Fortive Corporation (FTV) Earnings Call Transcript & Summary

Good afternoon. Welcome to the session for Fortive. I'm Rob Mason, the senior analyst at Baird that covers advanced industrial equipment, which includes Fortive Corporation. Very happy to have Fortive with us here today. As many of you are probably aware, the company made news a couple of months ago, announcing its plan to spin out its Precision Technologies segment in the fourth quarter of '25. So I'm sure we'll talk about that as well as put more focus and more emphasis just on what new Fortive may be -- may look like on a go-forward basis. So real happy to have with us Jim Lico, the CEO of Fortive, who's going to walk through a few slides, make a few introductory comments, then we'll be able to take your questions. And if you have any questions, feel free to send those up to the iPad. I think we're at [email protected]. So Jim, I'll hand it off to you.

Thanks. Thanks, everybody, for coming. I thought we'd just go through a few quick slides, given a little bit of new news as Rob said a couple of months ago, but does kind of put some things into perspective for everybody. So we'll talk a little bit about the quarter. Obviously, we think slightly in a lower-growth environment, we think we had a really strong performance relative to strong earnings and free cash flow growth in the quarter as well as the year-to-date certainly with our guide. We think we're set up well for '25. We'll talk a little bit -- I'm sure we'll talk about that today in a number of ways, but certainly seeing some of the stabilizing demand trends in our Precision Technologies segment, which has seen some of the bigger headwinds this year. So we feel like that's positioning us well. A lot still up in the air in some respects, but between the consumables and recurring revenue, software growth that we have in the business, it's really carried us forward this year along with some of these stabilizing demand trends. We think that sets up for a good '25. We'll spend in '25, as we'll talk about that in a minute, but creating 2 companies, and I'm sure we'll get into that. So I won't spend a lot of time on that. And I'll give you a window of what past performance has been in that just in a second here. And then finally, while we're in the middle of the spin, we prioritize share repurchases. We said about 75% of our free cash flow between now and the time of spin will be committed to share buybacks, will really give some certainty to how the cash flow will be deployed between now and then and also gives investors, I think, a lot more certainty as to what the balance sheets might look like at the time of spin for both businesses, which will be investment grade. Real quick on what is really New Fortive, and that's the combination of our Intelligent Operating Solutions or IOS business and our Advanced Healthcare Solutions. And I think some of the things that jump out, 50% recurring revenue going forward in those businesses reduced. A lot of the work -- a lot of the hard work we've done over the last few years to really build more durability into the portfolio. These slides will be available to you as well, so in case you're trying to write every number down. But really shifts us to a very strong growth company. And you can see some of the numbers. Over the last 5 years that we're an independent company, we would have an 8% CAGR on total growth. And over the last 3 years, 6% on the core side so really strong growth. And of course, 12% adjusted operating profit growth. So strong -- very strong growth relative to profit. And obviously, the free cash flow and earnings that come from that as well. So we think positioned very well given the durability of the business, about 4% in the third quarter. So really continued resilience in the business on the backs of -- while some -- obviously, some challenges in the demand environment, really good durability. We think that sets up well for a more focused company going forward and a more focused and balanced deployment of capital around capital allocation, balanced roughly between 50-50 roughly around buybacks and returning money to shareholders as well as bolt-on M&A. The new company to be named is our current Precision Technologies segment. So you have good history there. And that -- those numbers are 4% total growth over the last 5 years and 4% core over the last 3 years and about 9% adjusted operating profit growth. So still really strong performance over the last 5 years, we think sets up well, but more of a through-cycle growth company. And we'll talk a little bit about the strategy of the spin. But really part of that is these 2 great growth companies set up to be independent with slightly different growth profiles, but still really strong earnings and free cash flow associated with their growth, we think, sets this business up to -- for real success in '25. And then finally, maybe just to bring back to what Fortive has done in total. And I think really one of the things I think you can count on is the 2 businesses go forward is the continued results orientation culture that we've had and demonstrated over the last several years. You can see it on our -- a lot of the financials here, 17% compounded annual growth in our free cash flow over the last 5 years, earnings in the 14% range around continued margin expansion, 125 basis points we've averaged over the last 5 years. So I think those kinds of metrics along with good strong growth in different growth profiles, I think, really speaks to the power of our continuous improvement culture, what we call the Fortive Business System and both businesses set up for independent success in the future. But we've got some time between now and then. So looking forward to giving you a perspective of where Fortive is at today. And let's -- Rob and I can sit down and do that.

Perfect. And again, if anybody has any questions, feel free to shoot those up. So let's just start on the spin-off topic, Jim. I'm sure this is almost like the obligatory question that you get, but why now? But maybe frame it a different way, what about the life cycle that Fortive has gone through since it's been spun out that makes this the best outcome right here?

Yes. I mean I think in 2016, we spun out, and I really think of our life cycle in sort of 3 phases. If you think about the early days in which like the Altra transaction and some of the Vontier spin was really about building the durable growth model, changing to a more durable, higher growth, we moved the growth rate up on the business. And then Phase 2 is really about some of the very, very important acquisitions we did around facility and asset life cycle software and around ASP getting instant health. And the foundation of -- it's really the foundation of -- along with Fluke will be the foundation of who Fortive will be going forward. So I think that Phase 2 is really around the acquisitions and building the more durable growth, putting more recurring revenue into the business. And now we're just in a really good position with those foundations in the 2 businesses, one being a 50% plus recurring revenue business. It's got great growth profile, another through-cycle grower that's got good growth but has some cyclicality to it. And I think increasingly, Rob, as we really looked back last year and we did some of our strategic work early in the year, what we really found is that these 2 businesses are really living within one. And unlocking the potential of both really is about unlocking those growth profiles so that strategically, they can go after the kinds of things they're really going to do. And our capital allocation strategy, because of the spade work we've done over the last 8 years to build on these foundations, the capital allocation model can be different. It can be less risky to some extent. I think over the years, people have looked at some of the M&A deals we've done and some of these in new markets to us and in places where we hadn't been and looked at that as more risky M&A. I think what you look going forward is now that we've built those foundations, so we've got those great pieces for Fortive going forward, we've got an opportunity then to have a different capital allocation, less risky, higher return profile that we're really excited about. And subsequently, the new company has a great potential as well. It will have some cycles to it, but it's the engineers or engineering company. It's really tied to the great technology transitions that are going into the world. They have some cycles to them, some investment cycles to it, but that business will take advantage of those opportunities as they become available. They have taken advantage of those opportunities as they become available over the last 5 years, as you've seen in the numbers. So we feel like that independent path is going to be really strong for them as well.

Yes. The couple of slides that you just showed kind of the history of the 2 companies. Interesting in that new Fortive core growth around 6% CAGR, total growth 8%. As I reflect back on the last 5 years and then I think forward, what could change in that? It seems like ASP is in a different place than what it was. Accruent could be in a different place from what it was. Is there anything as I just -- that you would like to point out around the history and we project forward that presents different?

Yes, sure. And I think when you look at the durability, I think it starts with just stepping back and saying, the company going forward, we've done a lot of the heavy lifting to get some of these businesses into a profile as you just described, right? Accruent, a little bit more of a challenging deal that we did a few years ago is starting to really start to change in terms of its order profile should have better -- had a better '24 than '23. It will have a better '25 than '24. That brings our facility and asset life cycle software business into a really great set of businesses. And I think in ASP, obviously, the pandemic wasn't helpful. The transition out of J&J was a little tough, but that business is really performing over the last 3 years really well. And so I think that's a good setup. And then maybe the last thing I would say is if you just step back and say 50% of the company going forward is going to be recurring revenue. That's going to grow somewhere in around the high digit range. And the other part of the business, the other 50%, which is really reoccurring great franchises growing in the mid-single digit also means that, that business will -- as we continue to invest M&A capital and money into our organic revenue strategies, we're going to continue to mix that recurring revenue number up and mix the growth profile of the company over a long period of time. And I think that's what really gets us excited about the new business.

Yes. And you touched on perhaps the opportunity to shift the capital allocation strategy. How are those -- how is new Fortive set up today to be able to move more towards bolt-on? Has there been shifts? Does it require a shift in the corporate development work? Is there more internal sourcing at the operating company level? Or just does anything really need to change with the M&A structure?

Yes, it doesn't change, but it shifts. I mean I think when we think about new Fortive at about $1 billion of free cash flow. You think about half of that is going to be deployed back to investors in forms of buybacks mostly. Then we got about $500 million roughly. I think our sweet spot is going to be deals probably $50 million to $200 million range. So those are deals we've done. We just did 4 of those in the fall of '23. So there'll be more emphasis on that. But I don't think it requires any new muscle necessarily but certainly more emphasis. And the thing I really like about that as well is when you -- if you think about the 4 bolt-ons that we did in the fall of '23, 3 of those were sourced from relationships and because we're in the industry, we're in the market, people we've known for a long time. They weren't competitive. And so I think the process of cultivating independent owners of businesses within the domains that we're so strong in really gives us, I think, an advantage in a number of the bolt-on, the kinds of deals that we'll do. And we -- I think we demonstrated that muscle a year ago, and it just means more of an emphasis in that kind of capability going forward.

Fair enough. And then I would say, again, this is not your first rodeo in this regard regarding spin-off. So I guess, is -- Vontier and then the Altra business as well, any learnings you take from those that you carry forward that's kind of -- so as you present this new business to the market suggests that it gets off on strong footing?

Yes. I think there's a couple. One, we learn from each one of those. And obviously, our own spin out of Danaher, probably another one, right? So we've got a little bit of experience in doing this. So I would say that there's certainly a lot of learning in the process in terms of the sort of mechanics of it, right, how you do the tax step plan, how you do the Form 10, some of those things. There's lots of experienced professionals who know how to do that work. I would say that things may be more related to getting the company off and running. Number one is we like the -- we started to see PT transition with order growth in the back half of this year. We think that starts to bode well for revenue later in maybe the second half of '25. So we'll be spinning in the tailwinds, which we think is a good thing. Obviously, when we did the Vontier spin, as an example, that was -- that business had some secular challenges. They've done a great job in dealing with those, but they -- we knew those were going to be there. So I'd say some learning is if we can find an opportunity to do that into the tailwinds. I think the second one is being clear about the capital allocation strategy. One of the things we found when we've done some of this other work is people didn't know how we were going to spend our free cash flow between now and spin. And so because of that, they couldn't guarantee the balance sheets. So by being more very prescriptive as to how our free cash flow, I think you get a lot more certainty when we say we're going to have investment-grade balance sheets when we -- at the time of spin. You can be unbelievably highly confident, I can't say that enough, about what the balance sheets and investment-grade profile is going to look like for both companies going forward.

Yes, very good point. Could you just comment real quickly just on the management teams of the 2 companies? They're both operating leaders within Fortive today, very familiar with the businesses. But quite honestly, the work that Tami has done at PT and tech, in particular, it's been pretty well documented as to how that business has transitioned. Olumide is newer to Fortive, but he's been running those IOS business for a bit. Just how do you see -- what are the hallmarks of some of his presence in, I'll say IOS, but just at Fortive overall?

Yes. I mean I think 2 great leaders were -- we've -- my legacy with Danaher and obviously, of 20 years before Fortive, we've -- I think we know how to get ready for CEO succession. It's been -- succession in general is a really important part of how we think about leadership and successful leadership. So we're in a very fortunate place where we have 2 ready leaders for both of these businesses. Olumide, as you said, is a little bit new to us. We brought him into the company because he had data analytics and software experience. He had real experience in growing recurring revenue businesses. His CoreLogic experience prior to Fortive and even before that with some real demonstrated success in that regard. And his fingerprints are all over Fortive, whether it be on FBS and how FBS can add value to these businesses. We're more successful -- more recently, some of the successes I described at Accruent, the building out of our FAL portfolio, the work we've done on durability at Fluke. He's had real strategic fingerprints into those businesses, and he's a good operator so -- which is obviously important as well. So we feel really, really great about his new leadership. And this is 8 years of work for me in Fortive is -- I mean, for me, handing it over to somebody is handing something incredibly important to me. And I wouldn't do that without a strong confidence that we've got 2 great leaders, and I'm really confident we do.

Perfect.

I'd just add, a number of folks have seen -- a chance to see Olumide and Tami here as they've been out recently, and we'll continue to do that. So I think the ability to see them as segment leaders versus seeing them as CEO -- new CEOs is a little bit different. So they'll certainly be out and about visiting with investors over time. And I think the feedback thus far when they've been out has been incredibly strong.

Yes. I want to shift gears just a bit. We'll go ahead and cover this ground, because it's been a common topic at this conference thus far, just a week off the election and all the policy proposals that are bound. But certainly, the first round -- we'll start with China tariffs, but the first round of China tariffs or the last rounds, Fortive was on your front foot there and trying to deal with those. So just if we see this again, how are you set up to deal with that, just up level set on kind of the exposures that you may have?

Yes. I think about this as really a 6-year effort. And I think everybody forgets that the 2018 tariffs have been in place ever since then. So nothing has gone away, right? And on top of the tariffs, then we had supply chain inflation, and we had some of those challenges. And so for those 5 or 6 years of time when all of those things have been enacted, our ability to countermeasure those challenges has meant that we've continued to grow gross margins throughout and operating margins, obviously, 125 basis points over the last 5 years. But we've also grown gross margins as some of those things have impacted COGS. And it really comes down to our ability, the strength of our franchises, the quality of our teams to really do the things that are needed to countermeasure some of those actions. And what we've done over the last several years is continue to derisk the portfolio. We've continued to move manufacturing into locations where the tariffs wouldn't be impacted. We've doubled -- we've dual-sourced our supply chain so we have options around our supply chain. So we're much more resilient than we were a number of years ago. And as you said, a number of years ago when we first started, which none of us have really had a lot of experience in tariffs at that point. We did a great job of countermeasuring those. So we're confident that we can do that. And we've already started to action some things based on scenarios that we built prior to the election. But I think it's still jury still out as to what those are actually going to look like. But we're starting to prepare for what we might be able to do. I think the way I think about it is where we have pricing power, which is pretty much the entire portfolio, we've got opportunity. We've got an opportunity to move sourcing. So if we're dual-sourced, we can move to one source versus another. And then finally, given our sort of asset-light manufacturing, we can move manufacturing products into different regions of the world relatively quickly. So all of those will be actions to take in if -- depending on the severity of what we see coming out of the election.

Yes. And just as an observation, whether it's Fluke that would be impacted Tektronix, I mean, you're talking about businesses that have leading brands and the kind of premiums in the marketplace starting point as you think about maybe pricing around.

Yes. I mean, you always want to be careful, but I mean I think what we demonstrated during the last 5 years is these franchises have tremendous value. We think of it more as our innovation capability, our customer value allows for us to get more value out of the market. And when these things happen, we built -- we spent years building these franchises. We have deep relationships with customers. And these things tend to be more understood by customers, quite frankly, than anything else, right? I mean there'll be headlines for sure.

Just real quickly, just to reflect back on the third quarter and then as we move here in the current quarter, fourth quarter, just wanted to get quick viewpoint on how your order performance played out in the quarter and what -- just level set us on the kind of momentum that you think you're carrying into the fourth quarter from an order-demand standpoint.

Yes. I think obviously, the revenue was 1% core, 3% overall growth in the third is a little bit lower than we had anticipated, a little bit more noise. But we -- but as you said, the order growth was good. So we were starting to see some better reactions to orders. Orders for Precision Technologies were double digit. In the quarter, Tek was high single digits. Fluke was high single digits. So we started to see the third quarter dollars of orders for PT was higher than the second quarter, which I think is a good trend. So I wouldn't say there's an inflection necessarily. I would call that more stabilization. We expect the same in the fourth. So we would anticipate that stabilization is really where we're at right now. I wouldn't call an inflection at this point, dramatic inflection. Some of that order growth is comps, but some of it is actually seeing -- starting to see some green shoots, some orders that were delayed in the second quarter, we did see in the third at Tektronix as an example. So there's a few things out there that would suggest things -- at least we feel good about the stabilization side of this.

Yes. Is there any business you'd single out gaining momentum at this point, though? You see no inflection.

Yes. I mean, certainly, if you were to look at PT, you'd look at our businesses tied to the utilities, it's principally at Qualitrol. But anywhere we have sales into that, we've seen strong growth. Our defense business has been strong growth. Anything tied to data center, I think that states the obvious. We've got a little bit of that in sensing. We've got -- we certainly see that on the Tektronix front, a little bit at Fluke networks. So anywhere we're tied -- we're seeing some of those things just continue to accelerate. But I think the other piece is the recurring revenue is really strong, right? Health care has been good. It's continued to be really strong. Our software businesses, we had high single-digit ARR bookings growth in the quarter. So I would say our recurring revenue businesses, principally in software and health care, are continuing to be strong.

Yes. Just around the consumable business, I think everybody is well aware, you had some easier comps there. But how to think about that business as we come past those easier comps? So what kind of cadence do you think [indiscernible]?

Yes, I think when you look at -- if you step back because, obviously, the North American channel aspect of the third quarter last year, we'd still be in the mid-single-digit range for this year. And if you took a 3-year look where you kind of look through that, you'd be looking at solid mid-single-digit growth for health care. And we think that's a good number for the future as well.

Yes, yes. You also made some early 2025 comments, early framing of 2025, I would say, just around how you're viewing recurring parts of the business versus, again, some of the product orientation. Just kind of give us your thoughts there as you're trying to dial people in for 2025 at an early stage in [indiscernible].

Yes. Well, yes, we'll get to a guide. I would say some of the backdrop that we're thinking about is we'll see continued order growth in Precision Technologies between now and the end of the year. So that should set up well for maybe a little bit more of a later -- there's usually about a 3- to 6-month lag on that. So we should start to see things start to improve there in that time frame. We think the recurring revenue businesses will continue, health care at a mid-single-digit, software probably in the mid- to high single-digit range as well. So those are going to be -- I think those all be good strengthening pieces to the -- to '25. I think China is -- we're down about 9 -- high single digit to low double digit in the year for China. I don't expect that to come back. So we've had good order growth regionally around the world. The one place we haven't necessarily is China. So we don't think China necessarily has a step down at this point, but we don't necessarily see it coming back. And so I think planning assumption for next year is going to be that China probably doesn't add to the growth rate. Those are maybe the big pieces.

Yes. How do you think about -- you also discussed the level of innovation that's going on in the portfolio and new products coming to market. How are those expected to impact as tailwinds, I suppose, in 2025?

Yes, it was a great story in the third quarter. I think one of the things you and I have talked about this, we've really revamped our innovation process on a pretty consistent basis from the start of the -- but we really saw the benefit. And we've seen the pilot for that new process was at Tektronix. And a lot of the revamping and success of Tektronix over the last 4 or 5 years has really been that new product development process. It really leans on new innovation and breakthrough innovation and the heavy focus. And so we're starting to see a lot of -- really the green shoots of that throughout the portfolio. I was most pleased in health. We saw it at ASP. We saw it in Provation. But we also saw that Fluke is a sort of perennial innovator, but even Fluke had, I think, the best quarter it's had for platform new product launches than in time since we can remember, and my memory goes back a long time. So we really feel like we'll have even more of that in '25. So some of those are coming into a little bit of a more difficult market, like Fluke, as an example. So I think even the ones we've just recently launched will give us some traction next year as well. And then we've got a new realm of things as well. So I think we're really seeing the benefit. And I think that's probably the third piece of things that can add to some tailwind next year as we launch things throughout the year. All of those won't be launched in the first part of the year. They'll be launched throughout the year.

And then just circling back to Fluke as what you mentioned, I mean, those products that launched this year, you did call that out as at least in the second half, maybe the uptake around some of those campaigns. How does that resolve itself? Is it just -- is that kind of a macro or a year end as we go into year-end thing with those customers' channel?

Yes. I think what we said was we would probably put even more marketing dollars into some of these things if -- but we mostly sell through channels. And so if the channels are seeing the kind of growth environment we're seeing right now, we might not get the uptick of those programs or we might not see the channel traction. Historically, the Fluke product launch, we might get a buy-in that really allows for a more expansive launch, if you will. We didn't get that in the quarter. We're not anticipating that this year. That's why I say I think some of the tailwinds we'll see in '25 will come from what we had anticipated might happen in '24 but will now move into '25.

Yes. Maybe just stick on Fluke just because as you go forward in new Fortive, it will be the biggest business -- I mean I guess it's the biggest business today, but it will even comprise a larger portion of the revenue. So much of the innovation work, as you've talked about, is really innovation work and just the recurring revenue mindset filtered through the entire portfolio comes out of Fluke. Why is that such an engine for that activity?

Well, we have gotten is the why Fluke and NewCo question sometimes gets asked. And I think it really boils down to a couple of things. It's a tremendous global franchise, the largest installed base by far of any company we have within Fortive is the Fluke installed base. And it really somewhat acts like a recurring -- I would call it more reoccurring. But when you have over 20 million instruments around the world and completely satisfied customers who are always looking for the next thing, we sort of think it fits our sort of land, expand, endure business model that we're really creating in new Fortive. That fits the software models. Everybody understands that in health care, right? You land the equipment, sterilization equipment. You then have consumables that expand the market, and then you continue to build on that. We think we can do that with Fluke, and we've had some success from new product launches, which is really expanding the share wallet. When -- most Fluke customers don't buy the entire portfolio. A lot of times, weirdly, they don't even know about it. So the marketing effort and the new product efforts have really been focused on trying to expand that share of wallet. We think we're in the early days of that sort of strategy, and we think that will build a growth year, Fluke. And when you think about a number of the places where we sit today in new Fortive, they've come out of strategies at Fluke, right? Fluke wanted to get into maintenance software, which led us into a facility and asset life cycle software. Fluke is really a safety company, electrical safety company that led us to gas detection and ultimately into EH&S. Fluke Health was a business that had us in the hospital and gave us a lot of understanding of what was sort of industrial health care, which led to some of our thought processes around things like advanced sterilization products or ASP. So it's really been at the forethought of a lot of the ideas we've had because of the global reach and expansive nature of the business. And it certainly provides a tremendous amount of free cash flow in which to give us more degrees of freedom as well. So we think it's a great franchise. It's a wonderful business. Its a financial profile looks more like a software company than anything. And we think it's a great -- one of the great building blocks that we'll have in new Fortive.

Yes. And then within PT or NewCo, Tektronix will be an anchor piece, an anchor asset there. That did return. You saw orders return to year-over-year growth. Just kind of speak to what as you look forward the end markets, in particular, that may offer more opportunity for continuation or acceleration.

Yes. I think there's certainly the part of -- the business has some tie to semiconductors and when it's been semiconductors or investments tied to data centers, that business has been really good. We saw some really good order growth in the quarter relative to that, primarily in our Keithley business as an example, within Tek. We anticipate the broader semiconductor market in multiple technologies will start to inflect a little bit better into '25. Certainly, the industrial production and PMI improvement will help some parts of Tek as well. Some of the onshoring that's happening in the U.S. will be helpful to Tek as well. So -- because that's a lot around the electronic supply chain, which is really their customers. I mean their customers of the global 1,000 technology companies. And so there's been some perennial delays in some of those places and investments, we also think that starts to come back as well. So we've seen some of those green shoots in the quarter, and we'll certainly see that in the second half led to some of that order growth, and we think that will continue to get a little bit better in '25.

Perfect. We're at time. So we're going to break there. There is a breakout session afterwards if you have any questions and like to join us. All right. Thanks, everyone. Good to see you.

Appreciate it.