Fortive Corporation (FTV) Earnings Call Transcript & Summary

Good afternoon, everyone. It's Deane Dray, RBC multi-industry analyst. Delighted to kick off the presentation with Fortive. We're delighted to have Chuck McLaughlin, CFO, joining us this afternoon. Chuck, thank you for joining us virtually. I know, and you know, we all know we'd rather be doing this live in Las Vegas. But this -- having you here remotely is certainly appreciated. Where are you joining us from today?

Well, today, it's from the state of Washington. And not -- like a lot of West Coast, we got a lot of smoke around here, so it's a lot to deal with this year. 2020 is certainly throwing us a lot of curveballs.

It has -- we certainly appreciate it. So make sure you and the team stay safe there. Our hearts go out to everyone affected by those fires.

Look, lot of changes in 2020, but one of the resilient positives is we see Fortive holding up well, making the right decisions, acting prudently in a downturn. And you created some excitement last week with a positive pre-announcement on the revenue side. Look, this is your first opportunity in a public forum to talk about what has gone right in the quarter that allowed you to update the range. So give us an update, especially on the pace of monthly improvements.

Well, I think, Deane, we saw some improvement in June and really into July. And we saw [indiscernible] one, just August has printed and continued -- we didn't see any downdrafts from what we were seeing in July. And so that's, as you know, important. Although September is the biggest and the most important [indiscernible] of the quarter. I think that we've seen improvement or we know we've seen improvement on both segments, Professional Instrumentation and the Vontier group of businesses. They both improved versus what we guided to 5, 6 weeks ago, seems like so much longer. But -- so they both improved. And on the margins, it's just been a very broad base. But if we had to pull out a couple of other things, I'd say that Western Europe and really the developed countries in North America, a little bit stronger. And probably the one maybe continued surprise here is the Matco is recovering faster than we thought with a return to positive territory from what we've seen so far. So those are the main things. There are also no major step backs from what we expected and what we signaled at the Q2 earnings call.

Talk about China. And also, your mix is more short cycle that the ones that we're seeing. And the good news is on a short-cycle mix, if there's an uptick, you're going to see it sooner. So China and short cycle.

So I think -- yes, I think that there's some balance or -- I wouldn't say it's been taking a big step up, either in China or the short cycle, but it's very stable with what we saw in July. So that's not to the point of what we updated and said, "Hey, what looks better?" It's not -- certainly, it's not worse, but I don't think that's driving our -- the 8-K we put out last week.

All right. Interesting. So you and I always like to talk -- at least I do, and then maybe you just go along with it. But I always like to put the pulse -- finger on the pulse of Fluke and the distribution side in terms of kind of the pace of the business. What is the Fluke sell-in sell-through broadly telling you about where business stands today?

Well, when we take a PI and take our forecast up for the quarter, it's not just Fluke, but you can't do it without Fluke generally. And so again, not a massive shift from what we thought, but a little bit better in North America and in Western Europe on the point-of-sale that you're talking about. But not massive shifts. For this, it's really just another -- it's another quarter printed and moving slightly in the further sequentially improving direction.

Good. Now look, in the positive pre-announcement, it's positive on the sales side. Is there any commentary about margins and kind of the drop through?

No. We only gave an update on what we're seeing on the top line. As you know, there's a lot to go in the quarter. But when we go back to our Q2 announcements back at the end of July, I think it was -- we talked about 35% decrementals, and you could -- I feel like what we would expect that to be, that we'd be trying to manage that. It's not a perfect science, as you know. And when the top line comes back a little faster, you can't quite balance the spending. But I still think that's a good framework to be thinking about going forward.

Good. In a global pandemic, where we're all up against some enormously different marketing or operating conditions, it's -- must be a big positive to have the Fortive Business System and a playbook on how everyone's on the same page in terms of actions to be taken. Just kind of behind the scenes, how has the Fortive Business System been a factor over the past couple of quarters here?

Well, I think that the -- it's been a huge factor. It's the base on what we do. Everything we do in good times and in bad. And what it does is, as you know, it has many tenants to it. But understanding your businesses, you saw how well we did on our free cash flow in Q2. And a lot of that -- not a lot of it, but a big -- a significant driver was the deleveraging of working capital. And that comes from a daily management, how the team's putting those things together. The need to be able to break and plan and put things into bite-size pieces so that to bring it all together, that's a skill set that has shown up in a lot of ways in Q2. But as we move forward, because while things are improving sequentially, that's just another way of saying, "Hey, there's a lot of change going on that's happened pretty quickly." And so the strength and the focus of our teams in understanding our supply chains and what we need to do and how that can help us here, keep up. And it's really -- part of it is -- I wouldn't say that FBS is always -- you think about it as change management, but it helps you get to the details that will actually deliver a positive result. So it's been a lot of [indiscernible]

So it was also interesting, looking across the multi-industry sector, how the companies responded when there's such reduced earnings visibility and outlook. Some companies gave scenario analysis. I found it really interesting, the 4 buckets that you framed Fortive businesses in. Trying to [indiscernible] set the stage, why those 4 buckets? And is there anything inferenced on prioritization of businesses? Do you -- that -- I'm trying to think of like, why did you pick those four? And do some of -- does it -- might there be some divestitures, implications on who've landed in what bucket? Just take us through that, please.

I -- so we didn't develop the 4 buckets for -- to try and do anything with in terms of a portfolio analysis other than to what we're really trying to say is, look, we were dealing -- we are dealing with a very uncertain time. And in Q2, we were trying to understand how is everything doing and in what order will it come back. What we weren't saying, and still aren't saying, is exactly when we'll be back, but helping everybody understand, group 1, actually not declining and still growing. And group 2, probably -- it's close to group 1, but maybe like ASP where elective surgeries were hampered, but not really a market downturn. And then 3 and 4, you can look through and see some -- what we're trying to say about groups 3 and 4 is just which ones will come back first. So it's just helping people understand because when we put that together, back at -- I think that was in April, we didn't know as most people didn't and why so much guidance was suspended. But we needed -- people needed a framework to how to think through what to look for and how this will come back. I also think it highlighted what you saw in groups 1 and 2 where a whole bunch of -- the majority of our acquisitions ended up in that group that really highlighted what -- why we like those and the value we placed on them. So that's really how to think of it. But in no way are we saying, "Is it a good group or a bad group?" It's a portfolio of businesses. And you can see the direction we're going to reduce our cyclicality in total and how the business is going to continue to transform and evolve going forward and be able to put those pieces together.

That's a great perspective on those. And the idea of the recent M&A and the portfolio pivot that you're doing that's emphasizing businesses and software-as-a-service and in medical. That portfolio pivot, I've never seen a company move as quickly, as deliberately strategically into areas that make perfect sense for us. What inning are we in, in Fortive's portfolio transformation? And is it -- are there more in that funnel? Is that, that group 1 and 2, SaaS and medical?

Well, if you go back to -- when we started talking 4 years ago -- 4.5 years ago, I think, we were on a road show talking about the business, what we said was we wanted to reduce cyclicality, increase the growthiness. And you would see us do that through increasing the recurring revenue percentage. And that's really been what some of the hallmarks of what we've been trying to do. So what the few -- next 5 years will give us the opportunities to be, to do, I don't know. But I think, still, we like the recurring revenue. That doesn't have to be software, it's -- as our biggest single deployment has been around ASP. And that's in that medical space, and we love that essential technology there. So we're very happy with what we're doing there. And I think you'll see us -- if you look at everything we deployed on balance, it's a little bit more hardware consumable type of businesses. And then, yes, there's been these softwares because -- but what we're really trying to do is reduce that cyclicality and working on those connected workflows. So I think you'll continue to see us move in that direction going forward as well.

That's great to hear. What's different about the due diligence in the software-as-a-service business versus -- look, at ASP, I know you can deploy the right people to make the right decisions as to what the market presence is, where is the growth opportunity, where is the technology, where is it growing revenue. How does -- how do you do that in a software acquisition?

Well, in -- there's some things that are easier -- it's never easy. There's just what do you need to do and what can you do. Historically, non-software businesses, there is a lot of on-site visits. The good thing about software businesses right now is there's not so much on-site going in to look at a factory. So you don't have to do that piece of that, but the due diligence is about your market work, reaching -- understanding the customers and how sticky they are. And if you're specific to a SaaS-based business, you can actually do that some -- a lot of that due diligence, not all the same way, but you're able to do that in this environment. That doesn't mean we can't do due diligence for other types of businesses, but you have to find workarounds. And we have been, I don't want to say lucky here, but we deployed so much in 2019 that we came into this with a year that we thought this would most likely be a bolt-on year. And that's really how it's being played out maybe for a lot of reasons. But I don't think that we're going to change, pivot to on our due diligence long-term to always do it the way we've been doing it right now. But there's still a lot of things that you can do. And it really comes from spending a lot of time in your markets and businesses so that you know what you really like when it comes actionable. And that's probably the bigger foundation for us.

Look, we don't want to get -- I mean it's a very helpful explanation. I appreciate that. Is there much -- what are the implications when you do a bolt-on in a software business that it seems to really limit you in terms of what assets you might even get to consider because it has to kind of fit an existing platform as opposed to saying, we are looking for the best sort of unicorn opportunity that might be unrelated to any business that we're in right now, but we like either it's barriers to entry or cash flow characteristics? Are you limited in looking for bolt-ons?

No. You mean limited to looking on bolt-ons this year, it's like we've only been looking at that? Or...

Yes.

So I'd say no. In fact, I know -- no. We just thought that was the most likely case coming into this year. But Deane, you've talked to us for a long time, and you know that we have a big funnel. There's lots of things in it. Some of the businesses we're looking at, we look at for years. And those big -- there are some bigger things that when they come to market of something that we think that we're really interested in, we'll move into final due diligence space, and we'll find a way, assuming it makes -- creates shareholder value that we would consider. And we haven't stopped that work. They just -- it's just the timing with the pandemic, it does slow some of those bigger things coming to market for what we were looking.