Fortive Corporation (FTV) Earnings Call Transcript & Summary

Great. Well, thanks, everyone, for being here. It's my pleasure to have up next from Fortive, Jim Lico, President and CEO. I think Jim will kick off with a couple of slides and then Q&A.

Great. Thanks, Julian. Good morning, everyone. Great to see everybody. So great to be in person. For those of you who know Fortive, we talk a lot about elective procedures. It's -- my leg is not a prop for elective procedures that are coming back or anything like that. Anyway, we thought we'd just -- given we haven't been together in a couple of years, thought it would just be a good opportunity here just to very quickly go through a few slides before we get to some questions. So for those of you who are new to Fortive or maybe reacquainted with Fortive, this -- we've got our 2022 numbers. A lot of things that we've done from an evolution perspective since we separated 5 years ago. I think one of the things -- numbers that jumps off the page is we'll enter 2022, 40% recurring revenue and incredibly strong margin profile over the last several years from all the work done with the Fortive Business System. Geographically, you can see still about 50% -- a little over 50% U.S. revenue, the rest of it situated nicely around the world. And our revenue by end market continues to be, I think, good segmentations around a number of end markets with good secular drivers. We're now 1 year into our segmentation. And so of our 3 segments, I think this is one of the really defining moments in the company as we've done a number of things around the portfolio now to really situate us for 3 strong segments for growth. I won't go through all the details here, but I think what you see within the segments is sort of consistency around the margin profile, the consistency around the continued evolution of great brands and strength of market positions. It really gives us, I think, the opportunity for strong growth, whether it be in Intelligent Operating Solutions, which really focuses on solutions for commercial and manufacturing operations; our Precision Technologies is really all about the engineer and the product development and bringing technology to market; and then our Advanced Health Care, which really helps hospitals really deliver high-quality health care at the lowest possible cost. And I think those 3 segments, in many respects, really all foundational to what we do today with strong brands in both hardware and software, within each of the businesses and as well as a continued evolution towards strong recurring revenue, no matter what the business model. We've done a lot of M&A in the business. And so I think it's always important just to see the playbook. We think about markets first, company and then can we create value? We have to have a good grade in every one of those 3 in order to move forward. What you've seen since the -- since our separation in 2016, excuse me, is really about $2.5 billion -- almost $2.5 billion worth of revenue added. Very strong growth characteristics on the hardware side at around mid-double digit -- or mid-single-digit growth, excuse me. And then on the software side, low double digits. So good growth profiles for both of those. Operating profit continues to grow substantially, up 80% from the time we would have bought those companies as well as operating margin expansion of 800 basis points up. Really, seeing both the power of, I think, of our acquisition strategy around growth and attaching ourselves to strong secular drivers as well as the business model changes that really, I think, deliver outstanding margin profile as well. That really puts us to where we're at today in 2022 with about 7% growth at our midpoint. You can see the rest of the statistics. About 20% margin -- cash margins, I think, which is another demonstration of the strong changes we've made to the portfolio that are really positive for the business. So real quick run-through. You'll have an opportunity to have the slides and certainly love to talk about them and answer questions about them. I think we feel very good about where we stand today. A lot of things out there that we'll talk about certainly even as of this morning, but I think we're well situated for success this year. Thanks.

Great. Thanks so much, Jim, for those comments. I suppose first off and maybe just to remind people, Fortive, we should have the QR code up for them. But once that QR code is up for Fortive, just as a reminder, you can send questions to me. And of course, please have a go at the audience response survey questions, if you get a minute. But perhaps starting off, Jim, that was a very good kind of strategic update. Your financial guidance, I suppose, is the most recent thing that people have been talking about. And I suppose it looked to a lot of investors sort of somewhat back-end loaded, not unique at all to 40%, I think probably 90% of the companies here have a similar sort of jump in the back half for various reasons. Maybe talk through kind of the logic behind that -- Fortive and the confidence and the conviction in that type of sort of guidance cadence?

Well, I think we would look at it and say, when we look at the first quarter, it's about 23% of the full year. And historically, that's about the historical average. So when you look at sort of the years that we've had and what I would say, the actuals that we've had, 23% is about where we stand. So we feel that, that's a good starting point. And I think when you look at where we stand relative to years past, we have even more confidence, given the fact that the recurring revenue is now 40%. And our backlog is at a record level, and we won't deplete any backlog in the first half. So we'll start the second half with actually creating backlog through the first half after already creating significant backlog in 2021. So I think as we look into the second half, there's certainly the growth rates on a 2-year stack normalize out a little bit as well. So I think we don't feel it's as back-end loaded as maybe the original perception. I think as people start to understand it, we actually feel -- we feel confident given the profile we have right now that what we'll look out as we get -- as we turn the calendar in July is really in a very good position to deliver the second half. And I guess -- and this kind of probably gets to your other question is the 1% growth in the fourth quarter makes for a slightly easier comp than originally anticipated...

And just on that point, I mean, it feels like sort of ancient history now, Q4. But to the extent it mattered, I suppose people were surprised at that -- maybe the revenue shortfall a little bit. Any particular drivers a bit behind that? Or is it fairly kind of broad?

I would say it's really 2 things. And we talked about a $50 million move out of the quarter and about 70% of that, really, what I would say, supply chain, and get into that in a second. And the remaining part of that is really elective procedures going down through the quarter as we saw Omicron sort of hit hospitals and consumables, sort of slowed in the quarter. So those will be the 2 categories. In supply chain, primarily in our hardware businesses, really -- so we feel -- we certainly learn a lot every time those things happen, but I think we're countermeasuring a number of those changes as we get through the year. And obviously, supply chain constraints are probably a topic du jour. But I think in our case, we saw improvements from the third quarter to the fourth quarter. We actually shipped more in the fourth quarter than we did in the third. And we think those -- our countermeasures will continue to allow for us to continue to deal with some of these challenges through the year.

And in terms of the first quarter, how satisfied are you with the progress or the update on the 2 issues from Q4 supply chain and elective procedure? How are those 2 things playing out right now?

Yes. Well, I certainly think when you -- in our -- sort of in our guide was the fact that electives probably would stay about the same. We thought electives overall will be flat for the year versus '21, but we thought they'd be -- the fourth quarter and the first quarter would look pretty similar. They'll get a little bit better through the year. That's, I think, where we're seeing things that probably played out pretty consistently. And I think we're continuing to make progress on our supply chain challenges. We'll have better organic growth in the first. And we'll -- but I don't think the challenges themselves though are less. I think it's really the actions that we're taking are having greater impact. Our teams are doing a super job of dealing with a really challenging environment for sure.

And how much of it is, I suppose, that -- the chip aspect, maybe in some of those higher spec or higher tech pieces of businesses like Fluke or Tektronix as you've made those kind of smarter and upgraded them.

Well, you're spot on. I mean I think when you look at the challenges that we see as we kind of go up the curve and sophistication of instrumentation, we see probably bigger challenges. It probably stands to reason logically that if you have a more complex set of electronics, you're going to probably have more opportunities for challenge. So as we saw sensing in the fourth quarter where we have a lot of electronics, but probably a little bit less complex, we saw high single-digit growth in sensing. So there was a place where we were able to try to measure prematurely. You look at Fluke and Tek, as you point out, they'll get better through the year. We have a tremendous backlog. We talked about our hardware backlog being up 84% at the start of the year. So I think both Fluke and Tek are well positioned to take advantage of the market opportunities they've created through continuing to improve their situations relative to their supply base.

Perfect. And I suppose, geographically, Fortive has a pretty good presence in China historically. And some of that sort of electronics and test and measurement location are an obvious reason for that. How are you assessing kind of China demand right now?

Yes, it's -- we, as you said, we -- there was a lot of speculation, I think at this time last year that China would be slowing and there'd be challenges and yet we did exceptionally well. I think we have -- we're attached to some good secular drivers over there. Our health business, ASP is doing exceptionally well over there since we bought it from J&J. So I think we continue to see opportunity over there. It's always -- and we've talked about this over the years. It's always hard to read China at the end of February. It's sort of like you've almost got to get through the first quarter to really have a strong sense to get through the Chinese New Year. There's obviously been some COVID things that have occurred here recently. So -- but I think by and large, we still see China as a good growth market, certainly in 2022, for sure.

Perfect. And when we look at sort of the supply chain issues and companies dealing with it in different ways, your inventories are a little bit elevated perhaps versus history as, again, every company, I think, at this conference has the same issue. What I find interesting is the difference between that inventory and then when most companies talk about customer or distributor inventories, yes, they always tell us they're really low. And so sometimes, it's hard to get our heads around that. How do you assess Fortive's channel partners, OEM customers, all of their inventory is really that low? Or it's just difficult to tell?

I think I'll break that into the 2 pieces, right? Our sensing business where we have a good chunk of OEM business is -- we have a good sense of what that backlog looks like. And we have orders out into October and November. So we're seeing -- we certainly have a profile there where people are trying to get in line in order to make -- to assure supply. So without a doubt. And that's baked into how we think about the year. We see -- we kind of know what that's going to look like, and we get good visibility. On the -- where we have the bigger distribution businesses at Fluke and Tektronix, we really look at 3 things when we answer this question. We look at what they have on hand, we look at what they have on order and then we look at point of sale. So we don't just look at the inventory level, we also look at what they have on order. So as an example, if somebody had 7 months of daily sales on order, but their inventory was low, then we wouldn't say that they're in a good position, right? We'd say they've ordered for the year. And so we really do look at that on a case-by-case basis in order to make sure amongst our large-scale distribution folks. And then we do some data analytics around the smaller folks to really have a sense of -- I'd say where we stand today right now is in a pretty good position where we don't really feel like there's anyone getting too far out ahead of where the -- where we would be nervous about where there might be order cancellations or anything like that.

Perfect. And then when you look at sort of ASP and what's happening there, how much do we think that the revenue headwinds are purely end markets and open elective procedures? How much of it is still kind of cleaning up a business that had lost some share under the prior owner, maybe lost its focus, lost its way and you're trying to sort of get it back on track?

Yes. I think what we're really excited about and we've talked with folks about here recently is really how we -- how our strategy has really played out at ASP. When we think about the original hypothesis of the acquisition, it was really around 3 things. It was certainly we were going to be able to take the organization separated out of the J&J structure and a very focused organization around purely around sterilization, we thought would enable and really incentivize people for success. And we've certainly seen that with the kind of growth we've seen outside the United States, where most of those, as we used to call day 2 countries existed. We've now brought all those into our own leadership. We're running those businesses like we would with the Fortive Business System, and we've seen really good growth. So I think our high-growth markets were double digit in the fourth quarter as an example. I think the second thing that we've really thought was we could continue to improve things like attach rate on services. And we've seen that play out pretty well in addition to that. The third one was the secular drivers around elective procedures, the fact that the demographics in the United States and living proof of this right now is that we would -- we'd see more procedures going on through both in the developed world, but also as the high-growth markets continue to evolve their health care systems. That's probably not played out as well as -- because of COVID. But I think that what bears out is we've been able to grow the installed base on a capital perspective, low single digits, both year-end last 2 years, able to still grow the business from that perspective because of the installed base growth that we've been able to -- to be able to do over the last few years. So we feel good about that. We feel we're primed and ready for when things start to come back. We know they will, inevitably. I think it's harder to predict when, but I think it's a strong prediction to say they will. And then I think we've done a great job on the margin front, which is, I think, the place where we've seen really, really good margin expansion in the business. We saw that impact throughout the entire segment, and we'll see that in '22 as well.

And I took the broader structural questions we sometimes get from investors on ASP. One is around that sterilized versus single-use dynamic. And the second is the sort of -- the market share had a sort of a monopoly initially, it felt like. And then the sort of the patent thing plays out. So where are we on kind of those 2 fronts?

Yes. I mean we have a good competitor in STERIS, in the business. So I would say we feel good about our position there, but there's certainly -- I wouldn't -- I would say they're a good competitor. I think on the single-use front, we don't feel there's a big exposure there. That's mostly in the GI world where we don't have as much revenue. And I think in most respects, what we really see as the advantage of a lot of these secular drivers and a lot of the work we've done to continue to really, really strengthen our commercial efforts. We haven't really gotten the innovation flywheel moving yet because it just takes longer with medical -- with medical approvals and things like that. So we haven't even yet to see that impact. But I think what we've seen is strong impact around a lot of our FBS tools related to growth, around commercial activities, digital marketing, sales and service attachment, as I mentioned before. And I think we're well situated to compete in the future for sure.

I think it was sort of interesting to see that, I think, over 800 bps of margin expansion of acquired businesses, which I think is something that may not be appreciated fully. How has that sort of margin uplift played out across different acquisitions that Fortive has made?

Yes. I think when you look at it, really almost all of our acquisitions have had substantial margin expansion, as we pointed out. The one that maybe stands out is a current where we haven't -- I think what -- we've been transparent about the fact that there was a little bit more work than we originally anticipated at the time of the deal. But we feel like the last couple of quarters, we started to hit our stride here a little bit. We've been pretty focused on transitioning that business from a -- to a SaaS perspective to some of the significant growth products that are in the portfolio there. Probably not as much margin expansion because of that, but a business like that, that will grow mid-single digits this year, we'll start to be able to deliver strong margin expansion just given the gross margins that sit in the roughly 70%, 80%.

And more broadly, when you look at Fortive's operating leverage, 40% of revenue recurring gross margins are touching 60%, so well above the average of companies here. What kind of operating leverage should investors expect in a normal inflation environment, like given how much that business has been upgraded?

Yes. Yes. Well, we did 210 basis points of margin expansion in '21 despite the inflation environment, which we think is really a standout in terms of performance. And that's really a combination of FBS and some of the business model profile that gets -- that we continue to work towards. As you said, now approaching those kinds of numbers. 40% is a good number right now, I think for that. We're obviously going to fall through it a little more than that, but we'll take some of that and reinvest in the businesses to try to accelerate things like innovation or grow outside the U.S. So we'll sort of balance that. It can move around a little bit, as you know, from quarter-to-quarter. Sometimes if we see a little bit more revenue, it might be a little bit higher at times. But 40% is a good number for the year. I think we did 39% last year with some added investments. So I think that's a good number, and we'll continue -- obviously, as the portfolio continues. We expect the gross margins in the business to continue to expand. And as we do that, we'll see where that number goes over time. I suspect at some point in time, certainly, we would start talking about a different number.

And I think one point that is an interesting discussion when we think about sort of price versus cost. There are some companies here where -- has been a material kind of margin headwind, that equation. And so people sort of think, investors think, okay, maybe I can play those for the post inflation environment because of the rebound. Others like yourselves at the other end of the spectrum, really strong operating leverage despite price cost. So how does it play out for someone like you once cost inflation eases? Like do your -- like does your operating leverage get even bigger because of spread opens? Or is it just very tight on the way up and the way down?

Well, I think what will happen, we've always been able to do pretty well on the price side because of the strength of our brands and the level of innovation. I always say that it's as much the level of innovation that we have that allows for us to be able to get price in the marketplace. I suspect when we come on the other side of this, we'll start to get more material cost reductions, our price number probably goes down. It's not -- maybe it goes back to -- maybe it normalizes for a little while. But I think in this marketplace, we can -- we're likely to hold on to some of that, and we'll get material reductions. We had gross margin expansion through the first 3 quarters of last year because we were still getting material cost reduction, and we had gotten ahead of the inflation side by getting priced into the market. I think that's something we want to continue to stay attuned to, to make sure that -- maybe because of the events of this morning, we might be thinking more about more inflation and maybe not less. But we'll see where that environment is, we'll stay ahead of price cost. And I think as we turn the tide, we would work pretty hard to keep as much price as possible, but also be strategic about it to make sure that whether it's a share gain opportunity or partnership opportunity with a customer, we're not going to be a whole -- as we are today and the way we put price into the marketplace, we want to be -- we have a partnership with customers that makes sure we're really doing things strategically.

And just on the innovation point. I mean it's interesting that Fortive is one of the higher R&D to sales companies here. But if I look at some of the others who have presented, 3M, high R&D to sales; Roper, high R&D to sales. You get the real sort of bang for the buck from the higher R&. D? And is partly just people are thinking about it wrong, like you should be looking at the gross margin payback from R&D, not simplistically the organic growth?

Well, I do think that you look at organic growth and gross margin expansion because I think we've always had a deep-seated belief in our organization that putting more innovation in the marketplace allows for you to grab more of the gross margin dollars in the market. That said, I think what we've done over the last few years that we're incredibly proud of is we've launched what we call lean portfolio management. And then -- I'll try to stay out of vernacular too much, but the Fortive Business System really has a very strong aspect of product development in it from a tools perspective. And LPM is the newest tool that we've developed over the last couple of years that really takes a lot of the learnings that we've had in a lot of our early-stage innovation work, particularly with our partnership like with Pioneer Square Labs which is an early-stage incubator. So we've really taken all that learning and we've incorporated that into it. So it's a long-winded answer to what LPM really does at its grassroots is really 2 things. Number one is it's really strong about prioritization and making sure that as an organization, we're getting good returns on our R&D investments and that we're maximizing the growth and margin expansion opportunities within a set of portfolio decisions that an operating business of ours would make. And I think the second thing is really making sure that we're spending time on, what I'll call, early-stage innovation, where it's more -- what I'll call more breakthrough kind of innovation as opposed to maybe the next generation of things. And so we're always going to have a passion to come out with the next multimeter, or the next oscilloscope or the next feature for our Intelex software, but it also is to say, well, what's the new feature set or what's the new product that could go after a new application. It's why Tektronix has -- has been so successful, I think, this year. They were really our pilot program. And what they've done is really designated more innovation around new applications and things like power density and automotive, where there are real growth opportunities, and that's shifted the growth rate there a little bit. And we can do that in every one of our businesses over time.

Perfect. And as a reminder, please have a go at the QR code, the audience response survey and send me any questions. I thought it would be better to move quickly on to capital deployment. I think people might accuse of me malpractice as we're 24 minutes in and we haven't touched on that yet. So there was the buyback sort of news a few days ago, looks very timely perhaps given some of the macro stuff going on at the moment. So any -- is it a change in philosophy, purely opportunistic? Any broad...

Yes. Well, I think first, the news is really that we -- it's a little bit of corporate hygiene. We didn't have an authorization. So number one is that. And I think there's no change in capital allocation strategy. But what we have said is that we might be opportunistic from time to time when it made sense where we would invest really, quite frankly, in ourselves when we thought the stock was undervalued. And I think what you've seen from us is just a sort of getting that process set up so that if we wanted to do something, we'd be in a position to do it.

Got it. And is there something about it where -- an aspect where, yes, your own multiple has come in like a lot of companies here, but the sellers for acquisitions are still hanging on to valuations as of December?

Well, I don't think there's that. As I said, there's kind of 2 stages when you're in these sort of situations. The first stage is one of denial where maybe the valuations have changed. What you start to see in that stage, and we've seen this, is that things don't just transact, right? You get involved in a process, but then inevitably, nothing happens. And so we're in that stage today. Then there is inevitably a stage of where people reevaluate. And I think that we're not in that yet, but I suspect we will be shortly. What we've announced is not anything to do with that. I think those maybe are more just serendipitous. But I think at the end of the day, where we stand today, we love what we did last year with Provation and ServiceChannel. We're in a great position. We're patient and disciplined at this point.

And on the M&A front, as you said, Provation and ServiceChannel in aggregate, relatively large. You've taken the leverage up a touch from a very low level after the Vontier exit. How aggressive should people expect Fortive to be this year on capital deployment in general, whether it's buyback or M&A? And how much room do you think you have this year?

Well, we said $5 billion over the next few years. Well, obviously, a strong free cash flow this year.

Yes.

We could do -- we certainly are not prohibited in any way, shape or form from doing anything. I think what we've demonstrated over time certainly to folks is the ability to take the leverage up a little bit and then -- with a commitment of bringing it back, given our strong free cash flow. And quite frankly, the profile of our cash flow hasn't really changed significantly, which I think makes us even a better bet. So I think in many respects, we're in a very good position. But again, I think we're going to be patient. I think right now is a time we're -- never say never. We're busy, but I also think it's a good opportunity for us to also remember that we just -- and for investors to remember, we just did 2 great deals. And one of them was only December 30 or something like that. So it wasn't that long ago.

Right. And I think partly, the buyback update was, as you said, sort of corporate organization and partly just where share prices are. And partly, maybe that valuation derating has been due to some company-specific questions around sort of acquisitions and so forth. What do you think kind of investors miss about the acquisitions that Fortive has done? Is it just a timing function and so a buyback then makes a huge amount of sense because you can see the returns are there, the market doesn't. So absolutely, a buyback, you'll get very high returns on when we look back.

Yes. I don't think -- that is true. So I certainly don't think that's the rationale for doing it. I think what we need to do and what we're trying to do, Julian, is, number one is those segments are only 1 year old. And I think investors are looking to observe those segments, not on a pro forma basis, but on a real basis, right? And I think when we get through '22, and certainly, I think you'll see it -- you certainly saw in '21, you're going to see the repeated performance of these segments. And within those segments, you're going to see how those acquisitions are driving success, not only for our core business, but also -- or in the segments, both the core and the acquisition performance continues to really drive the segment performance. And as that becomes more observable, I'm a big believer in the facts will really be on our side for sure. And I think when we look at our acquisition performance, we're on track on so many of them, almost all of them. I mentioned occurrence, a little bit off. ASP will really get back on track with electives coming back. So we feel like we've really done a nice -- these businesses are in a nice position in '22 to really continue to accelerate, and you'll start to see that move in the segment performance. And I think that's probably what people are looking to understand in a more observable way.

And on the -- not asking you to walk through sort of deal by deal, the returns. But how would you feel about the returns in aggregate? Any sort of broad range of year 3 or 5 type returns on the announced and concluded acquisitions -- the longer-standing ones...

Yes. I mean the ones that we've done in 5 years, the postscript is all very good; eMaint's the one that's 5 years old, it's 5x more profitable, and I think we grew ARR 30% in the fourth quarter. So I think that's our oldest acquisition. It was a smaller one for sure. As you sort of go through, Landauer has done a great job. We're in a very good place with Industrial Scientific. And those are probably the ones that are a little older. As I mentioned, when you go through, Gordian's in a good place. Accruent, I mentioned is a little bit of self-help, so -- and ASP is the big deployment. So I think we're in a very good position. These businesses are -- with what we were looking at from the profile of the segments and the profile of Fortive overall, I think it demonstrates that success. And I think '22, we'll do it again.

And a lot of the M&A, it's either going into health care and you've talked about ASP and Landauer or it's going into that sort of facilities management arena with ServiceChannel, Gordian, Accruent. How satisfied are you with that footprint you've built there? How do you sort of stack up competitively now or market share-wise versus the broad list of peers?

Yes. I think when we look at -- maybe because the time will go quick, in facilities and asset light cycle over $0.5 billion of revenue in that space, with ServiceChannel, Gordian, Accruent, we feel very good about where that position is today, its ability to deliver innovation, its ability to globalize, move the business. So I do think we're really in a good place there. I think we could go through all the workflows and say we're in a good place. And I would also say, maybe as -- we're looking at hardware and software. I think sometimes, yes, people think of that as only as a software. We really see our niches when we can take advantage of hardware positions to bring software and data analytics to build competitive advantage.

Perfect. Well, we covered a huge amount of ground. So thank you, Jim, for being so efficient and coherent and beyond.

Great to see you. Thanks, Julian.

Thanks again.

Thanks, everyone.

Thank you.