Fortive Corporation (FTV) Earnings Call Transcript & Summary

All right. Good morning, everybody. We're going to keep things rolling here on day 2 with Fortive. I'm joined on stage by Jim Lico, President and CEO. Jim, thanks for joining us. Always a pleasure to have you out here and I guess a shorter trip for you than most, but we appreciate it all the same. Just as a reminder, everybody, like I've been saying all week. If you have any questions about our research disclosures, please visit the research disclosure website or reach out to your salesperson. Jim, if you don't mind just kind of starting us off with maybe what you guys are focused on, paying the most attention to? Bigger strategic imperatives. We can dive into all the macro stuff after that, but give us a little bit of overview of what's on your mind.

Well, yes, I think, first of all, it's great. It is always great to be here and see people certainly great to be in person, too. So Josh, I would start with probably, we obviously had a very strong first half on the backs of broad-based demand, a number of very important strategic things that are playing out well that are really driving, I think, our financial performance. We can get into those details. So I think the portfolio is really tuned. I think what we're seeing -- we'll get into the details, but I think we continue to see the strength of that portfolio playing out through the remainder of the year. So we feel like we're in a good place strategically. We -- operationally, we've continued to -- certainly, the use of the power of the Fortive Business System continues to really help us from a performance perspective. And then finally, I would just say, what we've done over the last several years is to build a portfolio around safer, smarter, more productive workflow solutions, both with hardware, software and services. And I think we're really pleased with the way that strategy is playing out both short term and long term.

Excellent. So maybe just kind of starting off with the macro, and I know a lot of folks here have been kind of on a treasure hunt for where you're seeing kind of cracks in the system. Things seem very strong, but it's hard to ignore the headlines. What are you guys seeing across the business? And is there any sort of canary in the coal mine that you're watching more closely?

Yes. Well, with 40% recurring revenue, we're going to have the nature of the business right now, it's more stable, less volatile. But I think we continued said in the second quarter, given the strength of our backlog, given the continued work we've been doing to drive the business, things are pretty good. The things we looked for, both -- we sort of think about things as we've got a health care business that's stable, we've got some things that are driven by electives that we can talk about, but in a good place. Our hardware businesses more broadly have a tremendous amount of backlog. And so that certainly provides some good things. Canary in the coal mine, obviously, we've talked over the years has been our Fluke point-of-sale and that's held up well. So from that standpoint, we always thought the second half would be a little slower from an order perspective, would still be grow -- would still grow. And that's played out. We're still building backlog in several of the businesses. So we're watching backlog. We're watching point of sale at Fluke. We're watching our distributor inventories more broadly in our channel businesses. Those things are all playing out well.

And that backlog commentary is kind of an important component because it is -- these are shorter cycle businesses. They're not highly configured, I think in a lot of cases. How do you go about sort of scrubbing that and checking to make sure there's like sincerity there. People aren't double ordering. It sounds like inventory is not the issue, but how do you sort of square that away with the underlying demand?

Well, I would think -- I think if you look at the portfolio, you're really thinking about that in 3 places. Our sensing businesses, which really are more longer cycle, long blanket contracts. We're seeing that business still hold up. We are seeing people order for next year. But quite frankly, they're doing that to get in the queue given supply chain things. And we're encouraging that. So to get them -- to know what their demand is a little further out. On the Tektronix side, backlog -- a really strong backlog. And people don't just thought of -- our people buy in advance. People don't spend $20,000 or $50,000 on solo scope and triple order those things. It's just not the way the business transact. So we feel good that that there's a real growth story there. And then finally, Fluke is a little bit probably more short cycle. And there, we look at point of sale, as I was describing, plus what's in -- what's on our order. And so we look at the combination of that divided by our point of sale in order to understand that broadly around the world. And those metrics are holding up pretty well.

Excellent. And as your lead times improve, the expectation that starts to work down as well and those customers don't feel the need to go out? Or do you think this is more of like a shift in their behavior where it's more of an adjusting case.

I think we're going to -- it's going to depend on our business, but I think at the end of the day, I think we're a long way from customers starting to think that they're not going to have some challenges. I think the world of supply chain challenges remains pretty robust.

And to combat that, just sort of flipping over to supply chain. How do you guys think about your own supply chain? I mean there's not a lot of, what I would call like, direct material conversion in the business model. I can't imagine there's a pallet of steel coming in or [ roll of steel] coming into the dock very often. Are you guys thinking about who you need to be partnering with or expanding scope or sourcing more locally? I don't want to lead the witness, but what are your sort of actions there?

Well, we certainly have -- quite frankly, we've been on a journey around -- reducing the risk of our supply chain around the world. Really -- well, we've always done that, but done it with more an aggressive pace ever since the tariff situations were hitting several years ago. So we've been on a path of having, in some cases, double sources, dual sourcing; in other cases, moving locations. We're mostly final assembly and test, as you pointed out, where we manufacture. So we have the degrees of freedom to move pretty easily. We're not moving large-scale factories and things like that. So we've continued to evolve. And then on the other side, we've -- from a design perspective, we -- our engineers have spent the last couple of years now, really designing in new components more broadly, things that are going to have less risk. And what you're seeing now is the benefits of all that work. I wouldn't necessarily say the supply chain lead times have necessarily changed all that much, but it's really been the work of countermeasures that we've done over the last several years that we're benefiting from.

Got it. And I guess the foil to supply chain is inflation and price cost and things like that. I mean I think the portfolio and its pricing power are pretty well documented, but how do you think about what you're seeing inflation wise? I mean we're starting to see some leveling off and some of the inputs, not CPI, but I don't think you guys are buying chicken too often. You also don't have exposure to the metals either like -- are you seeing disinflation? Or how do you think about kind of that price cost curve, maybe in the medium term?

Yes. I mean, one is we've been ahead as you know, price cost for pretty much since all this kind of started. So we continue to -- that is a key metric that we look at by business every single month. Our business have done a wonderful job because we have such strong franchises. And as you said, if we're delivering tremendous customer value, tremendous innovation, we ought to be able to price things and be able to deal with some of these challenges, which I think we've done incredibly effectively. I don't necessarily think -- most of what we buy is electronic components, and we're still seeing pricing maybe on the spot market and things like that when shortages occur, that still remains pretty healthy. So I would anticipate that to go away over time. So as we look into, hopefully, some point in '23, things will start. There are investments being made by the supply base. We'll start to see the benefit of that. Probably, there might be some demand destruction, as you point out, given all the work that central banks are doing. That combination of that would suggest, I think at a pretty high confidence level that those things are going to start to mitigate, but we'll be able to hold, I think, the majority of our price.

Got it. Any way to sort of size what that frictional component is? Because like you said, not direct -- disinflation or inflation that you're seeing so much from here is things like air freight, not have to do as much. Are those kind of big items as they drop off?

Yes. I think even if you sort of said, okay, maybe pricing at a core level will -- costs at a core level might remain a little bit higher than normal. Most -- about half of that inflation that we've been offsetting is what you just described, which is freight, it's surcharges or spot buy stuff. And that should definitely go away. So at least half of that inflation, I would say, should not be sticky from what we've seen. So I think the combination of maybe the great work our supply chain teams have done over a decade, quite frankly, to really make sure that we continue to have this focus on continuous improvement with our supplier partners. I think the combination of that, in fact, some of these things go away and our continued ability to have pricing power, I think really -- and the business model changes, I think really suggests that we're almost at 60% gross margins now. And I would expect us to continue to be able to grow gross margins here in the future.

Got it. And are those items as kind of more frictional items starting to go in the right direction for you?

Not yet. A little bit on the freight side, but I think the constrained side, we're dealing with a lot less part numbers that are challenged, but the part numbers that we have, we need them all at one time. So at the end of the day, it doesn't matter if you have 1 or 20. So we're seeing a lot less in terms of numbers, but the ones we have are still there.

Got it. And then just sort of bridging off this kind of talking about in-house productivity. I mean -- as you said, a lot of the cost in the business, a lot of the cost of goods is really related to like sourced material. How do you think about the big buckets of productivity in the organization? It's not the guy operating some machine a lot there because you're not doing the conversion. But where do you guys spend your time focusing?

Well, I think, first of all, we're big believers in everything and every dollar we spend can be done more productively around the company. And that's really -- really that's the power of the Fortive Business System is. It doesn't really matter if we're in a manufacturing business or service labs at Tektronix or what we do in the back office of our software businesses. At the end of the day, everything is a process and those processes can be value stream mapped and they can be -- we can find waste and improvement in those. So yes, I think we do that in everything from our R&D labs to what we still do on the factory floor. And that, I think, is still really an opportunity for continued work in terms of productivity.

I guess the same question from the customer's perspective, a lot of what you guys are selling is maybe not outright automation, although there's some kind of maybe marginal definitions of that. But it's definitely productivity in a lot of cases. How would you sort of size that across the portfolio? As you think about like what customers are buying with the anticipation of -- I'm buying this to save money, it's not like a capacity call or something like that.

I think it's been intentional in the sense of we've really constructed the portfolio around safer, smarter, more productive. And about 80% to 90% of our revenue today is in that safer, smarter productive -- more productivity. And that's -- as I said, it's intentional because we really believe that those secular drivers are really -- and we can talk about the details of those secular drivers, but they're real and they're going to continue to really provide great opportunities for our businesses in the future.

Yes. So a couple of examples of that would be great. Or just how customers maybe think about what that payback looks like.

Yes. Well, I mean you think even if you start with legacy, what Fluke does on the condition monitoring and connected reliability standpoint is uptime. And what customer today isn't trying to get more out of the assets they have. And so I think that's number one. And there's a -- I mean people want to move to preventive maintenance, but they still do a lot of troubleshooting, they still do, and we're providing those solutions from the time a machine goes down to the methodology and data that is required to figure out how to keep that -- how to create a preventive maintenance schedule that keeps that piece of equipment up and running to what we do at Tektronix around now solutions that are hardware, software and probes that really around specific applications. And then finally, our Provation is a great example. The GI doctor today wants to do more procedures. The hospital wants or the ASC wants to do more procedures because that's where they make most of their money and putting in Provation has months not -- months, not years, kind of return on investment because what they're doing is really digitizing that entire workflow, combining activities and being able to do everything in less time, so the doctor can do 1 or 2 more procedures a day or maybe 3 or 4 a week, whatever it is. And ultimately, that rings the cash register from the standpoint of what the healthcare community is doing.

Got it. And it sounds like the core of this is labor productivity, right? So scarcity matters because that helps the business.

Yes. And our whole digital strategy around continuing to progress workflows and take advantage of the data that we create ultimately to provide more insights to customers is in and of itself always a productivity discussion.

Got it. Maybe going to the -- not the other end of the portfolio, but maybe some of that gets a bit of a bad rap is Tektronix where I think people sort of think that business lives and dies by what's going on in electronic cycles. But I can't remember how many companies I've talked to over the last 6 months that have talked about product redesigns. We couldn't get the old stuff. We have to redesign it or if we're near shoring and need to qualify new suppliers or build new products ourselves, I got to imagine there's an oscilloscope that's being purchased to support that? How do you think about maybe kind of the old versus new paradigm for that business?

Yes. I think first, we really have since inception, but really getting real traction over the last 5 years was the continued efforts to make Tektronix less volatile. And that was really centered on a big service business. It's now 20% to 25% of their sales getting out of some product lines that were more cyclical like our video business. So that was sort of on the one side of the portfolio. Then the other is on the organic side is really directing the business, as you pointed out, away from being -- having more semiconductor exposure to really more broader, around real secular drivers like power, like data centers. Some of the things were -- really have good drivers that ultimately will help them in a downturn because they're secular in nature. And as you said, this is a bit of the age of hardware. Everybody, customers around the world today, whether it's -- we're seeing more solutions in automotive because of what's happening with EVs. We're seeing more batteries are being produced for everything. I always talk about the battery power chain side, bought the other day. And at the end of the day, that required an oscilloscope to do the design work on that product. So I think just more broadly, as you point out, those are some things that the number of applications that are out there today is just more -- is greater than it was, say, 5 years ago for sure.

And that's not just like a triage item, as folks are scrambling with supply chain, that should persist?

Yes. No. I think reshoring as you pointed out, I think just the continued importance of the connected world is ultimately going to drive more IoT. It's going to drive more -- the desire for customers -- consumers, quite frankly, have more connected devices. And ultimately, for companies that are designing those things, they're going to need an oscilloscope.

I want to shift over to the software businesses and maybe take a step back because I think that as the Gordian, Accruent, ServiceChannel have come together so maybe -- so a little bit of misunderstanding about what these businesses do, what the value proposition, why Fortive should be in this kind of from scratch of, maybe just talk a little bit about why you see those as an attractive area and how they fit together?

Well, we always saw the challenges more broadly of what facilities managers do every day because of the view we had at Fluke. Fluke sells to the maintenance manager and facilities manager. And that's been where we've been. And those opportunities and the challenges that those people have is really something that really led us to Accruent, Gordian, and ServiceChannel $0.5 million -- $0.5 billion franchise -- software franchise with double-digit growth opportunities with great profit potential, great profitability today. And we really think that set of core assets that really helps the facilities manager manage their assets, manage their things like their leases. We certainly have a return-to-work strategy around a current that we call workforce management, which is a great set of solutions to help people decide how they're going to bring people back into the office and tools to help with that. So we think the secular drivers there are very strong. And again, getting back to safer, smarter, efficient, it's all about -- it's really more about productivity and efficiency with what we do in those 3 businesses.

Is there something that I guess we should keep in mind there with what the kind of the starting point is. So like this is a market that I think a lot of industrial folks don't have as much exposure to. But if someone adopts these business models, is it displacing like a yellow pad or paper [indiscernible] Excel file? What is kind of the before...

Well, there's a couple of things. Number one is people want to understand a better degree of data and how they're spending money around all their facilities around the world. And you're right, it was Excel spreadsheets. Today, it's got -- we've got solutions. We're connecting to IoT sensors in some cases, and we're really providing a customer a collective -- in many cases, a collective view, maybe it's the whole country, maybe it's the whole world, whatever, but it's giving a more collective holistic view of what -- where their assets are and where they're more -- and facilities are and that allows for them to make the decisions they need to make around how do we make those more effectively. And in a day where labor shortages are more of a challenge, particularly in what we do at ServiceChannel. We're really a holistic facilities management solution that really helps them deal with how do I find contractors. And in a day where labor shortages are a problem and probably will continue to be a problem, particularly in U.S. and Europe, we think that's a driver that's going to be really strong here for the next few years for sure.

And I think we were talking last night at dinner about this is a $10 billion market and you guys are big. It's almost $600 million. I guess 2 things go within that: one, does the market need to consolidate? And two, is there sort of a natural cap where only companies of a certain size or only markets with some kind of level of complexity or facilities that are 20 stories tall, whatever you want to metric look at it, that sort of says here's our stopping point and why it wouldn't be bigger.

I think a $10 billion market, as you pointed out, we have a #1 position, not only from a revenue perspective, but also from a customer satisfaction perspective. I think the combination of those things give the business a great opportunity for continued growth for a long period of time. And we feel really good about the assets we have today. I don't feel like we need to do another deal into that. We think the organic properties and -- of the businesses and the technology that they have today really provides us with the kinds of things we need -- we can go do to give that business with the kinds of things we need. We can go do to give that business a real runway for growth.

I would imagine the industry is growing well with...

Yes. Mid- to high single-digit kind of industry growth. And I think when you look at our businesses combined, we'll certainly exceed that this year and have for the last few years. So we feel good about our ability to outperform that market.

And this growth in the industry or in your business rely on some sort of innovation or new product funnel where you're solving something new? Or is it just sort of socializing what you already have?

Well, I think it's the beauty of those businesses, is that you're always looking for new features to upsell and cross-sell. So net dollar retention is such an important metric, and it gives us the opportunity to continue to really create a deeper, longer-lasting relationship with customers where we're selling more every year.

Got it. Then just switching over to EHS. Maybe remind us where we're at on elective procedures, if there's any sort of regional component to that that stands out. And what you think sort of the trend line might look like there over the next few quarters?

Yes. I mean I think we said electives would probably be even with last year at about 88%. We think that's probably where it's at. We don't -- we'll see where we end up with the quarter. We don't get perfect information around the world on a monthly basis, but it's a little bit of a trade-off. U.S. was -- as we said in the second quarter, U.S. was a little better, but China was obviously not as good. We still think there's going to be the opportunity for that to get better next year. As we talk, labor shortages are a little bit of a challenge for hospitals. But we feel good about where the business is. That business -- particularly when we think more broadly around EHS that business has some real strength and continued growth potential. ASP has had -- has not been immune to supply chain issues either. So we've had a few there. Orders are -- in the second quarter, we're good, better -- a little bit better than shipments. So we think there are some green shoots there to continue to build on. The good news on that is that our profitability remains strong, and we were just with the team because they're here locally yesterday for the strategic plan, and I think they outlined a number of really strong opportunities for growth and profitability in the future.

If we're sort of in an environment here where it's hard to grow elective procedures too much over the next few years, just because someone actually asked to do the procedure, what's your view on how much EHS or ASP, specifically, can outgrow -- maybe what procedures are doing? Or is headcount or staffing in facilities kind of the limiting factor.

Yes, maybe a little early. I think we're in an important point of seeing how things play out in the remaining part of the year. But we don't -- we've grown the installed base every year. We continue to do that. And we continue to work with our hospital partners on really what their sterilization strategy is because some of the growth dynamic of the business is not as more procedures being sterilized. It's coming out of disinfection or -- and being more sterilized. So there's a bit of a trend that was really a secular driver for the business that kind of got disrupted because of COVID. We think as we start to normalize hospital operations here a little bit, we'll start to see that. We're starting to see some regulations that are talking about that in places like the FDA. So we think the secular drivers remain good. Where that plays out, we'll see on a global basis what electives look like. But between the installed base growth, between some of these secular drivers, we think that business is a mid-single-digit grower for sure.

Is there an area of kind of the broader healthcare market that you look at that maybe doesn't require exposure to elective procedures?

Yes.

Like on one hand is where they make all their money, so you want to make money -- but on the other hand, like, is there something we're just having the lights on could be a benefit to you?

Yes. I mean we continue to believe that this whole safer, smarter, more productive view is very much also a hospital strategy. And there are lots of places in the hospital where that resonates. We bought Provation last year for that reason. It was very consistent with that, that thought process about what we can do in the segment. And there are continued opportunities for that from M&A and quite frankly to extend some of our solutions today in places where that will continue to resonate.

And I guess on the M&A front, so where were your priorities today? I think the portfolio strategy is fairly clear. But you kind of -- you flushed out a good software platform, the hardware position seem good, you have the way you want in EHS. Sort of how do you pick your spots from here?

Well, we -- I think where we're at right now is a great example. We do our strategic plan cycle really in the month of August and September. We come back off that almost right away and refresh our view of what the operating businesses need to do to accelerate strategy. And that is our M&A strategy, is really about accelerating the strategies of the segments we're in today and the businesses we're in today. And we'll do that. That's what gives us a deep and broad funnel of opportunity. And we'll have a better sense of what the businesses need, having just completed some of the strategic plans and some of those things -- most of those things don't change a lot year-to-year. So I would say we're 75%, 80% already knowing what that looks like from a year before. But we'll update some new ideas. And I think all 3 segments have opportunities to advance their strategy, and we continue to -- and consistent with the financial profile that we're trying to build it for it.

Do you think the -- a typical -- deal from here now there's anything that's typical, like matches more with what you own, where there's a logical like, "Oh, I understand where this goes?"

Yes. I think, particularly if you looked at really what we're thinking and trying to do around the segments. Certainly, we're not looking to add a segment or anything like that. I think we really feel that within the construct of the segments we have today, we have real opportunity to continue to build those segments out.

And then I guess how are you seeing the market out there for properties? Clearly, public markets have come in a little bit of geopolitical chop that maybe lights a fire under some folks. What does that look like from your perspective?

Well, I don't think we've seen prices come down with any measurable amount in any way, shape or form. We've just seen some deals in the last couple of months that were priced pretty rich or priced, I would say, well, maybe rich in some cases, but more broadly consistent with maybe what we saw over a period of time. So -- we always said it was a 12- to 18-month cycle of getting things to change. I think sellers certainly need to see more happen. What we're seeing now is processes go longer. You're seeing less deal activity. Those are sort of the early signs of things starting to change, but I think we need a little bit more time to play out. Now you're -- a little bit more chop as you point out, a little bit more -- a little bit longer period of that certainly has historically been a good thing for M&A.

Excellent. I think we have time for a question in the room, if there are any. All right. Perfect. Maybe just one more on M&A. Maybe give us an update on how you're scoring for deals that you've already done and kind of how you're working versus the return metric?

We're on track to our return metrics broadly. We -- I think we've been very transparent about the fact that current was a little bit more work than we thought. We're starting to close that gap that we really saw. We mentioned in our second quarter call, some good stuff. I think ASP, as I just talked about, certainly we didn't have a COVID [indiscernible] COVID scenario, but we're starting to see that start to progress as well. So -- and then more broadly, we're certainly seeing places what deals we've done before that, the eMaint, ISC, the Landauer on track or better. So we feel good where we're at and we're continuing to progress return strongly. And I think that's what you saw in the second half, right -- or the first half, excuse me. What you saw in the first half of the year was free cash flow, I think, was very strong. So gross margins continue to be strong. So our margin profile will be good. And I think that's really a result of how these things are playing out.

Excellent. I see we're out of time, Jim. I always appreciate it. Thanks for joining us.

Thanks.