Rockwell Automation Q3 2024 Earnings Call Transcript

Thanks, Blake. We'd like to get to as many of you as possible, so please limit yourself to one question and a quick follow-up. Julianne, let's take our first question.

Good morning.

Thanks, Scott.

Scott, the $250 million is exactly as you said, as a year-over-year benefit from the productivity and cost safe margin actions we're taking. We expect the bonus expense next year if we're delivering to plan to be between $160 million and $170 million. Other things on top of that where I'm saying it's largely being the $250 million in total cost and margin benefits are being largely offset by bonus and other compensation. I'm including our anticipated merit increase for fiscal year '25 which will round that out to about $250 million when I add in the bonus. Is that clear, Scott?

Scott, we're -- that's certainly the objective is to increase the conversion on incremental revenue. Last November we talked about 35% and we said that that wasn't going to be dependent on mid-single digit top line growth. So a little bit more aggressive stance there. We'll hold off before talking about exactly what we expect in terms of core conversion, but you can bet that that's on our mind to increase the incremental conversion on revenue.

Thanks, Scott.

Hey, Andy.

Sure. Andy, for a little bit of context, we have talked in the third quarter about expecting mid-single digit sequential order growth. We've seen sequential order growth through the year, and we said, because we were continuing to see the impact of excess inventories at distributors and machine builders that was going to yield mid-single digit order growth. As that kind of merges with some weakening in end markets, that's where we saw the low single digit sequential orders growth in Q3. And we think that that continues. So rather than a one or two quarter sharper bounce back, We think this is going to continue to be a gradual recovery. Inventories are depleting, both at our distributors and our machine builders. But we have seen some weaker conditions in end markets.

And I would characterize that in a couple of buckets. You see a couple that are affected by consumer demand, such as automotive, as consumers are going a little slower in a rush to EV. And you also see it in food and beverage and home and personal care. We see consumers, and you've heard this from the brand owners themselves, are going a little bit down brand as they're being more discriminating on what they pay for packaged goods. Then you also see some pressure based on policy uncertainty going forward. I would say semiconductor and questions about the disbursement of CHIPS and Science Act funds are weighing on semi manufacturers and then an energy transition.

So in those broad buckets, that tempers our view on the good side, on the tailwind side, as we go into next year, we're going to be lapping some of the quarters that had the most significant -- that were more significantly impacted in this fiscal year by inventory. And there'll certainly be a lot less inventory at distributors and machine builders in Q1 of fiscal year '25, for instance, than there was in Q1 of fiscal year '24.

Yes, a couple things there, Andy. First of all, the mix between Q3 and Q4 on the $100 million of cost savings that we're expecting, that's shifted a little. I earlier had said one-third, two-thirds, it's now more like 40-60 between Q3 and Q4. We got some good progress in Q3, a little ahead, moving some of those actions earlier. So the differential isn't quite as big between Q3 and Q4 as what we thought three months ago.

Now moving into margin and what we're expecting going into Q4 for margin. We had some things noticeably impact our margin better than what we were expecting in Q3. Primarily we guided in Q3 that we expected our -- in our software and control business, we expected a sequential decline of 20%, which would have -- what we said on our last call is that, we thought that would bring our margins in software and control down to the mid-teens. With the strength in the Logix, orders and sales that we saw in Q3, that did not materialize to that level. It ended up, rather than software and control being down 20%, it was down 10%. And that extra revenue and the mixed benefit that brings help boost the margins in software and control much higher than what we were estimating. And that's the primary driver of our over performance of margin in Q3.

Now into Q4, we will be getting the benefit of these additional cost actions. In software and control, we don't see an additional ramp up happening in Q4 for our Logix sales. We think that'll be very, very similar to what we saw in Q3. In fact, we think what we saw in Q3 is going to be almost a carbon copy into Q4 from a revenue standpoint, from a margin standpoint for software and control. Intelligent Devices and Lifecycle Services, we expect for both of those a sequential decline. We had some -- both of those businesses had some favorable mix. Driven by, in Q3, we see some of that mix reversing into Q4. And in Lifecycle services, it's part of our customer and project mix that was very beneficial to us in Q3. We think that'll abate some in Q4 and why we see margins going down a couple hundred basis points sequentially. Still part of a more than doubling the margin for the full year than what we saw last year. And then Intelligent Devices, we see about 100 basis point drop in margin. That is also driven by some of our product and project mix there.

Thanks, Jeff.

Jeff, I'll offer some comments on that. I think to start with, what is largely back to normal is orders and sales of our products kind of coming back right on top of each other. So getting back to historical pre-COVID levels of book-and-bill. When you get an order for a drive or a Logix controller in the quarter, being able to ship it down and recognize the revenue in the same quarter. Back to very high percentage conversion, operational performance is good. Customers are looking for that material in about the same time frame that they were previously. So that's really good news and puts orders and shipments back very similar from quarter to quarter in terms of products.

As we look at next year, we're going to be lapping some extremely low order rates. And so, beginning with the fourth quarter, as we start thinking about year over year rates again, you're going to see some big numbers in the fourth quarter and likely going into next year. And we do see continued investment. We talked about project delays, but we're winning projects as well. We are seeing the impact of higher than traditional levels of investment, despite the uncertainty for North American manufacturing plant.

So I think looking at Q4 as a jumping off point is inevitable, but as we said, we expect continued gradual sequential increases into next year and then we'll certainly be given a lot more detail in November.

There's certainly risk with that, Jeff, but there's also the amount of business that we didn't ship in the beginning of the year because there was inventory sitting at distributors and that was a meaningful number throughout the year and it's far less as we move into next year. So you get some tailwind from that.

Yep. Thanks, Jeff.

Yes, so our visibility into distributor stock is very clear for the distributors on our DMI program, which is 100% of the distributors in North America. And it's not all the way gone, but the vast majority of it has dissipated there. We see continuing stubborn inventory in China, and we'll call that out, and that's going to take a little while to get to the bottom of that, because if you think about it, what paces those inventory levels has a lot to do with the end market demand. And so, if that is weaker, then it's going to take longer to burn through that stock sitting on distributor shelves. But we have very clear visibility in the U.S. where the vast majority of our business goes through distribution.

I painted the picture in China and then we have a higher amount of direct business with machine builders in Europe, there it's basically talking with them about what their levels are. And we have consistent questions that we review with them on a monthly basis. We're confident it continues to go down, but it's not all the way there yet.

Yes, our Lifecycle Services margin -- thanks for pointing that out. It certainly has been a noticeable improvement over fiscal year '23 with our margins for the -- our estimate for the full year of more than doubling. A portion of that year on year improvement in the margin and in the margin you're seeing is coming from the absence of any kind of bonus or incentive compensation this year. The majority of our improvement is coming through better profitability in our Sensia joint venture. It's coming through structural productivity that we set in place late last year. It's coming through better project execution. Those aspects we think that will continue to build into fiscal year '25. But I just will point out that the benefit from the incentive compensation, we expect that not to be repeated into fiscal year '25. If incentive compensation were paid as per the plan, that would have reduced life cycle services margin for the full year by approximately 200 basis points.

Yeah.

Thank you, Nigel.

So a couple of comments, and then I think Nick may provide some additional color. In the quarter, inventory reduced nicely at distributors. So tracking that, as I mentioned before, pretty explicitly with our DMI program, being able to look at the high runners, the A items, as well as the B and the C items, we saw an overall reduction of the inventory levels and through that -- first part of the year we saw positive year-over-year growth in shipments coming out of our distributors to the end users. So as we talked to them, they have been having a reasonably good year as they're shipping out, particularly to those end users where they're not dealing with higher stock at the machine builders.

Yes, Nigel, a couple things to add. One is, yes, we do track the amount of new orders being placed on our distributors. And what we see there is, we are seeing that continuing to go up. But part of what we're highlighting in our revised estimate for Q4 is we're not seeing go up at the pace that we were expecting, implying that the end demand is not as robust as what we were thinking three months ago.

And then in terms of your question about added visibility into 2025, I'm sure you were asking more about revenue, but I will just add from a margin perspective, what are some of the headwinds and tailwinds we're thinking about for margin next year? The headwinds we've talked about of compensation, both the bonus and our annual merit increase, and we expect to continue investments in new products and digital offerings. Tailwinds that we expect in our margin next year. That $250 million of margin expansion and cost reduction actions we think will be -- we know will be benefiting margin next year.

We continue to expect positive price cost next year and then we expect continued margin improvement from our recent acquisitions in the last two or three and that coupled with, right now what's anticipated, no new M&A, we think that will also be marginally enhancing for us in 2025.

Yes, I mean the biggest contributor to the M&A this year is Clearpath and the mobile robots. That's project business. I mean those are fairly expensive sales. And so, it's going to be lumpy through the year. We're seeing very strong year-over-year growth overall for that business, but it's going to move

Around a little bit from month to month and quarter to quarter. We remain very optimistic and proud of the accomplishments of that acquisition as well as the verb on the cybersecurity side.

Yes.

Sure, Julian. Thanks for asking. So from an inventory standpoint, given where we have been in the last 2.5 years in terms of ensuring that our customers are getting the products they need. We have been very focused on making sure that we have the stock we need in place to be meeting our customers' requirements. As we went through the -- our plans for fiscal year '24, as we went through the year, is that we expected that in the second half of this year, we would be seeing increased demand on us depleting quite a bit of that excess inventory that we ourselves are holding. As we're seeing the demand on us not having that ramp up, but more of this gradual increase that we're talking about, that's leaving us with noticeably more inventory in terms of days of inventory at the end of our fiscal year than what we were estimating earlier in the year or even three months ago. And that's the most significant part of our cash conversion story.

In terms of our prior guide of 80% now bringing it down to 60%, we've known all along we have these one-time non-recurring headwinds, things like our extra tax payments that we'd be doing well in excess of our tax expense. We also knew that we'd be having the cash payments for our restructuring actions. So those things are contemplated as part of that 80%, but we were also counting on a noticeable roll down in that working capital and inventory in the second half of the year. And while it's still going to come down in the second half of the year, it's not going to come down nearly at the pace. That's really going to be more of a 2025 development for us.

Yes, so we did talk in the last quarter about some weaker capex spend, particularly in food and beverage and auto, around new capacity. We indicated that while, for instance, food and beverage customers are still investing in resilience and efficiency, they're pausing new capacity. And similarly -- and I think the well-read theme of EV slowing down a bit as well. We're still seeing projects and behavior that we would characterize as delays, push outs, but not cancellations.

And we certainly hope that it doesn't move to that. We're watching it. We're taking a clear-eyed view of what's happening out there. But people are pushing for some of the reasons I mentioned before, as we said, looking at consumer demand, interest rates, and then some policy uncertainty. It doesn't all just stop, you know, until the elections, for instance. So we're going to see major projects that are awarded this quarter that are coming from customers across a variety of industries, but not at the pace that we would have thought, say, three or four months ago. And you're right. The dominant theme for the first part of this year was the inventory issue at distributors and machine builders. And now, as that dissipates, we're seeing some pause in capital spend in manufacturing.

Yes, thanks.

So I'll take the first one and then Nick will chime in on the calendarization of the cost actions. We haven't given a specific figure in terms of the inventory at distribution and machine builders, but it's hundreds of millions of dollars. And it's a larger factor, as I've said before, than some of the investments that we've seen in North America. So it's a bigger number than the business on the good side that's been won this year based on investment in North America. It's dissipating, we're seeing a smaller contribution in each quarter, but it's been stubborn. And as we said, we expect that there's not going to be one month all clear where suddenly it's gone. And that's why we say gradual sequential improvement in orders in this quarter and then into next year.

Yes. And then, Noah, as far as the quarterization or calendarization of the benefits of that $250 million. Well, first let me say, you are correct about the bonus, that that will be like largely equal throughout the four quarters of fiscal year '25. But in terms of the calendarization, of course, we'll add that kind of information in the November meeting for more detail. That said, what I can tell you is the restructuring benefits are more front half loaded, the things that we started in Q3, whereas those additional margin expansion benefits that we talked about that go on top of that, that is more second half loaded. But the actual calendarization of all of this, we'll share more of that in November.

Yep, thanks.

Hey, Steve.

Good morning.

So I'll start with the general comment and then Nick can add detail. But you're right, Steve. The productivity that we're looking at, the combination of the actions that were primarily reductions in force on the second half of this year, and the items in the more comprehensive program offsets the headwinds from compensation into next year. We expect our R&D spend, which is part of that overall operating spend. If you add R&D and SG&A together, that's our operating spend. And we expect R&D to be roughly similar as a percentage of sales next year.

Yes, and I think what I'll add to that, this $250 million that we're projecting for next year, that is roughly half of that that we see as benefiting gross margin and roughly half of that that we see reducing our SG&A spending. We're striving to keep our ongoing investments in R&D in light of the opportunities we see there as a percent of revenue relatively flat.

Yeah. The five I shared on Nigel's question, those are big five there.

Talk a little bit more about what you mean by overproduction, Steve.

Yes, in the last two or three quarters, it's -- Steve, it's -- the inventory is in both the last two quarters not going up. They're just not coming down as fast as we thought. And we think that pace of it coming down will accelerate in '25. But in terms of volume in our factories, in terms of a negative headwind

From underutilization in '25 versus '24, we don't anticipate that's a material impact on fiscal year '25.

Thank you.

Thanks, Joe.

Joe, I'm going to stay away from bigger than a bread box type of dimensioning for next year. But the customers we're talking to, including in automotive and food and beverage, are continuing to make investments in those areas. We look at not just potential capacity that they're adding, but it's about resilience, efficiency in existing facilities. It's one of the things that excites us about the mobile robots, for instance, is that you know, most of that's going into existing facilities. So customers, just like Rockwell, are working on their efficiency and their cost, regardless of what's going on in the external environment. And we're really well prepared to address that.

So I mentioned before, as we start getting into -- back into year-over-year growth in orders, we'll characterize what that means for shipments into the next year, but I'm very confident with our position.

Joe, we're implying that Intelligent Devices revenue will be almost exactly the same sequentially between Q3 and Q4. It's not -- we're not expecting a noticeable uptick or downtick sequentially in intelligent devices revenue.

Not a seasonal uptick there.

Julianne, we'll take one more question.

Sure, Joe, broadly, we've spent a lot of the last few years adding some capabilities that I felt we needed to move faster in, things like software capability, high-value services like cybersecurity, and some particular technologies like mobile robots, independent car technology, industrial PCs. At the same time, we've been playing a lot of defense with COVID, with supply chain volatility that has introduced inevitably some inefficiencies into our own processes. And so for several reasons, now is the time to integrate the parts, to bring together the things that we built and bought over the last few years, and to drive out some of the inefficiency that's built up with programs like this. And it necessarily involves headcount reduction, as well as actions aimed at reducing our cost of goods sold.

And so it's a broad-based approach that will yield benefits in this year as we talked about into next year. But then it gets rolled into a continuous operating model of continuous improvement that continues to drive these costs out and be vigilant to make sure that new costs don't creep in.

The benefits, of course, are for an investor standpoint, expanding margins to go with the higher growth levels. For customers, there's also a benefit. Things that we're doing to reduce that long tail of SKUs can actually increase customer service for the more frequently bought items. And when we reduce the cost of goods sold, we have the opportunity to be even more competitive on the projects that we choose to go after. So for a variety of reasons, integrating the parts and driving inefficiency out is the right time in our journey to introduce this as we started last November at Investor Day and will certainly be given more of an update in just a few months.

Yes, it is primarily structural. These aren't one-time things to address a particular year. The idea is that, the savings that we're making, the costs that we're reducing persist regardless of what the top line growth is going to be.

Yes, I think that latter is probably the best way to characterize it. We've seen sequential order growth quarter on quarter through the year and we expect it again in the fourth quarter and into next year, but it's at a more gradual pace.

All right. Thank you for joining us today, everyone. That concludes today's conference call.