All right, we're going to keep the morning going with Rockwell Automation. I'm Joe O'Dea, I do the multi-industry sector at Wells Fargo and we're very excited to have Tessa Myers with us who runs the intelligent devices segment, as well as Aijana Zellner who leads both investor relations and market strategy. So thank you both so much for being with us this morning. I think just to kick things off, if we talk about current state of affairs, what you're seeing out there, trends across end markets, trends across regions, just an overall update would be helpful.
Sure, I can start. Just to add, you know, before we get into the underlying end markets and the health of that, I want to just quickly talk about, you know, the guide. Right. Because a lot of it, if you look at what we talked about on our Q2 earnings call, in terms of our results and our outlook that was reduced, the vast majority of that reduction was driven by the excess inventory that's in our channel and mostly actually in our machine builders. At our machine builders. And so when you look at the end market themselves and the performance, the industries that are more product intensive, meaning where we have resell a lot more product, they're the ones that are more prone to this stocking, overstocking, destocking phenomenon.
And so when we talk about the vast majority of the reduction in our guide was driven by the depletion of this excess stock in certain automotive, semiconductor, parts of food and beverage, so discrete and hybrid industries. And that's why you see that market reduction in the outlook. Outside of that, you know, the actual end demand is healthy across the board. And we talked about warehouse automation, for example, that actually flattened out and is improving. And we actually increased our guide, our expectations for the year. And it's driven by investments not just in the e-commerce part and the ecosystem that supports those customers, but broader warehouse automation. So talk about traditional retailers, global transportation companies and global logistics companies.
Anyone who is upgrading and updating their warehouses, which need to be, which are very manual today. We talk about life sciences, continued growth there, even food and beverage customers who, while there are some, there's some sign of end-user CapEx slowdown, we noticed especially in Europe. They're still investing their greenfields in Mexico and Asia. A lot of investments in productivity in the U.S. in our strong market. So we continue to see strength there. Process industries grew in the quarter. Oil and gas growing double digits. Oil and gas grew double digits last year for us; we expect the same this year. Part of it of course is some of these industries in process are not as encumbered by product stocking and destocking. You have a lot more solutions content there. But on top of that, there are a lot of drivers.
Energy transition, decarbonization, a lot of solutions we have there. It's a long way of saying end demand is healthy. There are a couple of areas we're watching parts of automotive and the EV CapEx plans being delayed temporarily and parts of consumer packaged goods where some customers are maybe pausing and waiting and seeing what's happening from the consumer. But broadly would see pretty healthy for sure.
Maybe just to double down on that and test what you're hearing from customers out there in the field. When we think about the end market demand, broad strokes is pretty good. What is driving customers to invest and whether that's their demands getting better or trends toward automation? Just what you're hearing from them as they continue to invest.
Yeah, I think there's, you know, there's a number of challenges that industrial companies are facing now, and some of it as a result of, you know, last few years of supply chain challenges. You know, one is, you know, the rising cost of materials that they need to produce their products. It's causing them to look at how do I drive other efficiencies and improvements in my operations, so can I get a better yield, can I increase my quality? And so that, you know, as an offset to, you know, some of the cost inflation that they've seen. Secondly, and this is a really big, I think, area of focus for customers is the combination of inflation and labor rates as well as the just lack of access to the skilled labor that they need to operate their plants is a really big area of focus for companies.
So how do I mitigate the rising cost of labor and how do I mitigate the availability of the labor that I need to operate my plants? And automation is a really great offset to that. And automation technology is a really great offset to that. There's also, you know, a rethinking of global supply chain. So where am I operating today? What is the right plant network that I need to have into the future? And that's taking into account how do I get closer to customers and how do I mitigate some of the geopolitical and supply chain challenges that I've experienced? And so that's causing nearshoring, onshoring, reshoring. You know, that kind of overall shoring phenomenon is really understanding what's the right optimized plant network for me to have a resilient supply chain.
I think cybersecurity is a big area of focus and investment for companies. So how do they secure and protect and ensure that they can continue to operate? And so cybersecurity is a big area investment. What we're seeing, you know, the growth in our cybersecurity services and solutions, I think is representative of that. And so those are just some of the trends that we're seeing, I would say. In addition to that, there's new industries that are forming. So energy transition is creating investments in carbon capture and hydrogen and, you know, other renewables. And so that's an area where it's less traditional industries and more kind of new industries being created as well.
Great. And then Aijana, just in terms of the framework for orders for the rest of the year, when we think about, I think that the expectation is that from Q2 to Q3, orders get a little bit better and then there's a more meaningful step up from Q3 to Q4. Can you just talk about the, you know, what's that based on and the visibility that you have into seeing in particular that step up from Q3 to Q4?
Sure. The second half outlook and the calendarization, as you mentioned, Q3 and Q4 is largely predicated on our expectations for that excess inventory depletion at our distributors and machine builders. And so what's embedded in that is we expect North America distributors, which is the majority of our distributors, to get back to that inventory equilibrium by the end of our fiscal Q3. So the quarter we are in now, and we expect a significant reduction in machine builder excess inventory in Q4, Q4. So that's what we see based on, and we talked about it right. Already, we are continuing to improve our visibility into machine builder inventory. That's not something we had to do before the supply chain crisis. Our machine builders and our, you know, they haven't, they didn't really carry much inventory in the past before lead times got extended because of the chip shortage.
You know, customers could call, put in an order and get it in a matter of days or weeks. So this is something that's clearly more recent and we've been increasing our visibility, working, as I mentioned, with our largest machine builders in North America, largest machine builders in Europe, getting better visibility and granularity into their inventory levels, their expectations for those inventory burn rates, their incoming orders from end customers and their expectations on what the orders are going to be in terms of coming on us. And so all of that data is what informs us in terms of the Q3 and Q4 improvement we talked about on our earnings call, Q3 to Q4 sequential improvement in our sales and margins largely driven by that timing of destocking. But also we have some seasonality, so. So lifecycle services segment generally goes up sequentially from Q3 to Q4.
We have a line of sight with some bigger projects that are also slated to hit us in Q4.
Let's just stay on kind of the channel inventory side of things. And Tessa, maybe just talk about the go to market approach because there are multiple steps and so we think about the role that distributors play, the role that machine builders play and then there's an end user step and whether you can kind of break down for us what volume is flowing through each, but each is carrying inventory. And so that's something that you've had to manage through. So overall kind of go to market and then the importance of each step.
Yeah, maybe I'll talk a little bit about the kind of the shape of our channels to market, and then Aijana can talk a little bit about how to think of, dimensionalize that for you. So we go to market through distribution as well as direct to some machine builders and customers. You know, we have distribution partners really all around the world, and you know, they carry inventory of our technology. They're also a force multiplier for us in the marketplace. And so they're market making distributors. They have, you know, they amplify our sales reach and our sales coverage with the partners that we have really all around the world from a distribution perspective. And you know, much of what they focus on is all of our, the product portfolio that we have as a company.
We also have system integrator partners who take our technology, integrate those into solutions and they deliver those directly to end customers. And so we have a partner ecosystem of integrators all around the world. And the machine builders are really the companies that take the technology and build physical equipment and then deliver that to an end user. That's either to expand capacity in a plant, maybe to put in a new line in a plant or you know, it's a new greenfield CapEx investment that they're supplying to customers.
Yeah. And in terms of putting some numbers around that. So while we go, we work with all these customer segments directly, these customers then go ahead and procure it from distributors. So globally over 70% of our sales ends up going through distribution. We talked about machine builders. We estimate at about 30% of our total revenue. That percentage is higher in Europe. For us, we have a bigger presence with machine builders in Europe.
Then talk about what you've done to enhance the visibility that you have into channel inventory to give you some confidence that you know, by the end of Q3 things are in much better shape. That would drive order activity better in Q4.
Sure. I mean, we got close, much closer to our end user and our end users, our distributors and machine builders to the last few years working through the pandemic, then the ensuing supply chain crisis, then this whole stocking, destocking. And so we are continuing to improve the distribution. We've always had good visibility into North America distribution. 100% of our distributors in North America are on what we call DMI, Distributor Manufacturer Integration. So we have visibility into that, but we're getting closer with them on what are they seeing in terms of their sell through rates, what are they seeing in terms of demand from end customers. Machine builders is something that, as I mentioned before, we didn't really had much visibility.
Didn't have much visibility historically. Frankly, some of the machine builders themselves did not have very good visibility into all of their inventory across multiple facilities. So we are working with them together to get better visibility and get more granular in terms of what I've mentioned before, inventory levels, expectations for the burn through of that burn rate of that inventory, you know, pressure testing those assumptions, much more frequent cadence and asking the right questions. Now we talked about—Blake talked about—focus on process visibility in terms of using more processes, more technology, you know, new leadership teams, new ways of making sure that we are as predictable as we can be in this business, both in the top line, but also with our spend. We talked about that as well.
Just in terms of the, so you talked about this is largely at this point a machine builder kind of situation in terms of getting the inventory down there. But just talk about the cadence of this. When you started to see it kind of, you know, when was it at its worst? Have you seen improvement?
I guess, going forward, you know, you'll remember in fiscal 2023, really we started seeing that moderation in orders after, you know, record orders that we had in previous years. Right. Again, our backlogs were at record levels, our orders were at record levels because, you know, often our industrial peers couldn't get enough chips to ship them out to investors, to customers. And so in fiscal 2023 we started seeing this moderation which we called. We knew that after the ridiculous growth in orders, we're going to see some moderation as customers will start working through some of the excess. So the trough was in our Q4 of fiscal 2023 that was the lowest level. And since then we saw double-digit growth, sequential growth in orders in Q1 and we saw double-digit sequential growth in orders in Q2.
So there is improvement. There are distributors that already got to that equilibrium for the inventory and we actually are seeing that growth and the demand from end customers coming through to us. So we are seeing an improvement in orders, but broadly there's still excess inventory and that's why we did not see that ramp we were expecting. So you know, we were expecting a much stronger double-digit sequential growth in orders in Q2 and instead we got low double-digit. And further analysis we realized we underestimated just the amount of overstocks. Right. That we should know. And so, but it's improving, it's moving in the right direction. It's just more; there was more of that sitting machine builders.
And so that's what, as I mentioned earlier, the second half is just, you know, we're not, we're not embedding some kind of a heroic improvement in end markets, you know, in the second half of our fiscal year. It's really what are expectations for that inventory burn rate and some seasonality in Q4 and some bigger projects to a lesser extent.
Then this might be the last destock related question, but bigger picture I think Tessa, when you think about initial expectations for this year in Intelligent Devices, initially expected it could even be up a little bit now, you know, maybe down mid single digits. Just talk about what developed over the course of the first half of the year. Inventory is a situation, but anything from an end market side of things, anything from a project pushout side of things that you saw kind of develop over the first half of the year.
It's really, you know, it's related to what we talked about for the whole company, you know, the level of stock as we progress throughout the year and the depletion of that stock has really been, you know, kind of the kind of revised thinking and outlook on.
The rest of the year and then just shifting to more of a cycle-related question. And if you think about kind of where demand is today and how that fits into a cycle construct and when we look at it, there's been a lot of growth since 2019 in devices and software and control, but I think a fair amount of has also been price related. And so it might be the volume is up mid single digits or so. How do you characterize the cycle overall in terms of demand at this point is sort of normal-ish, above normal, below normal. Just how you're thinking about the demand environment out there?
Yeah, I think, you know, I think 2024 is a difficult year as a comparison because of the impact of the destocking. And so you're not seeing kind of full market demand, you know, coming through. I think what Aijana said earlier, characterization of the marketplace where we see healthy end demand, we see growth across industries. We see new emerging opportunities in industries like in EV and battery, in new energy as well. And so, you know, investments across, you know, industries and across regions, you know, North America, strongest market for us. And with, you know, kind of the tailwind of mega projects and investments in North America, that's a positive, you know, demand trend that we see as well.
And then when you think about the growth algorithm for intelligent devices, like how do you think about the right growth rate in terms of, do you think about that as a multiplier industrial production or just overall kind of where you want to see it?
Yeah, I think a good way to think about intelligent devices growth is consistent with what we laid out at our investor day in November around the overall how we're thinking about the overall growth as of the company. And so, you know, we expect to see automation growth kind of at a higher rate as we move forward. 3%-5% growth, you know, just, you know, with, with really trends in the industry that are driving investment things like, you know, mitigating labor cost meeting, rapidly changing consumer demand, ensuring resiliency and cyber resiliency in operations. And so we think this backdrop of automation has a healthy growth rate as we move forward. In addition to that, we think we'll grow faster than market related to the activity that's happening in North America, which is our strongest marketplace.
We will be an outsized beneficiary of what's happening there, taking market share with, you know, our kind of core technologies. As we continue to evolve those and in new market spaces that we've gone into, you know, in areas like Independent Cart Technology, growing our footprint in things like semiconductor. So we think that there is an above market growth that we can achieve. Then we think acquisitions will play a part in the growth for framework for Intelligent Devices and the overall company as well. The only thing I'd add above Intelligent Devices growth for the company is really continuing to grow our ARR and our annual recurring software and services would be the additional growth kind of across the company.
When you talk about the growth potential that automation can drive moving forward and then think about what kind of a growth contribution it's made in the past. What do you think that growth rate associated with automation has been? You talked about kind of the factors that are going to contribute to a step up, but it seems like it's going to be a notably stronger growth tailwind moving forward than it has been in the past.
Yeah, we don't, we haven't really, we, we don't really quantify the kind of like the two, the from and to, you know, where we have, we have quantified, you know, historically, you know, we thought about the business as a multiple of IP and because there's these kind of other drivers to automation investment beyond, you know, IP. We think the growth framework that we laid out, which is, you know, a higher than historical automation market growth, our ability to take share and grow faster than the market because of new capabilities and investments that are being made in the North America market and the addition of capabilities in annual recurring services and software get us to kind of the long term growth rate that we've laid out.
And then similarly in terms of the investments that you're making and maybe related to kind of North America strength. But I'm curious just what you see as the biggest differentiators for intelligent devices in your competitive landscape, why you win when you go to market.
Yeah, look, all of our teams drive to have the best possible individual products. But I think one of the biggest differentiators for us is that overall from a Rockwell perspective, what we're delivering is an architecture and system to our customers. And so we take the intelligent devices, the Logix scalable control platform based on a single design environment integrated across a common network and the ability to leverage the data and the information from all of those devices is a huge differentiator for us because the breadth of our portfolio and how we've integrated that together enables faster time to market for customers, less cost and risk in designing and implementing the systems that are much easier to operate and maintain.
So individually we want our products to have the right features and functionality and performance that's above, you know, that's market leading, but it's really how we bring all of that together and we integrate that together that I think is really valuable for customers. I think we do have and have developed and acquired some market leading technology as well in new areas. Our Independent Cart Technology is a market leading, high performance intelligent conveyance system that's being used across automotive, battery, semiconductor, food and beverage. That's really providing really highly flexible production lines for customers in those areas.
In terms of platform integration, our edge computing capability in addition to Clearpath and OTTO Motors with autonomous mobile robots and our ability to really help customers end-to-end orchestrate material flow through their plants is, I think, an important differentiator because it's not just about mobile robots, it's about how we bring that together in our overall system, help customers integrate it into their production line. That, I think, is an important differentiator for us.
I want to touch on that and sort of collaboration between segments a little bit more. But before going there, just in terms of margins and what we see from quarter to quarter and you can see some swings within all segments, I guess. But really devices we could see five or 600 basis points from one quarter to the next. Can you talk about that? I mean some of that's going to be the environment we've been in. But just in terms of what you see from one quarter to the next and mix and factors that contribute to that.
Yeah, I think the things that will drive margin quarter to quarter will, you know, largely volume will have an impact and volume leverage in any given quarter, and then second mix would from quarter to quarter have an impact on the margin performance of the business.
Anything within mix that we should be mindful of, anything like any examples of these are products within devices that are sort of the most attractive mix or these are.
We have a combination of offerings in the segment from standard stock product to more configured to order business, and you know, products will be a higher margin, configured to order be, you know, a lower margin.
Gotcha. Can you talk about devices and software and control and the collaboration that goes on between the two? We can think about them as sort of segment reporting and siloed. But just how closely you're working together in your go to market approach?
Yeah, I think it's one of the kind of unique and differentiated things about Rockwell: how we do collaborate across our various business segments. Because, as I said earlier, we're delivering an architecture and a system solution to customers. And so we partner really closely with the software and control business for the integration of our devices into the overall control architecture. I think there's two really exciting collaborations that are happening across software and control and intelligent devices. One is around our emulation and simulation capabilities. So how do we fully represent our intelligent devices and our emulation and simulation capabilities?
So when our industrial company wants to design and implement a new system or to build a new plant, now we have the ability to give them the simulation and emulation tools that they can build a full digital twin of that plant and those production lines before they ever touch a piece of hardware or before they ever break ground and start installing equipment. And so we work really closely with the software and control team to fully represent the characteristics of our smart devices in those emulation tools. Another area of collaboration that I think is really exciting is around applying AI artificial intelligence to production systems and in particular to our smart devices.
We recently launched a software application in software and control called Guardian AI, which is an anomaly detection artificial intelligence application that helps companies understand when a potential failure might occur in an industrial asset so that they can schedule maintenance and ensure that they're kind of resolving a potential issue before it exists. That software application uses information that's available on our PowerFlex variable frequency drive, monitors the electrical signals embedded in those drives to be able to look at normal operating conditions of an asset like a pump, a fan, a compressor, and then be able to look when things are getting out of range and be able to predict that an anomaly or a failure might occur.
And so it's an exciting collaboration because we're taking the know how to, to leverage artificial intelligence, build the software application, we're taking the knowledge and experience of our teams on what the information a drive can make available to that application and then the domain expertise of the team around, you know, how should assets like pumps, fans, fans, compressors operate? And so it's just a really nice example, I think, of the collaboration across the businesses.
Could you just expand on kind of the evolution of the capabilities through AI? Because we've heard about predictive maintenance for a while before we've heard about AI. Right. And we hear about, well, we can monitor sort of vibration variances or temperature variances and it's going to tell us that something's wrong. But where AI has taken this to enhance the capability?
Yeah, I think, you know, there's, we see AI as a great opportunity for productivity for customers when applying in industrial operations. We think it's important that you have the combination of AI expertise plus automation technology, data and expertise is really important when you're applying AI to a use case. We've really taken this approach of how do we apply AI in our systems and with our technology to make it easier for customers to adapt and faster for them to get to value from the application of AI. So we've been working and launching capabilities from a Copilot with our FactoryTalk Design software that helps automation designers develop and deploy automation systems more quickly by helping them create their automation projects and providing them a code assist for developing their automation projects. We've developed FactoryTalk Analytics GuardianAI applied directly to devices.
We have AI embedded in lots of Logix platform which is really about process control. And you know, a lot of the use cases around applying tighter predictive process control is when I want to improve quality, I want to improve the yield of a process, I want to get to greater output. So monitoring process variables in real time, training models and then making adjustments to the process in real time are what is driving that. And then we've applied AI in our software cloud-based software applications. So whether that's monitoring the work order history of maintenance activities on an asset to be able to predict potential risks that an asset has is applied AI. We've developed in our field software platform and then predictive scheduling and demand management demand planning in our Plex software.
And so I think you'll continue to see our approach is, you know, how do we help customers identify the right use cases, how do we help them solve their particular challenges with the application of AI and how do we productize AI by applying it in the various hardware technologies and software technologies that we have so we can make it easier for customers to get value out of it.
And so in some cases capabilities that you had, but maybe an ability to apply it in a faster, more real-time, maybe more accurate way and then in other cases new capabilities. In terms of kind of growth drivers and devices and software and control, should these segments typically grow at similar rates? I think what we've seen and I think this is distortions but if we take it kind of pre-pandemic to current, I think both segments are probably up like high teens. But software and control is going to have a tougher year than devices this year. And I think that might be Logix's destock.
It's Logix de stock, tougher comp. Logix grew 30% in 2023 and so you've got both a tougher comp and a deep stack that's happening in the Logix business. Pre-Covid the segments grew at similar rates and I think it's reasonable to expect that in the future. I think Blake did share that we expect software and control to be our highest growth segment.
As we move forward.
A ll these segments will grow and different levers for growth, for top line and for margin expansion. We talked about it at Investor Day back in November. But yeah, software control is the one that we think is going to be faster growing, longer term
okay.
And then wanted to shift to Mega Projects. There's a lot of focus on this. But you know, what, what you're seeing, how you've seen this evolve over, you know, say the last 1-2 years, the degree to which you can identify, we've got some real growth drivers out there tied to this and the degree to which you can say the wave is growing.
Yes, we've got a dedicated team that are focused on kind of the North America mega projects. You know, we're seeing a combination of, you know, projects related to government incentives, but also, you know, brownfield expansion investments, other greenfield investments for, you know, companies that are looking at their overall manufacturing network and ensuring that they've got good resiliency and good global footprint. We're seeing the pipeline growing and continuing to grow. We're engaged in a lot of opportunities. You know, we still think we're in the early innings of, you know, the mega project impact and that we'll see, you know, the, you know, the real sizable impact as we move forward in the future. But you know, we're seeing really strong development of opportunities and you know, pipeline and, and large projects.
And how does that convert from a large project timeline perspective? Because you talked about like sometimes the orders can be days or sort of weeks from sort of book to ship. But when we think about something on the scale of a $1 billion facility, what that means for when you would get those orders, when you would, when you would ship that product.
You know, we've outlined at our investor day, sorry to be, we talked about, it was an example, an illustrated example of a mega project and we chose EV battery as a good example. And so what is the, you know, an example of the timeline before the project is announced? There's a lot of work on designing digital twin digital services, working with EPCs and EPC companies. Then there's an announcement and there's. Before the groundbreaking, there's a lot of other work. Right. In different offerings and then more the longer lead times. We now have autonomous mobile robots in our Intelligent Devices business. We acquired this company, OTTO Motors Independent Cart Technology. They have longer lead times than the rest of our automation offering. As we get closer to start of production, that's when you get a lot more orders for Logix and drives and HMIs, more software.
And then we set the production. You have MRO, right? You need maintenance, repairs, operations and then you have this recurring aftermarket service. So we've kind of outlined the timeline. General timeline is going to vary by industry, is going to vary by the type of customer. Sometimes it's shorter, sometimes it's longer. But it also shows just how many more capabilities we have as a company, both on the services side, on the software, but also intelligent hardware side where we can actually have a lot more visibility. And we get pulled in much earlier in that automation life cycle of a greenfield or a large brownfield upgrade.
Tessa, I'll fit in one more in the remaining time we have. Just from sort of an M&A side of things. Anything on the portfolio where you think about key capabilities or just in the product suite where you're like organically, this is a little bit of a tougher stretch. This makes more sense from an M&A side of things and how the pipeline looks.
Yeah, you know, I think, you know, we're going to continually be looking out for where there are technologies and capabilities that would add value to our customers. Our M& A priorities are, you know, application specific technologies that we think are important for industries continuing to, you know, around annual recurring revenues, software and services. And we've had as a priority acquisitions that help us drive growth in Europe and in Asia. But I think what Blake has shared with you investors a number of times is that we've added a really nice portfolio of acquisitions from industrial compute platforms to annual recurring software, to autonomous mobile robots. And so we've added a lot of really strong capabilities to the portfolio. We think our portfolio is second to none.
We think the highest value work that we can be doing right now is really integrating all of the acquisitions that we have made and the technology. You know, that's really kind of the highest value work that we can do. So that's why we're going to focus on that here for a little while. You know, our priorities kind of remain the same as we look ahead from an acquisition perspective, but we'll really be focused on how to amplify and bring together the things that we do have.
Great, thank you very much. Really appreciate you being here.
Thank you.