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

Good afternoon. Welcome to the second day of BofA Global Industrials Conference. I'm Andrew Obin, BofA's multi-industrial analyst based in New York, so I cover U.S. multi-industrials. And we're here for the fireside chat with Blake Moret, Chairman and CEO of Rockwell Automation. Blake, welcome to New York. Thank you so much for coming here. And I think Blake has some prepared remarks, and then we'll go to the fireside chat. Thank you.

Thank you. Well, good afternoon, everybody. It's great to be in London, and I am looking forward to spending a little bit of time talking about Rockwell Automation. I'll give you a bit of a baseline of the company, what we're about, what we've said recently about the business environment. And then I'm going to give some more specific information on current business conditions. And then Andrew and I are going to chat about questions and things that you might have on your mind. To start with, Rockwell, $9 billion in sales, worldwide company. And specifically, there is not a company that is a more common supplier of smart manufacturing technology in American industry, which I think is particularly interesting and important at this phase. We're a pure-play company. All we do is industrial automation and digital transformation. We do it across multiple high-growth verticals. So we have great existing market access today in discrete industries, hybrid industries like food and beverage and pharmaceuticals and in pure process industries like energy and mining and chemical. We've done a lot of work in the last half dozen years to build up our software capabilities. And today, I'm very proud to say that despite some headwinds thrown at us like a pandemic and supply chain shortages, we have a second-to-none portfolio for software solutions on-prem, at the edge and in the cloud for production processes for manufacturing, for energy, for material handling. And we continue to work hard on integrating these pieces together with our hardware and in solutions for manufacturers across these industries. I should also say that we continue to enjoy double-digit annual recurring revenue growth. We talk about 15% growth, and that's a good number for ARR, which is expected to be over 9% of our business this year. So it's a nice development over a relatively short period of time to develop this profitable recurring stream of revenue. At our Investor Day in November in Boston of this year, we were happy to be able to take a moment of satisfaction on reaching some important goals that we had set forth in 2019, just a couple of months before COVID became a household word. We said we were going to accelerate profitable growth. We said we were going to grow faster in our core. We were going to have double-digit growth in areas of new value like Information Solutions & Connected Services. We were going to add a point or more of acquisitions a year to move faster, and we were going to do it within a profitable framework. And I'm happy to say that we accomplished that. At the same time, we introduced a new framework for growth. And we said we're going to continue to grow at a faster pace than we have before, 6% to 9% total growth, 5% to 8% organic growth that takes advantage of faster growth in the underlying market, share gains and increased served market through acquisition of technologies like mobile robots, growth from annual recurring revenue and continued growth from acquisitions. And really importantly, we accompanied that with some specific targets for margin growth in our business segments. These are our 3 business segments. And we said while we've hit some of these margins before in these businesses, we're going to tune the business so that we can do it with, let's say, normal growth rates through the cycle and not relying on special swings and things like incentive comp or spend or supercharged growth like we saw at different points last year. And we're well along in the processes of adding capabilities to drive that cost and efficiency out. I think it's the perfect time in our journey to take that faster growth that we've seen. And as we get past inefficiencies and the messiness, if you will, of supply chain challenges to add the expanded margins by focusing on product cost, manufacturing efficiencies, continued gains from price and looking at our SG&A. So we have a lot of opportunity there, and I'm happy to say that we're well along with full support across the business of achieving these goals. Resilience is an obvious part of this, resilience against external events. It's also resilience against swings affecting our business, and there's an operational component to that. There's also the markets that we choose to compete with. And one point that I think is especially important in this business for profitable growth is simplification, internal simplification to drive efficiencies and margin, external simplification to make us the easiest to work with, to have technology that integrates together with less complexity. We've always been known for that feature of our technology, and we have every intention of extending that, especially with our increasing capabilities in software to be able to knit these solutions together. So in summary, you should take away the clear message that over the next year or 2, our focus is going to be on putting the pieces together. We've been very busy in assembling a portfolio that's second to none between hardware, software and services. And we intend to continue the above-market growth that we've seen, but also to add the margin expansion that you expect and the efficiency by doing less in the way of acquisitions. We've already got 1.5 points of growth for this year from acquisitions that we've already done. And while there might be some minor activity in that place, I think the opportunity to take what we have to get the synergies, both in terms of revenue and cost and to be able to expand margins, increase ROIC are things that hopefully you'll welcome. And I know the organization has a lot of appetite for bringing it all together into the most integrated offering in the market today. Given the market volatility over the last few years and our commitment for additional visibility, I want to give some comments about our second quarter as well. First of all, our second quarter is tracking as expected in terms of sales and margin. We're seeing a high percentage of book-to-bill conversion in the quarter. And we talked about last quarter the importance of building safety stock, and I'm happy to say that, that's going quite well. We're also on track for flat sequential spend in the quarter as we talked about in the last couple of public events. Also importantly, our recent acquisitions are performing very well, both in terms of top line and on margins. So we've been very happy with some of the recent acquisitions, including Clearpath Robotics and Verve cybersecurity. And the productivity projects that we started at the end of last year when we recognized that this was going to be a year of lower growth are well underway, and we're seeing the benefits of those. Second quarter orders are growing double digits sequentially. However, the order growth is taking longer to accelerate than we originally expected when we put forth guidance at the beginning of the year. And specifically, it's the machine builder inventory normalization that you've heard about that's taking a little bit longer. We hear from these machine builders that there's strong underlying demand and good activity with their end users, but that inventory of product that's built up when it was hard to get those products is causing their orders to be delayed in terms of picking up. And we do look at this as more of a timing issue than a softening in terms of underlying demand. From where we stand today and assuming that the pace of orders continues on its normal trajectory, we would expect our financial results for the full year to track around the low end of our current guidance from both the sales and an EPS standpoint. We're watching the orders closely. We're not done with the current quarter, and we certainly have March and April before our earnings release. But we're looking at that and we're not updating guidance today, but we would expect to update during our earnings call in early May. We remain confident in our ability to continue to grow share. The market conditions and underlying demand are good and particularly with our very strong position in North America, where so much of the investment is taking place. We look at opportunities ahead as very strong with the fundamental drivers of demand intact. We're seeing good execution and cost control across our businesses. And we'll continue to control costs, including incentive compensation, in line with the expected orders and revenue levels. And we also remain confident of our ability to achieve the productivity that's necessary to reach the long-term margin goals that I talked about just a couple of minutes ago. And we'll continue to give updates of that with high visibility in the quarters ahead. So with that, I'm happy to take questions.

Can you just remind us because I think there has been confusion about the second quarter because you made some statements before about the second quarter. Can you just remind us, how does the -- I think you've actually referenced what it looks like versus the first quarter. Could you just remind us explicitly what you've said before, just to repeat it?

Sure. We gave explicit guidance in our first quarter earnings call that second quarter was going to look like the first quarter in terms of revenue as well as margin. And then in the conferences that were public last month, we gave further detail of what the buildup of the growth by business segment and the margins were to support that.

Right. And is it fair that I assume that EPS in the second quarter, just everything else being equal, should be very similar to the first quarter?

Yes. We said it's fine. We said that the development of the revenue as we got past the shipment challenges at the beginning of the fiscal year [ are well ] in hand and the cost control yields margins and EPS that are coming out like we expected.

Excellent. So yes, so maybe we can just talk about because you sort of started talking about near-term business terms and clearly, orders, you gave us -- you've given us some color here. Can we just talk about backlog normalization, how you look at that? I think our framework for Rockwell backlog coverage is that while it's clear it won't stay in the 60% peak range from '22, won't go back down to historical levels of 20%. So how should we think about just backlog coverage over the long term?

Sure. So we talked about exiting this year with backlog of around 35% of full year sales. We expect before the end of the year that we're back in a situation where you don't really care too much about backlog in terms of products because we're back to a pre-pandemic kind of paradigm of orders coming in and getting shipped out with very quick lead times. So that orders and shipment numbers in a given quarter for our products, which is the largest part of our business, are about the same. Now the overall backlog number in terms of dollars will be higher, and that percentage is higher because we've got new offerings. So we've added Clearpath, which is more of a configure-to-order business. Our engineered lineups are seeing good growth. And so the mix is changing a little bit there. But in terms of this unusual situation where we were talking about product backlog and do we have the chips to ship out, I think the industry is back to normal where we're going to see normal behavior as we execute with a high conversion of incoming orders for products in the quarter turning into shipments. So about 35% backlog as a percentage of full year shipments is what we're thinking at the end of the year.

And should we think that, that's sort of the new normal?

I think that's in the ballpark. I think that's relatively accurate going forward.

And then you just sort of talked about machine builders. I was wondering if you could provide a little bit more clarity. I think one of your competitors has highlighted weakness in China. I believe China is 5%, 6% for you, so quite a bit smaller. But maybe if you could give visibility as to sort of geography, maybe sort of industry vertical where you are experiencing this slower order activity versus expectations?

Sure. I'll take it in order. So machine builders were the companies that were most affected by the supply chain shortages that we saw in fiscal year '22 and '23. They can't ship their machines, they can't get revenue, they can't get cash flow without having the complete set of equipment, including our controls on their machines to ship out to their customers. And so they ordered unusually high amounts to make sure that they could get whatever was available and also to provide the number of months of coverage of their machines that they had orders for when lead times had gone out much further. So it's something that we and others have talked a lot about. They have more of that equipment on hand than they need to prompt new orders at this point as they work through their backlog of machinery. And so that is what's causing their orders in terms of machine builders, both that buy their product through distributors as well as that buy it direct to be slower to recover to normalize their inventory. And that's really the single biggest issue in terms of classes of customer that's caused the pace of that acceleration to be delayed. In terms of geographically, you said it. China is about 6% of our revenue. So we're less exposed than our competitors in that respect. And China has a basic supply-and-demand issue. They have too much supply, whether it's the value of the produced goods with so much capacity. They're seeing deflation in the price they're getting for those goods. They're seeing real estate overbuilt. They're seeing unemployment with too much labor supply. So they need more demand. And I think that's going to be a problem for China and businesses in China for some period of time. The strongest area of demand geographically is North America, and so we're happy about that. We have by far the largest market share. We have the deepest relationships. There's a lot of investment going on in North America. And while we're still in early innings for the so-called mega projects and projects that might have been catalyzed by stimulus money, we're already seeing results of that. And we're very confident that we can continue to win that business at high levels of share.

Got you. And just hopefully, John [indiscernible] over the next question, but I'll try. I'll try. If we think about the path of earnings through 2024, right? So is the idea that we are back on track by Q4? Or should we just sort of -- because you sort of said Q2 is on track. There are 2 quarters. How should we sort of assign the shortfall? Is it all third quarter? Or is it sort of evenly split between third quarter and fourth quarter?

Yes. The underlying assumption in the comments that I just made were that assuming orders continue on their current trajectory. So as I said, we're seeing double-digit sequential orders growth in Q2. That's a good thing. We haven't seen the acceleration in that sequential growth yet. And so we're not counting on it. And so we're looking at constant sequential growth in the remaining quarters, and that what forms our view currently. We still have March to go. We still have April to go before we issue our earnings call in early May. But that's what we're seeing, and that's the underlying assumption.

So basically, a less steep ramp into the fourth quarter, so maybe a lower exit rate for the year than we were thinking before.

I wouldn't necessarily say that because I think the compounding of double-digit sequential growth in 2 more quarters is strong. So yes.

Okay. Excellent. So -- and just with your customer base. So you talked about machine builders. What are you seeing? What's your visibility? Because I think visibility is the key for the entire industry. What's your visibility into the rest of your distribution? And maybe you can give us some insight as to what your distribution model looks like. And what gives you confidence that you have visibility into the rest of your channel?

Yes. We have an unequaled distribution channel in -- particularly in North America, where we have such a level of collaboration that we do have full visibility into the inventory levels at our distributors. So we understand where they are today, what's in that inventory, how much of that is committed, how much of that is available for new orders and what the characterization by SKU is of that. We also have good levels of visibility into inventory levels at the machine builders that we work directly with because these are big companies. We're an integral part of their business, and so there's a lot of collaboration there. So we understand the trajectory of that inventory usage and work closely with them to manage it so that not only they're getting the right levels of working capital and free cash flow, but they're also making sure that particularly on the heels of supply chain shortages that they're able to provide a very high degree of customer service by making sure that there's enough inventory on hand in many cases, at higher levels than pre-pandemic in terms of number of turns of inventory of these products that we just got into a healthy situation with.

Excellent. So maybe we can just talk about just [ grow ] through the cycle. It does sound you remain optimistic about the overall shape of the cycle. It's just a question of when, not if. So where are we in that cycle? What are those conversations like? And how should we think about the timing of your orders relative to the overall timeline of the project?

Yes. So as I said, in terms of the specific large projects, I think we're still early innings. We see orders. We saw orders last year. We see more orders this year. We see considerably more orders next year resulting from these mega projects. And we've talked publicly about some of the examples, where we've already monetized that. But I think even more broadly than that, in our growth algorithm, we talk about 3% to 5% growth of the automation market. And so things like workforce scarcity are affecting all manufacturers, not just in EV and pharmaceutical and energy and semiconductor, but it's hard to find workers in manufacturing who can work the line, who have comfort working with the technical equipment. And that's not just a U.S. thing, that's around the world. And so that's going to spur additional automation. I can think of specific conversations that are yielding orders to Rockwell worth multiple tens of millions of dollars, where large multinational companies are making sure that they're going to complement scarce resources with the technology so that they can have those resources, that labor go as far as possible aided by that technology, in 2 different industries just in the last few weeks. So I think those are positive reads for the general trends ahead in -- that favor automation and favor a company like Rockwell.

Can we just sort of -- some of the pushback I get was Rockwell and reshoring is that, well, for example, semi fabs, like we don't think about semi fabs as biggest area of strength about Rockwell or a lot of the machines that are coming over, they will come from Europe. So clearly, will be dominated by the European control guys. So as -- at the same time, it does seem that U.S. is sort of the fastest-growing industrial market in the world right now. And you have a very strong position, a very strong ecosystem in the U.S. So how does this market share in these areas is playing out right now? And what do you see happening over the next several years? What does this shift, right? Clearly, when China was the fastest-growing area, that was a disadvantage for you, right? Others did better. Now that your home market is the fastest-growing area in the world, what does it do to your market share and your ability to work with machine builders that you would not necessarily have worked in the past?

Yes. Well, we think that we're gaining market share both in the U.S. and worldwide. Starting with your specific question about semiconductor, we continue to add capabilities to get a greater share of wallet in semiconductor. So it's true that it's not our largest industry, that we have relatively lower share, but with new capabilities that we've added over the last few years, that represents large capabilities going forward. Multimillion-dollar orders that we have already seen with independent Cart Technology for wafer transport, facilities management and control systems that we were doing in Asia for a long time, but now that fabs are being built here, we're doing here as well. Cybersecurity services that we didn't have 7 years ago that we're providing now, panel fabrication services for some of the largest tooling suppliers in the world going forward. So there's an opportunity for significant growth there. To your general question about machine builders coming in, that's not a new play that our European competitors seek to ride in on their friends in Europe to the U.S. And while it represents continuing strong competition, I don't take any of them lightly. We have far larger support. We have far larger market share, the best channel, the deepest relationships and by far, the largest installed base that these companies are familiar with. So I like the hand that we have.

Excellent. And maybe just supply chain for you, right? So -- and I know you and I had this debate, and I had this debate with your team, but during COVID, many companies increased the complexity of their supply chains in order to deliver to the customer. So can you just describe where are you in terms of normalizing the supply chain? Because I remember there were these -- we did these calls with distributors, and you couldn't get a full round of the necessary chips so you would go to alternative supplier or the supplier that you used to rely on proof to be not as reliable as you would have thought, so you would have to go somebody more resilient. Can you just talk about the changes you've made to make your supply chain more resilient? And how do you normalize things now that you've made so much progress in normalizing your lead times?

Sure. So I don't think that we necessarily need to accept increased complexity in our supply chain going forward. But there was a lot of additional work during the heart of the semiconductor shortages. And for all the reasons you said, we had in some cases, switched suppliers. We had to design new chips or redundant bills of material in. We implemented a design for resiliency index for all new and existing products. And there was a certain overhead of cost and effort that went into that. It got us through the crisis. But I'll tell you, we intend to continue that swing, continue that arc of work to make sure that we're resilient forever more against those sorts of issues. And that involves making sure that we design our products, first and foremost, for resiliency, that we're working with the semiconductor suppliers for which we're an important customer and the road map that's important to them is the road map of technology that's important to us, personal relationships with my peers at those companies to make sure that we have a governance model that is escalated before there's a crisis, long-term supply agreements to get preferred or guaranteed supply for these chips. We've done all these things. And while I think there's an inventory, in some cases, for chips that aren't easily engineered out of the solution, that's a piece of it as well, all of these things are going to add a little bit more cost and effort to our systems. But as we saw over the last couple of years, that extra effort and that extra resiliency is worth it. And the team has embraced it, and we drive it into just regular standard operating procedure so that it's not an obstacle for doing new things and a continued source of inefficiency.

So maybe we can shift to your digital strategy because I think you have a slide outlining all your acquisitions on the software side, and I'm not sure the market appreciates just how much heavy lifting has been done in building your digital capabilities. So how do you think about growing your digital capabilities internally versus externally? And what would you describe as your biggest digital strength right now? And what are your priorities going forward?

Sure. So yes, there's a timeline that shows the acquisitions that we've made with some common themes in them over the last 6 or 7 years. When I got into this role about 8 years ago, I knew we needed to move faster in certain areas such as building software capability, high-value services such as cybersecurity services, consulting services that can help customers build digital twins, a certain more assertive posture in regions where we didn't have as high share. And I'm very happy that despite the headwinds of COVID and supply chain shortages, we were able to build those capabilities. Every one of those is a good fit with the strategic priorities that we set forth. And we're seeing good progress, varying levels of progress, but good progress in total in terms of profitability and meeting the targets that were a fundamental part of the criteria as well. Over the next couple of years, we're going to take time to get the benefits from all these acquisitions by driving the inefficiencies out, by slowing down the pace of acquisition so we're not adding new integration costs for new activities because it's a lot of work to do these and to make sure that we get the efficiencies, both in terms of technical integration for customers, cost synergies to be able to help with the commitment to expand margins. And so that's what we're going to see. And it's not as fancy and the headlines aren't as great as when we buy something new, but it's a fundamental part of the process now to bring the organization together to integrate these new solutions and also to make sure that our team and the ecosystem is fully aware of the benefits of these pieces together. What are the things that we're proud of? Where is there plenty of work to be done? Clearpath Robotics is just a star. That's a recent one, so I'll mention that first. And the mobile robots have captured the imagination of customers who might have been long-time users of our fixed automation, our control, but see the opportunity to take mobile automation, combine it together by using common technology platform by taking the data that's a natural byproduct of those things, bringing it up to the information sources. It's one of the reasons that NVIDIA was so excited about the collaboration. We've been working with them for a while, but working with them on the mobile robots to be able to infuse their capabilities and put that information into Omniverse is something that we're all very excited about. I'll give another example of technology that we talked a little bit about at Investor Day. We're coming up -- we have introduced and we're adding functionality to a cloud-native programming tool for Logix. Cloud native, it's going to be an industry first. And later this year, we're going to have a gen AI front end on that tool to be able to provide ChatGPT-style queries to be able to bring the programming out of this arcane language of custom ladder logic and function blocks that have characterized our industry for a long time, but to be able to use natural language prompts to be able to develop code for our flagship programmable controllers, Logix family. That's this year. That's happening now through a great partnership with Microsoft. And so those are some very exciting activities, I think, that really characterize what we're doing on our own and with a very strong ecosystem.

Can we just talk about the NVIDIA announcement because I think -- I don't think people think of Rockwell connected to AI. But what is the nature? Because they clearly have highlighted you yesterday as one of their key partners. I think there was a press release. So what is the nature of your relationship with NVIDIA? And what does this mean going forward?

We've been quietly incorporating artificial intelligence and machine learning in a lot of our products for a long time at the device level, at the controller level, in our software like Plex and Fiix. With NVIDIA, we're connecting our Emulate3D simulation software to their Omniverse Cloud. Emulate3D is just an awesome software package that can take the actual code that's being used to program processes in a wide variety of factories and simulate the throughput and then to be able to optimize that to be able to reduce commissioning time, which is a huge issue in manufacturing, being able to do it virtually without having everybody from all the different suppliers having to stand shoulder to shoulder physically on the plant floor. You can bring that commissioning point to the left, so to speak, and debottleneck by being able to simulate the throughput, identify the bottlenecks and come up with alternate workflows. That's a use case that is providing tremendous value. And we're not just talking about it. We're doing it. We have customers that are using that today to be more productive and more competitive in their own right.

So is it fair to describe the relationship as both integrated your offering with what NVIDIA has, you are a user of NVIDIA products, but also you are a supplier to NVIDIA as well?

Yes. I think it's -- I think at this point, it's really identifying the use cases that our IP collectively can add value to. And mobile robots was the specific subject of that announcement, but we've been working with NVIDIA for a while. And we expect this to be the first of many specific use cases that we identify to work on with them.

Got you. Maybe just talk a little bit about EVs. What activity have you been seeing in this area? I think the market is concerned about maybe a slowdown in EV activity. If you actually look at the announcements, it's not as simple. What are you seeing?

Well, so specifically in the U.S., EVs will go from around 7% of the market in terms of vehicles on the road to around 10% this year. And we've seen great success with some of the early capacity builds with EV and battery. But if a company decides they're going to invest in hybrid because that's what's being invested -- that's what consumers are buying, that's great as well. We do hybrid just fine. A lot of the processes are very similar, and we have a long list of installed base at hybrid vehicle plants. Same with internal combustion engines. There's a lot of people who love their Ford F-150s, and we're going to continue to do a great job of providing technology for those gasoline-powered vehicles as well. So I think transportation, it's only 10% of our business. I say only, that's down from historic levels from decades ago. But it's important, it's growing. And we see the EV space within that as an attractive way for us to grow share because those applications are particularly attractive to us in terms of the specifics of the application.

And how should we think about your positioning on EVs relative to internal combustion vehicles? And what was your historical position on drivetrain with internal combustion?

Yes. So a lot of the processes are similar in terms of stamping and body paint, assembly, trim, chassis, final inspection, different processes in vehicles. I think we've always had a strong position there. In powertrain, the powertrain within internal combustion engines, that's largely a CNC specific application. You're boring cylinders. You're finishing metal surfaces. And that wasn't a great application for us because we're not in the CNC business. The process of creating propulsion for electric vehicles is much more of an assembly application, where we have a much higher readiness to serve with technology like our independent Cart Technology, where we've seen millions and millions of dollars of success involved in battery assembly, for instance.

And I guess the last question, maybe looking a little bit in the future. What are your thoughts about software-defined automation, right? It's a hot topic. I suspect you're spending quite a bit more of your time internally thinking about it. What are your latest thoughts about the evolution of software-defined automation?

Well, a lot of the differentiation is going to come from software going forward. That's why we work so hard to build a great capability in software. And a couple of very specific examples of that are our FactoryTalk Design Studio, the cloud-native programming application for Logix that's already been released. But then putting more of this differentiation of Logix into the software run time so that it can run on other hardware. So today, Logix is sold through bespoke hardware, but giving customers the optionality of running Logix on other industrial PCs and so on is something that we're well underway with. We showed it at Automation Fair in November, and it's a funded part of our road map over the next year or 2.

I think we're right on time. And thank you so much. I think with that, we're going to wrap up. Thanks so much for being here.

Thanks, Andrew.

Thank you.