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

All right. Good morning, everyone. I'm Joe O'Dea. Really happy to kick off day 3 with Rockwell Automation and Christian Rothe, CFO and Aijana Zellner, who runs IR and market strategy. Thank you so much for being with us this morning.

Thanks for having us. Good morning.

Good to be here.

Good morning. Day 3, right?

Day 3.

Let's start on the demand side and in terms of what seems like resilience on customer spending patterns despite what we're seeing on elevated uncertainty. And so the question is really why? Why have we seen -- it's not the acceleration that maybe we were hoping for, but it's also not necessarily a deterioration that we might have been fearing. So what you're hearing from customers out there on that resilience?

Yes. Maybe I'll split it up in a couple of different pieces. So the first part is that the product side of the business is, it's coming together nicely, and we are definitely seeing an uptick in the demand side for the product portion of our business. And really, those are some of the fundamentals that you would see maybe at the early point of the cycle, right? It's -- we have labor availability issues, labor cost issues, people continue to try to drive efficiency in their operations, especially in the light of uncertainty. The other portion of it though, that, again, we would hope is going to come together better, but it's not yet is really the capital equipment demand side, the more capital-intensive projects for our customers that uncertainty that I mentioned that is maybe helping a little bit for folks investing, trying to continue to keep their operations running but without larger projects. It's hurting us on larger projects. And so we're seeing that come through in life cycle services portion of our business as well as the configure-to-order portion of our Intelligent Devices business. So that portion, we still got some runway there. We need to see maybe some of that uncertainty fall away.

And just to dig in on that a little bit more and the demand patterns you've seen in life cycle and the configure to order as we started this year, things were getting a little bit better, right? And we saw it within the PMI trends. And so where are you seeing momentum build in some of the more CapEx-intensive heavier-spend areas and then that paused?

Yes. And let's -- just to frame it, when we talk about the demand side, when we're talking about sort of activity, it's really not the bookings side of it. It's really the quotation side of it. That is whether we're doing a budgetary quote for a customer or we're actually getting farther into a project. That activity level was pretty good as we exited last year and came into this year. And frankly, there's still a bunch of it that's in the works. And so when we talk about a delay in customer delays, it's really delaying them from taking a quotation to an actual booking for us. So it's not -- so it's definitely showing up in our orders don't have a mistake about that. But it's really about getting them over the finish line. Now at the same time, those customers and in fact, I just was having a conversation this week with some of our leaders, those customers are not abandoning their projects. They're not canceling the projects. There's obviously some modifications that they're doing. They're working hard. Those customers are working hard to try to make sure that there's a great ROI for them, which is exactly what, frankly, you would expect them to do in this moment of uncertainty.

Yes. And I'll just add that the project delays we saw in Q2, a lot of them were centered around automotive and energy. And energy, the life cycle services being a little bit more invest towards process industries, that's where you see that impact on projects and capital intensive projects.

Got it. And then I wanted to talk about revenue mix a little bit and the MRO side versus brownfield, greenfield side and just what the mix is and then what you've seen in those different sleeves?

Sure.

Want to take that one?

Yes, sure. So historically, we've had about 2/3 of our business driven by CapEx and about a 1/3 of it by MRO, right? And within CapEx historically, it's been a lot of brownfield, the brownfield upgrades, expansions. Now more recently, we're seeing more and more greenfield in terms of the projects going forward. But in general, the majority of our business is driven by these big CapEx projects that historically been brownfield. So that's kind of the breakdown what you see with MRO, as Christian mentioned, that's where we saw some good progress in Q2, good flow. Now there are still projects going on. It's just some of the bigger CapEx projects that are being delayed -- uncertainty. And it really depends on each industry and what's driving the behavior there. Some of it is tariff costs and uncertainty and customers trying to figure out what happens to their global supply chain footprint. Some of it is consumer driven and what's the adoption of certain things? And what's the preference and the macro situation. Some of it is policy, right? If you look at energy and renewables. So some of it is low commodity pricing. And so there are different drivers for spending and they are different drivers for some of the delay and customers triggering that bigger spend, but we still see very good demand for productivity, efficiency, we talked about it. Even these customers that are in the industries are challenged, automotive or energy. They are spending. They're spending on our autonomous mobile robots. They're spending on our software, they're spending on our cybersecurity services. So they're effectively trying to increase their production capacity by increasing their throughput, reducing quality issues and being more efficient.

And on the greenfield side of things, and where you're seeing a little bit of activity there, just in terms of the verticals, I mean, I know you've raised the outlook for things like warehouse and e-commerce, but just where those verticals are that are seeing some of the greenfield activity?

Yes, you're right. So we increased our outlook for several industries in our fiscal Q2. E-commerce and warehouse automation is doing -- is continuing to be a very strong vertical for us. It is a combination of e-commerce as an industry and also warehouse automation as an application across many industries. And we see a combination of greenfield and brownfield investments in that bucket. E-commerce, we do see after a period of digestion in fiscal '24, we see more build out of new fulfillment centers, so it's a greenfield. When you look at warehouse automation broadly and a lot of companies, whether it's parcel companies, whether it's traditional retailers that are trying to upgrade their existing warehouses, modernize them. They want to either catch up with their competitors or leapfrog them, that's a lot of brownfield. There's a lot of -- and there's a lot of core automation we provide there. So our logic controllers, our drives, our software. So we are seeing both of those firing on all cylinders right now. And in addition to that, we see some business with data centers. It's not a big part of our revenue, but we do have some exposure to the power distribution side of the data center business through our acquisition of Cubic and that's growing strong double digits, and we expect that to be a durable demand. So that bucket is a combination of greenfield and brownfield. Life science is another industry where we saw a good performance better than we expected in the quarter, and we increased our outlook for the full year. And that's where we see also a combination of greenfield and brownfield investments. And then there are some parts of process industries where a lot of it is -- it's not necessarily a greenfield investment, but a lot of upgrades, a lot of aging equipment, aging infrastructure that needs to be updated, that you have to have efficiency, you have to have ability to tender more data and security. So we see kind of across the board.

If you take your own spend plans as an example, are there a number of projects that you'd like to move forward on, but given a little bit of uncertainty out there, you're trying to choose the right timing. And so just to get a sense of customers are spending, like you said, but we're trying to think about the wave of spend that could be held back right now and moving forward? And do you kind of have that playbook?

Yes. I mean there's definitely a number of factors when you're looking at projects inside an organization that you look at. And absolutely, there are changing dynamics, the things that are in your control and things that are outside of your control. The things that are outside your control are the frustrating ones. And so yes, there's -- obviously, we have resiliency in our organization. We are using some of that resiliency to try to avoid some of these costs that are coming in. But there's other things that we potentially can make some investment in to try to avoid some of those costs, which is fine. But are you doing it for a temporary purpose or a long-term purpose? And how do you think about it from the perspective of whether or not that's a large investment. And can we really dig deep roots with that? Or are we doing it for a really transitory reason. And so that absolutely goes into the decision-making process. And the honest truth is that if it feels like it's a temporary thing, we go back and we do our work another time through or 3x through or 5x through just to make sure that we are going to get the ROI on our investment and that usually ends up with some modifications to the project. But underlying the whole thing, the notion, the underlying reason why we wanted to do it to begin with. It's not just typically driven by those outside forces. It's driven by something on the inside that we really are driving towards. So whether it be new market growth or going after assisting some of our new product development launches, those kind of things. And so it starts at its core with good strategy. But then again, some of these other factors can be really influential to it which is really where you were going with the question, which is, well, is that happening with your customers? And I think absolutely, that's happening with our customers.

And when you talk about the pent-up nature of demand that's out there and you talk about aging equipment and replacing it, like are they just getting to a point where you can't push it out anymore. Are you experiencing any of that?

Yes, I think that's part of what -- again, what we would do in our own organization, which is, hey, we really were interested in doing this. And maybe we're not going to be in a position where we want to invest millions of dollars because of all these other uncertainty factors. But you do get a little bit hooked on, okay, but this was a great opportunity for us. Are you sure there's not something else we can do -- to turn and so you modify it and either downsize it or you change it in a different way to try to ensure that you can still go after the original objective.

Then shifting to the tariff discussion. Just walk us through kind of the sizing of those costs, how that's developed over the course of the last couple of months in addition to what we're seeing on steel and aluminum in the latest there?

Yes. So the -- at our Q2 call, I would have given an update around what our second half costs were for fiscal '25, that number at that moment in time with the data points that were available at that moment in time was $125 million of headwind, and we were in a position to recover on that from an EPS perspective via supply chain works, workarounds as well as pricing recovery. That since then has changed, obviously, with some of the China tariffs moving around a little bit. So that number went from $125 million down to $70 million, maybe to put it in context around what drives that $70 million. It's about $20 million that is from Canada and Mexico that is non-U.S. MCA compliant. There's a little bit of work that we can do there to try to help that -- some of it is -- it's going to be hard to be able to make it compliant. There's about $20 million that is related to China, both -- going both directions and then $15 million that is related to recently acquired businesses that are different impacts from an organizational perspective, right? Those customers tend to be a little more focused in certain verticals. So we're working through some of those and then $15 million through a variety of other factors, a portion of which is steel and aluminum tariffs. It's still a relatively small number for us. So now your next question is, okay, that $70 million, that was the number that we were given, I don't know, 3, 4 weeks ago. So after the China matters, but before the changes on the steel and aluminum tariff that we recently saw. So again, relatively minor. We're not giving out exactly what that number is, partially because it wasn't just taking that tariff number up, but there were a couple of other subsections in there that requires some -- a little bit more analytics on our side. But again, it's not a huge number for us. It's definitely -- in the grand scheme, even that $70 million, it's relatively immaterial.

And then when we see headline figures like 145% tariffs, we think about what kind of price impact does that mean customers are going to have to absorb, but is also kind of spreading at a -- any perspective on some of the largest price increases that you've had to put in place in response to tariffs?

Yes. So the approach that we're taking on tariffs is that we are when we're recovering with price, we're trying to be fairly surgical in our approach to it. That is we have just under 1,000 product family codes that we use inside the organization for our 300,000-plus SKUs. In -- with various tariffs when we're making changes, we might impact price on 75 to 150 different product families just again, depending on where the product is coming from and all the shipping methods that we're using. And so that is, again, a fairly narrow group and we try to be, again, strategic around what we're doing with regional pricing even. So generally, I would say that most of our price changes related to tariffs have been in the kind of low single digit, mid-single-digit range. There are a few that are higher than that. And the ones that are higher than that are areas where we look things like non-US MCA compliant that have a margin profile that are -- that is not as favorable as some of our base business. So if you have a higher cost, obviously, and it's tariffed, then you have a bigger lift on the price recovery, but those are fairly minimal in the grand scheme of things for us. And I would think of it more like configure-to-order type of product, where it's more project related. And so we can build that in relatively easily.

And anything on rare earth elements in terms of exposure, and it seems like maybe we're seeing a little bit better environment in the latest stuff. But just your exposure there, any supply chain considerations for you?

Yes. I mean rare earths are -- I don't think you're having any industrial at this conference that would tell you that we have no rare earth, right? It's there. We all have it. And so if rare earth never come out of China ever again, then we're all in trouble for a variety of reasons. And so it's probably just as much of a concern for us around our customer base and what it means for our customers than it is for us in our own business. . That being said, our team -- our supply chain team did a pretty good job trying to get ahead of things. And so we've got some buffer there. But again, if we never get any rare earth ever again, we'll have a problem just as will our customers. So there -- it's not a huge portion of the spend, but it can be critical on certain components and products.

And then I wanted to shift to cycle and with the amount of pricing that was required over the last number of years, trying to think about the volume side of the cycle. And so when we look at, let's say, '24 versus 2019 and think about kind of ITD and think about software and control, anywhere from kind of 10% to 17% growth between those 2 segments, if you look over that entire period of time. I would imagine a pretty significant amount of that is price related. And so where are we on the volume side when we think about the cycle? And where are we strong on the volume side and conversely, a little bit softer?

Yes. So maybe I'll start, and Aijana can jump in. First of all, I appreciate talking about over a 5-year window. So often, folks get focused on year-over-year. For me, I'm a big believer in CAGRs. I believe that when you think about evaluating performance for us as an organization, frankly, for salespeople, for distributor partners for all sorts of things. It's really about the multiyear stack, and it's about the CAGRs that you get over a longer period of time, right? Anybody can have an easy comp from the prior year and post a big number. But having a really solid number over a longer period of time, that's really how I tend to think. So I appreciate the way you're thinking about it. So that being said, when you talk about intelligent devices and software and control, I think the math you did was a 10% growth. Again, that's not a CAGR, right? 10% growth for intelligent devices kind of from '19 to '24, '17 was for software and control. And you're absolutely right. Most of that is pricing. And so the end answer is that we are down in volume in both of those businesses compared to 2019. And we did talk about on our Q2 call, that the Logix business and our Logix product category, which is upwards of half of the software and control business, it is still below 2019 levels as well. So when you think about the runway then that we have in those businesses, both of them have a fair bit of runway on the volume side, which is good. Now I think you asked about mix as well in there from...

Let's go to mix. Yes.

Yes. So the mix side on software control has adjusted somewhat over time just because we've done a number of transaction acquisitions that have added more software to our portfolio, which is a good thing. It's given us a little bit better growth rate. That growth rate is part of the reason why you have that 17% versus the 10% for intelligent devices. So software and control is -- has a mix that is, again, a pretty good mix between the software portion and what is Logix and the product side. When you talk about intelligent devices, we've been talking about even this morning around how the capital equipment environment is a more difficult one with the uncertainty that's uncertainty overhang. And so that is impacting the CTO business configure-to-order. And so while the product portion of Intelligent Devices volumes are down from 2019, the configure-to-order portion is even a bigger drag.

That's helpful. If you have a question, just raise your hand and I'll get to you. Let's talk about margins. We'll do it segment by segment. So I ITD, I think you're on pace, like back half of this year, it looks like it would be tracking. We'll do the 5-year thing again a little bit below like '18, '19 level. Talk about, again, like the mix side of things, the acquisitions that have come into the portfolio as well as just the cost burden of an inflationary environment as we think about where you are today on margins versus then?

Probably I could talk about this one for a while. But -- so intelligent devices, you're right. We -- the momentum is good, right? We've got some margin expansion that's happened over the last a couple of quarters, which is great and optimism for the remainder of the year. But even for the full year, we're going to be down on the volume side year-over-year -- sorry, down on sales year-over-year, which obviously is also translating to volume. And so the -- that definitely is a pressure point for us. When you put it against that 2019 time frame, to put it in context, if I were to think about 2025 sales dollars and where we're tracking, you just take some numbers and annualize them, we're going to be ahead of 2019 from a sales dollar perspective. But that gap up is really acquisition-related. So in particular, the ClearPath and Cubic transactions. Both of those are dilutive to margins. And so that would be the biggest driver around what's happening with the margin profile from intelligent devices from kind of that '19 to '24, '25 time frame. To put it a different way, yes, we've gotten price that is essentially offsetting the volume. And so then there's the -- and there's definitely been an inflationary environment. Price cost has not necessarily been the best during that time frame. That's part of the reason why we are in the midst of a margin expansion and cost reduction activity right now. Intelligent Devices being one of the largest beneficiaries of that. There's a good opportunity there. We have a corridor that we're targeting of 22% to 24% segment operating margin for that business. That is a -- that is a 2 and through kind of number. That is -- it's not a ceiling. So when we want to run after it and achieve it and then after we do, we'll talk about the next step.

When you think about that 22% to 24% or software and control 31% to 34%, the path there, any kind of dimensioning of how much of that is self-help? How much of that is volume dependent?

Yes. Definitely, volume dependency is there, right? I don't think we can do it without volume coming back even to the 2019 or better kind of levels. But the self-help program is a good one. And it's today, where we are right now where we've taken a bunch of costs out, and I'm sure we'll probably talk about this in more detail. It started with more SG&A-related expenses. But now we're really digging into things that are more cost of goods sold related. And that really, again, that happens in waves. The first couple of waves have been more focused on logistics costs, direct material costs. But I think as we continue to mature the program, you're going to see us do things more around operational efficiency, which is outstanding.

Shifting to channel inventory and some of the distortions we saw in '23 and '24. And I'm sure it's not a perfect science in terms of sizing. But any perspective as you've evaluated that on what you saw from the magnitude of channel inventory stocking contribution to growth and in particular, in '24, what that contribution was to the organic declines?

Yes. So I think the story actually goes back to '22. And obviously, I wasn't at Rockwell at the time, but I certainly have been studying kind of some of what happened. And I think that's important to know that history. So as we think about forecasting, we think about trying to make sure that we don't have some of these matters happen to us again that we should be really cognizant of how it came together and what levers we would pull, having perfect information in hindsight. And so it really -- it started back in '22 supply chain crisis. Their demand levels had increased dramatically. And so there was already a ramp that was happening then. That was driving a larger backlog. And of course, as we all know, the supply chain crisis happened and things started self-perpetuating, right? And so you can't deliver or lead times go up, people have to order more because they don't want to get stuck, blah, blah, blah. And so that really developed. It started in '22, built late '22 and then developed during the course of '23. And '23 is kind of where we peaked out on our incoming orders. And then started to crater on the incoming orders as we exited '23 and went into '24, but we were shipping off of a heck of a lot of backlog all the way through, frankly, the first 1.5 quarters, maybe 2 quarters of fiscal '24. So there was a lot of backlog reduction that happened even in, let's say, 15, 18 months ago. So the -- and then, of course, then generated the high inventory levels in our channel. And so the high inventory levels in our channel then had to work their way down. That really was the second half let's say, Q2 to Q4 event for fiscal '24. So there was a lot of movement that occurred during that time frame. And this is my really long answer of not giving you an answer. So dimensionalizing is -- I have views around the dimensions around it just because I can see -- I have visibility to what the actual distributor inventory levels were. It was definitely material. And it was -- it really did move things around a fair bit. So -- and we did go back and do some analytic work around, okay, if they hadn't had the overstock, what would demand have actually looked like for us based on what their demand was. The good news is, is that they did not have -- while it may have looked like we went through a serious trough period around a lack of demand. The demand on them actually was relatively good during that time frame.

Well, the good news now is we're largely done with this destocking. And so now we don't have to worry about that buffer, right, that suppressing that underlying demand.

Switching to the software side. I think there's a fair amount of focus on required investments in software and more on competitive positioning. So just talk about your approach to software and in particular, your competitive positioning there?

Do you want to do that?

Sure. We have been investing intentionally with speed and urgency in our software portfolio. We are -- really, we have built out a leading portfolio of scalable and flexible software, both on-prem and cloud native over the years. And in the space where we play in, the space of production design and production automation, we think our portfolio is second to none. And if you look at how we approach it, we look at the customer investment life cycle. So from the design of their systems and plants to operating them and run time and then maintaining them and then upgrading them and throughout the entire life cycle we have a leading portfolio of both on-prem and cloud native software offerings. So we can meet customers where they are. And depending on what their use cases, which plant they're trying to optimize or what they're trying to do, we have leading offerings. So we've invested in R&D. We've developed on the design side, industry first cloud-native design environment, which certainly gives us a leg up in terms of how we develop, how we optimize and also helps us with our generative AI offerings and capabilities as well. We look at operating and maintenance fees, as I mentioned, we bought companies like Plex and Fiix, leading cloud-native companies that actually have these offerings at scale. So that's helping us really penetrate and help customers drive more productivity, even more yield, even across industries that are already pretty automated today. So if you look at acquisitions, this is where we buy these companies in that space. Some of our competition is investing quite a bit in other areas of software from a technology stack standpoint in areas like product life cycle management or computer-aided design or EDA. These are not the areas that we play. And so while it may seem like there's a lot of activity in the software acquisition space, that's not the area that we view as strategic to our growth momentum.

Got it. And I should have asked this earlier, but related to the acquisitions comment when you talk about something like ClearPath and Cubic and you think about the margins getting better. What kind of margin trajectory do they have in front of them for how long might that be a drag on segment margin?

Yes. So ClearPath is an interesting one from -- when we bought that business, we were very clear that, that was a loss-making business when we bought it, and that the target is for it to be breakeven in fiscal '20 -- to be profitable in fiscal '26. And so next year is a big year for them. So I do love moments where you go from a negative earnings number to a positive earnings number because it actually does -- you get a little bit of a double up benefit. So the expectation is that they do go into profitability and they continue to drive their profitability much higher. That's really a revenue gain, right? It's got to be driven by leverage on the P&L because we have a great infrastructure in place. The infrastructure is oversized for the volume of the business that we have today, which is fine because the growth rate is great. It's a double-digit grower. And that's the reason why we bought it, and we believe that it's a great solution for our customers. On the Cubic side, Cubic is a business that because it is capturing a lot of growth opportunities right now. We need to continue to invest more heavily in that business, and that's brick-and-mortar as well as OpEx for the business. And so we're committed to it. We like the runway in that business. And as long as we can continue to drive that growth, I think we're going to be willing to continue to invest. Now a lot of the CapEx investment is mostly behind us. it's really now about trying to get it to be fully optimized. And so that does have an opportunity to bring a better margin profile in the near term than maybe ClearPath does because, again, ClearPath coming from a lower position in that.

And then on acquisitions, you've talked about a pause. How long do you think about a pause being in place?

Obviously, our balance sheet is in a good spot. So it's not necessarily a pause from a capital deployment perspective. It's more of a pause with regard to -- we wanted to make sure that we did a really good job integrating these businesses. And when you think about integrating the businesses, don't think about it like, hey, we've got them on our back office systems. We've got them -- so they're the functional areas are reporting to the right folks and that we've harmonized benefits, all that kind of stuff but those are relatively easy. The opportunity for these businesses is instead to put them into the broader Rockwell portfolio to put it under that umbrella of the assistance for and the expertise around the production environment and bringing this whole host of solutions, the ways to win to those customers. And that's what we're talking about when we're talking about putting the entirety of this together and integrating these businesses. And that's -- it's a great opportunity for us. The team has done a really good job. We've got a little bit more work to do. Now if the right transaction came around today, we'd be looking at it. We've got an active pipeline that we're working this moment, it happened to be timing-wise good for us, we were taking a pause because, frankly, not a lot of deals were getting done over the last 12 months anyways for a lot of other reasons. So that -- the uncertainty in the market also created a lot of uncertainty in the M&A market. So it hasn't really hurt us all that much. But I think we're going to see more and more transactions start to come through just in the broader industrial universe, and Rockwell is open to participating again with the discipline around, we want to be focused on that production environment.

And then you've talked about on the CapEx side and willingness to invest a little bit more and talk about an asset-light model, expand on that a little bit? And then what that would mean from a spend dollar? What it would mean for the percent of COGS that's sourced versus made just in terms of understanding the magnitude of this kind of change?

Sure. So yes, historically, Rockwell has been an asset-light organization. And I'm not saying anything that is a big surprise to folks. If you looked at Rockwell for quite some time, you would notice that their CapEx spend is relatively modest. But on top of that, if you look at our balance sheet, there's a -- we don't have a ton of assets on our balance sheet. So the -- and that's a philosophy that works for a number of organizations. At the same time, we are still at our core, we're an industrial company that manufactures a lot of stuff. And what we do as a business and how we actually sell to our customers is we sell to people that make things in a lot of cases. So there's no reason why we shouldn't also be investing in ourselves to make our things. And so there's a shift inside the organization that's happening right now, where we are looking to be a little bit more asset intensive. And to put that in context, okay, historically, we've been about a 2% sales CapEx spender. Does that number go up to 3%? Potentially. But it's again -- it's really driven by the ROI that we get on those investments. And the opportunities coming out of the cost reduction and margin expansion work that we've done, where we have really gone heavier after our spend, our direct material spend. And that's okay because when you're asset-light, you've got a larger direct material spend because you're actually spending with outside parties that are doing a number of things for you. But the more we look at it, the more we see opportunities to bring things in-house that is, do the buy-to-make analysis and start to do some of those things for ourselves. Essentially, spending some CapEx dollars, maybe a little bit of OpEx dollars, but we're doing it to get a yield by removing other people from our profit pool. And so we want to bring them in, bring those things in and push those other parties out and hopefully use that to expand margins over time. And that's just one aspect of it. Again, asset-light, you're probably not going to invest as much as you would in your facilities. Even though we are an automation company, we have still a pretty good runway on doing more automation, even again, we're more of a light assembly kind of operator today. And those assembly operations continue to be automated, which is great.

Great discussion. Thank you very much for being here. Really appreciate it.

Thank you.

Thank you all. Appreciate it.