years and years ago, Rockwell would typically have a book-to-bill of about 1 that as orders would come in, there would be some lead time, but it would be in fairly short order, shipping that out. And we would have pre-pandemic; we would have had a backlog at any given time, somewhere between $1.5 billion and $2 billion. That's been our history. Now in the last 2 or 3 years, orders have grown dramatically. Some of it for the secular things going on, some of it because we've had longer and longer lead times because of the -- some of the supply chain constraints plaguing the world. So as an example, in fiscal year '22, we had orders of just over $10 billion against our sales or shipments of $7.8 billion. So we grew our backlog throughout fiscal year '22. In fact, we grew our backlog in the first half of '23. With orders of $4.8 billion and a backlog of just over $5.5 billion at the end of our second quarter. As we're seeing our lead times start to compress, and I'll talk a little more about your second part of your question. We think it's the logical thing for many of our customers to say, "I don't need to order as far in advance as I was in '22 or in the first half of '23. We've had some parts of our portfolio that have gone through lead time compression already in the last 6 to 9 months. And as we look at what happened with order patterns with those parts of our portfolio, we take what we've learned there and apply it to as we expect these lead times to continue to compress, we do see the logical thing that orders are going to come down. And as you said, and I'll reiterate it. The vast majority of what we see of our planned orders in the second half of the year, that compression versus first half is not driven by any change in underlying demand really being driven by that compression in lead times. Now the second part of your question is in regards to where are we on supply chain and lead times. And you asked it in the framework of innings of a baseball game. From terms of recovery of supply chain and our ability to access what we need, when we need it, I'd say we're in the sixth or seventh inning there. We've been seeing improvement. It's getting better. We've been talking for a few quarters now about continual gradual improvement that's happening. But it's not done. We still have constraints we're dealing with every week. And -- but in terms of the ball game, we're getting into the sixth or seventh innings. Now in terms of what that means to our lead times, there is a bit of a lag that from the time we get better access to chips, working its way through our supply chain, starting to work through some of that backlog. That can take 2 or 3 innings if I follow your framework. So from a lead time reduction, I'd say we're 2 or 3 innings earlier maybe in the fourth or fifth inning there.

All right. I appreciate that. And then kind of taking orders and going back to demand, which has been a little bit more disconnected probably than it's ever been before. When we see that $4.2 billion order expectation for the back half. How does that frame up versus demand? Because on one hand, you said last year it was 10. So part of the way, actually demand is better because it got pulled forward last year. Or on the other side, you could say, well, lead times are still elevated. So maybe there's still some of this extra duration ordering.

Yes. We -- if I were to look at the $4.2 billion I think we could argue a good case that actual underlying demand is greater than that. But the truth is, time will tell on this. But I think the superior argument right now is our actual underlying demand is greater than the $4.2 billion.

Yes. There's a lot of investor focus on backlog, not just Rockwell, but really everybody, but you guys have seen probably the biggest increase in the backlog. Can you talk about cancellation rates. The company talked a little bit about the Investor Day about the cleansing policy of the backlog, which got some attention. And also deferments, -- anything there that we should think about?

Yes. First on cancellations. At any given time, we're monitoring of our -- all of our orders, what percentage are being canceled, where a customer comes to us and says, "you know that project I was going to do in this order I had, I don't want it anymore -- something's changed, I don't want it." That typically runs in the low single digits. We -- and that's -- if we go back over years, that percentage has been in the low single digits. And that's where we continue to be now in low single digits of order cancellation rate. At the beginning of the year, we instituted an order cancellation policy where we got -- became more explicit about our terms and what that would mean from a cancellation perspective, where if we're meeting our commitment in terms delivery and in order -- and a customer chooses to cancel that order that there are fees assessed on that, partly because we are making commitments to our suppliers based on the orders coming into us. And we just want to make sure that these are good, well-thought-out orders that are being placed. And so we referred to it in November when we were talking about this as we just see this as really good hygiene -- you went a little further to call it cleansing. I'm not sure I would use the word cleansing to describe it because we didn't really see it as a cleaning up anything from the order book perspective because I don't think there was things to clean up, but we just want to make sure a good hygiene on the part of our customers going forward. We expected that to really have no impact on ordering. And our view is it's not having an order -- an impact. We have -- when we're inquiring, is this having an impact is little to none impact. But our customers are aware of it and they're thinking about it as they're placing their orders. And then the last part of your question was on deferments. And that's another part of our order health that we're looking at is there deferrals going on -- and in the last couple of quarters, we've been talking about our warehousing e-commerce space. That is the one space where we are seeing some requests from our customers for deferments where they'll say, "We have this project, we wanted it done in September. We don't want it done in September now. We want it pushed out to next January. And so we want to take delivery of these things later." That is occurring. We are seeing some increase in deferments in that particular industry.

I appreciate that. You mentioned the hygiene. I used the wrong synonym earlier. The hygiene, you said it's not having an impact on orders. Do you think it's had an impact on cancellation rates? Do you think cancellation rates would have been higher otherwise?

No, we don't think so. We -- our cancellation rates are staying very steady in that low single-digit range. I just really don't think it's having an impact. And we think it's just mainly having an impact of foreseen good thought before an order is being placed.

Yes. A lot of the -- kind of the slides in the prepared remarks, kind of talked about being a solutions provider not just hardware or software, service. Does that -- does the combination of that and also obviously being a U.S. company? Does that help when you guys are going out and trying to win some of the work for these mega projects that we see coming through?

In a couple of ways, Chris, it helps -- first of all, it helps and that it gives us more places to win. And so let me give an example. A few years ago, when we were addressing the semiconductor industry, much of what we would do would be around the environment -- managing the environment in a semiconductor facility. With what we have built out and adding things like cybersecurity, adding independent car technology and continuing to build that out. What we're finding as we go to semiconductor potential opportunity, we feel we have more places to win, where we can even be providing a more complete solution to customer there. And so having these more places to win is one thing. The second thing, and I'm going more to even more point on to your question is -- many times in these investments, there's a degree of desire for simplicity. So in the case of a battery manufacturer or something a new facility going up for EV. The offering that we can provide that creates even more simplicity in that manufacturing process. And sometimes that's -- our hardware is working in conjunction with our software to create more simplicity. And the fact that we have a life cycle services business that can provide that complete solution. That's the way Rockwell wins. And as these big projects come up, we see that is very helpful to our approach in winning more of those big projects.

I appreciate that. When we were kind of doing work on reshoring and looking at the market's best position, one of the first things we looked at is, okay, who has the lowest labor, what end market labor as a percentage of COGS. Auto is always kind of one that stood out there. But I was wondering, are there any end markets where you're seeing like a rate of change on the rate of auto adoption? Maybe 5, 10 years ago, there wasn't a lot of automation just because of the technology was there and now for whatever reason, you're seeing uptake kind of accelerate?

Yes, a few things like -- and auto is one, and I don't want a pigeonhole automation into labor. I mean, often, automation is about I want better quality. I want fewer defects. I want to make sure that this is producing on a consistent basis the way I want. And so places where there's low tolerance to defects or a high cost of quality, that creates an opportunity. And that's why automotive still remains an attractive space where our solutions can help address quality issues as well. Like other industries where we see automation playing a bigger space. So we haven't talked about it yet, but in Life Sciences and Pharmaceuticals and the direction that industry is going to smaller and smaller batches of personalized medicine. That requires a different type of manufacturing process, one that's more agile often much more distributed in where it is and increased need for automation in a space like that. Energy transition. That's an industry that still early on, but that industry is going to continue to need more and more automation to solve some of the challenges that's happening in the creation of alternative energy sources, but even traditional energy sources like oil and gas, the increased need for carbon capture or better management of data. That's exactly where Rockwell comes to play with the technologies we offer, where we are seeing increased need for automation. If I name some specifics -- I'll just say a lot of -- there's also a broad of not so much the labor rate, but just labor availability that can drive a need for I want to have more automation in this facility to make sure I'm agile regardless of what happens with availability of labor force.

Yes. I appreciate that. Maybe turning over to price a little bit. Historically, I wouldn't describe the company as an outsized pricer. If we look at the mid-teens kind of organic growth this year, can you just kind of remind us what percent or what portion of that is coming from price? And then looking forward, has the way the company thinks about price change at all just given the value add of labor productivity and information is arguably higher than it's ever been?

Yes. So first, some facts than more of the philosophy that we have around price. The midpoint of our organic growth guidance this year is 15%. And of that 15%, we estimate that 5 percentage points of that 15% will be coming from price growth over fiscal year '22. And that's on top of I believe, between 2% and 3% price growth in fiscal year '22. If I go back over the history, like if I go back 5, 10 years, we typically averaged about 1% price growth year-over-year. The main reason we were raising prices so much in fiscal year '22 and in '23, was really driven by unprecedented inflation that we were facing with our input cost, with supply chain constraints, semiconductor constraints seeing how much prices were going up there. Our approach was to be pricing to offset what we were seeing from an inflationary standpoint. And through part of fiscal year '22, we were actually behind. While we were raising prices, we weren't raising them enough to keep up with inflation. By the second half of fiscal year '22, and throughout '23, we've made that up and we're ahead on the price cost equation. And we think that will continue that we have the ability to continue to price to offset what we see from input inflation. As we look to the future, we're probably -- we're not anticipating the type of inflation that we've just been through the last 18 months. However, we do continue to see pricing as part of what -- and raising pricing is part of what we'll do. We just don't see them the pricing increases that we have in the coming quarters or years nearly as significant as what we've been doing in the last 18 to 24 months.

And I appreciate that thing maybe kind of go into the cost side of that. How has the bill of materials, so to speak, been trending? Are there any areas where you actually are seeing costs come down? I mean is it more of just of plateauing?

In terms of the bill of materials, electronic components, we are still seeing year-on-year inflation. The one place where we have seen year-on-year costs come down is in logistics -- that -- and that's actually better than what we had planned. We had planned for that to be closer to flat, and that's coming in down some from where we were. The electronic components that I talked about from our bill of materials, that is largely coming in where we expected. We expected some continued inflation throughout '23, and I'd say that's holding true to what we expected.

And then the other kind of side of price cost is just productivity and efficiency, a lot harder for all of us to kind of capture that in the model. But what does that mean to you? It clearly hasn't been the easiest 2 years to be a global manufacturer.

Yes. And Chris, I may disappoint you by not giving you numbers on this, but I'll talk directionally. The last 2 or 3 years, have not been the optimal environment to run a factory for optimal efficiency, meaning -- I mean, they have a really efficient factory. You have very predictable levels of supply coming in, you can staff accordingly, do your production run as efficient as you can out the door, we and others have had to deal in the last couple of years with not always able to count on the supply coming in, maybe for the bill of material 19 of the 20 items made it in. So you're then faced with, well, do I shift and not produce this now and move to something else. Or do I do a partial assembly and then come back and get the 20th item added later on. And so those types of things create inefficiencies in the manufacturing process. So we've been -- that's been part of our results for the last couple of years. As we're seeing better predictability, better availability with our inputs coming in, we expect that time to be turning. Probably not substantially at first, but if I go out another year or 2 years, we think that's going to reverse and we'll be back to really being able to operate our facilities in even more efficient manners that we were used to pre pandemic. So I'd say to try to help you out, it's been part of the headwind we've been facing. In the last couple of years. And in the next couple of years, we're going to start to see it as a tailwind. I'm not sure I count on a lot on that, but it is a directional change we see coming.

I appreciate that. Maybe staying on the topic of margins, but shifting over to services. Life Cycle Services is an area that the company has talked about some margin upside. Can you just talk about the drivers of there and what investors should expect on the margin front there?

Yes. What we've said for our Life Cycle Services business, we expect to exit the year with our profit -- our operating margin in that business getting to over the 10% level at the end of late in the year. And that's actually -- that's a little delayed. If I were to look at the plans we had a year ago, we saw ourselves getting to that level a quarter or 2 earlier. So this is some delay in what -- in our move in that margin. Our first objective is to get this to be a place where it's fairly sustainable in the low double-digit operating earnings margin. And then ultimately, more to, like, I'll say, the mid-teens from a margin. And that's over several years that we see that happening. Some of the drivers that we see happening with there is we've been focusing on productivity in that segment, making the right investments to enable future productivity, having the right pricing on the projects we're doing there as part of what we see continuing to enhance that margin. In particular, our Sensia business, which has been a headwind for that margin, we see that first coming to a point where it's more neutral to the margin and ultimately to a point where it will be accretive to the margin in the Life Cycle Services business.

I appreciate that. Only a minute left, so last one here. And I know it's early days, but I feel like I couldn't -- I think it's a requirement that I have to ask about AI in every fireside chat. So the company -- really the foundation of the businesses you have devices that collect data and then you have software that kind of digitizes and provides it. So again, early days, but what does AI mean to you when you think about Rockwell?

Chris, don't take this the wrong way. Like -- thanks for joining the club. We've been in that club for a long time. We -- if you look at the last several years at Automation Fair, Investor Day as we talk, we've been consistently talking about artificial intelligence, how we're embedding it into our hardware, embedding it into our software to be creating better and better outcomes for our customers. So thanks for catching up to where we are. And yes, we -- it continues to be an exciting opportunity of what this can continue to do for our customers in terms of the solutions and the simplicity of operation that we can be providing. And as you said, we have the hardware creating that data, the software that brings that data together, and we think that's just a really important enabler for where the world is going with artificial intelligence.

Well, I could ask questions all day, but we're up on time. So thank you so much, Nick. We really appreciate you joining us. Thank you to everyone in the room, and thank you to everyone listening in, and have a nice day.