Rockwell Automation Inc

NYSE:ROK

Earnings Call Transcript 2018-Q1

[Operator]

Thank you for holding, and welcome to Rockwell Automation's Quarterly Conference Call. I need to remind everyone that today's conference call is being recorded. [Operator Instructions].

At this time, I would like to turn the call over to Steve Etzel, Vice President of Investor Relations and Treasurer. Mr. Etzel, please go ahead.

[Steven Etzel, VP of IR & Treasury]

Good morning, and thank you for joining us for Rockwell Automation's first quarter fiscal 2018 earnings release conference call. With me today is Blake Moret, our Chairman and CEO; and Patrick Goris, our CFO. Our results were released earlier this morning, and the press release and charts have been posted to our website. Both the press release and charts include reconciliations to non-GAAP measures. A webcast of this call will be available at that website for replay for the next 30 days.

Before we get started, I need to remind you that our comments will include statements related to the expected future results of our company and are, therefore, forward-looking statements. Our actual results may differ materially from our projections due to a wide range of risks and uncertainties that are described in our earnings release and detailed in all of our SEC filings.

So with that, I'll hand the call over to Blake.

[Blake Moret, Chairman, President & CEO]

Thanks, Steve, and good morning, everyone. Thank you for joining us on the call today. I'll start with some key points for the quarter, so please turn to Page 3 in the slide deck. We had a good start to fiscal 2018. Organic growth was just above 5%, which was in line with our expectations. Continuing the trend we saw last quarter, growth was again broad-based across the regions. From a vertical perspective, Heavy Industries performed well and were up high single digits in the quarter, including good growth in oil and gas, chemicals, semiconductor and metals. Consumer was about flat. Transportation was weaker than we expected with Automotive down about 5%.

From a regional perspective, the U.S., our largest market, grew over 5% organically. We saw good growth in Heavy Industries, partially offset by softness in the Automotive and Consumer verticals. Oil and gas grew double digits. EMEA was up 5%, a continuation of the good growth we saw in the fourth quarter. Sales to OEM machine builders remained strong.

In Asia, we saw a double-digit growth in China. India was about flat, and Japan and Korea were down. Recall that Asia was up 20% in Q1 last year, so certainly a tough comparison. Latin America grew 8.5% led by Heavy Industries and Consumer.

I'll make a few additional comments about the quarter. Logix was up 6% compared to last year. Our Process business continues to do well and was up 12% year-over-year organically. This includes the results of our MAVERICK acquisition, which is now included in organic sales. Adjusted EPS was up 12%, reflecting solid operating performance. Patrick will elaborate on our first quarter financial performance in his remarks.

Let's move on now to our outlook for the balance of fiscal 2018. Global macroeconomic conditions remain solid based on PMI measures and the latest forecast for global GDP and industrial production. Obviously, U.S. tax reform is an important event, but we are optimistic that the impact of U.S. tax reform on our customers' investment decisions could provide an additional tailwind to our future performance. It is too early to quantify the benefits. An immediate benefit of tax reform for us is a lower effective tax rate in Q1 and going forward. The lower tax rate will drive improved profitability, thus, giving us the ability to make additional investments. Another benefit of tax reform to Rockwell is that we will have much more flexibility to deploy capital. That said, I want to emphasize that our investment and capital deployment priorities remain the same, as summarized on Slide 4.

Our first priority is investing in our business to drive organic growth. A new guidance for fiscal 2018 includes incremental investments to accelerate profitable growth and other long-term objectives. Examples include accelerated software development, investments to help our employees be even more engaged and productive and, importantly, spending to enable customer innovation and complement our existing workforce development initiatives.

Our next priority is strategic acquisitions. We are actively engaged in the evaluation of inorganic opportunities to accelerate our connected enterprise strategy. We will then return remaining excess cash to share owners through dividends and repurchases.

Turning to guidance. We still expect our fiscal 2018 organic sales to be up 5% year-over-year at the midpoint of guidance and expect full year reported sales to be about $6.7 billion, including the impact of currency. Compared to our expectations back in November, we now see slightly better growth in Heavy Industries and a weaker Transportation vertical. We continue to expect Consumer to grow at about the company average. We are adjusting our EPS guidance to include the expected impact of U.S. tax reform on our full year results. Our new adjusted EPS guidance range is $7.60 to $7.90. Patrick will provide more detail around sales and earnings guidance in his remarks, including more specifics on the impact of tax reform on our Q1 financial results and fiscal 2018 guidance.

Before I turn it over to Patrick, let me add a few closing comments. At Automation Fair in November, we showcased how we are bringing The Connected Enterprise to life for our customers. We continue to make progress executing this strategy, and the new value from The Connected Enterprise continues to grow at a double-digit rate. You've heard before from us how we practice what we preach, and I'm glad to say that we are being recognized for our efforts.

Our Twinsburg, Ohio plant recently received the 2017 Plant Engineering magazine top plant award for its innovative use of technology to enhance work or productivity. We've deployed our own manufacturing execution software and analytic tools to optimize productivity, improve quality and increase sustainability. Congratulations to the team.

Finally, I would like to thank our employees, partners and suppliers for their contributions to another successful quarter.

With that, I'll turn it over to Patrick. Patrick?

[Patrick Goris, SVP & CFO]

Thank you, Blake, and good morning, everyone. Before I talk about our quarterly results, let me make a few additional comments about U.S. corporate tax reform. The new tax law not only leads to a lower expected -- effective tax rate going forward, but also provides us with greater flexibility to deploy the cash we have, regardless of where it is generated. Like many other U.S. companies, we've had a large amount of excess cash held outside the U.S. We have initiated the repatriation of that cash, a process that will go beyond the current fiscal year.

As Blake mentioned, our priorities for capital deployment remain the same. Funding accelerated organic growth remains priority #1 followed by acquisitions, then the dividend and, finally, share repurchases. In Q1, we recorded provisional charges associated with tax reform totaling about $480 million. These charges include $386 million for the deemed repatriation and $94 million to reduce the value of net deferred tax assets. We excluded the $480 million charges related to tax reform from adjusted EPS, And updates in future quarters to our estimates of these charges will also be excluded from adjusted EPS.

With that, let's move to Slide 5, Key Financial Information, first quarter. As Blake mentioned, we had a good first quarter of the fiscal year with reported sales up 6.5%. Organic growth was in line with our expectations at 5.3%. Currency translation contributed 2.5 points to sales growth, a bit less than we expected. And the fiscal 2017 Q4 divestiture reduced sales by 1.3 points. Segment operating margin was very strong at 22.4%, up 120 basis points compared to last year. A margin tailwind from good organic growth was partially offset by higher investment spending. Margin performance in the quarter was a bit better than we expected, as overall operating performance was very strong, but also because spend was a bit light.

General corporate net expense of $16 million was up slightly compared to last year. You will note on our financial statements that we excluded about $11 million of third-party advisory costs related to the Emerson proposals from general corporate net and from adjusted EPS. These costs were not included in our November guidance and are unrelated to the operating performance of the company. Adjusted EPS of $1.96 was up $0.21 compared to the first quarter of last year, an increase of 12%. The year-over-year increase in adjusted EPS is primarily due to the benefit of higher sales, offset by investment spending.

Last quarter, I mentioned during our earnings call that we did not expect our Q1 EPS to exceed last year's. However, our actual Q1 results came in better than expected, mainly as a result of the much lower-than-expected tax rate and, to a lesser extent, better-than-expected segment operating margin performance. Free cash flow was $179 million in the quarter or 70% of adjusted income. During the quarter, we paid the annual incentives that our employees earned in fiscal 2017. There was no such payment in the first quarter of last year.

A few additional items to cover not shown on the slide. Average diluted shares outstanding in the quarter were 130.1 million, up 0.4 million from last year. And we repurchased about 1.1 million shares in the quarter at a cost of $208.6 million. This is ahead of pace to get to the $500 million full year target we shared with you last quarter. More on that in a little bit. At December 31, we had $400 million remaining under our share repurchase authorization.

Slide 6 provides the sales and margin performance overview for the Architecture & Software segment. This segment had another quarter -- another good quarter with more than 7% sales growth. Organic sales were up 4.6% year-over-year and currency translation increased sales by 2.7%. For the quarter, segment margin remained pretty flat year-over-year at a very strong 30%. Operating leverage associated with the sales growth was offset by higher investment spending.

Moving on to Slide 7, Control Products & Solutions. Reported sales were up 5.8% for this segment. Organic sales growth was 5.9%, currency translation contributed 2.3% and divestiture reduced sales by 2.4%. Growth in our solutions and services businesses in this segment picked up nicely in the quarter and came in at over 6%. The product businesses in this segment were up more than 5% on an organic basis. Operating margin for this segment increased 200 basis points compared to Q1 last year, primarily due to higher sales. Very good margin performance for this segment. Book-to-bill performance for our solutions and services businesses in this segment was 1.20 in Q1 compared to 1.11 a year ago.

The next slide, 8, provides an overview of our sales performance by region. Blake covered most of this slide in his remarks, so I will just reiterate that, like last quarter, growth was broad-based across geographies. Also we saw good growth in emerging markets, which were up just under 10% compared to last year.

This takes us to Slide 9, guidance. We continue to project sales of about $6.7 billion with organic sales growth within a range of 3.5% to 6.5%. We updated our currency assumptions, and we now expect that tailwind from currency translation to be closer to 2%, rounding really. And the sale of the business in fiscal '17 will, of course, remain about a 1-point headwind. We continue to expect segment operating margin to be a bit below 21.5%. We believe the full year adjusted effective tax rate will be about 21%, 3.5 points lower than our November guidance and mainly as a result of tax reform. Our current estimate is that for fiscal '19 and beyond, under the new law, our adjusted effective tax rate will be in the range of 19% to 21%.

We're now targeting about $1.2 billion in share repurchases for fiscal '18, up from $500 million per our November guidance. To support this increased share repurchase activity, our board recently approved a new $1 billion share repurchase authorization. We now expect average fully diluted shares outstanding to be about 128.4 million for fiscal '18.

We are increasing adjusted EPS guidance range to $7.60 to $7.90. At the midpoint, this implies a $0.40 increase compared to our November guidance. The lower tax rate accounts for about $0.35 of this increase and a lower expected share count for the remaining $0.05. The incremental investments Blake referred to in his comments and somewhat unfavorable mix are, for the most part, offset by stronger-than-expected core performance.

A couple of other items to close. We continue to expect free cash flow conversion to be about 100% and general corporate net is still expected to be about $75 million for the full year.

With that, we'll move to Q&A. Steve?

[Steven Etzel, VP of IR & Treasury]

Before we start the Q&A, I just want to say that we would like to get to as many of you as possible. [Operator Instructions]. Thank you. Operator, let's take our first question.

[Operator]

[Operator Instructions]. Your first question comes from Richard Eastman with Robert W. Baird.

[Richard Eastman, Robert W. Baird & Co.]

Blake, could you kind of maybe elaborate, if you would, on maybe the abrupt deceleration on the expectations around the Transportation, if you could just speak to maybe whether it's geographically or other?

[Blake Moret, Chairman, President & CEO]

Yes. I don't think we would call it isolated to a single geography. Although we certainly saw weaker-than-expected performance in the U.S., it's not purely projects, some of which have been pushed out. It's also the MRO spend. We have a very large installed base and so that's a significant portion of our Automotive business in any given quarter. We continue to see new program commitments, particularly in EV. And you've seen some of the news from some of the big brand owners about their large investments in that area. But it's hard to predict the timing of whether some of the business that we're already tracking will come in, in 2018 or push out to 2019. So I would call it, mixed results, but it's -- it includes some MRO as well as program softness.

[Richard Eastman, Robert W. Baird & Co.]

Okay. And then just as a follow-up question. Patrick, could you just kind of speak to -- you had mentioned in the segment profit commentary that investments in the first quarter came in a little bit light of expectations, could you just perhaps maybe put a number on the shortfall there to plan? And then also does that come back in the second quarter and actually increase a bit with your commentary around more cash flow, more flexibility on investments?

[Patrick Goris, SVP & CFO]

Rick, it was a few pennies of EPS. And our assumption is that some of that will come back in the balance of the year.

[Operator]

Your next question comes from the line of Andrew Kaplowitz with Citigroup.

[Vladimir Bystricky, Citigroup]

This is Vlad Bystricky on for Andy. So you highlighted growth led by Heavy Industries, including oil and gas. So can you talk about, within oil and gas, how that market is evolving, whether you're seeing larger projects start to come back in oil and gas specifically and then more broadly in Heavy Industry, whether you're seeing accelerated large project activity?

[Blake Moret, Chairman, President & CEO]

Yes. So in oil and gas, the strength and growth is a mix of what we might characterize as more flow business as well as some large projects starting to hit. So I think we are seeing that across segment profile of the various types of business. There are other parts of Heavy Industries that are also strengthening. So we're seeing it in metals, for instance. Pulp and paper in several industries. We include semiconductor in Heavy and that continues to be at high levels of spending.

[Vladimir Bystricky, Citigroup]

Okay, that's helpful. And then can you maybe just give us a little more color on orders during the quarter? Did you generally see a continuation of, I think, you talked about high single-digit order growth in 4Q? And did you see any change in order trajectory as the quarter progressed?

[Blake Moret, Chairman, President & CEO]

We saw a little bit of softness at the very end of December. I will say that January orders -- or business has started in line with guidance.

[Operator]

Your next question comes from the line of Josh Pokrzywinski with Wolfe Research.

[Joshua Pokrzywinski, Wolfe Research]

Yes. So I missed part of the initial comments. I'm on another conference call. But I guess, any comments or any feedback from customers so far on how accelerated depreciation or a write-off there drives more spending? It sounds like if through January, your order rates are in line with guidance, you're not really seeing that acceleration. Is there any pause or kind of pipe -- a pipeline of project accumulation that's still ongoing? Maybe try to calibrate that for us.

[Blake Moret, Chairman, President & CEO]

Sure. I think there's a substantial amount of optimism in the market, particularly among U.S. manufacturers, but broad-based across many verticals. And that optimism, whether it's in the treatment of capital investments or lower tax rate to be more competitive worldwide, there's a lot of things to be optimistic about. It's too early to quantify those benefits. So we need a couple of points to be able to draw a line and to be able to come up with a magnitude of the potential impact on additional spend on the part of our customers. But the mood is definitely optimistic.

[Joshua Pokrzywinski, Wolfe Research]

And just a follow-up on the order commentary from last quarter. I think, even the last question, I think high single-digit order rates coming out of Q4, unusual for Rockwell as a company to talk about kind of consolidated order rates, but I've always thought of you as a shorter-cycle business. And clearly, organic growth was less than high singles, Is there some pipeline building here or backlog that get you -- gets you guys particularly excited? How should we think about that high single-digit pacing out to the business?

[Blake Moret, Chairman, President & CEO]

So when we talk about the strengthening in Heavy Industries, Heavy Industries is biased more towards our solutions business, services and solutions, which is a longer-cycle business. So in that business, some aspects of it may have, on average, a 5- or a 6-month lead time. So we get a little more visibility for that. And because Heavy Industries are up and we talk about a strong book-to-bill in the quarter, we are seeing increased backlog.

[Operator]

Your next question comes from the line of Noah Kaye with Oppenheimer.

[Kristen Owen, Oppenheimer & Co.]

This is Kristen on for Noah. Just wanted to follow up on some of the conversations that you're having with customers, particularly with your auto customers. Are you talking with them about what's going on with NAFTA? And do you see any risks to your customers from that point of view?

[Blake Moret, Chairman, President & CEO]

No, we're not hearing our U.S.-based manufacturers talk about spending with us being impacted as a result of that. Obviously, we're seeing some very large spending being announced by some of our good U.S. customers. I think Ford made an announcement a week or 2 ago, and we'll continue to see that biased around EV. Outside of North America, I can say that earlier this month, I was in China meeting with automotive customers and I was very encouraged. I was talking to indigenous Chinese companies. So these weren't JVs or U.S. companies servicing the China market, wanting to talk to us, a lot in the EV space, both in terms of brand owners as well as Tier suppliers. And there's obviously a lot of activity going on there, a lot of new players. And I'm happy to see that we're covering all of them.

[Kristen Owen, Oppenheimer & Co.]

That's helpful color. And then just wanted to follow up on the A&S margins, really impressive there. I was wondering if you could give us a little bit more detail on some of the puts and takes. What's the natural leverage of that business off of organic growth versus how much are you really allocating toward reinvestments there?

[Patrick Goris, SVP & CFO]

Yes, so you're correct. The margin is at 30%, and that's a very high level. We expect it actually to be the high point for the year for this segment. It's really a function of organic growth offset by investments. As we intend to increase some of the investments during the balance of the year, we think that the segment margin there for the balance of the year and the full year will be a bit below the margins we saw in Q1. In terms of incremental margins for that segment, I would recommend you look over a longer period of time over several quarters as to what the incremental earnings has been or the earnings conversion for that segment. If we talk from an overall company perspective in incrementals of 30% to 35%, earnings conversion at mid-single-digit organic growth, we would usually expect earnings conversion a little bit better than that within Architecture & Software.

[Operator]

And your next question comes from the line of Joe Giordano with Cowen.

[Tristan Margot, Cowen and Company]

This is Tristan in for Joe. I just wanted to go back to the incremental CapEx in software that you mentioned in your prepared remarks. Is that for a specific product or specific industry? Could you just elaborate on this?

[Patrick Goris, SVP & CFO]

You refer to the incremental investments that Blake mentioned in his comments?

[Tristan Margot, Cowen and Company]

Yes, specifically in software where you're investing.

[Blake Moret, Chairman, President & CEO]

Sure. So in software, a couple of the main areas of software investment and these aren't new, so these are strengthening existing investments. We talked a lot about the new value from The Connected Enterprise as including information software. And so we certainly see increased investment there, but also in our core. In our core would be the control, the configuration tools as well as the visualization software. That's an important area for us, as we have a common software environment for all the different types of control, whether it be discrete or process or hybrid. And we continue to invest heavily in those areas to simplify the experience throughout the life cycle. So whether it's in the design part of a control project, they operate or the maintain, those are important areas that, we think, we provide differentiation and we intend to continue that.

[Tristan Margot, Cowen and Company]

That's very helpful. And then if we could just shift on Logix. It looks like it was the slowest growth since 4Q '16, if I'm not mistaken. Is there any reason for this? Any comments there?

[Patrick Goris, SVP & CFO]

I would start out by saying that Logix still grows above the A&S average. The other thing I would point out is that we've had a really good year in Logix last year. It was up 10% year-over-year for the full year. And in Q1 of '18, we grew 6% on top of 8% organic growth, which we delivered in Q1 of fiscal '17. So I think continued good growth in Logix becomes -- become a little bit tougher.

[Operator]

Your next question comes from the line of Rich Kwas of Wells Fargo Securities.

[Richard Kwas, Wells Fargo Securities]

Yes. I jumped on late, but just a couple of quick follow-ups on the order slowdown in December. Any particular verticals that you would cite as being more significant than expected?

[Patrick Goris, SVP & CFO]

Rich, this was at the very end of December, the last week or so of the year. It was just slower than what we expected. It was in the U.S. No particular vertical.

[Richard Kwas, Wells Fargo Securities]

No particular, okay. And then on the auto commentary, Ford is changing their plans around electrification and devoting a lot more investment and CapEx to electrification over the next few years. In terms of your thoughts on what you're seeing in terms of the slowdown, anything attributable to kind of just shift in plans and that maybe there's a push or delay? Or do you think it's maybe early stages of something more fundamental? Just curious.

[Blake Moret, Chairman, President & CEO]

Yes. I think we continue to see the basic backdrop of softened SAR, so there is certainly a reduced growth in the overall units. On the other hand, we see the mix of the brand owners continuing to be strongest in their highest-profit products, so the trucks and so on. And that's good for us, as well. EV and the number of new suppliers, the number of new models envisioned, that's an offset to the general reduced growth in the raw number of units being produced. It's hard to say how those will end up balancing, but what we're guiding to is about flat for auto for the full year.

[Patrick Goris, SVP & CFO]

And maybe to add to that, that's compared to fiscal '17 where auto globally was up over 20%.

[Richard Kwas, Wells Fargo Securities]

Right. So some of it's comp-related, right?

[Patrick Goris, SVP & CFO]

Yes. Auto was up over 10% Q1 last year.

[Operator]

If there are no more questions, I'll turn the call back over to Steve Etzel.

[Steven Etzel, VP of IR & Treasury]

Okay. That concludes today's call. Thank you all for joining us.

[Operator]

This concludes today's conference call. You may now disconnect.