Fortive Corporation (FTV) Earnings Call Transcript & Summary

Excited to have Fortive with us today. We've got Chuck McLaughlin with us. Chuck has been in the role of Senior Vice President and CFO of Fortive since the company has split from Danaher. In the past, he's worked as a Principal at HPE, CFO at the Diagnostics Group of Danaher and a long industrious career.

So I think the way I want to start, Chuck, is maybe talk about Fortive. So some people in the room might not know Fortive that well. So maybe talk about what makes Fortive unique? Why is the Fortive Business System as good as it is? What does it do for you guys?

Well, Fortive Business System started really with the Danaher Business System, which really came from the Toyota Production System, which first started on the factory floor with lean manufacturing. But that was probably 20 years ago or probably 25 years ago. And what's happened since is we've moved into other elements and tools, and it's a set of tools around that's fundamentally focused on continuous improvement. And it's moved off the factory floor and into more processes and focus on -- everything is your customer, whether even if you're in the accounting group or the accounts payable group and how you make absolutely everything as a process more efficient and taking waste out of the system and making a better experience for you and your customers. And then as we progress through time, we added elements. As we acquired companies, it's a learning and a growing system. So what it was 25 years ago is a fraction of what it is today at Danaher, at Fortive and what it will be going forward in the next 5 years because we acquire companies. We take best practices. We share them. We build tools. Focusing on growth and innovation are probably the 2 biggest things now. So really it just keeps growing on how we can make businesses better and with the idea of continuous improvement on every process and customer fulfillment.

Chuck, how, if at all, did you guys evolve FBS from DBS? Was there any changes that you made or...

Well, certainly not immediately. But as I noted, DBS had been evolving and has been evolving and will continue to evolve. And for us, it's got more of a focus around probably the innovation, especially around some software innovation is what we've been changing a little bit, but it's still 95% as it was. I don't think we've subtracted any tools out of the tool set, but we continue to add to it. And the way the system works is like there's quite a number of tools in it, but there's no one company that uses all the tools or even of all the tools that they do use in the tool set, they're not using them all the time. It's really specific to what problem they're trying to solve.

So maybe we'll step back and you can level set us of where we are sort of sitting here in Q1. You were one of the few companies that talked specifically about coronavirus impact in Q1. So maybe update us on sort of where you are. You've continued to have strong results in IT. PI has been under a little bit of pressure, but margins were a lot better in Q4. So maybe update us on what you're seeing out there in China and anything else that you can talk about like that.

Sure. First, with the coronavirus. I mean it's obviously a tough situation. Our first priority is to make sure that our employees are safe and that we're not trying to rush back our production that puts anyone at risk. And so we're monitoring that very carefully. And what we did when we put our guide out, we took $0.02 off the top line and that it moved us from relatively flat into a low single-digit decline was our best estimate at that time. What's happened since then, we get daily reports in how our factories came back from the Chinese New Year, which had been extended by a week, and how we're ramping up. And last week, it ramped up very consistent with what we expected, which is about half of the capacity. And now when we come out of Chinese New Year, it doesn't ramp up to 100% anyway. But last week was about 40%, 50% capacity. All of our factories are open. And now I think, yesterday, I saw it crest over the 60% capacity mark. That's largely as we expected, so nothing new there. The thing that we really are trying to understand is what our supply chains look like and delivery. And while we are in constant contact with our vendors, I think this is a evolving situation, and we haven't yet got to the point where we would expect constraints to be limiting our build beyond what we'd already expected. So there's no change from our point of view. But with 5 weeks left to go in the quarter, I guess, 5 weeks of ending Q1 and this one particularly quite a bit. Having said that, however this plays out, we see it largely as timing between now and the rest of the year. We don't see a scenario that this causes us to lose market share. And at this point, our bookings remain very consistent and strong. It's really more of the plant capacity.

So does it help you? I mean you were moving supply chain because of tariff to some extent last year. So has that helped you kind of avoid to some extent?

Certainly, we did. And you mentioned last year, we were hit with the full force of tariffs. And it took us into the fourth quarter to be able to fully offset that with the supply chain moves and then the price, which we did. We had a strong fourth quarter there. So I think that the supply chain moves likely will have made a tough situation a little bit better. And as we can tell, from whatever it would be, but that doesn't mean we certainly didn't exit all of our production or supply chain from China. And therefore, there'll still definitely be an impact, and that's what you saw us trying to reflect in our Q1 guidance.

So I just want to hit geography just in 2 ways. One is, you have a big European business that seemed a bit weaker as the year went on, to some extent, or at least it was in Q4. But you also have a big North American business, and that seemed a bit stronger, at least than you expected, is still weak, but like a little bit better. And I think people are watching pretty closely for businesses like Fluke that go through the channel to see if there's inflections and stuff. So maybe talk about those 2 particular markets and what your thinking is for 2020 around those things.

Yes. I think that a couple of things. First, talking about Western Europe is, it definitely slowed as we went through the year but not differently, especially as we got into the third quarter and started to see that slowing. It took a step-down. How we expected Europe to play out for the fourth quarter. I think as we said on the call, that played out pretty much exactly as we thought it would. So I think that's positive, but it's still down. But it's not accelerating and getting worse, but that's not the same as actual growth. But stability is what we expected to see, and that is what we saw, but at a lower rate from the year before. In North America, I think North America was positive but not much more. There's an EMV tailwind that's going on, has been and will continue at Gilbarco. That's probably what you saw when you see North America was positive. When you pull that out, I think, and you look on the PI side, we saw a slowing in Q4 in North America. But again, not different than we expected to see and nominally better for PI revenue overall but not in a material way. So Q3, we saw the step-down and slowdown. We had an idea of what Q4 would look like. That came in very close in all geographies. And in Q1, before the coronavirus, we had expected that we'd see more of the same, but the only difference is being year-on-year compare. But when you look at normal seasonality, the markets aren't getting worse than we thought. And from Q3, Q4, Q1, our question coming into the year and what we said, I think, in our third quarter call as well is, how far into 2020 will this slowdown be. And we had confidence that, unfortunately, it would be in Q1. And I would expect into Q2. But if it were to turn, it's going to be sometime between Q2 and Q3 is what I would guess. And that's before the impact of this coronavirus. Now you got this overlay that could have something moving out of Q1 into Q2 and maybe Q3, but depending on that. We're waiting to learn on that.

Just one more question on Fluke. Like how do you look at it from the context of, it's got an industrial overlay, but then it's got some energy exposure. Obviously, you've been adding digital to it. So like how do you guys look at it? Do you parse it out like that, where you're like, well, if our energy part stabilizes, we'll see that. Like how do you look at Fluke as a business?

We know that we sell into those end markets, but we don't really talk about it specifically that way. We think of more of the facilities we're in, whether it's office buildings or factories and think about it that way. From an energy, especially if you're talking oil and gas kind of things, we don't have much exposure directly there. It's more of a second derivative. Some of our customers have that. So it's not unimpactful, but it's not really how we've felt the need to track it. And as a major driver, that is good predictor of growth.

Got it. So let me step back and then ask you about margin in one sense. And that is, you guide to 50 basis points of margin improvement in 2020 and low single-digit core organic, right? And so when I think about it, that's sort of Fortive, 50 basis points usually. And I think you were asked this in some ways on the call, but I'll ask it to you this way, right? You have a significant restructuring that you announced. And so you should have some tailwind from that. Price versus cost we just talked about, right? It kind of switched a little bit more tailwind. So we're all trying to figure out if it's conservatism or not, I guess. And so I'd just ask you, are there other headwinds that we're not thinking about on the business?

I think in any year, you did say 50 basis points, well, that's Fortive, and I would agree with you. But what we say is, what we've been saying is, it's 50 basis points of operating margin expansion through the cycle. So when you get to a down cycle, I wouldn't expect 50 basis points. Doesn't mean it's necessarily 0, but it's definitely when it's down, it's going to be less. And right now in PI, we're seeing negative margins or negative growth in Q1 and Q2 and not growth for really flat for the year. So if that in isolation, what would that mean? Would it mean 50 basis points? No, it wouldn't. That wouldn't be consistent through the cycles. However, we did do the restructuring to protect and deliver for our shareholders and said that, look, we needed to ensure that we would do that, but that doesn't mean we were trying to -- if we thought we could deliver 50 basis points in PI, for example, in earnings growth, not sure that, that would have been the call to do restructuring. The restructuring is so that we can deliver 50 in there.

Got it. Got it. No, that's helpful. And then you obviously made a bunch of acquisitions but a bigger one in ASP. And so you basically had it for almost a year now. So like, if we step back, there was some confusion at first, right, with the transition service agreements. There was growth, whether it's mid-single digits or low single digits. Maybe assess where we are now in this business and the improvements, tell us about the improvements you've been making to the business. We know about the TSA rollout in 2020, but it seems like it's a good source of upside if you think about over the next couple of years if you do this right.

Well, we agree. I think that we're very excited about the business. We've just completed our third quarter that we've had it under our wing. And I think we're helpful to that business and as we get FBS deployed in that business. But it really hasn't been that long and it's not fully under our -- we're still working with the TSAs, which means at the beginning, 1/3 of the revenue was through J&J working as a distributor, and you have less direct control and understanding and ability to change things like logistics. Those things are going to come in the future and I think are going to be great opportunities for us. Having said that, what we guided to was, oh, that we thought it'd have a $0.20 earnings per share impact net of the interest payments this year, and we ended up at $0.22. So we feel like we're right on track with what we communicated. And I think that when we look at how the business is growing at the end markets, I think it's a little confusing because in 2017, the year before we bought it or struck the deal, didn't grow at all. That was the main question. But we know the market's growing mid-single digit. And then 2018, as we got ready for the separation, there's some increase there. And what we're trying to assess right now is, was that real growth or was there some stock up in inventory? And they started talking about a mid-single-digit growth. And then what we're seeing -- so we're looking at a 2-year stack of 3% growth right now and accelerate. I mean 3% is lower than mid-single at the market, but it's a lot more than the flat. And I think that as we move through time and we get everything off the TSAs, which will get to, with the first half of this year lapped and then that's not just when we'll start. Of course, we're starting now. But these things take time for us to move forward. But we think we're accelerating as we speak. And we're excited about the numbers that we'll be posting here going forward and especially when we get out the TSAs, where we've got the high-growth markets in there, that's going to help us. Also very excited about Censis coming to the business and how that's going to blend in with our connected workflow. So a lot of good things there, but we're at the beginning, not even the middle innings of that business.

Yes. And just out of curiosity, does coronavirus have any impact on that particular business, maybe even good in the sense of that is or...

So we'll have to see. I think that we did talk to them about what maybe happened in the last big outbreak in early 2000. And there's some other things that they sell that there could be upside. But mostly, we think this was going to be timing here. I think that there's placements that will likely not happen, but they're not big revenue movers. And then certainly, it's hard for us to see a scenario that we're going to lose market share here due to this. I don't think anybody is. Safety is the #1 thing for the employees. And if it takes a little longer, and -- we'd expect the revenue later in the year, and we'll deal with that.

So Chuck, because you're coming off of sort of a wave of acquisitions, like I kind of think given the FBS, that system, you tend to have increased investment and new product launches that happened maybe a year or 2 years after you close on these things. So I think you did say that new product launches could help you in the second half of this year. Maybe you could give us a little more detail on sort of what that means. Is that a decent uptick in the overall business that could help with organic growth in the second half of the year?

Well, I think there's a number of things. First of all, there are some opportunities where we accelerated some spend and that's helped grow the business. And there are some really good new products. I know at ASP, they've got some products coming out, but those are 2 or 3 years in the making. And so it wasn't anything that has happened in the last 9 months that we've kicked off. It's always on diligence. And we're excited about how that's going to play out. But what I think is really going to help the growth rate is when you think about the significant deployment of capital since we split, we've got $2 billion worth of acquired revenues over the last 3 years. And when you look at what it's growing at the end markets, I think it's growing at certainly high mid-single digits and moving towards high single digits. And I think that as those things roll into core and you blend in what that means for the business, I think that we will have taken the PI business from a GDP, a GDP-plus kind of business into mid-single-digit territory. And we'll probably get to an Analyst Day where we'll weigh that out a little bit more completely, but we like where we're going with that and the impact that just the businesses and how well they're growing in total and what that will mean when you blend it in with the rest of the business.

So I want to open up to the audience in a second, but let me ask you specifically about new products for Tektronix for just one second, in the sense that you seem to bring it up more often that there's product cycles at Tektronix. Like, how do we think about Tektronix over the next couple of years? Because, as you know, it's been pretty cyclical so can it stabilize based on new product cycle even?

Well, I think that there's a couple of things going on at Tek. One, we started adding service businesses. It is, I'd say, now our most cyclical business. That's not wrong. But that doesn't mean it's not less cyclical than it's ever been at any point in its career. Last year, the sale of the video business to put it into PE fund and put it together with another video business to make that scale, I think it was a right strategic move. And it's going to help Tek be less cyclical. Kind of a perfect storm, though, for Tek, unfortunately, in 2019 with exiting that video business due to the tariffs, Huawei, that's a government regulation that we'll comply with and are complying with. That's unfortunate that it hits our most cyclical business and that's tough. And also, then we're also having some outside tough compares in the Keithley business, which isn't really oscilloscopes that's in that Tek business that had a big run there relative to the year before. So a lot of things happened that came up in 2019 that I wouldn't expect to happen in 2020. We've talked a lot about the platform that we write out with the 5 series and 6 series and now more recently, the 3 and 4 series. So even though Tek in total has got some things causing them to move into negative territory, that portion of 3, 4 series off to good start is driving growth in the platform, and we like our positioning there. And I think there's going to be better, more stable days ahead for Tek. Certainly, 2019, after, I think, 2 or 3 really good years, that was in 2019, but I think I like what they're doing and where we're going there.

I think before I turn it over to the audience, I should ask you, like semicon seemed to turn a little bit in Gems, I guess it is, but not really in Tek, if you may. Why is that?