Fortive Corporation (FTV) Earnings Call Transcript & Summary

[Audio Gap] for being here, it's my pleasure to have our next Fortive Corporation. Jim Lico, President and CEO. Jim, I think, has a couple of prepared remarks, and then we'll go into Q&A.

Yes, I'll keep them brief. Great to see everyone. Thanks for attending. Yes, I would just say we're in a great place. We feel really good. I think as we come into today and having conversations with folks. I think the work we've done over the last several years to put us in a position relative to maybe some of the heavy lifting on the portfolio, a lot of the innovation work we've done really, it manifests itself, I think, so much in 2023, and we think a much more resilient durable Fortive in '24. So I think across the financials, we've tried to -- on the earnings call, lay out what our '19 to '24 performance looks like, and we think that stands up really well in terms of double-digit compounding on EPS and free cash flow front. So we're in a good position to do that and excited to talk about the details there.

Fantastic. Maybe starting with the short term, a lot of industrial companies have this sort of muted top line in the first half year-on-year, better second half, Fortive no exception. But maybe talk about what drives that improvement? Is it just comps? Is there some degree of end market recovery dialed in? Just flesh that out a little bit.

Well, I think number one, when you step back, Julian, we're at about a 48:52 ratio for the first half, second half. And that is our traditional sort of sequential number relative to -- a little bit lighter first half than second half. That's historical. It's kind of where we normally are. So not a big -- the ramp-up is more of the comp kind of situation than it is anything else. We always had a really strong first half as we -- last year as we were really sort of shipping some of our backlog and things like that. So there isn't a dramatic move if we just think about the dollars and traditional sense. There are some things that are going to get better through the course of the second half. Certainly, health care is going to get a little bit better as we said. And we'll start to see some of the precision technologies where we've seen some more declines over the last several quarters. We'll start to see some -- we think we'll -- we certainly believe we'll see improvement in orders in the second half, and that helps a little bit of strength in the second half as well. But again, just stepping back, it's in our normal seasonality.

That's very clear. And on the -- you mentioned the sort of product hardware orders, a mix of sort of precision and a couple of other businesses. I think they were down kind of mid-single digit year-on-year last quarter. How do you see the slope of that orders playing out?

Yes. So I would break it out. I think if we think about our big hardware businesses, we sort of think of Fluke within iOS and then obviously, [indiscernible] Tek and Sensing and PT. Fluke had a good head and growth quarter in the fourth quarter. They grew orders in the fourth quarter. They had good growth and quite frankly, the projections for this year are good. I think it's a benefit of the resiliency and durability strategy we had, both on the organic and inorganic front. I think tech was down 1% in the quarter -- in the fourth quarter. Orders have been down about 5 quarters. So we think we -- we're starting to hear funnels getting better, that kind of thing. And that is, as we said, we think towards the second quarter, or into the second quarter, orders start to turn positive. And Sensing's been down a little bit more, as you said, than that. And we think we start 2 of the 4 Sensing businesses. We think we'll start to grow orders here. And the remaining part of Sensing probably in the back half of the second quarter. So as we sort of turn the switch on the calendar relative to the second half, we think certainly, what we're hearing from customers, what we're seeing from order funnels, things are starting to progress towards what we anticipated, and we feel good about what we're hearing.

And clearly, in the product hardware side, there's a range of end markets there that you're selling into. Electronics has been a lot of destocking pressure, let's say, telecom, it's maybe more of a fundamental demand drop we've had. So maybe any color on the different verticals of businesses like Fluke and Tek?

Yes. I think somewhat different. It's really a field instrument business, playing into a number of good secular drivers right now, whether that be solar, things around the energy transition, the grid, and that's been why their business has been more durable. And haven't seen pockets of inventory destocking, but not a lot. I think on the tech side, certainly, what we've seen is some slowing amongst some customers as I mentioned, on the order front, but some of that is just so many years of strong orders that we're just seeing the customers take a breath. A little bit of destocking in a couple of regions. I think we called out -- that called that out on the earnings call in the fourth quarter, a little bit in North America, a little bit in China. But I think we're -- that's mostly behind us at this point. And so I think as we look forward, the natural demand will start to take over. You mentioned a couple of verticals. The power market at Tektronix has been really good. That's really anything that has a battery, whether that's chipsets that are required to go into data centers and go into products, they're trying to conserve power batteries themselves and everything. That business has been good. Our mil/gov businesses continue to be good. We've seen some -- as you said, we do have some exposure to semiconductor in Tek with our Keithley business, and that's been slower, but customer conversations are actually quite positive right now.

And I think from the outside, it can be difficult for people to sort of contrast Fluke versus Tektronix in terms of markets and cyclicality in the business model, kind of any quick synopsis of that that you provide? Why does Fluke behave differently to Tektronix? Why is the cyclicality different?

Yes. I think number one is Fluke has always been a much broader set of businesses, both vertical-wise and geographically. Anywhere where you need to measure electricity in a home, in a manufacturing plant, in a commercial building, in school, whatever. And that's every country of the world, and so it just has a -- it doesn't have one vertical that plays strongly. Tek is really about innovation center. So it's really about the top 1,000 innovation companies in the world and the design and engineering, we're selling to the engineers who are designing the next generation of future technologies. That tends to be not every country in the world, right? That's more predominantly in countries that tend to have more innovation spend and investment. And so that's -- so it's not as geographically dispersed. It's a little bit more focused on certain verticals as well, so it's not as broad. Still a great business, though. I think when we look at the transition we've really had at Tektronix, I mentioned a second ago around power. We've gotten out of a number of the business, as you mentioned. Comms -- we've gotten out of the comms business. We're not in that business anymore. We've sort of -- sort of smaller on the premise side than it used to be. We hope we got out of the video business to tech. So we've really oriented the business towards a number of these sort of secular drivers of tech, which allowed for us, as you know well, from a low single-digit grower, maybe a decade ago to now going forward more of a mid-single-digit grower. So we think we've really done a nice job of improving the growth rate of Tek, making it more durable. My last point just between the 2 differences, we do have a pretty sizable software business in Fluke, our eMaint business, which is pretty sizable. That certainly helps on the durability front as well.

That's helpful. And Tektronix, as you said, more of a push, perhaps in system applications, power, data center. Maybe help us understand kind of how have you got there? How satisfied you with your penetration in those businesses and kind of the market leadership?

Well, we think the opportunity is great. We feel like we're getting a very good share of those opportunities, for sure. We look at win-loss that's informed by win loss rates. That [indiscernible] today is very global. So we have a great global footprint, which to take advantage of those opportunities. So I think we believe deeply in the success of the business. And that's a business that's really applied for business system really well into their innovation process. So to your point of what's been deliberate around the change, it's really about making our R&D investments. We've gone to more platforms that allowed for us to really innovate more quickly. And we're seeing the benefits of those innovation cycles now delivering solutions faster to the marketplace. And we'll see more of that in '24 and '25.

That's interesting. And when you think about across Fluke and Tek, historically, maybe investors through them as more like through cycle, no single digit now, it seems like it's more mid-single. How is -- to what extent is that a function of maybe some secular drivers in the end markets versus the past? And then also how those businesses have kind of moved into niches that move higher growth? [indiscernible] some more specular discussion around drivers in test and management, that's driven some of the M&A in recent years?

Well, it's a great point. I mean when you look at the going off your last point, the M&A we did in the fourth quarter, 2 deals for Fluke really around solar and around condition-based monitoring, really good growth drivers. Accelerates our obviously, small bolt-on good high return but also [indiscernible] our strategy and power in renewables and sort of the energy transition at Fluke. So that's been a deliberate attempt over years of both organic and inorganic invasion. I would say it's really been more of a mid-single-digit growth full cycle over the last couple of decades. So we feel that, that business is in a great place. And I would just step back before [indiscernible] with that. I think that's indicative of where IOS sits today. When we think about the IOS segment, Intelligent Operating Solutions where Fluke is -- that's where a lot of our transition work to really make this segment better. Both are more durable and you really see that play out. [indiscernible] health care, I'm sure I'll leave that to the side. In PT, we're just moving into as much transition. We've had a lot of transition in IOS. We see that in our results. Now with the EA acquisition, we really have an opportunity now to make PP growth here like Tektronix growth here. So I think both -- it's a good example of one segment that we've done a lot of great work to make that segment, I think really strong. PT, we're still in it. We've done a lot of great organic work to make that segment better. Now we add inorganic growth to that to make it even better. And EA will make PT [indiscernible] much more growth impact, in particular, more growth [indiscernible].

I think we have one driver of that development of the business model at IOS [indiscernible] that facilities and asset life cycle on FAL election of businesses. Maybe talk about the growth rates in that FAL subset, what's the profitability level like? And do you need to do something like that in PT to bring it to where IOS is now? It's a different part of transformation.

Let's talk about [indiscernible] first. I think that really scalable, incredibly strong [indiscernible] 40-plus group of businesses today. Great opportunity. We did a small -- a couple of small acquisitions in the fourth quarter. One to give us some SaaS capability in one of our product lines, the other to give us some data capability in a region. So good bolt-ons, high returns. Our opportunity to continue to do that [indiscernible]. We think that's a long term is a $1 billion set of software businesses with really strong profiles across the board. Those opportunities do exist in PT. Whether or not we go down that [indiscernible] or not, you always have to never time acquisitions. But when we think about the $10 billion for the served market that sits in PT, roughly $10 billion, $10 billion or $15 billion, and that might be a little -- there's plenty of opportunity for more durable businesses, whether that's in software, whether that's a services or it's a business like EA that just is really dedicated to a secular driver that has really good long-term profile. So we'll certainly -- our M&A strategy is really around that growth platform or the connected workflow. Do you think that's a good strategy for hardware, software and services based on our domain expertise? And we have that in PT, you do anywhere else. And we certainly have the capital and the balance sheet to be able to do that over the next 5 years, sure.

And switching maybe to health care. That's been more like a sort of low single-digit CAGR, your own business in the last 5 years. A lot of it is because of maybe portfolio moves you've made within it, stepping back in some areas and probably the end market has grown a little bit faster. From here, how do you see the health care segment growing and the end markets?

One, we think it's a mid-single-digit or I think when you think about COVID and some of those things, there certainly were some setbacks, some headwinds relative to [indiscernible] procedures. But I think when you look at ASP, you sort of think about COVID impacting [indiscernible] procedures. And also sometimes what gets missed is that was our largest business in Russia. So we had -- did a good chunk of that business. So those things are behind us. When you look at ASP since COVID, I think it's grown mid-single digits. So a little bit of noise because of the channel transition we made last year and the go to market, which was incredibly important towards long-term growth and strategy. So that's behind us. We feel really good about where health segment is going to be this year. Relative to its growth rate, it's going to grow -- margin is going to span margins of 125 basis points or a little bit above average. We feel good about where that segment is at. I might just unpack -- when you look at house today in that $1.4-something billion of revenue, 50% of that is consumables. So half of that business is consumable. We also have software and services, too. So the [indiscernible] -- as we move through over the pandemic and move through into a more, I'll call it normalized health care market where the secular drivers of more procedures, more technology and procedures, demographics moving our way, those drivers of the market will start to take over and the growth rate of the market will really be -- the growth rate will be good, and we'll certainly participate well in it.

And it sounds like things are pretty well set for steady to accelerating top line growth across the company. When you think about that kind of $420 million to $450 million earnings goal number for next year, put out at the Investor Day, what kind of the conviction on that? Does it require a big uplift in the macro environment or several huge acquisitions on your part? Like maybe help us understand the path to get to that rate?

Well, nothing's ever on a glide path, right? [indiscernible] that easy. But I think when you look at it and using kind of a [indiscernible] kind of jump off point from this year, right? I mean, when you look at a mid-single-digit growth next year, you look at the typical fall-through that you see and the margin expansion, you get pretty close to those numbers. You get EA adding more value next year and you sort of see the benefit of delevering relative to the balance sheet, and you get pretty close to those numbers. So future success is never guaranteed. But we feel -- we put -- I would step back, in '21, we put out free cash flow target for '25, and we re-upped that in '23. We put out margins that we've exceeded. So we feel good about the long-term targets that we have, and we feel good about our ability to achieve it. That said, it's nothing is guaranteed. Those are -- at this point, that's not a guide for '25 by any stretch of the imagination. And as I also pointed out earlier that you asked is the step up from first half to second half is not dramatic even. It's pretty typical. So I think as we start to think about the components of getting to that number, not a big step out about first half to second half. And sort of a number -- we're going to delever the balance sheet over time. We just did a debt deal that frankly solidified a really nice interest rate on Euro bond. So we're -- I think the balance sheet is in a really good place. We'll delever through the year and tax rate on the EA deals better than we anticipated. So just a number of things that give us confidence relative to next year.

And on the -- you mentioned the drop-through of you think that the core growth is sort of 40% leverage the right figure -- that as Fortive keeps mentioned IOS have sort of graduated to target where you want to take it, PTs on the way. Does that leverage increase potentially over time?

Well, first, I would say, we don't tell the IOS team where they need to be. So let's keep that between friends. We think there's plenty of opportunity for IOS to continue to get better. I think I would just step back -- if you just really step back where we're at now, we're in a good place relative to where we're going. I think the questions around the delevering aspect of it -- we're generating a lot of cash and I think our opportunity to continue to do those things. That said, we think there's plenty of opportunity for M&A. So yes, we've got lots of paths to '25. And again, we don't want to get into a guide or anything like that or guarantee, but we do think there's real opportunity. And that's why we put out the long-term target. We wanted people to have an opportunity to [indiscernible].

And that 40% operating leverage kind of dropped through that really for the current business?

When we think about 40%, we sort of think about it as embedded in your prior question. We want to make sure we continue to [indiscernible] invest. You'll probably see higher fall-through if the revenue goes up, right? So you saw a higher fall-through when revenue was above mid-single digits. So I think it's fair to say that if revenues up, you might see things fall-through it a little bit better. On the other hand, we also are going to take the opportunity to take some of that overage and accelerate our strategy. Obviously, all of our investments have -- are tempered over time to the extent that we maybe are in a little bit better shape than we anticipated, we might pull in some of those investments in order to get to endpoints faster. And I think our history has been to try to get to advanced targets faster, and we do that by taking the opportunity when maybe we have a little bit of upside to sort of deploy that. So we'll obviously fall through at a little higher rate than the 40% sort of assumes that we'll have an opportunity to reinvest some.

And with that, maybe we'll start some audience response, [indiscernible] questions. The first one, you currently own [indiscernible]. Please use those gray boxes.

[indiscernible]. Number two, aside from ownership, what's your general bias or impression right now, positive, negative, neutral?

So many negatives.

Number three, through-cycle earnings growth for Fortive versus the, let's say, just multi-industry average were generally above. Number 4 is around excess cash you said so it should be some balance between 1 and 2 probably or 6. So generally, bolt-on acquisitions. Number five, is around what sort of PE should Fortive trade at? Okay. So generally, a premium to the index. And last question is around -- this is for Fortive [indiscernible] so don't worry about them here. This is around what's the major share price headwind or reason not to own the steps [indiscernible]. Okay. So organic growth the main concern or question mark.

So maybe, Jim, with that in mind, acquisitions, couple of years without much than the EA deal, which I think the market reception has been pretty positive towards. If we're thinking about the use of cash for hardware versus software acquisitions? Or is that just not the right way to -- it's not how you think about it, I'm sure, but just how would you sort of characterize that in your mind? Again, trying to mix up PT. Does that lend itself to one or the other or the type of business you're looking to buy?

I think our strategy has been I think certainly very constituent over the years. And that is in these growth platforms, we see opportunity for hardware, software and services. The reason -- so I think it's all the above. Some will have more than others, [indiscernible] as an example. It sort of is mostly a software. It's almost all software. So that's probably going to be -- if we expand the 2 deals we did in bolt-ons, [indiscernible] was a fast solution to one of our product lines. The other was data, as I mentioned before. So [indiscernible], it's probably going to be mostly software. But where we have domain expertise that we've forged over time, whether that's a connected viability and IOS sort which is primarily Fluke or in product realization rate of Tek. We certainly -- and certainly in health. We have real opportunities for hardware as well. And so that domain expertise that we forged over time gives us really unique capability to get synergy, to do more for customers. And so we want to leverage those advantages. It makes [indiscernible] we're competitive on deals. It gives us a real opportunity to globalize the business. What you see with the A is because those products are ubiquitous to our customer sets throughout the world, our ability to leverage that around the world is [indiscernible]. I think we certainly deeply believe in this connected workflow or growth platform strategy. We think it gives us more synergy. We're going to be disciplined around returns and all that goes with it, but we -- maybe to that bolt-on question, that one of the most bolt-ons are too. So -- but we certainly see the value for customers and ultimately, the value to us by being broaden our thought that hardware, software and services, the combination of all that is all in the M&A [indiscernible].

And in terms of, I guess, sort of size of transaction, our M&A market has been tough for 2 years. You think that naturally, you might go back to doing larger acquisitions soon if the broader market picks up or not necessarily?

Well, there's always more opportunity in bolt on. So whether that's a bias or not, really [indiscernible] as you move up to larger deals, there's fewer. We certainly have a scope of larger deals that we like a lot. EA was one of them. If those become available, they're hard to predict when they'll become available. That's why we do a lot of funnel management. That's why we're cultivating EA for a long period of time. We're doing that in other companies. And if they become available, we'll certainly work with them. And if there's opportunity to have good returns and acceptable trends in the way we want to, then we would do something. The good news is the balance sheet is going to be in a good place to do what we need to do this year, and we feel really good about our projections in terms of what we can do with businesses from a strategic perspective over the long term. So that -- the confidence in which we can build on those things have never been greater.

If we think about AHS, does that need to kind of prove higher organic growth from here before getting a lot of M&A capital or not necessarily?

Well, we sort of say we have to prove ourselves every day to some extent. So I think we get -- the better we execute, gives us more permission to do things. I think what you've seen is really solid execution out of health here, certainly over the last -- in '23, a little bit of a challenge. As I said, we've seen mid-single-digit growth there. And a couple of -- the Invetech situation is something that moving that into PT makes some sense for a bunch of reasons. I think where we stand today, we did a small partnership agreement with -- for ASP in the fourth quarter. We think that's a good organic opportunity. We certainly have a landscape that's meaningful if there's an opportunity to become available. Health care is the M&A market that on a broad basis on what we do, which is really industrial health care. At the end of the day, what we're really doing is we're really making a hospital safer and more productive which isn't that different than what we do in a manufacturing facility or an engineering lab to some extent. Our health care is really very similar, in many respects, our health care segment. It's much a vertical conversation about doing a lot of the same things as to what we do in other places. And we think that market is -- that M&A market, which has been a little slower last year simply because of COVID, a lot of -- we think probably opens up a little bit in the second half. So that might be one place where it might be as much the opportunities might become more available in the future. But I think when you look at the value that we have for the year, the growth rate, the margin expansion, the quality of the business that we have is certainly -- I would hope we have -- and hope we have more opportunities there because we're executing on.

And we mentioned at the very beginning, it's been a public company for almost 8 years now, standalone, and there has been a lot of portfolio heavy [indiscernible] already that's taken place. Should we rethink about that -- you kind of have a lot of the -- in a lot of the markets you want to be in today. So future acquisitions or organic investment will be in the existing areas? Or no, there's still the scope perhaps to make push somewhere else that you're not lodging right now?

I think we like the segments we're in. We have $60 billion worth of served market. There's plenty of opportunity for us going forward. We'll continue to do a little bit of portfolio pruning like we talked about. But I think when you really look forward to what we have, we reevaluate this every year, we look at the portfolio on a regular basis with the board. But when you look forward with the serve market that we have and the position we have in the market, we've never been in a better position.

When you think about the kind of some of the parts type valuation because there are some disparate verticals, disparate business models as well, software services, hardware. How do you think about the sort of -- when you look at that, where -- what it is today, do you see a big gap. If so, what do you think you can -- are doing to narrow?

Well, we certainly think we're undervalued. Everybody would agree based on the survey. So we think no matter any way you would analyze it, we think we're undervalued. So that's the opportunity that we got executing every day. I think what we tried to put in our earnings presentation back a few weeks ago was the power of what we've done over the 5 year, 2019 to 2024. And I'd take that EPS free cash flow [indiscernible] that you've seen core growth and then the total revenue growth those numbers stack up really well. And I think if you apply those in any way, shape or form you were undervalued against any analysis. So that's the exciting part. It gets us excited every day to live up to that. Ultimately bring the company up to a valuation that we think is appropriate.

Fantastic. Well, on that note, thanks very much, everyone, and thank you James.