Fortive Corporation (FTV) Earnings Call Transcript & Summary

Good morning, everyone, and good early morning to those of you on the West Coast. My name is Joe Giordano. I cover industrials, automation and robotics here at TD Cowen. Next today, we are lucky enough to have Fortive with us, and we have Pete Underwood, SVP and General Counsel. He also runs sustainability. Pete is going to start with some prepared remarks and slides, and we'll jump into Q&A. If anyone on the line has questions, you can e-mail me. It's [email protected], or you can submit through the dashboard, and it'll pop up on my screen. So with that, Pete, I'll turn it over to you. Thanks for being here. We appreciate it, and take it away.

All right. Thanks, Joe. Good to see you again, and thanks, everyone, for the opportunity to talk to you today a little bit about Fortive and what we're doing from a sustainability perspective. I had the opportunity to do this at our Investor Day about 2 weeks ago. And so I wanted to maybe start with just a short summary or introduction kind of where we are in terms of the sustainability actions we're taking, a little bit about our strategy and a little bit about where we intend to go in the future. So I want to make sure that I'm clear because I think it's really important to talk about how Fortive -- how our business strategy is connected to our sustainability strategy. So the primary way that we can connect sustainability with the business strategy is through the strategic decision to position our portfolio in markets with secular drivers -- with the power of secular drivers behind the higher growth markets, markets that have these secular drivers rooted in sustainability. A lot of the megatrends that you're seeing. We've got some of them on the board here. But a lot of them do have their roots in sustainability. And so what that allows us to do through the positioning of our portfolio is to take advantage of that sustainability tailwind in almost all of our 5 workflows. And the best example probably is our EHS workflow where we have companies like Industrial Scientific and Intelex that are taking advantage of those tailwinds to sell products and services and solutions that help their customers with things like worker safety. You see it also though in our perioperative loop workflow where the megatrends around the aging population allows us to take advantage through the sales of products and services and help patient health and safety. You can see it also in facility of the asset life cycle management, where the trends around energy efficiency and the transition to renewable energy are helping us drive growth and -- all in, we have -- Fortive has over 60% of its revenue that is derived from the sale of products and services that help our customers achieve more sustainable outcomes that are aligned with the UN Sustainable Development Goals. So product portfolio positioning is key. Also, I think it's important to note that strategy and positioning is one thing but, without the right people and the right culture in place, may be hard to take advantage of that. We have exactly, I think, the right culture from a sustainability perspective. Sustainability is inextricably linked to our shared purpose. Our shared purpose is essential technology for the people who accelerate progress. So many of our customers' challenges these days are rooted in solving some of the world's biggest sustainability challenges. So we're exactly the right people from a cultural perspective. We're a group of engineers. We're a group of innovators. We're exactly the right kind of people that are there to solve customers' problems from a sustainability perspective. I want to talk a little bit about our journey. Our sustainability journey has been characterized -- like much of what we do, been characterized by continuous improvement. When we started as a spin-off in 2016, we had a collection of operating companies that was doing great things. We realized we needed to do more, though, to be positioned to tell our story appropriately and to develop ambition to continue to have impact in the future. And so I think the progress that we've made has been really characterized by relentless execution, the use of our FBS tools and the refinement of our sustainability governance to ensure that we're aligned with our operating companies that we're trying to accomplish. You can see, I think, this improvement here in a few ways. You see it in the evolving quality and content in our sustainability reports, the last of which was -- the most recent of which was published this -- just this week and is available on our public website. You can see it in how we're aligning to recognized standards like GRI and SASB and, most recently, TCFD in that reporting effort. You can see it, I think, in the improvements that we're making in terms of scoring from sort of the ratings providers as well as the recognition we're getting from outside third parties. But I think most importantly, you see it in our ambition. We have started to publish and go after more aggressive sustainability goals, and you can see that in a couple of places that I'll go through here right now. Our sustainability effort is focused around 5 pillars. I don't want to talk about them all, but I want to highlight a couple of things. The first is our pillar to protect the planet. This was our very first public sustainability goal. In 2019, we announced the intensity-based emissions reduction goals that we accomplished well ahead of schedule. And so last year, we announced a new goal. Our goal is now an absolute goal, not an intensity goal. And it's to reduce our Scope 1 and Scope 2 carbon emissions by 50% by the year 2029. That's a goal that's aligned with the Science Based Targets initiative. So -- we're excited about that goal. We -- our effort to achieve this -- and I think we'll talk about this a little bit later as well, but our effort to achieve this goal is rooted in FBS, much like everything else that we do. We have -- thanks to the way we use FBS and the tools that we use, including our own Intelex sustainability management platform, we've actually made great progress already. We've reduced our Scope 1 and Scope 2 emissions by 20% from our 2019 baseline already as of the end of '22. So we're well on the way to achieving our target here. Another area I'll cover is responsible sourcing. This is an area where we have a very large company with a lot of multinational operating companies. And so we have a complex supply chain. This is an area we've recognized, for a long time, needs a lot of risk management. We have a proprietary tool that we've created. That's an FBS tool that helped us manage that risk. Recently, we've added sustainability-related criteria to that risk tool that we're able to better identify potentially higher risk suppliers, and by higher risk, I mean those that might have a potential human trafficking or other human rights-related issues in the supply chain. We're able to identify where we think those problems could, in theory, exist and go out and do things like audit and make sure that we don't have any of those issues inside of our supply chain. We've also embarked on a great supplier diversity program. We've set a new goal to have $100 million annually of spend with diverse suppliers by the end of 2025. That would be about 10% of our North America spend. It would also be about a 25% improvement from when we started this program in 2020. I think importantly, in addition to the impact that, that has in the community, that's value to the organization through more localized supply chain, which helps us reduce supply chain risk. So a lot of great things, I think, that we're doing from the perspective of responsible sourcing. When we think about the future, I think it's important to understand, as again, I said our ambition, we intend to continue our focus on both value and impact. We intend to continue to be ambitious. We did -- we announced, for example, in our sustainability report and at our Investor Day that we have a new goal to reduce water usage across Fortive by 10% by the year 2029. So we continue to set those more aggressive goals, and hopefully, we'll continue to be able to have an impact. So I think to summarize this, we're well positioned from a portfolio perspective. We've got the positioning there to take advantage of sustainability tailwinds. We've got the mandate through our shared purpose to solve those customers' big challenges. We've got the ambition through our kind of culture of continuous improvement. And we certainly have a tool set in FBS to continue to do great things that provide both value and impact for the organization. So I think -- Joe, I think that covers the summary that I wanted to walk through, and I'm happy to take some thoughts or questions. I'm going to take the slides down now.

All right. Perfect. You mentioned it a couple of times in the remarks, and maybe it's the right place to start. But you guys talked about FBS a lot. It's at the heart of your strategy. It's not something you'd normally think of with like a sustainability strategy. So how are you using that to kind of like tinker and make appropriate adjustments to the strategy as you move along?

Yes. It's an important question for us because it is foundational to who we are. It is at the heart of how we operate. So I think about this in a couple of different ways, maybe 3 ways. I think first is the cultural -- FBS gives us the cultural foundation in the organization to -- FBS is all about continuous improvement, right? So it gives us this cultural foundation to look at problems in a different way. We look at problems and challenges. We know we've got a set of tools and things that can help us accomplish them. And so we approach it culturally with this idea that we can go do this. We can go fix this problem, and we can make it better and better. The second thing, I think, is it's a common language. I've talked about this before in the context of setting up a sustainability program for our corporation. You've got to put what you're doing in a language that is understandable inside your own organization. So for us, that's FBS. It's how we communicate. It's how the business has communicated. It helps us communicate across opcos, across geographies and time zones and the like. So it's an important foundation for us to communicate with each other. And then I think lastly, it's a set of tools. It's a fantastic set of tools for problem solving and for making sure that you're able to approach challenges, problems and issues in a systematic way and in a way that you have confidence you'll reach an outcome that works. So lots of examples, too, of specifics. But I think from the standpoint of sort of how we think about FBS in sustainability, and that's probably the answer.

Now how do we think about incentivizing employees and leaders on this? Because I mean, look, you can make a case that long-term success on sustainability issues can drive customer success and long-term operational success, fine. But when we think near term, they might be somewhat mutually exclusive to some extent, right? Like if you're making a decision to utilize less water or do this, it may cost more or may do something. So how do you balance sustainability targets and operational targets in the more near term with leaders and employees?

Yes. I think the first thing that's important there is to look -- we look for those places where we can have both impact and value. So there -- yes, there can be tension there. But there's a lot of opportunity to find the places where you can either do things that have impact in the community or impact to the planet but don't really bring value to organization and vice versa. You do things that have great value of the organization that don't -- that either are counter to a sustainability idea or don't move the needle. We try to look for and highlight inside of the goals that we're trying to accomplish those places where we can do both. So I think the obvious example, right, is the cost savings you get from energy efficiency. That's sort of your low-hanging fruit, right? That's bringing operational value as well as doing good stuff for the planet. But in other cases, there are other -- risk mitigation is a great example. I talked about our supplier diversity program. Bringing -- localizing your supply chain and having additional suppliers, we've all seen this very recently, obviously. It's a risk mitigation tool for the organization. So not only are you helping underrepresented folks in the community get -- have an opportunity to create for your business, you're also reducing the risk for the organization. And so we try to recognize that as part of the value that we're bringing to Fortive. In those places where it might be harder to make that connection but we still want to accomplish it from a sustainability perspective, we do a couple of things. One is to make sure that everyone understands what our priorities are. So our carbon emissions reduction goal is a great example, right? That's a priority for the organization. And so we're doing things to try to surface ways to make sure that we get that goal. And if those ways mean that we have to say, for example, on a certain project, accept a payback period that might be longer than we would otherwise accept for commercial reasons, our team understands that that's a priority for us. We're willing to take that -- to make that bargain to fulfill the goal that we've set that we want to accomplish. So it's about incentivizing through, first, finding the right things to do and then, secondly, just prioritizing.

And are sustainability targets like specifically -- or metrics, specifically in incentive plans now?

Yes, where appropriate, right? So I would be a great example. My -- we -- the executive compensation for us is we have a personal performance factor that's a percentage of what -- of our annual incentive bonus. And for me, that is tied to achievement or progress towards hitting the goals that we've established and the metrics that we've put out there. The same can be said for the folks in positions -- in important positions to accomplish that, right? So we pushed that down to EHS leaders, for example, or others inside the organization who can have an impact here. They will have -- usually in their personal performance factor but also sometimes as part of the company performance factor, they will have goals and objectives that are tied directly to the sustainability achievement of our goals and the metrics that we outlined. ID&E is a diversity -- is another good example of where we try to make sure that we've got appropriate incentives in place where they can be impactful to make sure that people are following the programs and ideas that we put in place to help us achieve our goals on diversity and hiring.

So I think you guys also just put in like -- you're starting to like factor in climate risk to like the existing like overlaying risk-identifying matrix that you use. Can you talk a little bit about that and what that's doing to how you view forward opportunities?

Sure. So I think a couple of different ways here. One is that we have a process where risk our -- think of it as our ERM process that is our operating companies do on an annual sort of -- annual basis -- it's an annual cycle. It's continuous throughout the year, but it's an annual cycle. And that process is -- starts at corporate with a -- think of it as a -- it's an FBS tool, right? But think of it as a set of criteria or suggestions or risk areas that, we think, need to be looked at and key risk indicators inside of that. And so what we've done in the recent -- in the past couple of years is we've added a category around sustainability and climate change, and we've also provided the operating companies with the tools and the sort of suggestions and the skills necessary to go and make sure that they're thinking correctly through how that -- how to analyze those climate risks. And then in terms of making sure that our operating companies are kind of on the same page, we -- every year, we do -- we have not only a kickoff, but we have rotating training and Q&A sessions to make sure that what we're trying to get accomplished through the risk assessment process is pushed down to those operating companies and is well understood. So -- and we've had good success. We've certainly surfaced some things that, I think, in the past, it may not have been surfaced because we've provided the team with the tools and the sort of visibility to be thinking about these things in a different way. I also mentioned what we've done from a sustainability perspective in our risk assessment tool for suppliers. That's been another important piece of what we're up to.

How do you kind of evaluate this at the opco -- at the individual business level because you're a very diverse organization doing a lot of different things? So it's -- how do you set a policy that makes sense at the umbrella level and kind of like maintain it down at the opco level?

It can be a challenge. I think we -- first and foremost, we recognize that all of our companies are not created equal. So the carbon emissions goal is a good example. We set a goal for Fortive overall. We know that we have a series of -- a set of higher-emitting operating companies that have more opportunity and a set of lower-emitting companies that have less opportunity. And so we will set -- for example, for our sixth highest emitting operating companies, we've set more aggressive annual targets. We said that we watch this, right? And for the next dozen or so less-emitting companies, we want them participating, but we expect sort of a less sort of on an annual basis, right, because there's less opportunity. So it's identifying -- we can have an overarching -- water use is another great one, right? We just announced this, so we're just embarking on it. We have 11 facilities that we've identified that are in a high-risk area for water scarcity. We know there's more opportunity there to have a greater impact. It doesn't mean, in other places, we won't be doing things because in some of those other places are some of our higher use -- water use operations. So we'll make sure we're doing -- they're doing their part too, but we're able to kind of focus through this. Think of it as a risk-based approach, right? We're able to kind of focus on the places we need to focus. And the last thing I'll say about that was the differential -- the difference in the operating companies, that also does help us or it informs us as we set those goals, right, because we might have -- our materiality analysis might suggest that we need to go after something, but there's really only one opco that has that issue. If that's the case, we're less likely to set a Fortive-wide goal on that, so more likely, we just go at that operating company.

How does this inform many of [ your decisions ]?

Say that again?

How does your overall view on sustainability and your goals inform acquisitions and what you're targeting?

Yes, a couple of ways. I think first, I mentioned this upfront, we are in markets where the secular drivers are -- they're not entirely sustainability. Obviously, we have a lot of sustainability-related market drivers. And so our acquisition targets are usually -- they're sort of -- they're not on the end of the sustainability spectrum from where they're going to cause issues or be -- not be well received from a sustainability perspective. That's sort of number one. But we look at targets in a couple of different ways from a sustainability perspective. First, we want to understand what are their sustainability challenges and frameworks, right? So what regulations apply to them? Where are they geographically? What are the challenges that their particular industry has? And then we try to fit that into the model of what would we do with this organization once it becomes part of Fortive. I would say we have never said -- we've never rejected an acquisition because it's going to create a problem for -- it's going to lower our score somewhere or something like that. We look at that the same way we might look at margin improvement, right? We look at that and say, this is an opportunity for us to actually significantly improve that profile of that acquisition target and, therefore, down the road continuously improve the Fortive outlook. So it definitely factors in. We've got a much more robust and aggressive sustainability-related diligence process and standard work now than we did 5 years ago.

Yes. I mean along those lines, right, so how do you think about where a potential acquisition target is in gross terms on sustainability versus like momentum towards sustainability? So like I assume if you were to do -- for bolt-on, it probably doesn't matter as it won't impact Fortive at the high level that much. But if you were to look at a large acquisition, for example, of a company that maybe was behind where you are but is like -- has a big forward opportunity, I assume you're not going to be like rebaseline where you are. So like if it brings you back but like how do you -- is this just semantics? Or how do you think about something like that?

No. I mean it depends on the aspects of sustainability you're talking about. So if it's carbon emissions, for example, you do go back and sort of -- pro forma is the wrong word, but think about it like that, right? You said you kind of pro forma that acquisition from your baseline starting point. So you need the data to be able to do that. But if they've made significant progress that actually -- and they may be behind where you are in terms of overall emissions or something else. But if they made significant progress in the recent past, that actually might help you, right? So we kind of think about that stuff. We definitely make sure that momentum, as you said, is important because it shows commitment. And so we make sure we look at that, but we also really look at what's the go-forward opportunity here. It's just, again, depending on the goal, but we believe strongly, just like we believe strongly that we can create value through margin expansion and working capital and cash flow. We believe we can create value through applying FBS to sustainability in places where it hasn't been done before.

When I think about your R&D budgets, are there -- are you guys portioning off a certain percentage or a certain dollar amount towards like specifically technologies or solutions geared to like be utilized internally towards achieving some of these targets?

From an R&D perspective, I think -- I would say, no, we don't have a specific R&D budget devoted to internal sustainability-related product improvement. We have -- we definitely have CapEx for projects, right? So we deal with CapEx for energy savings projects a certain way. That's an example. We utilize a lot of our own tools inside of our sustainability program. The most [indiscernible] example is Intelex. We use Intelex for our EHS incident management for audit, for -- we use it for sustainability to gather all our data and analyze our carbon emissions data and waste and water data. So we use that stuff. We use Fluke tools relative to energy efficiency opportunities and the like. We do that as well. We -- every year in our strat process, we ask our operating companies to ensure that they are thinking about what aspects of sustainability forward their business objectives and what aspects of sustainability are part of their business strategy. And so new product development from that perspective kind of fits into that bucket. In terms of the separate sort of do we have an R&D budget devoted to how do we develop internal tools, I would say the answer to that is no. But we've got -- we do have a plethora of products and services that we use ourselves that we know our customers use to forward their sustainability objectives.

So we spent most of the time talking about like what you're doing internally to meet your own kind of internal objectives here. Can you talk a bit about what your businesses themselves are doing to help your customers achieve their own targets and how that informs what products they're coming out with?

The best example there, as I said, would probably be Intelex and ISC only because they're so directly in the space of stainability, worker safety, providing the tools to customers to be able to do what I just mentioned we're doing with them, right, from a sustainability perspective. But there's really a lot more going on here. Our facilities and asset life cycle management workflow is, I think, a great example of a place where there are lots of sustainability-related gains for customers that don't necessarily jump off the page. But when you think about some of the things that -- Gordian is an example. Gordian is involved in procurement and estimating and job construction costing and making sure the right equipment and tools and the right raw materials are put into construction projects from it. And increasingly, that's around energy efficiency, right? That's even around the diverse suppliers that are providing those materials. Then you get -- you got your service channel, and Accruent is doing things like -- actually, we have a utility bill management module, for example, where we have -- Accruent has a -- Accruent is involved in predictive maintenance. And if you think about predictive maintenance, right, if you've ever had your heat pump go out, you'll see your bill skyrocket because you got to kick -- the furnace has to kick in, right? If you can predict that in advance and solve that problem before it even happens, then you're just running more efficiently. Your operations are running more efficiently. Service channel is another example, a platform for maintenance to be done on a regular basis, on a scheduled basis with people that you know and trust. And so that helps keep your operating cost, your total cost of ownership down. It's a lot of that stuff. I could go on, right? There's -- you talk about Fluke. Fluke is all about, in lots of ways, making sure -- when you're calibrating with electrical equipment and making sure it's running correctly, that's, in essence, all about making sure that you're not spending more or using more energy or electricity than you need to.

Can you talk a bit about how you evaluate your suppliers in this context? Because I mean if you're doing something like if you're not that vertically integrated in a particular business and you're purchasing components, like yes, you can lower your own emissions. But where are you getting these things from that you're utilizing? And how do you factor in like Scope 3-type stuff into your analysis?

So we're -- at this point, we are -- I would say we're in the middle innings on Scope 3. We have done a Scope 3 assessment. We've looked mostly at our upstream Scope 3. We're starting to analyze or we're getting close to finishing analyzing our downstream Scope 3. And really looking at it, what's the holistic opportunity here? Ideally, for a Science Based Target, we need a Scope 3 target. Right now, we're just Scope 1 and 2 with our 50% target. But once we understand this and can scope it better, we'll put that into -- we hope to put that into the overall mix here. When -- so a long way around that, we're definitely after it. I would say right now, this carbon footprint of our suppliers is we're thinking about it, but we're not making decisions on that basis yet.

And maybe just lastly. You mentioned on the emission specifically, you beat your target by several years and by a large margin. What were someone like the -- was this a kaizen-type process to get to that? Like what were some of like the big buckets that you were able to say, okay, well, here's like the 3 main things that you could just start doing this immediately, we'll get there. So it's obviously a big delta versus the target and what you did.

Yes. So first, I think the first thing to think about here is the -- in a big organization like ours, you can't overestimate the ability to get the right people in the room, get the right people together to organize and get behind an initiative and take the right steps, right? That sounds easy. It's hard. When you think -- when you have this set of tools where we're used to doing this kind of thing, cross-functionally across operating company, that helps, right? So we're able to organize and mobilize quicker, I think, in these kinds of instances than companies that don't have this. So we set the culture that way, right? We set the sustainability culture. We set the expectation that we've got a goal out there, we need to go get it. Then it -- energy kaizen is a great example, right? And historically, we focused this on energy. We're expanding it to waste and water. But when you get together from a -- for a kaizen to try to identify not just sort of capital project opportunities but process improvement opportunities, that's probably where we've moved the needle the most. We've had over -- through those energy kaizens, we've had over 200 projects identified. And I think we're at a rate of around 30% right now of those that have gotten approved. And that's yielding a 3% to 5% improvement on an annual basis for us in the things that -- in the -- from the perspective of our goal achievement. So that's number one. We also have a renewable energy strategy that I would say is early innings but is -- we're getting -- we're ramping up on that as well in an effort to achieve. There's other elements in there as well that are maybe less impactful but one-off things that we find from an emissions perspective or other projects that we've been able to tackle in that time frame. The other thing is business performance, right? So if you think about an intensity-based goal -- and intensity-based goal is emissions per dollar of revenue. So that factors in. Unlike now, which is we have an absolute goal, which -- and we're already -- as I said, we're already 20% down from 2019 baseline, which, on an absolute basis, is actually really good when you think about our financial performance over the last couple of years, which has been pretty, pretty good. It's working against us, but we're still able to make these achievements.

All right. I think unfortunately, we have to leave it there just from time, but Pete, it's good to see you again, and thanks for spending the time with us today.

Absolutely. Thanks for the invitation. Good to see you.