Fortive Corporation (FTV) Earnings Call Transcript & Summary

Good afternoon, everybody. Welcome back. Again, this is Andy Kaplowitz, U.S. Sector Head of Industrials here at Citigroup. We're happy to have you, and we're very happy to have Fortive Corporation with us. We've got Chuck McLaughlin, who is the SVP and CFO of Fortive; and Griffin Whitney, who is the VP of Investor Relations. So we're going to go right into fireside chat. Welcome, guys. Just for our investors, most of you know already. If you do have questions, you just hit the chat function and you put in your question, and I'll get it over e-mail.

So Chuck, maybe I'll just start with a relative soft ball in the sense that you just had earnings. So we obviously know that things don't change very quickly. But maybe you could sort of step back and talk about whether Q4's trends have continued and whether -- how comfortable you are with that sort of growth outlook that you put out of 4% to 7% given some of the noise that sort of we do see out there. And again, welcome, guys.

Thanks, Andy, and thanks for having us. We're thrilled to be here. It's been a good day so far as we've had a few one-on-ones. Versus what we're seeing now, not that far removed from our earnings call. And I'd point out, in our earnings call, we had the benefit of already seeing January. So not -- we wouldn't expect to see any meaningful news that would change your point of view from what we said there. And so that's not surprising. But what we did say there and stands -- is worth repeating, is to say, Fortive, we had a good -- given the situation, I think we had a really good year last year in that we didn't go down as much as maybe some others. And then we got all the way back to positive growth in Q4, which we felt good about that. And that happened with sequential improvement in most of our businesses as we went through the year. And specifically, in Q4 with Tek and Fluke actually turning -- coming back or making really good improvements from Q3, as we expected. And we expect those trends -- all -- basically, all of our businesses, that's what our guide is based on. We've got some easier compares, obviously, in the first half year. But as we go through the year, we expect sequential improvement as vaccines get deployed, as the virus goes down and the businesses open up. What we're not saying is that we're in some kind of snapback recovery or that we're back to normal by Q4. We're just saying it just progressively gets better as we go through the year. So that's what we're trying to communicate. And I think that's clearly what we're seeing at this point.

So Chuck, obviously, great momentum. What was a little surprising for me actually is that if I look sort of regionally, Western Europe was actually your strongest region if I look at the quarter. So maybe you can comment on the sustainability of the trend there. Obviously, China has sort of nicely recovered to up high single digits. So maybe talk about the regions. I know North America core growth was slightly down. That seems to be sort of last in, last out in terms of the virus, but maybe you can sort of talk about that.

Yes. I had thought about the last in, last out, but good cost accounting term there. I like that. So well done. But I think the theme here is that we're seeing sequential improvement. And yes, Western Europe was strong. And what we're seeing is each region's got its own story about how they're coming back. I don't know that Western Europe at high single-digit is what we're forecasting for next year going forward. But we do think just the environment will continue to get better. I think that while North America was down a little bit, as you talked about, sequentially, it improved. So again, we're seeing these sequential improvement themes. And China was actually, again, as it's been running ahead, maybe in terms of where they're at with the vaccine or virus infection rates being down, they're running a little bit ahead. And we expect that in 2021, probably all regions will have some ups and downs, especially in the first half, but China is going to be good in 2021 and be a good grower for us. And I think that we expect that. We expect both North America and Western Europe to be good as well. Western Europe, maybe not quite as strong as high single-digit as they were in the fourth quarter, but still in the -- moving into positive territory. In the first half, that might be a little bit more about the easier comps. That will be a part of the story. But when you look at what's been going on for the last couple of quarters here, this gradual understanding of how to operate in this environment we're restricted, I think that will continue. But then coupled with actual opening back up, that's what we expect, probably in every region around the world.

And Chuck, I'd be remiss if I didn't ask you, because I've been asking most companies. I mean, you're a very global business, but obviously, the weather is pretty crappy everywhere. So any sort of concerns about logistics or anything, interruptions in the business. Texas is a big state.

Well, I think you're right. Texas is a big state. There's a lot of weather out there. And -- but the good -- that's the bad news. The good news is it's February, and there's a long -- we've got quite a number of weeks between now and the end of the quarter. And well, logistics is always something you want to watch carefully. When it will be a disruption? I'll take that in the middle of the quarter versus the end of the quarter. If it happens the last 2 weeks of the quarter, that's far more of a problem. It's not to say that it's -- we don't -- the winter months always can have something come up. But I think at this point, we're not overly concerned about the weather at this point.

Got it. And maybe sort of a bigger picture topic of incremental margin, now that Vontier is separated, right? You've talked about sort of 35%. But if I look at this year, obviously, Q2 is a little different, but you've got 40% dialed in for the other quarters, basically. So is that sort of the way to think about it, now, Chuck? Is that the sharper focus, the higher gross margin of the company means 40% incrementals going forward? .

One sort of the other side of Q2, I do. I think that there's a little bit of -- still some onetime costs coming back in the back half. But 40% in the second half and going forward is probably a pretty good place to think about it. And as we progress with this portfolio, depending on the rate of recovery, I really don't think this is a recovery year just versus this gradual move forward. I think a recovery year is still in front of us. But yes, 40% going forward is something I think is the right way to think about. Maybe not every segment by every quarter, there's going to be different -- little bit movements. But when you step back and you look at it going forward, I think 40% overall is a good number.

And Chuck, I'll be honest, like I'm still getting used to the new segments, right? So like when I look at the new segments, I see little differences in margins, but I think you've said that you can get the high 20% in all of them, right? So maybe just talk about any structural differences amongst the businesses that should impact the way we think about the long-term margin trajectory for those businesses?

Well, yes, there's a few. First of all, I would say that we can get to high 20s across the portfolio. But I think that what you're seeing right now is IOS is already in the high 20s and with really strong at 68-some-percent gross margins. And I would expect them to get into the 30s over the next few years. I would think that, that's something that's very doable and especially since they're the most advantaged at this time on their gross margins. I think that health is in the mid-20s now, but I think there's -- with ASP, we're at the front end of what that -- what that's going to do. Elective surgeries are still a pretty good headwind on us. And when that comes off, and the fact that we're not even at the 2-year mark and we're just getting all these businesses off of TSAs and give us an opportunity to drive margin expansion and optimize really the logistics would be one thing that comes to mind here. I think that over the next 3 or 4 years, that also can be pushing 30% margins. I think professional technologies probably doesn't have -- maybe in the near term when you're bouncing back, you're going to see some elevated growth. They probably didn't have the long-term growth trajectory yet at this point. It's probably still a part of the portfolio. That's a 2%, 3% grower, but with really good margins, probably more in the mid-20s. But I still think that as we go through time, we still expect those things to show, deploy with FPS at every one of our businesses. Now 50 basis points margin expansion is what I would expect there. But still -- puts it all together, and I think that in a few years we'll be pushing 30%. But I'm talking 3, 4 years out or something.

Yes. Chuck, should we think about growth kind of in the same way for the segments? IOS this year is going to grow the fastest. But is there any sort of longer-term differences you think between -- I'd imagine you're going to tell me that health could look pretty good in terms of growth, too, long term. So -- but you tell me, like any -- who do you think is your fastest grower? Do you expect them all to be sort of mid-single-digit plus? .

Well, I think that -- and this year, if you're going to talk about core growth, I think IOS, you're right. If you're talking about total growth, actually, health is going to be the fastest grower here on total growth. Because we came off at TSA, so when you see the compare, you've really got the combination of what's essentially we call M&A because we get -- as we came out the TSAs, that's how we counted rather than putting it into the core. But we know like total growth, health is probably going to be double-digit growth here. Or it could be double digit, high-single-digit -- double digit.

Got it. Got it. And then, obviously, change is part of the process with you guys, or should I say, continuous improvement is probably a better characterization. But now you separated from Vontier, that's complete, how are you thinking about the portfolio going forward? Is there anything that's still chunky that needs to be pruned with understanding that you're always sort of adjusting the portfolio?

Well, I think it's fair to say that we will -- we always have been and we always will be evaluating the portfolio. And when you look out over a long period of time, is there -- would we never make a move? It's like, well, you look at even what Danaher did is I don't think there's a 5-year period where they didn't ever make a move. Having said that, we really like these segments. That's why we've broken them into these 3 segments, so we can give more clarity about what's going on, what their drivers are. And I think as we do that going forward and talk about what's driving the growth, what our customers are doing there, how we can expand margin, what our opportunities will be, I think it will become clear about, well, these are really exciting segments that, on their own right, all have something to fall to be deeply committed to. And so that's where we sit right now. But every year, the world changes and things don't -- you can't always predict how things will play out. So I'm not going to. But I would -- I do really like each one of these segments and what they do and how they're going to drive significant cash flow and growth opportunities.

So I'll ask you a bit more about M&A in a second, but let me just ask you about recurring revenue in the sense that now, I think it's up to about 40% of revenue. How much of a strategic priority is to get it to 50%? And like when you think about your ideal level of recurring earnings and you think about SaaS, SaaS is still a relatively small part of the portfolio, but it does seem to be accelerating, obviously. So what's the sort of imperative to get SaaS up as a percentage of the business?

Well, when we look at the segments and we look at what each of the businesses are and what they're trying to do, it starts with the strategy and how we accelerate strategy when it gets to M&A. But really, the strategy is that they're trying to execute, and also gets to what are our customers doing? Much of what we're doing, especially from acquisition, but also from an organic, really starts with what it takes to be successful, and ultimately, is what are the needs of what our customers are doing. That's what's really leading us in many of these directions. So you mentioned recurring revenue. One of the goals that we had 5 years ago or a couple of them were we want to make the portfolio growth here and less cyclical. And I think we've done that a lot. And the more you do it, the more you want to do it. So it's -- I think when we put out the goal a couple of years ago as, "Hey, we want to move towards 40% recurring revenue." But we didn't say that was a destination. That's just the next waypoint. And so I think that's probably the right way to think about 50%, is that, that's the next waypoint. How long will it take us to get to 50%? Not because it's a destination. It's just -- it's a -- more part of it is you want people to understand that we're progressing and making the business less cyclical. And they tend to remember 30, 40, 50 and where you are on that continuum. And so it's helpful in that to remind them that each year that we get closer to 50, they're like, okay, they continue to make the business less cyclical with that move. And I remember they can link it all back to our strategy. So that's part of it. When we get to 50, we'll probably say, wow -- I doubt we'll say enough with the recurring revenue, let's go backwards. We'll march forward, I'm sure. But that's really how we think about those. We want to be improving the business, put a mark out there that we deem to be improving. So recurring revenue and SaaS is a great way to do that. It's just not the only way, and it's not the biggest move. You look at what's going on at ASP, 75% of their business in the health sector being recurring revenue. That's just a great business model. So software is certainly a way to do it, but also consumables is another way that we like as well.

And Chuck, maybe kind of similarly, like when I think about FBS, right, it's always changing as well. I mean there's a core FBS strategy, right? But you separate Vontier, that gives you and the management team may be more focus over maybe a smaller subset of things. So does FBS evolve for you guys here? And are there certain things that you can sort of hone the focus on, like hone on an individual business or something like that? Obviously, you pay attention to all your children, but if you have fewer of them, maybe you pay attention to a couple more closely.

Yes, when a couple go off to college and graduate school, like Vontier has, maybe they don't get as much focus.

[indiscernible] not Masters yet, Chuck.

Yes. Well, that's for sure. So part of the answer I'd tell you is yes. But think about it this way. The FBS office has always been a tight knit of just zealot professionals, and it's always evolving. So it's always going to change, always gaining best practices, seeing how we can implement that. The other thing that where -- a lot of where they get deployed is to the acquisitions. We've done a lot of acquisitions in what used to be Professional Instrumentations, but in what is now Fortive. So a lot of our FBS, not all -- some are with Vontier, but a lot of them are deployed around the acquisitions. And that kind of formula to help those businesses gain traction and make steps forward, that's going to continue. That will be a hallmark of where we deploy our resources and what we're trying to do with them towards those acquisitions. So that's -- and that's also how they learn best practices and keep seeing opportunities and what we need to evolve. And what is FBS now is far different than what it was 20 years ago. I don't want to take away when Jim Lico ran the FBS office because -- he's a big catalyst of some of this change, for sure, so it's not like he's getting in the way. But it's a lot different than it was 15, 20 years ago.

Yes. And like you guys talk a lot about innovation and sort of upping innovation when it comes down to it. And you've got the partnership with Pioneer Square Labs. You've been talking about the FORT and sort of building that. So maybe talk about what stage you're at in terms of commercializing and monetizing the innovation that you've brought to the company through the FORT. .

I think both the FORT and Pioneer Labs is -- we're very early innings. I think we're at warm-ups with the FORT, but I'm sure we're past the first inning, if you want to use the baseball analogy. And I only say it because we don't have a basketball team here in Seattle. So anyway, not bitter about that, I'll move on. But we're definitely at the early innings here with that. And what we're doing in the FORT is bringing -- creating a center of excellence around the -- around big data, data analytics, how can we deploy that and how can they help -- similar to how the Fortive Business System works is going out and partnering with the people in the business and how they're going to deploy that. So that's really what we're doing at this point around data analytics and the FORT. We're very encouraged with some of the early returns there. But this is something that's going to take time. It's not -- it doesn't cut across suddenly $2 billion worth of revenue all at once. But it does start small in many places meaningfully informing us how. And we'll learn. We'll teach people how to do this, and then they'll expand from there. They're not -- so I wouldn't say that there are too many things that move the needle at this point. But we didn't expect them to. I think we're off to a great start, and there's going to be more things to talk about. When you get to Pioneer Square Labs, this is a way where we can jointly fund start-ups with Pioneer Square Labs and decide whether we want to spin them in to Fortive or maybe we want to spin them out and monetize the investment there. But ultimately, it's about innovation. We expect that we'll have some wins here. That we will turn it into money, that will actually move the needle, and we've got some things at the beginning. But concurrent with that, what we're also learning is how do you disrupt a technology? How do you bring out an innovation that attacks a market that goes faster than how we currently develop market or develop products sometimes? And what can we learn from that, that then along with the products that we might bring in, but also the processes, what kinds of things -- how do those types of companies move so fast and get such great results? I think it's, again, very early, but on both the -- what we're learning and maybe what -- how we got to adapt what we're doing for our own internal projects as well as identifying some early-stage things that we think could turn into something, I think we're very encouraged on both of those. But we're early innings on both of those.