Fortive Corporation (FTV) Earnings Call Transcript & Summary

Good morning. And welcome to the Wolfe Research Global Transportation & Industrials Conference. This is the Fortive fireside chat hosted by Wolfe's Managing Director covering multi-industry, Nigel Coe. [Operator Instructions] And now I hand the call over to Nigel.

Thanks, Tatiana. Good morning. And thanks for joining us this morning. I'm very, very pleased to be hosting Jim Lico, President and CEO of Fortive; and Chuck McLaughlin, SVP and CFO. Gents, thanks for your time. Look, I think everyone knows by now that Fortive was the spin-off from Danaher. That was back in 2016. Jim has been leading the organization through a pretty significant portfolio transformation. The next step of that transformation is the separation of Vontier when market conditions allow. So the format of this session is going to be Q&A. I will direct the questions, but there is an opportunity for you to ask questions. So if you do have anything on your minds, please type the question into the text box or e-mail us at [email protected], and we'll take 2 or 3 questions, if you have any.

So Jim, thanks again for being here. Chuck, you, too. Maybe a good place to start would be pick of the pattern from the earnings back in early May. It was only a few weeks ago, but a lot out there is changing. So I'd love to just hear right now what's on top of your minds.

Yes. Thanks, Nigel, and it's good to be with everybody. Anything that we can do that feels a little bit more normal these days is obviously a good step forward. So Nigel, given that we only had the earnings call 2.5 weeks ago and April was really incorporated into how we were thinking about the quarter, we've mentioned in -- or we obviously laid out a down sort of 20% to 25% second quarter. And I think given April was incorporated into those thoughts and we really aren't that far away from when we made those thoughts, I think we're very much in that same place today.

Okay. Yes. And given the kind of the reopening of activity that we're seeing with some of the OEM customers and China continuing to -- seeing this -- continuing to improve, I mean, how do you characterize kind of the total conversation with your customers, your sales reps, et cetera, out there in field?

Yes. We've been in -- we've certainly been in constant contact, as we said in the earnings call, relative to the discussions with customers, and we've certainly seen -- while we've seen from customers, by and large -- when we think about China, China is coming back slowly but surely on the back of a number of things. The economy opening back up, the elective surgery numbers starting to come back certainly are some of the key things that we continue to watch. So while not at pre-COVID levels, they continue to improve a little bit. If we take a little bit broader step back around the world, as you said, we're starting to see things open up but at a very -- at a pace probably as we described in the earnings call, which we knew would be -- would not be one of those things that the switch got flipped and everything came back to where we thought it would be. So I think it's playing out the way we thought. A couple of things. Obviously, in our earnings call, Nigel, you know, we laid out -- while we don't know the timing of how things would play out, we certainly called out sort of these various groups of -- we grouped our portfolio into 4 different places, and in that, we described how we thought things would play out. And maybe the one to describe would be like advanced sterilization products where it's very much an elective procedure-driven business. And so as those elective procedures start to come back as people start to get back into doctors' offices and hospitals and things like that, things would turn on. And at Gilbarco, where we would start to see permitting and construction start to come back on, and certainly, we're starting to see that but very early days. As we know, not even every state has turned on at this point. I think by Memorial Day, we'll probably see some version of that in every state in the U.S. and in the countries in Europe, and we just need to continue to see that play out. And obviously, that was incorporated in some of the discussions we had obviously back a few weeks ago.

Okay. And actually, you hit on 2 areas I wanted to just dig into a little bit more. I mean when you talk about elective procedures, I don't think anyone really likes to have a knee surgery or a hip replacement, but how much can that get this purchase thing? I mean what would you hear from your leaders at ASP? Do you think that what's been lost in the first half will come through in the second half of 2020? Or is that more going to be more multiyear recovery in your opinion?

Yes. It's funny, I have a relative who had a knee replacement surgery today, which, in a weird way, was good news. So I think what we're seeing is these procedures are starting, but of course, that won't happen right away. Hospitals have changed a number of the processes. We had -- Chuck and I had a review with the ASP business last Thursday, as an example. We got really deep into what they're seeing. They're really looking at a state-by-state, hospital-by-hospital kind of situation to try to understand how those things will occur, and that's really what's happening. So the procedures are getting turned on. But of course, you know that there's only so much capacity that exists in surgeons, if it's a surgery or in doctors, so inevitably, that can't all come back in a short period of time. We certainly have seen a number of things through various proxies and things like that about how things will come back. But I think at the end of the day, there's only so much capacity to get these things back. We know that patients are going to want to turn these things back on. We know the cases of heart disease and stroke and those kinds of things have all been down significantly as people don't go to the -- go into medical facilities. And all of that will get turned on, and care will start to occur at a more rapid pace. But there's only so much capacity that exists, and so in the case of ASP, we think that's a more muted turn on here over -- in the course of the month to come, if you will.

Okay. Great. And then on Gilbarco Veeder-Root, there's so much -- so many moving pieces here. We've got miles driven down heavily. We've got -- the EMV deadline has been pushed out now to April 2021. We've got the China, the whole double-walled tank headwinds, [ lots of them, heaps ]. How do you think about that business for this year? I mean I think one of your competitors is on record saying we might see some growth -- they might see some growth in their retail fueling business. Is that even on the cards here at this point?

Yes. I think what we're already seeing now as we thought in terms of seeing construction start to occur. We're seeing customers now with their plans. I think the -- you mentioned the China double-walled situation, which is a little bit of a tougher comp for us in China. China hasn't turned on maybe as fast as we -- China isn't turning on as fast as maybe the U.S. will because of the EMV dynamic. So just as an example, you might see a slower ramp in places like China and India. But in North America, you probably see a faster comeback just because of EMV and the need to get things in the ground. I think, Nigel, at the end of the day, as you know, the pushout of the regulatory deadline into 2021 probably impacts smaller retailers more than larger retailers. I think the larger retailers, as we know, and maybe more of our business is with those folks, will continue to invest at a rate that probably is more predictable. The smaller-network retailers will delay a little bit, and that'll mute the curve, if you will, and will stretch into 2021. On balance, it's a good thing. So I think the idea that the business will play out here over the next 12 months pretty close to what we thought is probably a true statement. Maybe a little bit different quarter by quarter, but we feel very good about the position we're in. And certainly, what -- the sort of momentary situation that occurs in North America, we think, comes back relatively quickly as businesses continue to want to be in that investment cycle, if you will.

Great. And obviously, Jim, there's been a real flurry of M&A activity. I'm not even sure if flurry is the right word for it. There's been a lot of M&A activity since separation. The thesis clearly was to reduce cyclicality of the business and improve the growth rates longer term. This is a funky recession in that we've got elective procedures pushing and we've got facilities shut, et cetera. But in general, is that thesis sustainable through this downturn?

Yes. I think -- I mean more so. Obviously, we didn't have a pandemic case in our acquisition thesis back 4 years ago with a number of the business and markets that we've entered into. But if I harken back to that grouping slide that we showed in our presentation at earnings, and I encourage everybody, if you haven't seen that, to maybe go to our website to download that. But what we tried to articulate was this sort of group 1 where many of -- almost all of our new businesses reside, and the resiliency that we're seeing in those businesses is really strong. And really, the only thing that's really maybe slowing those businesses is the lack of ability to get on to customer sites and implement things or do professional services. And then we have group 2 where places like our Landauer business and our ASP business reside. Our GTT business certainly also are there; also places of our business where are either new to the portfolio since the time we spun or they're new that we've added to the portfolio after the downturn in '08/'09, like tech services where we added a substantial part of our service organization to the tech business shortly after '09. So you see that roughly 2/3 of the portfolio which is -- we think will be very -- is very resilient from an economic perspective and will come back faster once some of these stay-at-home orders get rescinded. So I think, yes, very much the thesis has played out, particularly around economic consequences. And I think we understand that those businesses, if they've been impacted at all, they've been impacted by the lack of ability to get on site with customers from a sales and service perspective or just from a standpoint of things are impacted like at ASP and like at Gilbarco that I just was talking about just by the fact that we -- those types of things are just not happening in the way that they would even in an economic downturn. As an example, sterilizations are very resilient during a typical economic situation. Surgeries and elective procedures very much occur, continue to occur through an economic downturn. It's just the very specifics of this pandemic that have impacted the business.

So now I know you don't have a pandemic scenario in your acquisition kind of base case. And then maybe just hone in very quickly on the software and SaaS components of those acquisitions. How is that performing real time right now? Is it still -- in general, if you put them together, is the software and SaaS portfolio still growing?

Yes. And we had very good impact in the first quarter where we had -- I think our Gordian business was up double digits. Our eMaint business was up double digits. Our Censis SaaS business was up double digits. Our Intelex business was up high single digits. So a number of -- our iNet business was up high single digits. It's really more of a service business, but we really have seen the resiliency. You might see a little bit of a slowdown from those numbers here through the year as we -- as the on-site stuff has a little bit of an impact to it, but incredible resiliency, I think, that we've seen in those businesses. And the thesis really does hold up, so we feel very good about those moves. And secular drivers like health and safety, which has been a real thesis for us, both with the ISC business and with the Intelex business, I mean, are very much holding up during this pandemic, as you can imagine, as organizations continue to try to understand the findings that they need to do to make sure that their employees are safer and that their practices and risk management procedures are very much in place.

And then I had a question on -- a follow-up question there, but it's gone from my mind. So perhaps talk about the portfolio. I mean there's been, again, a lot of exits and sales with automation and now with Vontier. Maybe just talk about -- you've talked about Vontier being postponed until market conditions allow. I mean do you think we look to be -- now we're looking at beyond the end of this year? And obviously, the S&P is almost back to where it was before. I mean is there a possibility this could happen sooner than later? So kind of like how do you view that timing?

Yes. Nigel, I'll take that question. I think that we're seeing some things -- markets improve now. We'd have to see that for multiple months to do that. But there's certainly a scenario where it could happen before -- towards the end of the year. We're more in a wait-and-see mode for sure. But one thing we're not -- we think the strategy around the reason for separation still holds there. And so we're just -- when the right -- the market is stable and we'll get a good transaction for all stakeholders, then you'll likely see us move forward.

Great. And then how active is your portfolio review process? I'm assuming this as an annual formal -- annual review process. But once Vontier is executed, how do you feel about the core portfolio? Is that -- is this the business that you're comfortable with going forward? Or could there still be some surgery within that future Fortive?

Well, I think, Nigel, the easy answer to your question is really 2 pieces. One, I think we have an annual strategic process that we take the Board through. And certainly, during that time, we're talking about all the growth drivers in the business. We're talking about the strength of the portfolio. We're talking about where businesses and opportunities are for every -- all of our entire portfolio, but we're also talking about the threats that might also exist. And we don't always act on all those threats, meaning it might be a multiyear threat that we want to track for a period of time to understand. And that's an active conversation that we have with the Board, not only once a year during the strat process, but certainly, during -- an ongoing conversation around strategy that is very much a part of our Board of Directors process. And then certainly, within our individual operating company strategic plan, the operating companies themselves are looking at their own portfolios, and our platform leaders are looking at their own platforms to look at this as well. So as an example, as you know, last year, we came up with a unique transaction to transact our video business at Tektronix into a different situation because we thought it would be better served in a different place rather than at Tek, and that was really brought on by the Tektronix team evaluating their own portfolio. So within the businesses, we have an active conversation around where are the best growth opportunities, and then, certainly, more broadly, we have those conversations. And those are ongoing. There's no statement about our portfolio by the fact that we've always done that. And obviously, from our heritage of being a part of Danaher for a long time, we did the same thing in Danaher on a regular basis, and that's something we brought along because we think it's a rich strategic discussion. And as we all know, the post-COVID world will probably bring on more opportunities, maybe some new threats. We'll have to continue to evaluate as well.

I definitely want to get onto that topic in a second. But on top of the Tektronix semiconductor -- certain parts of the semiconductor verticals, we are hearing some positive trends. Are you seeing that in some of your businesses? And is there enough good news in semi and electronics to offset some of the headwinds elsewhere at Tektronix?

Well, we see a little bit of a mixed semi picture just yet. I think we're still bringing that overall thought together. So some businesses are starting to see a little bit of a pickup. I think it's too early to tell and determine how broadly that will be. Semi is still a very small part of overall Fortive, a little bit more in Tektronix as part of the question. So we will continue to kind of keep an eye on that. At this point, we've seen some pieces of that, but I wouldn't necessarily suggest that it's enough of a thread here to pull on that we would say it's going to offset anything. More to come on that probably. We're certainly watching those trends as we do every vertical that we're in to see where the opportunities will be despite maybe some challenges more broadly.

Okay. Great. Now I want to turn to post-COVID, and I wanted to dig into how you view the U.S. channel relationship and how maybe that influences your decisions on sourcing and manufacturing and maybe start there. I mean how do you view this world? And I know you do source certain parts of Tektronix in China for consumption elsewhere. Are you considering any changes to that footprint?

Well, I think the quick answer is no. Most of what we have in China is for China. We've -- we did make some substantive changes around tariff mitigation relative to supply chain and some manufacturing during some of the tariff situations. So some of these things have already -- not only -- they're not even in process. They're sort of completed at this point. So I think we've been -- some of the tariff countermeasures, by and large, have helped mitigate anything that might come if, futuristically -- depending on what happens relative to trade talks and, certainly, some of the conversations that are very much a part of the media today around U.S.-China relations. So I think we're pretty well prepared. We've got an ongoing risk assessment. We've got an ongoing manufacturing assessment that is part of our just normal process that we'll continue to evaluate as part of our sort of global supply chain strategy. Relative -- so I think that's really very much in, and we feel pretty good about where we're at right now. Relative to opportunity, I think it's still very early. There's a lot of talk obviously about potential manufacturing maybe coming back to the U.S. in some places. Certainly, in health care, I think that's probably a place where you'd start to see maybe some of our health care customers move and -- if possible or maybe. But I think that's very early. It's very much in the talking stages. We'll wait until we see -- we'll really start to -- wait until those customer conversations are deeper and we start to see those real plans action before we start to talk publicly about what kind of opportunity that might be.

And then, I guess, the most obvious change is the fact that we're sitting here in 3 different locations talking, I think, in a fairly clear way. You made some pretty big bets on business models that play into some of these things, and thinking about Gordian, Accruent, obviously collaborative workflows, et cetera. Are you starting to see early signs of an acceleration in the adoption rates of these technologies that you've been acquiring?

Yes. I think -- well, if I were to sort of look at the secular drivers that we liked coming into the pandemic, if you will, whether that be the thesis around health and safety that I was just discussing that not only put us into early days of ISC and Landauer but certainly into Intelex as well, whether it be some of the productivity and quality challenges that -- and cost challenges that happen that are solved through better facilities management, those drivers are still going to be there, maybe even more accelerated in a post-COVID world; as an example, certainly the health and safety part. But also, when you think about what we do in facilities management around lease management, space planning, those are real -- those are going to be good drivers as people start to reevaluate their real estate footprints. We're really not driven by construction, so we really don't need to see construction. Gordian is very much driven by the refurbishment of things that go on relative to facilities. So as you start to think about the changes that need to happen in facilities for social distancing or those kinds of things, those are very much going to be refurbishment kinds of things and will very much be a part of the Gordian value proposition. So a number of those drivers are going to continue to exist in a post-COVID world. So we feel good about a number of the things that -- and thesis that we had coming into this that will ultimately be -- will be there for us in a post-COVID world. A little bit of a short-term challenge as we try to get to customers and improve our value propositions. But I think when you just kind of look through the next 12 to 18 months, you can certainly see where those are going to be -- those businesses will see opportunities. They have some other headwinds, but the tailwinds probably certainly offset those other issues.

Great. So Chuck, I think maybe a question to you. I want to go into the dreaded decremental margin question. Maybe just talk about how you're viewing decremental margins both for 2Q and the second half of the year and maybe talk about the phasing of some of the cost actions that you're planning and how that keeps decremental margins in that range?

Yes. Thanks, Nigel. So for decremental margins, we're saying we're trying -- want to manage the business to 35% to 40% down. And we also outlined $300 million of cost actions. They're pretty ratable, meaning over Q2 -- a little bit in Q1 but through the year, might be a little bit more that show up in Q2. But what we're trying to say is we'll be down 35% to 40%, probably closer to 40% in Q2. But as you can imagine, as you move through the year and if the top line improves, we won't be down -- we'll be closer to 35% and maybe even a little better as you get into Q4, if it continues to ramp up. But what we -- the 2 things we are saying is what Q2 is going to be like and then what the full year is like. So if you think Q2, a little closer to 40% and the year maybe closer to 35%, that would certainly imply there's a scenario in Q4 that it's better than that as we move through. Does that make sense?

Okay. I think that's clear, yes. Then how important is mix in that conversation? Because I'm assuming that you have PIs and you have the [ Solomons ], you got some pretty high gross margin businesses there, so how important is mix?

Well, I think it is important. Right now, what we're seeing in Q2 is it just kind of happens to be in that 35% to 40% for both of those businesses at the levels we're seeing. But that's what makes it a little bit more difficult, is with EMV playing out in IT, likely giving it a better top line, that doesn't mean it's necessarily growing, but certainly better -- improving at a slightly better rate would be a reasonable hypothesis. You would see PI being -- having -- putting more pressure, meaning the -- moving it more towards that 40%. But there's a lot of factors involved here. But -- and the bottom line is PI has high 50s -- mid- to high 50 gross margins, and IT is in the mid-40s.

Great. And I think most, if not all, of the actions you announced in April -- May -- early May are more temporary in nature, more ratable in nature. Is there a need to ratchet up the structural cost actions at this point? Or is it still a wait-and-see?

Well, I think that what we're talking about is how we're going to manage through the year. But I'd say, definitely, there are some of our actions, furloughs and a variable pay, that is temporary. But there are some other things that we're -- we -- when you take out temp workers, for example, they're going to -- they're out and they're going to stay out. That's more permanent. The travel is going to go down and stay down. It's really tied to the top line of the -- for the same reasons that we can't get into facilities, that will slow our travel. So I wouldn't say that all of them are temporary. But at this point, the majority are. What we're looking at as we move through the year is, well, what's likely to -- as we get clarity into the second half and probably into 2021, do we have to look at rooftop consolidations or more permanent actions kind of things.

And Nigel, maybe just one thing that often gets sort of forgotten is the fact that we took some pretty dramatic structural actions in late 2019. You saw our OMX in the first quarter at 150 basis points or so. So we had very strong margin expansion and free cash flow in the first quarter on the back of some permanent actions that we already took. So a little bit, we sort of got to think about the future within the context of what we've already done as well, which I think is an important thing that sometimes just gets missed because we're so focused on what's really happening right now.

Right, right. Absolutely. And then we're getting close to the end of the slot here, but I did want to touch on M&A. And you're very active in 2019, very active in 2018. Where do you stand here? Is it still in kind of "batten down the hatches" mode here and solving what we have? Or do you see opportunity just maybe to grow more capital this year?

Well, Nigel, as a reminder, I think that the -- we did $4 billion last year. So we came into this year with a premise of more bolt-ons and delevering. And that's still, I think, the -- I know it's the expectation and what we'll be doing throughout the year as well as maybe repatriating some cash to help with that deleveraging. But I don't think that -- we're not off the market for sure, but probably if we did something if -- what we came into the year thinking about is bolt-ons.

Okay. And in that regard, are you seeing any change in some behavior? Are we seeing bid-ask spreads narrowing at this point? Or is it still too early for that?

Well, I think when you enter something like this, Jim and I have seen a few downturns in our careers here, is the -- there's a little bit of a -- there's a time factor here to get the bid-ask to align. So it's not our capabilities that's holding us back, it's waiting for everyone to -- what we now think it's worth given the situation we're in to get alignment. And we're -- I wouldn't have expected that all to magically align in the first couple of months of this.

Yes. And then my final question is you talked about obviously plans towards delevering at this point. At what level of leverage do you think that you're comfortable moving to a more aggressive kind of growth mode here?

Well, I think anytime we get under 2 is a time that, from a financial strength capability, you could -- we would look. But there's -- we're always open. We never say never. There's -- we're constantly evaluating the funnel cultivation and having things come up. And I think there's still choices that we could do. So I think that when you get under 2, we'll -- it'll be easier financially. But I think that, as I said, we're always looking.

Great. Well, I think we're out of time here. Jim, I really wanted to wear my Fortive top. I've got one of those, too. So next time, I'll definitely wear that. But any closing remarks before we say goodbye?

Well, I would -- I just -- I think, first of all, thanks for the time and the conversation, which is always, I think, helpful to us. I think the one thing I would just say, Nigel, is we've seen a number of things that we've done. It's hard to believe that it was almost 5 -- it was just 5 years ago last week that we announced the separation and we'll celebrate our fourth anniversary here in July. In that 4 years, we've done a number of transactions. And really, when you look at the portfolio today, it's really -- everything we've added is in those places of resiliency and durability. And so obviously, the pandemic is a momentary -- is a moment in time. It's going to be with us for a little while. We know that. But I think you're just going to see that resiliency in our free cash flow here as well as a number of things we're doing here to continue to build the business organically during difficult times. And we'll take what we get, and we'll -- I think as we always say, we'll play offense where we can. We've got a good playbook from a Fortive Business System perspective, in which to allocate resources to our greatest opportunities. And I think we'll come out of this in a position like we have through other downturns, in a -- with a position of strength. So thanks for the opportunity today to talk a little bit about that, and we look forward to some of the one-on-ones here throughout the day to continue to have a conversation. Thanks.

Yes. Thanks for the time, guys. Really appreciate it. Good conversation. And best of luck. really appreciate it.

Thanks.

Thanks, Nigel.