Good afternoon, everyone, and welcome back to day four of Oppenheimer's 20th Annual Industrial Growth Conference. We're very happy to have back to the conference Rockwell Automation, Aijana Zellner, Head of IR and Market Strategy. We've known each other many years, and really appreciate you making the time right after earnings to come talk to us. Aijana, let's get into it. You can submit questions for those listening on the webcast, you know, via the Q&A function. We'll try to get to them if we can, but we've got a lot to get through.
I do want to start with demand, not to take away from the margin outperformance of the quarter, but we lead with demand. I think, you know, last quarter, right, management was very clear. There was no demand pull forward from tariffs. And the argument there was, well, you know, orders were globally broadly strong, right? Then we look at 2Q, and North America outperformed other regions. So we'd love to understand what kind of, did you see what gives the company confidence that there wasn't any kind of tariff-related pull forward during 2Q, or at least not a meaningful one?
Absolutely. It's a very good question. And we looked for all the data points in Q1, and we did that with the same amount of rigor, if not more, in Q2, in terms of if there were any prebuys, where would they have been? So we looked at all the obvious places and all the other spots to think and to look at that. And here's the thing.
If you had prebuys, you would have much higher inventory levels in the channel. And so we looked at our channel, and inventory has been stable to actually slightly down quarter over quarter. So there's no evidence of stocking out there. We looked at our machine builders, and we've talked about we're improving our processes of serving our machine builders, getting more data points, getting much more visibility.
It's not perfect, but based on our discussions with machine builders and the data we've reviewed, we didn't see any indications of prebuys. We looked at product offerings in terms of, let's talk about Logix. During the supply chain crisis, when we did have that excess inventory buildup, it was Logix. A lot of it was Logix. So we looked at our offerings within that. And what was interesting, first of all, Logix has been recovering for quite some time now.
Sequentially, we've been seeing some good recovery, and it continued sequentially in Q2. Within that, we have multiple different offerings. Some did have tariff-based price increases. Others didn't, and volume grew across the board, right? And so there's an underlying demand that's improving. From a regional standpoint, yes, North America was our strongest region in the quarter, and we do expect it to be our strongest performing region for the full year, but sequentially, Europe improved as well. If you look at machine builders, we talked about Italy on our Q1 earnings call, some stabilization there. In Q2, we had strong sequential growth in Italy and Germany.
And we're talking about double-digit sequential growth. And we look at machine builder performance, specifically in, you know, food and beverage and home and personal care end markets, that's been very healthy. Double-digit growth sequentially as well. And so a lot of different data points. With that said, there might have been some prebuys, and we were clear. We wanted to make sure that we shared that with you. We are monitoring it. We're looking at it. We are accounting for that.
So we are building it into our forecast for fiscal for the second half. But we didn't see specific evidence of that impacting our Q2 results. I'll tell you one more thing. We did put some additional measures in place to better detect and prevent prebuys. In fact, we did have a couple of customers who tried to prebuy in Asia in Q2, and we canceled that. We stopped that. So there are measures on monitoring the ordering activity and not allowing that if something is not driving with their previous behavior. So it's getting more rigor, giving more rigor to existing processes, putting new policies in place. But it's not perfect. And so we're looking at that as well.
Well, it's interesting because I think one of the first things I thought when the 90-day pause was announced on the April 2nd reciprocal tariffs was there'll be pull forward, right, for anything that's short cycle. And going to the last part of what you just said, you put in some measures to try to detect and prevent that. But how do we think about the potential for a pull forward during this pause, you know, impacting what you're seeing in 3Q?
Like I said, we are vigilant about it. We're monitoring it. We're detecting and preventing it. We talked about our guidance for the rest of the year contemplates what we saw in April. So we'll give an update once we get to our Q3 earnings call, but certainly very focused on looking at all these data points, making sure that we are not surprised.
Yeah, yeah. And I get the part about monitoring the distributor channel and increasing sort of pulsing surveys of the machine builders, which just kind of feels like a good, healthy operating practice no matter what, right? Whether it's related to tariffs or just navigating demand.
But also the measures we put in place in terms of these unusual orders or stocking, that applies to end users as well, not just distributors.
So the order conversion cycle has normalized, right? You know, can we kind of level set on your production flexibility to respond to demand shifts? You know, certainly there's been an effort around SKU rationalization. I'm just wondering how that interplays with production readiness.
Listen, production, first of all, yes, you're right. The conversion has normalized, and we're seeing that, so we're back to normal lead times. Basically, our orders and sales are very close to each other, as we talked about, in terms from a book-to-bill standpoint. From a production standpoint, we do have the flexibility to move things around and to have the agility, so during the supply chain crisis, we've done a lot to add resiliency to our operations and our supply chain.
That was both from a production standpoint, having redundant production sites in different parts of the world, alternative sourcing, alternative components, redesigning things, and that's serving us well, so we have the ability to move things around. Part of how we're mitigating or planning to mitigate the potential tariff costs going forward is through pricing and supply chain moves.
The supply chain moves are very much coming from that added resiliency and flexibility we have. In terms of SKU rationalization, it very much, it certainly helps with that. If you think about it, by narrowing down the number of offerings you have to the ones that really matter, that helps you with your footprint. It helps you with your inventory management. It helps you with being much more agile in what you move. You know, in an enhanced tariff environment, a cost environment, or any kind of environment where you have to make these kind of moves, you really want to be optimized. And so we continue to do that. And it's good for productivity. It's good for simplification, like I said, for our footprint. But it's a big part of that.
Yeah, I mean, it's one of the reasons, right, why 80/20 works is that, you know, you're able to focus on high-value products and product lines and liberate capacity to serve them. So that all makes sense in the context of what you're seeing today. If we think about some of the demand trends by vertical, you know, certainly e-commerce and warehouse automation has been a standout so far this year. I think we were picking up very good demand indicators at ProMat, so not surprised. Maybe parse how much of that strength is being driven by the secular end market recovery versus some of the acquisitions that you've had?
Sure. It's been really a standout end market and continues to be, and it surprised us in the quarter. It continues to be very strong, and it's really a combination of things, so e-commerce and warehouse automation, first of all, the e-commerce part of it continues to be strong. So the e-commerce players, the ecosystem that supports those players, the fulfillment centers that are being built, the continued modernization, we have a great solution there, and there's great spend there, and that's continued at a sustained level.
The warehouse automation part is more of an application across many industries than a vertical by itself, so it's upgrading existing warehouses, whether you're a traditional retailer, it could be in food and beverage, it could be in home and personal care. You have warehouses, and you have labor cost issues and labor scarcity. And so you're looking at how do you upgrade manual warehouses and do more with that. Our offerings work there. Great. Parcel companies, we talked about our work with parcel companies and global logistics companies.
They're going through cost optimization. They're reducing their headcount significantly. They're investing in automation to be able to drive the improvements and be more profitable. And so we see very good spend there. And then finally, we do have this growth with data centers. It's a very small part of the business. This is why I'm talking about it last in terms of the order, but it captures people's imagination.
But it's great business. Our exposure here is through our acquisition of CUBIC. So really on the power distribution side, we participate in data centers. And so that's contributing nicely as well. All of that is what led us to increase our guide for the full year from high single-digit year-over-year growth to 45% growth year-over-year.
Okay. Well, we don't want everyone to hear. Okay, Rockwell's a data center play, and tell you with those trends. But it's good to know that that's a source of growth.
It's a small piece, but it's growing nicely. Yes.
What about by geography? You know, I think you mentioned North America probably in a state of strength this year. But you've talked about leveraging your share in North America to kind of gain share with the MEA machine builders that are selling into the U.S. market. Maybe talk to us about how those efforts are progressing and to the extent to which trade tensions might impact MEA and APAC share dynamics.
Absolutely. We're continuing to work with the leading machine builders, and we talked about the European machine builders who are working on cutting-edge equipment, and whether it's food and beverage, life sciences, automotive, tons of different industries. There's a reason why they want to work with Rockwell, given our technology differentiation, our footprint in the U.S., customer access, install base, and that value proposition hasn't changed.
I mean, tariffs, of course, introduce more complexity, so, you know, we're working with these machine builders. They need to figure out their footprint. How can they address the tariff headwinds? A lot of them have North America sites, U.S. sites, so they're able to kind of mitigate some of these headwinds, but in general, it's a great relationship, and the key is for us to help each other grow in our own respective strong markets.
We see continued growth from a technology standpoint. Blake talked about, on our earnings call yesterday, continued sharp adoption of our new offerings. A lot of them is by machine builders. They're very technology-forward. It's whether FactoryTalk Optix, it's whether our Armor PowerFlex. A lot of new offerings that we've just launched more recently are getting adopted. What we're doing with FactoryTalk Design Studio and our design and control portfolio.
Between all of that, we see an opportunity, continued opportunity to work together. In terms of the trade dynamic, I would say, yeah, we still see it as an opportunity. It's just near-term challenges. On the Asia-Pacific one, I would just say that from a company standpoint, our cancellations were very low in the quarter, in our usual low historical level, low single-digit. But we did see a pickup in cancellations in China with Chinese SOEs. And so it's a small part of our business, but there might be some of that trade dynamic there that we've observed. But again, very small impact to our business.
I think, you know, you called out some of the impacts of tariff uncertainty on demand on the call yesterday. You know, it's energy, automotive, some of the verticals. We call that project delays. Give us a little bit of additional color on how much of that push-out was in backlog versus kind of what you're expecting within the pipeline, you know, how much confidence you have in the project's shipping later this year.
Sure. Yeah. When we talk about these delays, it's really more what was in our pipeline. So it's not always something in our backlog and then it got canceled or removed. It's really more, this is what we're working together on our roadmaps and our plans with our customers. And it's just, it's being delayed. And the reasons, and Blake talked about some of the key reasons why these customers are delaying right now. One is just uncertainty on cost with tariffs.
You know, what's in, what's out, how is it going to impact their cost structure? And then the top line for them, what does it do to end demand from their customers, right? And so, you know, before committing to these CapEx projects, what is my top line going to look like? So they're looking for some of that clarity and certainty. You know, we heard different reasons, terms and conditions with tariffs, rate environment, just, you know, commodity pricing. Commodity prices, you know, clearly is a big consideration for a lot of process customers.
So we're seeing they're really focused on profitability, not just increasing their production. And so there's a lot of kind of that wait and see. So yeah, so this is what we observed. Automotive, clearly, tariff uncertainty is a big piece for the cost that I just talked about. You know, GM CEO talked about it takes a long time to build a greenfield. In the meantime, you know, they'll be increasing their production in the U.S. That's a great thing for companies like us. We have strong MRO in automotive. So if there's any kind of production increase in the U.S., that's good for us. But clearly, it's challenging when there's a lot of delays and pauses on big CapEx projects.
Yeah, and I also, I mean, like we can link some of that to tariffs. We used to talk, you know, some quarters and years ago about, you know, some of the policy or industrial policy stimulus efforts and how they could be kind of long-term tailwinds. You know, is there uncertainty around that also impacting, you know, some of the opportunities that, yeah.
For sure. I mean, if you look at CHIPS and Science Act, like there's still a lot of uncertainty about funding for semiconductors. So there's uncertainty on many levels. If you look at renewables, you know, within energy, we have a renewables business. And so there's still some uncertainty. Now, we do have very good business with Occidental on direct air capture. So we're continuing to invest in that. But there are a lot of areas where we'd like to get more certainty.
Yeah. I think one of the interesting things on the flip side is you've seen efforts from the new administration actually to accelerate and streamline permitting and, you know, get more domestic energy production built more quickly. You know, so there are some demand-positive things happening, you know, for your process business as well, as we see it.
Absolutely.
Okay. Let's talk a little bit about supply chain and pricing. You know, I think obviously the USMCA exemption obviously takes some of the more acute tariff pressures off for your U.S. sales. You mentioned the $125 million in tariff cost impacts. And as you seek to mitigate them, what are you using as your base case scenario for supply chain actions? Assuming like current effective rates or a return to 4-2 levels, you know, any variability around USMCA renegotiation?
Sure. So first of all, and I think you know this, you know, the vast majority of our stuff is USMCA compliant. The $125 million tariff costs in the second half of fiscal 2025, that's based on what's currently enacted. So in other words, we're not assuming the removal of the pause, right? So it's currently enacted. There's a lot of uncertainty there. The $125 million, we're fully prepared to mitigate that cost through pricing and supply chain moves.
We talked about EPS neutral in each quarter. And so we continue that. From a pricing standpoint, there are two elements. One is there's our regular annual price adjustment. And we actually saw much higher price in our fiscal Q2. We actually pulled forward our annual price adjustment to earlier in the year because we really wanted to kind of clear the deck for our customers, the distributors.
This is our annual adjustment, and that kind of it's there. Then we can talk about all these tariff-based prices, and we can track them separately so we can flex up and flex down, and we can remove them if needed and have that kind of flexibility. What's embedded in our organic top line guide is really just the price from our annual price adjustment. As we talked, you know, if tariffs persist, then we would have an upward pressure to our top line from price increases coming from tariff-based pricing.
That all makes sense in terms of how you framed up the guide. Can you speak to what pricing actions or tariff-related pricing actions you might already be taking, you know, assuming there's no change or will be implementing and what the timeframe on that might be?
I mean, we've been working with our customers and distributors very closely throughout this entire process, right? Through all of the changes, lots of communications. So we've also, during the supply chain crisis, we've really enhanced our pricing mechanism. So we are able to realize price real-time. So we can have price realization the moment we have our list prices.
And so there's no delay or lag. We had some tariff-based pricing in Q2. It was very small, very minimal. So out of the three points of price, it would just be very, very tiny impact. And we had small tariff costs. And so that was offset. So we are prepared to. We are prepared to do that. And we have very high confidence in achieving that, like I said, through pricing and supply chain actions.
Yeah. And I think it's interesting because you'd also talked about repricing, I think it was like 45,000 SKUs as part of your rationalization effort. Did that repricing take place as part of the adjustments? Is that a separate effort from this and tariffs? I'm just trying to be sensitive to the nuances between these different pricing initiatives.
No, it's a great example of us kind of demand shaping, right? So, as we mentioned, we've rationalized 36,000 SKUs in the first half already, and then 45,000 is where we're taking other action, including pricing, where we are increasing price and doing that, and so it's optimizing and it's driving that. So, it's part of our holistic price optimization and portfolio optimization, and it leads to simplification of our processes. It's very much all connected. Yeah.
Appreciate that. I want to talk a little bit about margins since it seems like that was an important part of what happened in yesterday's stock response. Clearly, the self-help benefits exceeded street expectations. And it's a great proof point for the strategy. I think that $0.65 of net benefit you called out works out to something like $350 million or so annualized gain. Now that we're expecting that on a full-year basis, obviously, but can we just get a little bit more specific on what benefits they were sort of pulled forward, realized in the quarter, and how that was accomplished?
Sure. And you remember this. We started this structural productivity journey in the second half of last year where we started to take out SG&A, right, headcount. So we realized $110 million of savings in the second half of fiscal 2024. Then we came into fiscal 2025. So we were expecting $250 million of year-over-year improvement. And originally, we were expecting the first half of the year roughly to be really more of an SG&A improvement year-over-year. It's a carryover.
And then the second half, we would have a lot of these projects in the COGS area, COGS productivity, direct material sourcing, indirect sourcing, efficiencies moving from air freight to ocean and SKU rationalization, all those things. So that was kind of the framework. As we got into this year, so we continued to execute on SG&A. Then we started seeing some of the benefits from the COGS projects realizing earlier than we expected through good execution, you know, faster yield.
So if you think about us renegotiating or moving to different suppliers on direct materials, whether it's consolidating certain vendors and from an indirect sourcing, it's logistics getting realizing more savings sooner, efficiency in our factories, so less overtime, better quality, things like that. So that's where we're seeing the improvement versus our forecast. So through the first half of the year, we realized $155 million. Originally, we thought it would be maybe roughly $120 million in the first half, right? And so as we look at the second half of the year, you know, we haven't changed. So we do think we will exceed the $250 million, but we actually haven't changed that in our model.
We're not counting on anything more. We think the teams are executing very well. There are lots of different projects in there to continue to do that. So if you look at $250 million, that means you still have $95 million of year-over-year productivity improvement in the second half. And that's on top of that tough comp of $110 million we already had last year from SG&A headcount reductions. And so the team is doing a great job. There's a lot of projects in play already and a lot of projects that are being evaluated. We're not done looking for more opportunities to expand our margins, but we just didn't provide any updated numbers.
Yeah. I think some of the answer to this question may be partly related to the math you just did, but I think management outlined expectations for the low 30s incrementals, right, on low single-digit sequential sales recovery in 3Q. Why wouldn't there be more of a carryover from 2Q in terms of self-help benefits to 3Q or the back half generally?
There is a sequential improvement, but because we pulled forward some of that into Q2, it's not as steep of an increase sequentially. So instead of tens of millions, it's more millions, as Christian Rothe characterized it, in terms of the continued productivity. But there'll be continued productivity both in Q3 and Q4. So we think, yeah, on low single-digit sequential sales growth, that makes sense. And then, you know, in Q4, we talked about higher sequential sales growth, and you'll see a bigger sequential improvement in margins. That's going to be partially offset by some of the unfavorable mix.
Right, because you have more or less cycle service.
That's right.
Yeah. Okay. Okay. So lots of puts and takes around margin trajectory, you know, for the year, though better, right, versus the prior guide. I think you still have like an earnout comp that you're lapping from last year in the second half, and you have restructuring costs as well as the benefits. You have incentive comp timing. When we look at the next year, though, I think there's potentially a far cleaner setup for margin expansion.
You know, you'll have the full year benefits of your restructuring, your pricing actions, you know, some of these productivity investments, and clear path, hopefully turning EPS accretive. So I guess that's a windup of saying any additional color you would offer on puts and takes for margins as we kind of start looking at next year.
Listen, the team has done a great job of executing these last few quarters. They're very focused, laser-focused on executing in Q3 and Q4 and getting the results that we just outlined yesterday, so we are focusing on the foundation of fiscal 2026. All the work we're doing, all these projects we're driving from a structural standpoint and improving our positioning undoubtedly should position us very well, but we're not quite prepared to talk about all of those puts and takes for next year, but I think we're laying down a very good foundation.
Yeah. Last thing related to margins is really around the portfolio. You know, you've got ARR at 10% now of revenue, right, and growing, and you still have MRO at a third of sales, so, you know, if we think about the mix of kind of recurring and maintenance being, you know, modestly higher today versus in the past, does that have any bearing on, you know, the margin profile and really incrementals and decrementals?
Oh, for sure. I mean, if you look at, I mean, ARR has grown quite a bit, both organically and inorganically. So, you know, it was like 3% or 4% of total revenue back in 2008, 2009. You know, if you look at fiscal 2024, for us, was a challenging year, right? But if you look at the last time our products were down that much was in 2009, and EPS was down a lot more than it was in fiscal 2024. A big part of it is the more resilient model. ARR is part of that.
That's been growing double digits up until the current quarter, but it's been growing good growth, seeing good growth, and you know, MRO is there. We're diversifying our end markets. We are adding more ways to win, right? More technologies, hardware, software, services. What we're doing with our structural productivity is going to have a big impact on our incrementals, I think, and our opportunity to improve that. But, you know, we think we're much more resilient. We'll continue to do that going forward, for sure.
You know, I think the last part of the call, we should really focus on the portfolio, you know, because when we think about the ways in which Rockwell has to win and how that's expanded over the years, I mean, that's a critical part of understanding the value proposition of the company and the stock in our view. So, you know, I go back to Automation Fair, where there was a lot of emphasis placed on evolving towards a more software-defined portfolio and more AI capabilities. Let me talk a little bit about which of those capabilities you're seeing garnering the most interest, and let's also talk about the partnerships with NVIDIA and Microsoft and where those are helping to drive adoption.
Sure. If you look at that in terms of AI capabilities and what's capturing kind of the imagination of our customers and what's gaining a lot of traction, it's the AI capabilities that can really enhance the behavior and the performance of the automation system itself, right? So AI, it's like another discipline within the automation system. And artificial intelligence, I mean, it's helping quite a bit. Think about an autonomous robot or autonomous vehicle, right? It's a great example where you have AI together with control systems driving these outcomes.
And if you look at when we talked about at our investor day, we talked about our software-defined automation portfolio, right? Software-defined and how the way customers design and deploy their automation systems is very different under this software-defined automation, right? And so engineers, they can start with creating digital twins of production processes.
Production lines could be whole factory, right? So they create a digital twin before any kind of commissioning, and then they use those digital twins as those training gyms for AI agents, and AI agents can control, they can optimize equipment processes, get better as they get more mature, then these AI agents can be deployed into the PLC code, and they can run the factory real-time, but that's the vision of software-defined, where you can do so much in the digital world, and then you can deploy it into the real world seamlessly, and to do that, you mentioned NVIDIA, Microsoft. The way to create this vision and bring it to life, you need to have distributed compute, and you need to have cloud infrastructure.
And so both NVIDIA and Microsoft are very big, very important partners for us for those respective areas to be able to drive outcomes for customers at scale. Because clearly, we have that PLC domain expertise. We have the code. We have the design simulation expertise and software. But to be able to bring that together with scale, together with cloud infrastructure is what is going to really accelerate it.
I think one piece that kind of stuck with us was the ability of generative AI to lower the barrier to entry on PLC programming. So, you know, initial data points you can offer on the impact of that on deployment times or, you know.
Oh, absolutely. And you know this, we were the first ones to actually launch and provide a cloud-native design environment, automation design environments. So we're well positioned to actually provide this capability from a GenAI standpoint. And we've launched, we talked about our FactoryTalk Design Studio Copilot. So it's a GenAI, it's a copilot. It's basically taking natural language instructions, and it can generate PLC code.
Importantly, it can take the existing code from many years ago, and it can explain it to you. It can document it. It can optimize it. So that can really reduce the timeline to deploy or to design and to actually put together a system for up to 30%, depending on the instance. So it's tangible, and it's really, it's helping how quickly customers can start up their operations. And so we have many. Blake talked about sharp adoption, increased adoption of newer offerings on our earnings call yesterday. This is one of them that we have a lot of customers who are using it right now, and it's speeding up their time to value.
I also think about deploying Edge AI as a really good way to accelerate preventative maintenance adoption. You know, that's, I think, overall, a lot of our customers are hearing that as like a clear customer-facing value proposition, right? Because they can see what's going on, right? So how do we think about the opportunity and the pace of deployment there?
Oh, absolutely. And you might have seen that when we had our tours at the Automation Fair. So, drives. We have drives within our intelligent devices. These drives, they power motors, and motors, they operate a bunch of equipment on the plant floor. So there's a lot of data. Just think about all the motor current data that's flowing through our drives for years.
There's a lot of data you can have. And so you can use these drives that our customers already had them installed. And so these drives can generate all the data and provide this predictive maintenance based on previous things. If something is an anomaly or the motor current is showing something that it could be a fault or some kind of a feature, that's what the drives are there for. And so GuardianAI, we talked about AI.
It's a perfect solution for that. And the beauty of it is customers don't need to do, they don't need to put in a new sensor. Drives are kind of a sensor already. So a lot of customers in the industrial world are very pragmatic. They don't want to have to add new things and test new things and integrate new things if they don't need to. And so the ability to use our existing capabilities and hardware overlay with software and have it at the edge, that's been very compelling. And we talked about other opportunities, like whether it's Logix AI or Vision AI, where you do quality inspection, you're using existing infrastructure, existing equipment with software to drive outcomes. And so we're seeing a lot of uptake across many customers.
Very interesting. I think there's sort of a closing question here. Just the implication for your legacy products and services is GenAI and machine learning capabilities accelerate. You know, what kind of integration or common architecture investments might the company need to make?
Oh, yeah, and that's exactly kind of, it's a perfect segue from a previous point. Customers in our environment, they don't want to rip and replace something just so they can have something AI-enabled, right? So if we're able to integrate what we have and leverage what they already have, the PLCs from us, drives, HMI, and then having this edge-enabled extension and software that can do that work, that's a great, that's a compelling proposition for them, and so we're investing in how do those disconnect and the software capabilities to be able to run a lot of those kind of AI workloads at the edge is what we'll continue to invest in.
Well, you know, it's something that we always appreciate, you know, from one Automation Fair and all the events in between to the next year, just seeing how the portfolio evolves and the capabilities and, you know, continue to really appreciate, you know, how you take each sort of technology iteration and really deploy it to make, you know, factories and manufacturing much smarter. John, thank you so much for a great discussion. We look forward to more of the future. We hope everyone has a great rest of their day at the conference. If you have any follow-up questions, you know where to reach us. Thank you.
Thank you.