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

Great. Well, thanks, everyone, for being here. It's my pleasure to have up next, Rockwell Automation. We've got Blake Moret, Chairman and CEO; and also as Matheus Bulho, SVP of the Software & Control segment. So obviously, a very topical point of discussion around software right now. So I appreciate you both being here. And Blake, I think you had a couple of prepared remarks for us.

Yes. Great. Thanks, Julian. So I know a lot of you have followed the name for a long time. I appreciate the interest this morning. I wanted to make a couple of comments to kind of frame the questions and answers. So to start with, Rockwell has become a considerably more resilient company here in the last few years. If you look at the distribution verticals that we serve, you may be surprised to see that process is actually the single largest served vertical, and that certainly helps with value through the cycle. We've also added annual recurring revenue, a mix of software and high-value services, continues to grow well. It's profitable for the overall company and a little greater than 10%, that combination of the software and the services. And then finally, really a redoubling of the focus on operational excellence. And you've seen that manifest itself certainly in terms of continual expanding margins here over the last year or so, and we have every intention of continuing that. We have a great mix of offerings for verticals across discrete, hybrid and process end markets. And what we're aiming for is to be able to provide the best solutions in the production environment. And in fact, today, we are the most used technology in American manufacturing. We introduced this growth algorithm in November of 2023 to reflect the strong secular attraction of automation and digital transformation, our confidence that we can gain share and add new served market as well as the contributions from annual recurring revenue and a modest contribution from acquisitions as well. We're taking a prudent approach to our guide this year, but there's a very good chance that we're going to be able to get into that 5% to 8% organic growth range as we move through the year. We take an intentional approach to the end markets that we serve. Some of the areas that we're proud of our growth in that weren't traditional Rockwell strongholds would include things like data center, still small but fast-growing served market for us that I'm sure we'll talk about in a minute; other aspects of e-commerce and warehouse automation; life sciences as people, I think, are going to continue to want to live longer, healthier lives, and we have a very good offering in that area of high investment as well. We have some important enabling technologies, software-defined automation, the pervasive use of artificial intelligence as well as integrating robotics into a complete automation system and, obviously, all guided by the domain expertise. The understanding of manufacturing in these specific applications still matters even with all the new tools. We also introduced margin expectations by segment and we're making good progress there. We're already in the corridor for Lifecycle Services. We've seen that point reached with Software & Control, Matheus' business. We still have a little bit of ways to go in Intelligent Devices, but with some very specific plans to continue that journey in all of these businesses. And you should certainly not look at the upper end of those corridors of margin performance as an absolute ceiling. We have plans to go to and through these figures. And we're going on offense. We've announced that we're going to be spending at a little higher level. I think it still keeps us in the asset-light category. But deploying capital in the service of increased market share and expanding margins, we believe, is a good bet to make. The primary areas are plants, talent and digital infrastructure. We're happy to talk a little bit more about that. But that's already started with our existing facilities, modernizing them, applying the same technologies that we sell to customers. And it's yielded some pretty impressive results of our own factories so far. And then just to recap our full year outlook. Guide currently sits at 4% organic growth at the midpoint. But as I just said, I think there's a good chance that there can be some upward pressure on that. Mid-single-digit top line growth, double-digit growth in earnings, and we are intentionally focused on both. So with that, we can get into the Q&A.

Fantastic. Thanks very much, Blake, for that. And maybe just to follow up on where you led off and concluded there. So you have the 2% to 6% organic sales growth guide for this year. You have that 5% to 8% medium-term goal, which you said there's a good chance of hitting this year. So maybe help us understand what explains that confidence at the upper end of that growth guide for this year looks more likely.

Sure. So the sentiment on the part of our customers is positive. What we are looking to see is that sentiment turn into actual orders across a little broader swath of our served verticals. So we certainly see it in some areas, e-commerce warehouse automation. We saw it in chemical actually in the first quarter. Our traditional markets were in growth, which is good, automotive, food and beverage, oil and gas. But a lot of that activity still is in modernizations of existing facilities. Customers are still holding off on some of their larger capital projects. And while we're working closely with them on those quotations, looking at the impact of new technology to, in some cases, add to the original scope of supply, I'd like to see that show up in the orders a little bit more. So that's kind of what we're looking at. Obviously, we have home field advantage, where so much of this investment is taking place in the U.S. with, by far, the largest installed base, the deepest relationships, the best channel and so on.

And if you focus on the U.S. in particular, I think a lot of investors are wondering, kind of U.S. short cycle industrial recovery, is it happening now after a lot of anticipation for 2-plus years? Sort of what's your perspective on that? How are you seeing CapEx intentions among your U.S. customer base?

So as we've talked about the last couple of investor days in November, there's a lot of CapEx that's been announced. And it's a nice split between some of the industries that are a little bit newer to us, like data center, and also traditional industries that we have a long history of serving in the U.S., food and beverage, energy, pharmaceutical and so on. So I think it's a little bit early to sound the starting gun and say, it's here, the dam has burst. But our first quarter demonstrated that we are seeing a higher amount of orders for new capacity in the U.S. than we saw last year, for instance. It contributed to North America having the highest year-over-year growth. We do expect strong double digits for orders in that new capacity for the full year, but it was against high expectations as well.

Got it. And when you think about those customer sort of appetite on the double-digit new capacity growth, is that fairly broad-based, that double-digit orders growth? Or it's concentrated in a couple of industries?

I think it's fairly broad-based, what we've seen.

And then if we think about away from the product side, on Lifecycle Services, the backlog has been under some pressure, on and off in recent quarters. How do you see the demand outlook there?

Yes. So Lifecycle Services, actually, we see the comparables get easier through the year. We did start out with a strong book-to-bill ratio of 1.16 in Lifecycle Services. But that's where you see my earlier comment about customers are still holding back on some of that capital. Now I should hasten to add, you shouldn't equate new capacity as just orders in Lifecycle Services. A lot of that new capacity will manifest itself in terms of Matheus shipping more Logix processors to a machinery builder who's serving one of the big end users, or an EPC, an engineering firm that is going to be sourcing that equipment and then supplying it to a system integrator. So the margin profile of that new capacity business is actually pretty good. Don't assume that it's all in the lower-margin Lifecycle Services. Although, obviously, we've made some nice strides in increasing Lifecycle Services margins here in the last few years as well.

Great. And maybe, Matheus, sort of flesh out where we are in that PLC, the more sort of control side of your segment. There was a big restock then a destock then a restock again in PLCs. Where do you think we are in that product category versus kind of trend growth if we try and zoom out from the de- and restock ups and downs?

Yes. So you saw in our first quarter, we had a fairly good quarter for Logix, 20-plus percent year-over-year growth globally, in particular, North America, even higher, 25-plus percent year-over-year. We expect Logix to continue to improve. We're looking at second quarter sequentially low single digits and, for the full year, very much in line with the segment. To your question on destocking, I think as you saw us comment on that during the call, that's behind us. We have very strong visibility into distributor inventory. We know what distributor shipments are and we can compute the turns fairly easy, and it's been quite stable there. So I think that's a nonevent at this point.

Got it. And what do you think the sort of growth entitlement is for Logix from here and medium term? And should this year's growth rate kind of line up with that medium-term trend expectation?

Yes. So we have enough indication to conclude that we've been able to manage through this cycle from prepandemic to now and achieve share gains across the globe, frankly. We're continuing to invest in R&D. At a company level, we allocate around 8%. But as you would expect for Software & Control, it's higher. We have a good start point with new product introductions being adopted. This year, in particular, Logix has a new platform that's off to a great start, even though it's smaller numbers at the early stages. And a fairly healthy pipeline of innovations, as we discussed at Automation Fair in Investor Day. So we'll see additions to the Logix portfolio not just last year, but this year and the year after that. So we're bullish about what Logix can continue to do for us.

Got it. So even though we've had that restock behind us now, the growth outlook still looks pretty good for Logix and the Software & Control segment.

Yes. The comparables get harder throughout the balance of the year, just like most of the company, but prudent optimism.

Yes. And this is value across the served verticals, so certainly in our traditional served verticals like automobile manufacturing, food and beverage, pharmaceutical, but in the newer verticals like data center. One of the real engines of our growth there is the conversion from traditional direct digital control in the building management systems to Logix, where people like the high availability, the safety, the ability to standardize on a single control platform for multiple applications. So that's been a strong growth for us. And obviously, where a lot of the investment in data centers are is in the U.S., where we have, by far, the largest share.

Great. And is there a way to sort of size, I don't know, the orders you've seen in the data center vertical or what proportion of revenue or orders data center could be exiting this fiscal year?

I'm not going to pin a specific time on it. We've talked about low single digits. But data center continues to invest. It's not unrealistic to think of data centers as 5% of our business in a not-too-distant future.

Yes. And I think that you had extraordinary growth in the first fiscal quarter in some areas like food and beverage and home and personal care that people might normally think of as being steadier industries, at least the revenue growth of the customers. Why is their spending, why did it have that bounce in the first quarter? Any sort of specific comp tailwinds that helped? Or they should be set for pretty good growth for the year?

Yes. So food and beverage is our largest served vertical. A lot of that activity is still in modernizations. And quite frankly, it's applying areas of new value that we've acquired or built in the last half dozen years in installations that may already have our control, our traditional sources of value. So cybersecurity rollouts and contracts there, being able to add supervisory control that's tightly aligned with the hardware where, again, we have the knowledge and the intimacy of those actual applications. Home and personal care, you think about tissue and diapers and things like that. Actually, that was against a fairly difficult comp because home and personal care was growing last year, but we have a great readiness to serve. And again, there, some of the big orders we've received recently had large amounts of product from the so-called production logistics area, so a large amount of mobile robots, for instance. Whereas the project in the past would have been PLCs and drives and motion. And that's all great. And we love it, we do. But being able to add the new value from mobile robots as those customers also share that vision of being able to integrate these multiple parts of modern manufacturing together in a single architecture.

Great. And then maybe away from the cycle, a lot of questions around the pure, let's say, software business at Rockwell that's not embedded in hardware but sold straight to customers. Maybe kind of size that business and, yes, where to begin, broad thoughts on...

Is it resilient?

Yes.

Sure. So look, our annual recurring revenue is a little bit over 10% of Rockwell's total revenue, and that's roughly split between software and high-value services, things like cybersecurity contracts and so on. Our total software business, just software, is less than 10% of our business even when you add in the part of software that's sold as a perpetual license. We see no indication whatsoever that, that's at risk. And in fact, we see opportunities for us to be a winner by incorporating artificial intelligence in that software. And there's a few reasons for that, I'll mention some and then Matheus can add some additional detail to it. But first of all, the software that we provide is closely integrated with the hardware in a runtime system. Second, you look at the importance of that software in mission-critical applications, often in highly regulated environments where it has to be performed, the logic has to be solved in exactly the same way over and over, which is a little bit different than the way an AI-only system would be based. It's highly deterministic. You're closing a control loop in milliseconds of time. We continue to test our assumptions there. But when you look at our ability to continue to expand our software and even grow the value through pricing and upselling and so on, we feel very comfortable with net dollar retention rates of over 100% for large parts of that business.

Yes. I think it was quite good there. I mean, there's strong network effects beyond what's embedded, computer software. There is a tremendous amount of criticality to the execution. And these are runtime systems. These are not seats on design environments. And there is a fair amount of context that's specific to the industry that creates, I think, fairly strong moats for us. I would only say that the cost of software is well beyond the development of the product. It has a lot more to do with managing it through the life cycle and operating the software, which is where we add a lot of value and domain knowledge.

Yes. Domain expertise still counts for a lot in these sorts of applications. And that's what we have always said, is that it's the combination of the technology with the expertise that sets Rockwell apart and creates that moat.

And in terms of the type of software product, is it fair to say manufacturing execution systems, or MES, that's the lion's share of the pure software revenue?

Well, I think that's a big piece of it. But you also have the programming tools as well that are closely aligned with the specific runtime of Logix in particular, where you're actually considering Logix to be able to interpret inputs from a wide variety of very specific devices as well as change the state of the outputs of these other specific devices. So that integration with the hardware is not just the compute surface, but it's also the very diverse universe of I/O that, that system has to be programmed to interact with as well.

That's helpful. And I think maybe switching tack towards kind of the cost side of things. And you're one of the more semiconductor-intensive companies at this event in terms of, well, selling into the industry but also purchasing chips. And Matheus, your segment, probably the lion's share of that buy across Rockwell. How comfortable do you feel about kind of chip availability in volume and then also the cost side of it and managing that?

Yes. We haven't seen an issue. We learned a lot, obviously, during the supply chain crisis back a few years ago. Memory is getting a lot of attention now. In some cases, we've actually increased our inventory of those memory chips.

Yes. Yes, absolutely. We have a lot of learnings from the recent supply chain set of concerns. Specific to memory, our usage is primarily on DDR3, not the DDR4, DDR5. But regardless, we're interested in improving our inventory position so we can service the customer. By far, our priority is ensuring service levels there.

Great. And the cost of a lot of things, you mentioned memory chip prices going up. How is Rockwell's pricing strategy playing out? I know that's been a big kind of renewed push the last 18 months or so. What kind of pricing are you pushing through on the hardware side? And do you need to go and do another round of it just because of inflation of things like chip costs at present?

Yes. We do expect that we'll be able to continue to get high realization on price. Two broad categories of the annual price increases to cover things like general inflation and just to capture the value of our products. When we talk about 1 point of price, 2 points of price, we're typically referring to what we're getting on the hardware part of our business. We're getting price as well in the engineered solutions. We're getting price and software. But we're not talking about that in the same way as the products. And so there's that piece. And then there's the tariff-related pricing. We've chosen an approach to make sure that we remain EPS neutral in terms of whatever tariffs are thrown at us and our customers and to be able to manage that with a high degree of transparency with our channel, with our customers. So if a tariff was removed, we would be able to do that and still have the same conversation with our customers as we're having with investors to say, that's coming out. But whether it's us going in or coming out, it's EPS neutral for us. And so I feel good about that. We continue to look for opportunities to increase the amount of annual price that we can get on products with a more surgical approach. We made a lot of strides, I'd say, 7 or 8 years ago with more analytics. But there's still plenty more to be done. It's a great data set, very rich data from around the world by customer, by region and so on. And we expect to continue to focus there as well.

And on the margin front, company-wide, you mentioned the kind of to and through view to get kind of to that low mid-20s, 23%, 24% operating margin and then push through it. When you roll together the sort of price initiatives, a pretty good volume growth outlook, what kind of incremental margins should we be expecting in the medium term?

Yes. I mean, this year, we talked about 40%. We still haven't changed the kind of medium range guide of you should expect 35%. That was up from 30% to 35% not too many years ago. I'd kind of like to have a little more wholesale changes in what you should expect midterm rather than dribbling out margin a little bit higher in this business segment versus another incremental is a little higher and so on. But we continue to look at that, and I want to make sure that we have a firm line of sight and achieve the current set of goals. And in due time, we'll talk about the next set of goals. We're not done by any stretch of imagination. I'd say we're a lot closer to just getting started, really.

And then lastly, maybe there has been more interest in kind of humanoid robots on the plant floor, and there's a broad debate around the use case for that. But wondered sort of your perspective, how is Rockwell positioned for that if we really see an uptake in that approach?

Well, I'm happy that we got into the robot business directly with the acquisition of Clearpath and auto motors, AMRs. There's also a Clearpath research, which does some of the more, let's say, exotic forms of robots. I don't see a near-term pervasive use of humanoids. I think there's some good technical reasons for that. One is you just don't need that many degrees of freedom for a lot of the tasks in manufacturing. AMRs are seeing widespread adoption. You're also seeing the technique of mounting an arm on top of an AMR as a mobile manipulator. And as complex as that equipment is, it's still far less complex than figuring out the individual finger dexterity of a humanoid. And wheels in many manufacturing environments are actually a pretty efficient way of moving things around as opposed to a humanoid, which you have to worry about stability and arrest state, battery life. There are just some other things that -- I don't want to say never, of course. And I think humanoids will have application in other aspects of our everyday life, but I don't see it as a near-term threat in manufacturing.

Great. And with that, we'll turn to the audience response survey, please. So the first question is around sort of current ownership of Rockwell. [Voting]

So about 3/4 are not yet. Second question is kind of general attitude to the stock today. [Voting]

So pretty balanced. Third question is around earnings growth for Rockwell versus the sort of multi-industry average. [Voting]

So in the middle of the pack. Next question is on uses of excess cash. [Voting]

So buybacks are the biggest portion there. Next question is on valuation multiple, just sort of year 1 PE. [Voting]

So around kind of 20-ish times. And last question. Kind of what's the biggest anchor on the valuation or reason not to own shares right now? [Voting]

So organic growth, the biggest question. So we'll see. Well, with that, thanks so much, Blake, and also, Matheus, for being here. Thank you.

Yes.

Good seeing you.

Thanks a lot, Matheus.