Fortive Corporation (FTV) Earnings Call Transcript & Summary

We'll get restarted. The time -- the clock is ticking here with Fortive Corporation. And very pleased to welcome the leader of the IOS segment to the stage, Olumide Soroye and Elena Rosman, Head of IR Fortive. So I believe we've got some slides to run through, and then we'll get into the Q&A session. Thanks. Olumide?

Excellent. Thanks for having us. It's good to be here. So just to set the stage for the Q&A, I thought it might be helpful to touch on 3 things. First, just a recap of how the year started overall for us at Fortive; second, just some reflections on the key drivers of our success at Fortive and what those and why they are enduring and sustainable. And then finally, I would just reaffirm the confidence we have in our full year 2024 outlook as well as the long-term financial targets that we shared just about a year ago almost to the day, a few blocks from here. So those are the 3 things just to get us started. So first, how has the year started for us at Fortive. I'd say it's been a really strong start to the year overall for us. In Q1, as you know, we exceeded expectations on revenue growth, earnings growth and free cash flow in all 3 of our operating segments. We were then able to raise our outlook for the full year. And again, we remain confident in delivering that outlook, which anticipates us delivering double-digit growth in adjusted EPS as well as double-digit growth in free cash flows. Now the key thing for us is, what underlies that success. Because if you think about it for the last 5 years, we've delivered double-digit growth in both EPS and free cash flow compound annual growth rate over 5 years. We've been able to drive over 400 basis points improvement in adjusted gross margins, 600 basis points in adjusted operating margins. We've been able to reduce our net working capital to revenue ratio by 550 basis points in the 5-year period. So what is it that helps us sustain those results. And I'll maybe suggest that there are 3 main things: The first one, is we've created this advantaged positions in these 3 operating segments, Intelligent Operating Solutions, Precision Technologies and Advanced Healthcare Solutions. We've carefully crafted those positions to make sure they have strong, favorable circular growth trends supporting us. We've created positions that have high recurring component, which helps it reduce cyclicality. The main thing for us in this segment is, what we do for customers. We deliver solutions that delight customers and help them improve their safety and productivity outcomes. Our teams are passionate about this. That's what drives us every single day. The second thing that underpins our success is the Fortive Business System. And you've all hopefully heard about how important that is to us. That's our culture. That's who we are. Now what does it really mean? And I'll try to express that in terms of 2 outcomes from the Fortive Business System. And the first is, what it's done for us in terms of accelerating innovation. Based on the new set of capabilities in the Fortive Business System, our teams have now identified over $1 billion of new revenue opportunities from the dream stage of our lean portfolio management system as part of FBS. That means a lot of new innovation ideas coming out. Now at the same time, we've been able to shift 25% of our development capacity from sustaining legacy products to helping build new things in the marketplace. That combination means, as you look ahead, just a lot of -- just incredible opportunity for new product introductions that delight customers and drive growth for us. The second thing FBS does, that's well known, is what I talked about earlier. How do you keep finding operating margin expansion, free cash flow improvement year after year after year. It's a big part of our value creation flywheel. We talk about [ over 75 ] basis points of adjusted OMX each year. A lot of years, we outperformed that. Over the last, again, 5 years, we've delivered, you've seen, in the IOS segment over 700 basis points of adjusted OMX. That's 140 basis points a year. So that's really what we're about. And that's what gives us confidence, again, that we would execute on 2024, would deliver the guide we've put out there, which again anticipates us delivering double-digit growth in adjusted EPS as well as free cash flows. Let me just spend a minute on the Intelligent Operating Solutions segment because in many ways, this is a demonstration of the Fortive strategic playbook that we're putting to work in all of our segments. And just a few -- just observations on the higher growth, higher margin and much more durable segment that IOS has become. The $2.8 billion of revenues we anticipate this year reflects about 8% compound annual growth rate in total revenues over the last 5 years. 5% core growth. Now I think it's worth noting that we kept the segment flat in 2020 despite COVID outbreak. If you look at the last 4 years, compound annual growth rate in revenues is 10% in total and it's 7% core. This also, at the same time, we've done while expanding our addressable market by 2x to over $30 billion. That means we have a lot of runway still ahead of us from $2.8 billion out of $30 billion. At the same time, we've been able to craft a 1/3 of the segment into recurring revenue models. There's over $800 million annualized software revenue value embedded in this segment now. That gives us a lot of resiliency through cycle. And again, we've been able to grow adjusted operating margins in the segment, 13% compounding every single year over this period and over 700 basis points of adjusted OMX in the period. The things I talked about earlier are the drivers of this. We crafted a segment that has 3 growth platforms in facilities, in asset and in people, and I'll come back to that in a minute. We've deployed FBS to drive the performance you've seen here and to accelerate innovation in this space. And we're going to keep doing that, in many ways, there's still a lot ahead of us. Everything I talked about we're doing in PT, we're doing in AHS. The deal we're doing in PT for [ EA ] brings in alignment with really kind of high-power test electronic solutions that will benefit from high-performance computing, renewable energy, mobility, a lot of kind of really important drivers of growth for that segment overall. FBS continues to be an anchor for us in PT. Same thing in AHS. We now have over half the segment in recurring consumables -- consumable-type models that tend to have a very stable profile, another $200 million in software revenues in that segment. Again, you've seen the margin performance year-to-date. That's the power of FBS, and we'll keep doing that. So this really shows you the arc of financial promise for Fortive overall. And I'll say for IOS as much as we're proud of this, we're far from done, and there's so much upside ahead of us. The other thing I want to touch on the next page is just the innovation agenda. And my colleague, Tami Newcombe talked last week about how we're winning in electrification and AI as a piece of that. And a lot of the innovation we've driven at Tektronix, which is in our PT segment, Qualitrol as well as Fluke on solar, on EVSE, on a whole range of other solutions that touch on this idea of electrification is really powerful and exciting. But it's the second swimlane of innovation that we're driving, which is about winning in digital transformation. And AI enablement of that transformation is turning out to be a powerful instrument for our teams. I'll just give you a few examples. We generally think in IOS that we do 3 things. We help customers transform the way they manage space, we help them transform the way they manage people, and we help them transform the way they manage assets and systems. For all those 3 domains, it's about safety and productivity. Our teams every day are coming up with new ways to help customers do that better, enabled by GenAI tool sets. Just a few examples, a few weeks ago, our team on the Facilities and Asset Lifecycle solutions space launched the Gordian cloud platform. What this is, think about is as a single pane of glass that helps the customer plan for their facility and the building they're in, in terms of the spend they need to incur in that facility, so the capital planning process. It helps them estimate the cost of specific projects and it helps them procure the constructions to actually get the projects done. And along the chain, there's a whole range of AI part analytics infused into that to help the customers make the right decisions. This is an exciting new thing for our customers. It's just incredible to see what that's doing for the team. The same thing we're doing on the people side. We've always had a great business in helping keep people safe, eliminating death in workplace. Our team's now bringing in AI-enabled analytics to predict harm and incidents before they happen. We're doing that in our Intelex business. We're also doing it in our iNet business, in Industrial Scientific. Same thing on the asset management side, you've heard us talk about eMaint business, which is a piece of Fluke and the fact that Fluke now has 5% recurring revenue in it, a piece of it is eMaint business. Well, we have an AI-powered machine health business that we acquired last year as 1 of our 4 bolt-ons and that's now integrated with eMaint to help customers not just manage their work outages but actually predict what might come next before it happens. That's just a few examples of how our teams take the power of the innovation engine in Fortive Business System, a deep understanding of circular growth drivers and come up with delightful experiences for customers [indiscernible] do. And this is why you see us showing more resiliency across the IOS segment is because of just this incredible pace of new product introduction. And then maybe just to close on the last page here, hopefully, in these few minutes, you get a sense of why we're incredibly excited about the journey we're on. We have a terrific value creation formula that starts with core revenue growth, and we talk about mid-single-digit plus through cycle, then goes with a powerful margin expansion track record we've shown, we talk about greater than 75 basis points a year as our baseline. You've seen us outperform that so many times, and we expect that to continue to be the case. We're incredibly disciplined with capital allocation and deployment for M&A, and we'll continue to be disciplined, but also decisive with the right opportunities. And finally, FBS is a wraparound it. That's what gives us confidence in the long-term guidance we put out there and the targets we put out there, which has us between 2023 and 2028 doubling our adjusted EPS and doubling our free cash flows. So thank you. And with that, Nigel, we move forward to questions.

Thank you very much. I'll give you a chance to catch your breath. Certainly, if you hit $6.75 in 2028, your stock today is on sale. So that's -- so while you kind of recover from that, Elena, maybe if you could just, maybe just touch on kind of non-IOS for a couple of minutes. Any sort of messages out there on kind of current quarterly trends, in particular, the PT inflection and confidence in that inflection.

Sure. We don't give mid-quarter updates in terms of how things are trending in the middle of the quarter, but I'm happy to reiterate our guidance for Q2, which includes 0 -- basically flat to 2% core growth. That has continuation of momentum in IOS and Healthcare with, call it, mid-single-digit core growth. And then for PT, we have PT forecasted to be down on a quarter basis mid-single digit. Across the company, at the Fortive level, we have roughly 75 basis points of margin expansion. Again, that's higher than -- it's closer to 50-plus percent incremental on margins. And we have -- that obviously translates into good earnings growth with $0.90 to $0.93 of EPS targeted for Q2. And I think that, again, the -- if you will, sort of the dynamic, right, that we sort of said coming into the year is our distribution of revenue, it's roughly a 48-52 split. That's normal linearity for the year. So we don't -- we are not assuming that there is any sort of large step-up. I think if you break that down, I think specifically, you asked about PT, it's a very similar profile. So for Tektronix, which is expected to be down in terms of revenue for the year, call it, mid-single digit, our outlook for PT now for the year is closer to flat. That again assumes a revenue distribution of 48-52. So really benefiting in the second half from some easier comps as we move through the year.

Okay. And just to be clear, the 48-52 split, that's very normal.

It's the revenue. Yes, normal.

Okay. Great. Olumide, you've been with Fortive now, I think, 3 years or so, I think it was mid-2021, you joined, I think, CoreLogic is where you joined from. Fortive's got a deep bench of very talented leaders, so they clearly saw something in you, very special. So maybe talk about the skills that enable you to run a business like IOS. And maybe talk about why IOS, the collection of businesses we see today in this segment makes sense.

Yes. No. Thanks, Nigel. So I mean, first of all, it's the culture and the team. So a lot of what I've really enjoyed is finding a way to unlock the potential in our people. We have a great team that really has a lot of passion about what we do at Fortive and that's what makes my job easy. So the main thing I try to do is really increase the passion for innovation, remove obstacles in the way of us getting that done, because I really believe, that driving top line growth and value for customers is what enables our success, both from a top line and sort of a margin expansion point of view because pricing is a big part of our margin story and you can't capture price, if you don't create value. So a lot of what I've tried to do is just really elevate the Fortive Business System, I'm a passionate evangelist of that and then help our teams just get more innovative. With respect to the IOS segment, it really goes back to the point I made earlier around digital transformation. And we have these 3 domains that you do it in the facilities, you do it in the space, think about it like that. You do it for the people that work in that space and keeping them safe, keeping them productive, the same idea. And we do it for the assets and system in that space. And whether you're in a manufacturing plant, whether you're in a power plant, whether you're in a mine, whether you're in an International Space Station, you need space, you need people, you need systems. So that's the way we kind of tie it together. The journey for us started on the system side with Fluke, and we very quickly found our customers not only wanted us to help them test and measure the performance of their systems, but keep the people around those systems safe. And so that led us into Industrial Scientific and Intelex. And then very quickly, we found that, well, there is also kind of the space that always happens in and that led us to Accruent, Gordian and ServiceChannel. So that's the way it hangs together for us. It's the same idea of safety and productivity across those 3 domains.

Right. Okay. That's clear. You've got a lot of experience with software and data management analytics in your prior roles. How would you rank the quality of the software business of the FAL businesses within IOS?

Yes. So our software businesses, which are -- the bulk of it's in FAL to your point, but we have some in AHS and same in connected reliability as well. I think my assessment of FAL software businesses is they are a terrific platform, right, almost $800 million of revenues. And if you think about it, it's a rule of 40 kind of FAL group. So solid growth and incredible margins, which a lot of software companies have seen. We'll give a lot for the margin profile we have. I think in terms of the quality of those businesses, I think about it starting from what we do for customers. And I would say that we have a terrific offering to customers across the FAL group. We've got almost 20 -- over 10,000 customers across that group. And I see the passion that customers have for what our teams do every day. I would say that we have a variety in the quality of the businesses in terms of the pure product quality of businesses. As you can imagine, Gordian is kind of clean data software business that's pristine and great. ServiceChannel is a very clean, sort of network software data performance benchmarking business, just terrific and Accruent, which is our first kind of toe in the water, a big toe in the water in this growth platform is a bit more diversified. And so a lot of the journey we've been on Accruent, which by the way, last quarter, the team is now seeing 20% plus growth in their new bookings. But a lot of that journey has been trying to take that potpourri of very different products that came in with Accruent, 30 plus of them and get that down to the 8 really high-quality things that we're now focused on, and that's enabling us to have a really solid foundation to grow from. So I think it's a great business as a whole. But as you would imagine, the kind of variations of the theme within that.

Yes. Do you want to touch a bit more on the Accruent turnaround? Because I think when you joined that was very much a work in progress at that time frame. And you mentioned basically 30 platforms, down to 8 core platforms. So is that a case of just divesting or just stopping these platforms? Or was there some consolidation within that process?

Yes. So our team at Accruent, I'm incredibly proud of the work they've done. So it's been a journey of taking kind of 22-plus different products and platforms that we had that kind of didn't have the trajectory of enhancements and improvement that customers need. So it's been a process of finding a graceful way to move those customers to the 8 that are really going to be the one we invest in. And that's -- as you can imagine, it's like flying a plane and then switching out the engine at the same time. And the team's been able to do that, and that's shown up in fairly choppy kind of top line numbers for Accruent over the last 3 years. But the good news is, once you finish doing that, you have that foundation, it's just an incredible story to grow from. And that's really the essence of what the team's been doing at Accruent, and we're at a great place. And I think you will see the fruits of that in the quarters ahead.

Okay. We think that the key competition for these platforms as [ pens ], paper, the Excel Spreadsheet. Where are we on the migration of moving these workloads on to the cloud or connected platform?

Well, everything we have in our software businesses at FAL, with the exception of, maybe, a stop that's less than 7% is fully cloud-enabled, fully SaaS. So we don't have a big migration project, which I appreciate. That's a different problem to have. So we don't have that problem at all. The little stop that we have that's not fully SaaS, fully cloud, it's really kind of customer preference in certain industries where they want to be on-prem. And we respect that, and we enable that to happen for them.

But the customer workflows themselves, they're actually using non-SaaS platform to do their workloads, whether it's product planning or construction planning. What is the penetration of your products? So is it mid-teens? 20%? Where do you see the market?

Yes. So we think about it as sort of there's a whole market that's possible, and to your point, over 60% of that is not yet used in anything. They're using Excel, they're using papers, they're using different things. So that's kind of the untapped market. And for the piece that's using something, we have a decent share of that, but we're still sub-10% of the vended market. So any way you look at it in terms of converting the 60% that's not yet on the digital transformation journey, which we find very attractive or frankly gaining share from some of the competitors that dealing with the vended market already that's kind of the headroom we have.