Fortive Corporation (FTV) Earnings Call Transcript & Summary

So, Jim, over to you.

Thanks, Nigel. Good morning, everyone. Good morning to those on the webcast. I don't know at what point we'll be in person or we'll stop saying it's so great to be in person. I think we're still in that phase where it feels new and it is just wonderful to see everyone and have an opportunity to be in person. We thought we'd just spend a few minutes just reacquainting everybody with the story and just kind of where things stand today with where we're at Fortive. Tami runs, as Nigel said, our Precision Technologies segment. And so she'll take the stage at the end, just to kind of give you a little bit more in-depth view of what's in PT, how that's going. So it would be a good opportunity for us to go a little bit deeper in those businesses as well. I've got -- I think the lawyers want to make sure I put the forward-looking statement up there. As you know, today, where we stand from a geographic perspective, we're in a wonderful position. We just had a very, very strong first quarter. Our demand profile, very good. We feel good about where we stand today in the quarter. So we're in a good place here relative to the business. And I think where we stand today, still a very global business, with still the largest segment being in North America. We see demand strong across really all our geographies. I think what differentiates us today is the number of markets and segments that we're in. You can see no one particular market over dominates from an industry and vertical perspective, really a breadth of businesses. And maybe one of the things that changed the most over the last 5 or 6 years has been when -- as you know, we came out in the summer of '16 out of Danaher is the amount of health care business that we have today. So good presence across a number of geographies. We've done a substantial change in the portfolio in the last few years, bringing in about $2.3 billion worth of new revenue, new revenue streams, more durable revenue streams, both hardware and software with a focus on recurring revenue. Now we're -- recurring revenue at 40%. Better gross margin profile, so the opportunity to continue to see dramatic leverage through growth through the acceleration of our gross margins as well and certainly on the operating margin level as well. So the portfolio today it stands incredibly well positioned from both a mid-single-digit growth like portfolio as well as a margin standpoint. And obviously, the ability to generate really outstanding compounding on the free cash flow side. Talk about that at the very end. Again, you see the changes that we've made over time, really thinking about our 3 segments today. I'll talk about that in a second, really positioning the businesses around a couple of things. One, certainly, connected workflows, taking the hardware positions that we have today, leveraging those hardware positions into software, services, data analytics to really take advantage of those positions that we have within some really great geographies. We've done some exiting of businesses to our automation business really to a more -- really more industrial business that we think had -- could be in a better place if we exited that business, the combo with Altra was a great way to do that and do that with an RMT and that business is off and running. And then last year, with the Vontier separation really putting that business in a position to be successful on its own. Some -- obviously, with exposure to internal combustion engines, but also the ability for that business to take advantage of a lot of the changes going on in the sort of mobility industry. We really put them off in their own path to do that. I think Mark and the team are going to be here later in the week. You get an opportunity to listen to their exciting future. We've taken much of the capital that came from that and made those changes to our portfolio really around better secular drivers, really repositioning the portfolio for really a great evolution here. We sort of sometimes talk about the first 4 or 5 years, really more of a transformation in the next several years, really more about evolution now that the portfolio is positioned where it is. We have 3 segments. I'll talk about a couple of them. Tami come up and talk about PT. We're really happy and excited about the segments we have today with our iOS segment really focused on from a facilities managers perspective within connected workflows around things like environmental health and safety, condition-based monitoring and plant facilities management, really great parts of the market really for us to have opportunities to continue to really build that business around the challenges that facilities managers, maintenance managers have today. And I think as we think about really what's happening in both commercial and manufacturing facilities, lots of digital transformation going on where we can take advantage of those opportunities. Our Healthcare segment now, what we call Advanced Healthcare, with the addition of advanced sterilization products, the carve-out we did with Johnson & Johnson really well positioned, really help hospitals really deal with the challenges they have. We always say, if you think about what's going on in hospitals, we're really helping bring in higher quality, safer health care, delivered at better cost positions. And whether it's hardware or the software businesses we have today in the portfolio are really positioned to take advantage of those challenges on a global basis. And really great structural part of that segment is the high recurring revenue and the opportunity for continued margin expansion like we have in the rest of the portfolio. So I think we're well positioned. I'm going to hand it to Tami for a couple of minutes, talk a little bit about PT and then we'll join Nigel for some Q&A. So Tam, I'll give that to you.

Thank you, Jim. I'm glad to be here to share some progress to date with Precision Technologies and also share how I believe we're continued and set up for good growth and operating margin expansion. So if you look at Q1, we were mid-single digits in revenue. But on the demand side, we've seen continued customer demand. We've had 5 consecutive quarters of double-digit growth. So the customer demand is strong. And you think about what's driving that and you think about the makeup, the brands that are part of Precision Technologies, the amount, the content of electronics that is going into end products is where Tektronix brand and domain expertise is really advantaged. And then you think about sensors and some of the other companies and not just any sensors but sensors where we have deep domain expertise and how those sensors can take data off the centers and help with very expensive assets to manage those. Those are the 2 areas that we see long-term secular trends that are advantaged for this particular segment. As I think forward to some of the exciting product launches that we have coming up, and we've called out and I shared with a few of you earlier, I would call out some of the work at Tektronix with the Fortive Business Systems and Growth Accelerator products. And you will see coming up here June 7, another breakthrough innovation and launch from the Tektronix team. So if you think forward to the next 10 years and think about will there be more electronics in our end products, will there be more sensors in our world, I think we would all say -- would say yes to that. And that's the strength there. As we move forward to kind of the wrap-up piece here, I think about the highlight around cash flow and really strong start to the year, another place where we have a proven track record of applying FBS. And you see that compounding effect that happens that will free up about $5 billion in capital for us to apply back over the next 3 years in M&A. And with that, I'll open it up for questions.

That was a great table. There we go. So I just wanted to pick up on a few of the things you mentioned there, Jim. It sounds like demand -- let's tick off the state of the union [ seeing the ] updates. So it sounds like demand remains still pretty robust. What about some of the canaries in coal mine. So Fluke is always seen as the canary in the Fortive coal mine. How is that trending right now?

Yes. I mean I think if we look geographically, we continue to see the demand profile. You get some of the supply chain issues make the revenue side look a little bit different there as you looked across our businesses in the first quarter. But, our entire portfolio had very strong order demand. And even in a place like China where we had some challenges because of the Shanghai shut down at the last week of the quarter, we still beat our revenue guide for the quarter, and we saw good double-digit orders in China in the first quarter. So as we fast forward to where we're at today, demand profile is coming out as planned. And we've got -- we feel very good about where we're at. And to your question specifically around Fluke tend -- and several of our businesses tend to see some of these things early. Really haven't seen the things that we would typically see if there was a slowdown. So we're obviously reading the same newspapers and everything that everybody else does and trying to sort through if we're -- so we're certainly not short of looking for some of those things. But I would say, as of today and where we stand, we feel good about our outlook, and we feel good. As we've said and we've said, hey, we probably are not going to take much backlog down this year, the demand would -- profile would look good throughout the year. Nothing to suggest at this point that that's any different than that.

Okay. And just to be clear, the ramp-up you've seen in the second half of the year, the growth acceleration in second half of the year is really predicted still on no backlog done.

Right. I mean, yes, and there's, I think, a little over $200 million of -- from first half to second half. Some of that is from China revenue moving into the second half and some of that's just sort of a normal ramp-up that we would typically see first half to second half. We break out 52-48, I think, in terms of first half, second half, 52% being in the second half. That's pretty natural for us. We always see a little bit more demand in the second half. So we feel really good about where we're going to be in the second quarter and feel good that the trends right now support a good second half.

And then there's always this question mark around backlog stability and does this backlog just go away if demand weakens. But in your experience in the past, even through deep downturns, has that backlog been there for you?

If you break down, first of all, I would say, when you look at our software businesses, you don't really think about those kinds of things, right? And that's roughly almost $1 billion of our revenue base. Our health care businesses typically are going to stay very stable during a typical economic downturn. So when you start to look at some of the hardware businesses like Tek or parts of Fluke and our sensing businesses, and we really historically have not seen lots of cancellations. People just don't buy or double -- we get lots of questions, do you get double buying. We just don't see that kind of double buying in the kinds of businesses we have. It just doesn't -- it isn't part of how people think about our demand pattern. On the sensing side, we're seeing early ordering. But quite frankly, that's just customers trying to make sure they're in line, maybe a little bit more like a component business, where they just want to make sure they're in line. So they're giving us early view to orders. And quite frankly, that really solidifies our second half revenue more than anything because those are real demand. That's not somebody just trying to build inventory. That's just going to be natural demand that people want to make sure we can fulfill and they're just giving us a longer lead time in which to look at it.

I do want to turn on to China and supply chain in a second. Maybe that's a good place to start with Tami. But ASP is another business that gets a lot of attention from investors in terms of the elective procedures and how that's trending. Any color there through the quarter?

Yes. I mean I think we're seeing things play out pretty close to how we thought. We said, I think, 85% in the first quarter. We thought things would start to get better above that number through the year. And I think there's -- I think the U.S. is tracking. There's been a little bit of noise in China probably this quarter but that's not the biggest piece of the business, but there'll probably be a little bit of noise. But I think in general, things are playing out the way we think. And the business itself across health is well positioned for -- as things come back. Obviously, our ASP is our biggest business. And what they've done this year -- and what they've done over the last couple of years, I think is just outstanding, despite the fact that we've had elective challenges, and that's the consumable piece being the most profitable part of the business, the fact that they continue to really drive the kind of margin expansion that they have already. And now with the forward opportunity of consumables coming back, I think just speaks well to the great job the team has done and quite frankly, how well that business is going to be positioned for the future.

Got no question. So maybe move on to China. I mean you had a $40 million hedge in your 2Q guidance for China supply chain issues, lockdowns, I should say. Maybe just [ bring some speed ] in terms of what you're seeing in China right now and has that sort of played out to your expectation?

So a big piece of that is Tektronix, which is one of the brands in the portfolio. And we have navigated the supply chain challenges for about 6 quarters now. So I think we've managed that. The piece that is different for us here as we came into Q2 was getting labor in the factories to actually build the product. So we had a game plan that we started with at the start of the quarter, and it was getting these people back in a closed loop process. We've gotten back to exactly the targets that we expected as we came out of May. So we're right on track there. The third piece of the puzzle that we have to put together is the logistics piece. And we've been able to open up domestic shipments. Just starting this week, we're starting to get some exports out. So as you look at those 3 factors, all 3 have to come together. And right now, we are about mid-quarter and on track.

Okay. That's great. So it sounds like it's labor and logistics more so than chip supply. So at this point in time, are you pretty comfortable that your plans are supported by chip commitments from the suppliers?

Well, the -- yes. And the reason for that is we had the visibility to what we were going to build for the quarter going back 6, 7 months ago. So that piece is -- I should probably knock on something because there's always changes, but we feel good about where we are with the supply. It's the -- we've got restrictions on how many people can come into this closed-loop process. And right now, it's starting to build exactly the way we planned, but we have to stay tuned for any changes from the government. So I would say right now, it's more logistics. -- immediate, followed by labor and feel pretty good about where we are for the quarter with supply chain.

Right. Okay. And maybe just to zoom out a little bit and just talk about how you see Tektronix trending over the back half of this year, maybe more the medium term in terms of the growth drivers of this business. You mentioned we're probably going to see more sensors and more electronics embedded within products. But maybe just talk about how that benefits your business?

Yes. When I -- so I mentioned that we have seen double-digit demand from our customer orders for the last 5 consecutive quarters, and that still seems strong. And whether it's our distributors, our direct sales, the signals are that electronics, again, you're seeing them every place. So you go back to prior a decade ago, most of your electronics went into PCs, mobile phones, maybe a television set. But now you're seeing electronics, with the combination of new batteries and electrification, you're seeing electronics in -- we're in 9 major verticals. We've got diversity of over 75,000 different customers. So you're seeing electronics go places that it never went before, which gives us more diversity.

Yes. And you've got the right products in place at this point to address a much bigger share of that market?

In the portfolio piece? Well, so we started in the mainstream, the mid part of our scope portfolio. We've re-platformed 5 different products over the last 5 years in that space. And now we're about to launch the next platform. That's what I gave a little bit of a sneak preview to for June 7, and you'll see a product that's built for the new generation of engineers, engineers that want to -- they want to be mobile, engineers that want to work remotely. They can tie into our cloud software and share data all over the world. They can use their tools, whether they're on a Scope or they're on their PC. So you'll see more software content, you'll see more cloud applications, and we'll continue to open up more served markets with the portfolio.

Okay. Now Tektronix has always been a business that's through downturns or recessions has always been quite physical. What do you think is making the business today, if at all, but what makes it more recession resilient going forward?

Yes. So the makeup of the portfolio is about 25% now in software and services. I think that helps. Most of our services are 3- and 5-year contracts. So that's a big piece of it. I also think the diversity of the end markets helps in this way also that even if there's a slowdown, well, we see the slowdown across every end market at the same time. Tektronix does not play a very big role in production build-out of [ SONET ]. That's not a place that we have played much. We have a couple of portfolios, maybe 2% to 3% revenue in that space. We play much more in the innovation side, product innovation, research, product innovation, new products coming out, which will -- I think that's why we will continue.

So we think about new verticals, well, not so much new now, but the nontraditional verticals like power, auto, data center, what sort of revenue contribution does that have today versus maybe 5 years ago?

Yes. I would take power as one that I think about across multiple verticals. So we're working power, yes, automotive for batteries in that space. But power -- like if you think about power being 10% to 15% of our revenues today with double-digit growth characteristics, it crosses multiple verticals. So you'll see we're working on power applications in consumer, power applications that will roll into agriculture, transportation. So it's a lot around the battery usage that crosses those verticals. When you think about data center, it's about wired communications and how do you get bandwidth between these data centers, that technology is now going into the automotive into your car. And it looks a lot like a data center on wheels. You've probably seen it referred to. So the testing that we do on all of those protocols, it just takes us into another vertical, which again gives us more durability to be in multiple of these verticals.

Right. That's great. All right. I want to get the audience a chance to ask a question. So if you've got any questions, please raise your hands. We've got maybe 10 minutes. I guess now we'll carry on here. Capital allocation. Let's talk about M&A. You've done $2.5 billion of deals in the last 12 months, service channel and probation. You've got a lot of capital to deploy from here. Where do you sit today in terms of the M&A market, the pipeline? Where do you see the opportunity set?

Yes. Well, I think number one is we always try to not -- we're always busy in M&A, as you know, you've known us for a while. We keep our staffing and resource deployment around M&A, pretty consistent, extremely consistent. We're always cultivating. We're always out doing market work and we're always looking for deals. But as you said, we have to remember, we just did in the last 12 months, we've done $2.5 billion. So we certainly feel very good about the capital we've deployed. As you said, we've got tremendous opportunity. We remain busy. But as we were talking last night a little bit, we still see the market right now in that phase of testing itself where companies are testing opportunities, but typically processes are slowing down or not moving as quickly or maybe even ending. So I suspect that's where we're at for the next several months for sure. So we're busy. We're engaged in things. This might be more of a bolt-on kind of time period where we'll see some things. But I think at the end of the day, we feel very good about where the segments stand today and the opportunities for M&A within those segments are all very good.

Okay. So it sounds like a bit more maybe patience, wait and see for larger deals at this point?

Yes. It's -- I always -- yes, I would say that's definitely true. And then, of course, something that we've been cultivating for 4 years, all of a sudden becomes available. And that can happen. So I know -- I always watch my words here a little bit. But I think as we sat down with our segment leaders, Tami and her peers, her 2 peers, they clearly have things they want to do across a broad, both big and small, and we have those kinds of opportunities. But I do feel like right now is a bit of a time phase where we're probably seeing things that may be slightly smaller and maybe more bolt-on-ish. I just think that's probably where we're at.

Okay. Okay. You mentioned the software portfolio today is at almost $1 billion, which is -- has grown by stealth. It's come into a pretty large chunk of the portfolio. And I know you get this question a lot hardware versus software. And I hate to ask this question, but going forward, how do you feel about the opportunities in hardware versus software acquisitions?

It's a question, it's an obvious question because I think you look at the last 2 deals we did, and they were software. And so that 2 points is a trend, I guess. So -- but I think at the end of day, if you step back and look at over the last almost 6 years, the constant has been deals that we're advancing our strategy around connected workflow. The other constant is whether it was hardware or software, it tended to have a higher recurring revenue, right? So even the Landauer, ASP, Industrial Scientific, those businesses that we bought that were hardware businesses are also have consumable stream, right? So they were still high recurring revenue. So I would say we do have a little bit of a desire to want to add to the recurring revenue level. But whether it's hardware or software, it's really about advancing the strategy. And I think what you've seen over the last 5 or 6 years is us advancing those strategies around our segment view of how we want to do things in a combination of those 2 deals. And I think there's plenty of opportunity to do both of those kinds of deals. And I think we're well positioned to -- with now with the segments -- the size and scale of the segments we have today that really are well positioned to be able to take advantage of opportunities on both sides.

Agree. PT is an area that we haven't seen a lot of deal flow recently. So just wondering what the opportunity set is there within Tami's businesses?

Yes, we can certainly talk about where that could be. But I think at the end of the day, there's always a segment that over maybe a couple year period tends to be a little bit more of a gap. But I think we think there's good opportunities in PT, we've done a lot of things organically. So it hasn't been -- it's really -- there's been some really good organic work, Tami was describing that in the presentation of the work we've done at Tek. The sensing work that we've done is a little bit further behind that, but it's still certainly in the future. So I look -- and I think the more we can advance those organic opportunities, the more that presents inorganic opportunities as well.

Okay. Great. Any questions from analysts, the last chance? Yes, one here. Please, you can just wait for the mic.

I had a question on pricing. So the incremental $20 million, I think you're guiding to on a half-over-half basis in the second half. Is that just a matter of the backlog right now? Or is it a matter of you guys just not necessarily trying to push price as much? Just curious on that dynamic.

I think our pricing first half, I don't know what Chuck [indiscernible] is probably pretty similar first half, second half?

It's a little bit stronger in the second half.

Little bit stronger in the second half. So from an actions perspective, we continue -- you just get -- as you get further in the year, the actions tend to just be a bigger part of the portfolio because not all of -- we took some pricing actions in the first quarter and you get a full quarter of that for a couple of quarters. So I think price cost -- the gross margins in the first quarter were up 60 basis points. Obviously, I think demonstrating our ability to stay ahead of the cost price side of this. We'll continue to take advantage of those opportunities where they're available. And I think we're well positioned to do it. So I don't really see a lot of risk in that number at this point. I think we've -- most of the pricing actions that we've taken that we need to advance the second half were already taken.

Great. I do want to finish off on probation on service channel. They are the 2 new businesses in the portfolio. Maybe just talk about service channel, how that dovetails with your facilities workflow strategy? And then probation, I mean, the 1Q trends out of the gate seemed pretty strong in terms of both the growth rates and the order wins. But maybe just kind of emphasize why you feel so confident about this business?

Well, I think when we look at Gordian current service channel, we now got about $0.5 billion of software revenue in facility -- helping facilities managers deal with the challenges they have every day around their infrastructure, their leases, their return to work, the future of work, just a number of trends around digitizing their facilities footprint around the U.S. or world or whatever. So -- and a contractor network that we bring at service channel in a Gordian, there really, I think, blankets the opportunity around that. It's going to be a double-digit growth business. Those businesses are incredibly profitable today. There's no reason why they can't even be more profitable. So we feel really good about it. There's some overlap in them, so -- but in many respects, we go after independent markets. Accruent is a complicated set of businesses because it's more than one business. But in general, I think we feel -- we -- Chuck and I were just with the current team last week. We've done a nice job. As we said, we -- I think we've been working to improve that business and teams made some nice progress. They put some good numbers up in the first quarter, mid-single-digit growth. So I think we feel very good about where that stands. And the service channel business is out of the gates very good, and we feel really good about where that business stands today. Everything that we thought when we did due diligence around service channel has played out the way we had hoped. Probation, very different business in health care, obviously, but really focused on helping really in that GI workflow today, both in hospitals and ambulatory surgical centers, helps give us more scale in ambulatory surgical centers for the rest of our health care portfolio. So some opportunity there. They've got a SaaS conversion that we feel very confident in over the next 5-plus years that will happen. And I think the growth profile is very good. We just did a 100-day strategic plan about a month ago or so. And we came out of that plan with thinking where you have even more opportunity than we originally thought. So that's what we do the 100 day for, right? We do that. That's a process that we've had in place for a long time. And it really is to look, make sure do that deeper dive now that you've got -- we've got ownership of the business. I think everything we walked away from that opportunity, not only seeing the power of the business and how they've really entrenched themselves with customers today, but also some of those newer procedures and the clinical capability that we have in some of those newer procedures we really saw in a deeper way. And there's clearly more opportunity on the new procedure side than we originally anticipated.

That's great. So if we take your software business in totality, is that a Rule of 40 business today?

It is. It is. And we have -- most of our -- I think most of our software businesses are Rule of 40, [indiscernible]. That's a combination of the growth rate and the operating profit percentage. And that segment today is a Rule of 40 business. Some of those businesses are in the 50s and approaching Rule of 60 business. So it just shows the tremendous compounding capability, not only in the growth and profitability perspective, but obviously, those businesses have tremendous free cash flow. Many of them are negative working capital. And just I think the opportunity to really compound our free cash flow. You saw the slide that Tami showed around how we -- how our confidence in the future growth rate of our free cash flow. And it's really exemplified in that side of businesses.

Great. Well, Jim, we're out of time, so let's leave it there. But thank you very much. Thanks, Tami. Thank you.

Thanks to everyone. Again, thank you.

Thank you.