Fortive Corporation (FTV) Earnings Call Transcript & Summary

Well, I think we've known for some time how FBS, the Fortive Business System, can be applied to software. Even when software wasn't a huge part of the portfolio, particularly on the product development side, we've had a lot of software development going on in Fortive for a number of years. 2/3 of our engineers at Tektronix, which is our largest engineering organization in the world, is our software engineer. So the product development aspects of FBS have always been tuned. Agile software tools, things like that have been always attuned to being a part of the improvement aspects of the business. So I think when we -- so that's certainly it. I think the other aspect of it is just the sort of core FBS tools around problem solving and the accountability and way we run businesses is very applicable to software businesses. In some cases, it's even better because you get more data, right? I mean you get real-time customer data of usage. When you have telemetry, you can understand how customers are using your product in ways that, quite frankly, we almost never had in decades in some of our other business -- in our hardware businesses. So I think the idea of problem solving and some of the things we're doing around really trying to really improve those businesses is really accelerated in problems in some of the software businesses. So I think that's -- those are certainly some of the areas. We've adapted a number of the things, as we've talked to you and many others over the last few years, around how we've continued to move our innovation model differently. And we've applied that into some of the new businesses, so we'll start to see some of that. We've really focused on data analytics, as an example. A lot of our corporate effort on data analytics or what we call The Fort has, quite frankly, been working in a number of our software businesses to accelerate their move from software to software and data analytics. Accruent just launched their second version of Accruent analytics, as an example, on that platform and bringing more data into that. So that's -- the way you improve the businesses may seem different, but a number of the aspects of it are the same. And of course, we're buying high-quality businesses. So at the end of the day, we're also taking a number of things that we've learned from those businesses and applying it appropriately into some of the other software businesses. Gordian has been a leader, quite frankly, in the use of FBS. And we've really benchmarked a lot of what they've done to apply to some of the businesses we bought after that. So I think that doesn't mean that there isn't a lot of improvement going forward. A lot of opportunity here going forward to continue to build continuous improvement into software businesses, just as we have in the legacy businesses over time.

Excellent. And then before we get into M&A and portfolio, I did want to touch on incremental margins and maybe decremental margins because the iron rule has been -- mid-30s has been the rule of thumb for old Fortive. I know you've pointed to 35% decremental margins in 4Q. So I'm just curious, going forward, now that we're in a higher gross margin portfolio, you pushed up towards 60% gross margins, could those incrementals go higher over time or some of the reinvestment needs also rising as well?

Yes. I'll take that one, Nigel. What we've said before is 30% to 35% in old Fortive. And now, we're talking about 35%, really, to get -- with all the moving pieces to give some clarity about how '21 is going to come out specifically or what we're managing to, remember, we've got some temporary things that are going to come back. We don't know the top line at this point. So that's a good place for us to be. But you're right, when we get to the other side of that into a normalized go forward, we'll reevaluate that, but we're very pleased with our gross margins coming up. And you would expect that instead of just going from 30% to 35%, staying 35%, it could go up higher. I think that's probably something that we'll be evaluating.

Okay. That's great. Okay. Move on to portfolio now. And Jim, I think you've been extremely active on the portfolio since separation from Danaher, probably a bit more active than we would have expected, not just on the buy side, but also divestments as well. Is this now the portfolio that you're happy with? Is this the portfolio you can live with for the next 5 years? Or do you still see scope for 1 or 2 disposals?

No. I think we really -- I think as we laid out the 3 segments with roughly $30 billion worth of served market opportunity, we feel very good about the opportunities within all 3 segments. And as you said, we just finished a few weeks ago a fairly rigorous strategic session with our Board, where we talked about the opportunities within -- both organically and inorganically over the next 10 years. And I think we're incredibly excited about the potential for all 3 segments. So never say never because, obviously, if things change in the market, and that's why we do strategic planning every year, but incredibly excited about really what we have in front of us and the opportunities really to not only -- a lot of the inorganic opportunities get a lot of play, but I think we've done a lot on the organic side. So Precision Tech, as an example, has not seen as much of the M&A capital. But we've done some nice things, really excited about a number of the things that are starting to play out in a number of those businesses organically. Obviously, Tek has been a leader in innovation over the last 4 years, while we've been out on our own. And Sensing Tech, the sensing businesses, I think, have done an outstanding job here in the last couple of years of really repositioning their business organically with a number of IoT-type technologies that I think are going to really help those businesses in the years to come.

So that -- I was actually going to go there. The next question is really that we've seen a huge amount of activity in IOS and health care, and Precision Tech hasn't had the same degree of inorganic investments. It sounds like you're more excited by the organic investments still in Precision Tech than inorganic. Is that the case? And where I'm going with this is sensing is an extremely fragmented market, huge market. You're a very, very niche player. Could that be an area where we start seeing some acquisitions?

It could be, yes. I think what why talked about the organic is simply because we put it in the context of a lot of the inorganic and organic work that's gone on in the other 2 segments, so maybe it's more the response of that question than it is really the excitement. As I always joke, we love -- I have 3 children, and I love all my children equally, the same way in our segments. So the opportunities are the opportunities will become available, and we think there's opportunities throughout the portfolio. Now we really are trying to position the company towards more enduring higher growth, more durable revenue. And so I think as we continue to look through, that doesn't mean just software. But as we see, ASP was a large hardware acquisition. So it doesn't -- but we are looking at places where we have the drivers for growth over time and continue to improve the durability, and I think we have opportunities to do that throughout the portfolio.

Okay. I think to the 2020, we probably had one of the longest periods of very limited to no acquisition, no transactions and for good reason. Delivered the balance sheet nicely. Obviously, we've got some proceeds coming in from the remaining bonds here, sell-down. How much patience is there at this point in terms of building the pipeline aspirations to start deploying some of that capital that's built back up again? How patient are you here?

Well, I think we're disciplined, and I think that leads to patience -- those 2 are almost hand-in-hand. I think at the end of the day, certainly, COVID is -- we have been busy. So we've certainly looked at a number of things. Our -- your question around the funnels, they continue to be interesting and exciting. But I think on the other hand, we're going to -- we know what good looks like. And I think we want to make sure that if we're going to add something going forward, we're going to do that in a way that will really continues to build -- accelerate the strategies that we have available to us. And I think that leads to discipline and patience. So yes, I think, does that mean we -- do I think we'll do a deal soon? Yes, I think we will. But again, as you know, and this isn't -- we could certainly talk about the last 4.5 years. But I think Chuck and I could go back decades and say you always have time when -- M&A always ebbs and flows. That's just part of the deal. That's why we want to make sure we've got good organic and inorganic strategies, and I think we feel very good about both of those things. So we'll -- I'm sure we'll get some things done. But by the same token, we want to make sure that we're -- to use your word, we're patient, but we're also disciplined. And that's what we'll really do here, going forward, as we have been in the last 4 years.

So I want to go back to -- going to Accruent because Accruent, for sure, the entry multiples there were obviously at the higher end of the range. With the benefit of another couple of years of S&P sort of inflation, those deals almost look like value deals in today's environment. So I'm just curious, with the S&P where it is right now, I mean, obviously, sellers' expectations have risen in parallel. I mean, is there a possibility of doing deals that aren't massively ROA -- that don't meet your ROA -- ROI criteria?

Well, Nigel, I'd take that and say I think there's -- we have the base frame of trying to get to 10% in 3 years for both times and 5 years for more platform deals, and that's still a very good construct for us. I think that at a point in time where a couple of times, we've been willing to look a little longer on that, and that's probably still the case. But I -- if you've said no returns, and we -- I don't see that. Jim's comments around being -- us being disciplined, we're patient, I think there's -- we've seen a lot of things, and I think we're going to remain so.

Okay. And maybe, Jim, give us a little bit of -- or even, Chuck, give us a little bit of color in terms of what you're seeing in your funnel right now. And I think we're also very keyed in on this, the kind of the software versus non-software. But obviously, you see the world very different to the way we do. But obviously, one of your sort of biggest industrial companies is increasingly waiting the software with some larger deals. Is that the direction you see Fortive over time is doing much more larger software-centric deals?

I think if we were to characterize the portfolio right now of opportunity, we would certainly see, Nigel, as I've talked over time, is breadth and depth, right? Breadth, meaning a number -- depth meaning size of deals, breadth meeting throughout the segments. And I would say the breadth and depth right now is very good. I don't think we're beholding to a couple of large deals. Rather, we see a number of opportunities. We've always talked about the fact that M&A is about accelerating strategy for us. So we're as likely to do probably a small, great technology deal as we are, maybe a larger deal that really accelerates us into a region, into a new platform or something like that. So I think what we've learned over the last 4 years is that managing that portfolio that way is -- we're in a good position if we do that. So I feel really good about what -- how that stands right now. And I think at the end of the day, it's really when we look at where we're coming from, these workflows that we've talked a little bit about, we'll continue to talk more about. Whether it's the EH&F workflows that exist in the organization or facilities and asset management or condition monitoring, based monitoring, which we have in IOS, or the perioperative loop and sterilization processes that go on in hospitals or the product development process that Tek plays in, these are great workflows. They've got large and small opportunities in which to play and as well as organic technology that we're all developing ourselves. And so we -- when we look across that, I think we've got plenty of opportunity in which to continue to build the company.

Okay. Great. And then one of the great things -- one of the aspirations for being an acquisitive company, of course, to the companies to have a currency, equity currency that's valuable and essentially there to use. And certainly, post the Vontier spend, you've seen a re-rating in your stock. You're trading at north of 20x EBITDA, mid-20s on a PE basis. Does this raise the probability that you'd be open to using your equity as a currency here?

I think that -- we've used some equity instruments before, and so we've always been open to that. Is it more likely? It just really depends on the deal and what we're trying to do and what the market dictates, but I don't think we would stay away particularly. But at the same time, we generate a lot of cash. And so we also don't want to pile up cash and have deployed equity, so it's a balance. It depends on the deal.

Okay. And has your leverage aspirations changed at all now that you're a higher-margin [ therapy ] more stable company? Is that 3.5x still the right level? Or could you make a push a little bit higher?

Well, you can -- could theoretically push a little higher, but I wouldn't say we aspire to get to that level. I think that's how we define how much capacity we have. And as -- again, it's just, if we get up there, then you'll want to see what we've done this year, which is go for smaller deals, bolt-ons and then delever back down because we're very committed to having -- maintaining our credit rating. We're in a very good position, a lot of options for us going forward right here, so we like that. But we're not -- I wouldn't say -- we're not timid, obviously, but we're not in a hurry. We're patient and disciplined, as Jim talked about.

And then sticking on the balance sheet, Chuck, there's -- you've got some maturities in '21, '22 on some of the instruments. Any heavy lifting to do on the balance sheet in terms of refinancings or maybe replacing some of the equity instruments, anything to do that?

No, no. There's a few things that we're -- we'll naturally settle out with the Vontier proceeds that were holding some short-term debt, even though we've got cash, doing the most tax-efficient way. So those things will easily be settled out. I think the mandatory convert in June just converts, and so that goes away. So it's nothing that we can't handle. And obviously, in this market, there's a lot of good options for us when we want to go into the bond market at the right time.

And then just touching quickly on that one. Could that be one transaction theoretically? Or should we think of that as more of a series of transactions?

Well, I think, in theory, I obviously -- we've been studying that. We've got a few things that we've got to get done here procedurally to be even able to consider when we want to go what I've been saying is the first half of next year. But you've seen other of these types of deals, and they go out. And it can go in one or it can go in a short period of time. We really will evaluate the market when we get there and what's best for all our stakeholders. Remember that many of the Vontier shareholders are our shareholders. So we want to do something that makes sense for both of us.

Okay. Great. And then we do have a couple of questions in the queue here. Maybe just one question given time. So Jim, what would you describe as your top priority -- your single top priority for 2021?

I would say, well, we -- it's hard to have one. But I think at the end of the day, business as unique to ours, it's hard to have one. But I would say if you sort of said, what are we continuing to do that really start to think about what impacts all the businesses? I think number one is we continue to build the talent level of the organization continues to be a top priority. Obviously, we have a tremendous amount of growth opportunities within the portfolio. We can't do that without continuing to grow the talent base. In the COVID environment, that's slightly more difficult because we're not getting a chance to be in front of folks. I think our teams have done an outstanding job of continuing to build the talent base for the team. And business-wise, I think we've really built some outstanding capability around innovation. And I think we -- that's been some core development that we've done in terms of building capacity. We've built The Fort, which is our data analytics organization, which is really supporting all the businesses. And then our relationship and our partnership with Pioneer Square Labs has given us an early-stage innovation capability that we didn't have. So I would say it's really twofold. One is to build that talent base around the changing amounts of the -- changing things that are going on in the business. And secondly, if I were to say, it's continue to build on the innovation capability that we've been working on in the last couple of years.

Yes. One priority is tough to do that. But I mean, that's not like a great closing statement. But any other closing remarks, Jim, before we draw line here?

No. I just -- I would -- certainly thanks for the day. I mean it's -- the opportunity to spend time with everybody. I think, hopefully, you get a sense from Chuck and I's words. We're -- a lot of heavy lifting this year, 2020, now as we were joking about, but a challenging year for everyone in so many ways. But I think what we've been able to accomplish during that time frame in a number of ways, despite the planning horizon wasn't to do it all virtually, whether it be the Vontier spin, whether it be bringing the ASP business into the portfolio in the way we planned, certainly continuing to evolve our portfolio, all of those things done in a very challenging environment, I think, just speaks to the continued appropriateness of the Fortive Business System into how we do things. We couldn't have done it without that culture of continuous improvement, continues to be the sort of linchpin to our unique success. So we're excited about the future, and we certainly are excited every day when we can wake up and here there might be another vaccine out there. We're certainly continuing to watch those things, and we think we're well positioned certainly into 2021 no matter what the environment, and we're planning accordingly. So hopefully, people get a sense of that as well. So thanks for the time.

Well, Jim, Chuck, the pleasure is all ours. Thanks for the time. You've been very active. So hopefully, maybe slow down a little bit going forward, perhaps. But you've been very active, doing a great job. Thanks for the time, and good luck.

Thanks, Nigel. Great to see you. Thanks, everyone.