Fortive Corporation (FTV) Earnings Call Transcript & Summary

And so maybe looking at the sort of the base business and the brands you have owned for a long time, I see there's 2 aspects that it looks like you're very focused on driving to sort of improve those. I think one is digitizing a lot of that core, things like Fluke Digital. So maybe give us some update on where you stand on that. And I thought the second aspect is some of the businesses like Sensing or Tektronix. I think you've talked about geographic diversification there and arguably at Accruent as well. But maybe just those 2 sort of axes of digitization and then geographic, where do we stand today?

So I think on the digital front, we've done a number of things over the last several years to build out our digital capability, whether it be changing the tools of FBS to adapt to more digital environment, whether it be the product development cycles to be more software oriented and help software business. We made a lot of progress on the FBS front to add value. So that's -- I think from a core foundation standpoint, I think we've built the capability needed to be able to do some of the things that we want to do. Relative to your specific questions, Fluke Digital had a good fourth quarter. Our SaaS business at eMaint had a double-digit growth throughout the year. So that continues to be a good story. And Fluke continues to sort of build out their offering around digital, and this will be a good year for that work. Excited to see them continue on that effort. Fluke Reliability, which is sort of their broader software services offering, could continue to get better through the year. So I think both on the hardware and software side, their offering continues to improve. On the tech -- in the Precision Technologies, where tech and sensing live, I think the tech team has done a nice job. It just released a couple of things on the software side that will -- won't have a lot of impact in '21, but should start to have impact in '22 and '23. So I think the tech team has done a nice job. Our sensor play is -- every one of our sensor businesses now has an IoT broader offering that they've innovated into. And so I think on that front, broadly, we've made some nice progress here despite the challenges of pandemic and in some of those businesses having been hit pretty hard by revenue in the second and third quarter. They still continue to make sure they were investing in those opportunities. So on the geo front, I would say most of our geo opportunity, certainly, the first and foremost is in the software businesses. When we buy these software businesses, they tend to be U.S.-centric. [indiscernible] you heard us in our fourth quarter call, talk a little bit about Accruent and Intelex and the growth they had in Western Europe as an example. I believe that there's opportunities to expand those businesses in some geographies for sure. And then ASP remains a good opportunity. We've now taken over all those countries in the world. And while we have a big growing business in China, we still think there's a number of opportunities in some of the other higher-growth markets. So yes, so I think I would say, where do we think ASP for sure, the software business is for sure that sort of rolls up to the new acquisitions, having opportunities geographically. And then there's just the blocking and tackling of continuing. We're much smaller, as an example, in India than we were when we came out because of -- mostly because of Vontier having a big India presence. And so that's a place where we're going to continue to look for opportunity just because we think that's a -- long term, that's going to be a big economy, and we need to be able to -- we should be bigger there.

And maybe switching to the margin side of things. I think you've talked last year about a 35% decremental this year, sort of 35% incremental. Is that 35% leverage sort of the right figure medium term? Or should we think that, look, as you get ASP consumables back to normal software and growing share of the pie, your incrementals over time should move higher than that 35% level?

Yes. And Julian, the way I think about it is this way. We've got a special situation going on in Q2 of this year, where -- because of what we -- all the actions we took last year, it's likely to be in the 20s. But if you set that aside from Q1 through the rest of the year and beyond, it's probably -- it's going to be 40%. That's the simplest way. So yes is the answer that the incrementals will come up.

And when you're looking, Jim, at the businesses that have been acquired, how much sort of reinvestment has it taken to get the growth positioning where you want it to be? Was there more heavy lifting that was needed at some of the acquisitions we have discussed? Or actually no, they could be moved in fairly efficiently by some FBS without heavy lifting and that sort of gets them into the right zone? And as an extent of that future acquisitions not yet announced, just want to ask how optimized should we expect them to be operationally on those?

Yes. It's -- every story is different, but I would say if we were to think about, certainly, you would say we had a lot of heavy lifting at ASP. A complete carve-out of Johnson & Johnson. We had to stand up a complete company, and that certainly was heavy lifting. And I think, quite frankly, we were well positioned to do it. It's a skill set that we develop through multiple carve-outs, our own carve- out of Danaher. So we really have a skill set around those sorts of complicated transactions. And I think fundamentally, we pulled it off even in a virtual environment, I think, speaks to the ability for us to know how to do this. But I would say, number one, that's certainly heavy lifting. We made some nice progress with FBS in 2020. But I think the -- there's more progress ahead across the board. Chuck just mentioned our review with them yesterday. So I think that's probably a good example of where -- we're very early innings of opportunity. And I think if I were to characterize the software businesses, by and large, they're -- there are more opportunity than fixing. So I would say in a case where you have to maybe do a little bit more SaaS conversion, you might have a little bit more technical debt. You might have to do some things from -- on the R&D side within the construct of things. But where we -- but as an example, Gordian was a high-quality business, but quite frankly, applied FBS very well early on and did a nice job. So Intelex and eMaint are a little bit different. We came out of the gate so well from a growth perspective that we really put more money into it to accelerate growth. We did a little bit of that with Censis last year, where we just added feet on the street, where we could have taken more margin to the bottom line, but we chose to put more investment into the businesses. But I think when we're growing at a double-digit rate in the business. We're probably going to ask ourselves, "Can we -- how can we accelerate that rate? And do we have those opportunities?" So again, there's not one answer to your question, but hopefully it gives you a little bit of color across the portfolio over the last several years what we've tried to do to manage the opportunities that will become available to us.

On that point on sort of reinvestment, and you mentioned a good example at Censis just now. When you're thinking about measuring the payback and the efficacy on R&D and selling costs and sort of what CapEx there is even though it's a low CapEx-intensive in the business, how do you make sure that as Fortive's business model has evolved into more software into more health care that you're getting that commensurate level of payback on R&D and selling and OpEx and CapEx because perhaps the return profile, the payback, the speed of development is different in those areas versus Fortive's sort of legacy or base businesses?

Well, the good news is we have a lot of these approaches, if you will, that have come from us in the Danaher days when we had a number of those businesses as well as part of the portfolio. So I don't think there's as much transformation from a -- of the way we've had to look at it. Health care, a little bit different on the R&D side simply because you have the -- you may have the FDA approval in the cycle. And so you may not necessarily be able to put $1 in and get that dollar as quickly as you would in a business that's had not FDA required. But that's something that's been known to us for some time. So nothing new there. I think the big difference -- I don't think it's a difference, but I think it's an approach is really understanding how this drives recurring revenue in SaaS particularly. Because a dollar that comes up in SaaS, that's $1, particularly when you've got a business, it's all, I'd say, [ $110 ] on net retention, you're buying into a business that's going to be compounding over a period of time that's different. And so we just need to incorporate metrics that are different. But I think we're very familiar with those, whether it be what the changes are in our recurring revenue base or our installed base; what's the improvements on upselling and cross-selling, which obviously influence our net retention -- net dollar retention. So I think it's less a return focused, Julian, because we're always going to be pretty disciplined about what the returns are, but it's making sure that the sub metrics to those returns are being driven as well. And I think we've been pretty sophisticated in continuing our knowledge and learning in that regard. And by the way, we pick up learning when we buy some of these businesses, too. So this is -- when we buy some of these business, what comes with that is some good thing -- things that we can learn as well. That's always been true in our history, and we always want to make sure we're learning some things in the companies we buy.

And as we think about future M&A, tremendous amount of optionality at the company. At the same time, the asking prices from sellers, I'm sure, are higher than normal history probably in most areas. So how do you weigh up those 2 things? Is the funnel better today than you -- or the opportunity better today than a year ago because you've got more cash and interest rates are even lower? Or are those sort of offset by sellers being very demanding in what kind of prices they think they can attack?

Well, I think it really starts with, do we have really good knowledge of the market and do we like the company? As you know, we think about market, company, value creation. And I think if we understand the market, we understand the long-term growth dynamics and we understand the company and we know we can create value, then quite frankly, multiples become less important. High-quality businesses are always expensive relative to the rest of the market or the rest of maybe what, a few years. Over 20 years, high-quality businesses have looked expensive from looking back to the year. That's been true for 2 decades now. So I think it's really understanding and be -- and then finally, it's being disciplined around those -- and we have a Board that's very sophisticated in this regard. We have, I think, a leadership team that understands this. And I think it really bears -- that's really how we have to think about it. So we have to be smart about making sure that we understand that value creation and the levers that are there or opportunities. And if we do, then returns will -- the strong returns, and we can never lose sight of the fact that when we're buying some -- we won't buy all software businesses. But when we buy a software business, as an example, which has a what seems like a higher multiple relative to a hardware business, the compounding effect that happens over a decade is much greater in a software business than a hardware business, particularly, net retention is high. So I think in those cases, you could be willing to pay a little bit higher multiple in the early days because of what the long-term returns are, they're just not -- they're very different.

And moving aside from sort of financial criteria and characteristics, I suppose you look back at some of the recent acquisitions. ASP perhaps surprised some people a little bit with where it was relative to where Fortive. Gordian and Accruent, the same in a way. So a little bit outward if we deploy cash from here. Could we expect as well that it will be a mix of some things that are very obvious add-ons to the existing base, but maybe some more creative or opportunistic moves into markets that are not obviously immediately adjacent to what you do today?

I think it's fair to say because we always had a -- where we're at today, we had a vision for 4.5 years ago. Not perfect vision, but I would say we have the core tenets of the vision we have today as well as articulated in the segments we have today. So it would be fair to say that it's more than likely that capital is going to be deployed. It will look consistent with how the segments talk about their view of the markets from where they want to add value. So I would say probably closer than farther away. You never want to -- and we like our focus. We've just spent considerable amount of time focusing the portfolio. I think it's fair to say you probably be -- I'm not sure how surprised people were. In some cases, maybe they were. I think, Gordian and Accruent were right where we thought where field solutions at the time was. But at the end of the day, whether that's true or not, I think where we stand today, and we'll continue to do -- hopefully, people continue to understand the depth and quality of the segments. And I think through that, they'll understand the opportunities that are available to us.

Very last quick one. I know we're essentially out of time. But Fortive, as we've seen, very rigorous portfolio management, exited a bunch of material businesses in the last 4.5 years. Is that process for now we should assume, okay, what you have now is pretty much what you should have in a year or 2, barring something strange? Or no, there's always going to be relentless sort of review of what fits and doesn't fit?

Well, I think we can always have a relentless review of what we look at and at the same time, be confident of what we have going forward. And I think that would -- I would take the -- I would defer to that because we do strategic plans and market assessments of the businesses every year, and we want to make sure that we're consistent. We're taking the most amount of opportunity or those businesses in the future. Sometimes that means that a separation is part of taking advantage of that big opportunity like a Vontier as an example. So I think we'll always do that. But I think when we sit here today and we look at those segments and the excitement we have across all 3 segments, boy, I feel like if we could execute the execution of our strategic plans over the next 3 years, it means those segments all performed very well.

Perfect. Well, I'm afraid we're out of time. Thank you so much, Jim and Chuck, for joining us today, and good luck with your investor meetings the rest of the day.

Julian, thanks. Bye.

Great. Thanks, Julian.

Thank you very much. Bye-bye.

Hopefully, we'll see you soon.

Likewise. Take care.