Fortive Corporation (FTV) Earnings Call Transcript & Summary

I think we'll get started now. It's my pleasure to have here Jim and Olumide from Fortive. Jim, of course, has been the CEO since the spinout 9 years ago from Danaher. Olumide will be the CEO of the new Fortive once Ralliant spins out in about 6 months' time. So thanks for being here. I think Olumide, you've got a couple of slides to go through first, and then we'll go into questions.

Great. Wonderful. Thanks for having us. It's great to be with you all today. So just a few things to set the context here. So we are excited at Fortive about the 5-year history that we're building on, a history that's shown us with sustainable performance with our core growth accelerating to mid-single digits, 350 basis points of gross margin expansion -- 600 basis points of gross margin expansion over the last 5 years. Great free cash flows, as you've all seen, and we feel quite excited about our capacity to sustain that level of performance with the Fortive Business System. As we also covered in our earnings call 2 weeks ago, we feel really good about our strategic positioning for 2025. We feel like with a stable industrial demand that we're seeing and the NPI, new product introduction momentum in all of our companies, we're set up for continued growth with our software and recurring revenue businesses growing at high single digits. We feel really excited that the spin process of Ralliant, PT segment is moving even faster than we initially thought, and we expect that to be done in early Q3. That then sets us up after the spin for new Fortive that is incredibly exciting. And as we get more firm about the spin date, we will have an Investor Day focused on really laying out the outlook for the company. But for today, just a few things I would highlight about new Fortive, the first one is we will be a much simpler and more focused company with a very attractive financial profile. Everything we do at new Fortive will be about innovating essential technologies to make the world safe and productive. Our Intelligent Operating Solutions segment will do that in industrial setting. That will be 2/3 of the company. And our Advanced Healthcare Solutions segment will do it in the health care segment that will be 1/3 of the company. It's worth noting that everything we do in health care will very much be about health care operations. It's the most manufacturing part of the hospital system. It's how you track your instruments, how you clean them, make sure they get to the right place at the right time and keep both providers and patients safe and productive. So that -- there's a lot of commonality across the business. All of that adds up to about $4 billion in revenues. You can see the margin profile, 65-ish percent gross margins, over 30% operating margins in the business, and half of the business in recurring revenue models. Importantly, over the last 3 years, we've shown that this constitution of Fortive, i.e., the IOS and AHS segment, has delivered 6% compounded annual growth rate in the business and the operating profit dollars have grown at twice that rate, at 12% a year. This gives us the basis for expecting we'll be able to deliver mid-single-digit growth going forward for the company. In addition to our organic performance, we are also making a deliberate shift in our capital allocation strategy going forward. We believe that based on the incredible work we've done in the last 9 years to create the current state of Fortive with strong positions in all the markets that we play, we can shift to a capital allocation approach that's much lower risk. That really balances share buybacks as a more sustained piece of our formula and then the M&A that we do is more focused on a very disciplined set of bolt-on deals that we execute on. Those bolt-on deals will be things that are close to our existing positions in the markets we play in. They will be things that are accretive to our growth rate and our recurring and durable revenue mix. They will be things that can benefit from the Fortive Business System's capacity to unlock value, and they would tend to be things that are very strong in terms of the cash returns on the deal. Just and that -- all of that would just reinforce our mid-single-digit performance. Just in closing, just to illustrate what I mean by bolt-on deals a little bit, this last slide, Slide 7, shows 4 deals that we did in the second half of 2023. So it's kind of a H2 2023 vintage deals in the IOS segment. And you can see there's 4 deals, generally, high growth rate deals, you can see 25% growth this year collectively across them. The higher recurring and durable revenue mix. Most of them are recurring and very sticky businesses overall. They all benefited from the Fortive Business System's capacity to unlock value. And hence, you see those delivering low teens ROIC in 2025, the second year. Not every package of deal we do will have this exact profile, but that gives you a bit of a taste of what we mean by bolt-ons versus the mega deals and big deployments, and we think this unlocks a lot of value for shareholders. So that's really the context I wanted to cover, but want to make sure we get to your questions.

Great. Thanks, Olumide. Maybe we'll just start with a couple of questions on sort of current Fortive and the near term. I think there's some concern maybe is the guide for the year a little bit back-end loaded. It's a very uncertain macro. I feel people say that every year, though. But anyway, assume this is uncertain. How would you sort of characterize that guidance? Sort of what are you seeing from customers near term?

Yes. I would say a couple of things. One, when we look at from a historic perspective and every year can be a little bit different. But the year looks pretty similar. The growth rates can vary a little bit. The first quarter growth rate varies for a couple of reasons, and I think there's maybe some thought around it -- your question because of that. We've got a few less days, which impacts our -- primarily our health care consumables businesses but also impact some of our software and services as well. We've got a tougher comp in China. So I would say the one thing, Julian, that is probably a standout from -- we're going to be down -- we were down high single digits in China last year as Fortive, but the first quarter is going to be down low double digit because last year, we were anticipating that some of the government programs, the equipment buy and renewal programs were going to take hold. And so there's some inventory built. So I think when you account for that, that sort of gets to a little bit of revenue at Fluke that happened in the fourth quarter instead of the first quarter as some channel partners got some incentives. That really constitutes the sort of lower part of the growth rate in the first quarter. But when we look sort of -- there's a couple of big orders on the PT front that are going to ship in the second half and that really constitutes really what would be different. But really, when we've looked historically, both from a revenue first half, second half, or EPS first half, second half, pretty consistent with what we've seen over the last few years.

Got it. And you mentioned orders. And that's a question, I guess, of the product hardware businesses at Fluke and also at PT or Ralliant. But I think orders have been a little bit better there. It's taking some time to feed into sales. Just maybe help us understand is the orders improvement, is that reflecting just easy comps or no, it's a genuine customer appetite going up?

Yes. I would say it's a little bit of both. I wouldn't necessarily say we've -- what we're not anticipating here is some big macro improvement through the year. We did -- after several quarters of deteriorated orders, we started to see orders come back and as you said, in the second half of '24. In Ralliant, they were up double digit. Fluke's orders were good in the third and fourth quarter as well. That constitutes our hardware businesses. We are seeing on the Ralliant side, a little bit of those -- that order -- and we talked about this in several earnings calls last year. We are seeing an order pattern where customers are pushing out their orders a little bit, and that's why I was talking about some of those investments are actually in the second half for orders we've received. So -- but again, we're not really -- some of it just kind of gets into comps rather than sort of a big expectation that there's a big shift in the need for the macro to improve anytime soon.

Perfect. And then Olumide, when you look at the sort of end market vertical mix of new Fortive. I think that you take industrial manufacturing, distribution, all that collectively is about 1/3 of the sales there. A lot of that at Fluke. How are you thinking about the revenue growth of that business this year?

We feel really good about the outlook for it. Just a few data points on that. Like Jim mentioned, Fluke saw high single-digit order growth in the second half of 2024, both Q3 and Q4. The point of sale, so the sell-through has also been quite strong, especially in the U.S., the Middle East and Africa as well as APAC ex China, some softness in China and Western Europe. So you've got a strong POS. You've got a strong order book coming into the year. And we mentioned Fluke got 200 basis points of growth from new product introductions in 2024. We expect at least as much in 2025. We're also continuing to get price in the business as well. So you layer all those together, we feel quite good about the outlook for growth and the guide we have.

Got it. And then one question, sort of shorter term, that comes up from investors is around this whole government efficiency push in the U.S. Government, a reasonably large vertical for parts of new Fortive. Any thoughts on how that could affect you? Is it positive, negative, too early?

Yes. So certainly, there's a lot more of the plot to unfold here. So it's too early to call it conclusively. But the government work that we do, a lot of that's in our FAL Gordian business. And everything we do there is really oriented towards driving productivity and cost savings for this government agency. So we feel that inherently that kind of skews towards the intent of all of the shifts. So far, we haven't seen anything to suggest that it would be a big risk for us. But it's too early to call. We like the alignment we have with the objectives that we've heard, but we're watching that by the day.

And on FAL more broadly, I think it's maybe a business that's not super well understood by investors. There's a couple of sort of marquee brands that are known from the acquisitions kind of 5 or so years ago. Maybe remind us like what are the 1 or 2 kind of strongest parts of the FAL franchise? Why does it win against competitors? Any sort of impressions around market share?

Yes. So FAL is about $0.75 billion. It's the biggest and we believe the strongest of those kinds of businesses in the spaces that we play in, in that workflow. The most distinctive things about the business, so the brands you know are Gordian, ServiceChannel and Accruent, it is a business as a whole that has a lot of network economies built into it. So a few examples of that. In Gordian, we have the -- perhaps the leading and only procurement network for job order contracting that a lot of the -- whichever state or local government you're in, they're very likely to be doing some of the big safety productivity-related procurements on that platform. And it takes a 2-sided network, which we have there. The same thing in ServiceChannel, where for the repair and maintenance operations of just about any multisite sort of retail restaurant operations, they need a network that connects the owners of the facilities with contractors for repair and maintenance. And again, we've got a unique 90,000-plus network of contractors that underlies that business. And so when you have a business that has those network economies, it's really a strong competitive advantage. Second is the data content of those businesses. Again, in Gordian, we have the industry currency data set for a lot of the construction data that feeds government procurement. On the ServiceChannel side, we have some of the leading industry benchmarks on what you should expect from repair and maintenance returns for this multisite retail operations. That unique data set that the industry counts on to track how they're doing versus the rest of the world, and they use for reporting to their Boards and management teams. So I think the thing I'll call out is we've picked the very specific positions in the workflow. We don't play across the kind of build, maintain, operate workflow. But the pieces we've picked, they're data-rich and network-enabled businesses. That's why we've been able to have a couple of years at Gordian of 20% plus growth and ServiceChannel continue to be a double-digit growth company. And Accruent has been kind of a journey of improvement, and that continues to really progress towards what we believe the potential of that business is. So it's a really great platform for us.

And when we think about, as you said, some of the brands have had different growth profiles in recent years. What's the sort of overall FAL through-cycle growth entitlement, do you think?

So we've -- we think about it as high single digits growth overall. And so that's what's built into our guide for this year as an example. And we -- it's also one of our platforms that we're most active in deploying new AI-powered use cases related to the data richness that I talked about. That's a proprietary data that we can unlock more value for customers on. It is also a business that still has a big kind of addressable market. So our share is really modest because it's a very fragmented space. So from an organic share gain point of view, innovation point of view, we feel like it's an exciting arena to be in. And right now, it's higher than our fleet average with the high single-digit growth that we're getting from it.

And then sort of operating margins, I think, for FAL are a little bit below the, say, Fluke within IOS. And I guess we would say it's unusual that the hardware business has higher margins than the software one. So how do we think about FAL's profitability from here? There's a huge TAM, very good growth runway. So you're kind of taking the time to invest a lot for x years. And then once the installed base is there, maybe move to more of a margin focus after that? Like how should we think about it?

Yes. And we generally take the end approach in everything we do. And I think for the FAL platform, as an example, the journey we've been on is between '21 and 2024, we've seen 800 basis point operating margin expansion in the FAL platform. And we talked about this in our earnings call 2 weeks ago, including 2,000 basis points of operating margin expansion for ServiceChannel. So these businesses came in with whatever profile they had. And with the power of Fortive Business System, we've driven that improvement. The way we've driven the improvement has not just been about just productivity, and we've done that, too. It's not just been about deploying AI tools to get more out of our engineering teams and reduce our cost to support customers. But it's also been about the top line growth. It's very -- to your point, very high incremental margins on the growth in those software data-rich businesses. So when Gordian is growing 20% plus for a couple of years, the fall through on that growth is incredible and does wonderful things. Same thing at ServiceChannel, same thing at Accruent. So we feel really good about the potential to continue that journey that we've been on the last 3 years.

Perfect. And the Healthcare division had some volatility after the acquisition and then around COVID, but it sort of seems to have settled down. It had good organic growth acceleration for a couple of years. When we think about that business from here, I think sometimes people ask about sterilization versus your big competitor. Are they growing a bit faster? Why is that? How would you think about sort of market share for AHS?

Yes. We really like where we are in AHS segment. It's taken a few years to get here, but we really like where we are. So again, just to frame that the AHS segment is -- think about it as 2/3 of it is ASP around sterilization and sort of sterile monitoring. And then 1/3 of it is health care productivity software, radiation monitoring for safety, equipment, quality assurance. And I think for -- on the sterilization side, I think there's a bit of a thesis that maybe we're losing share, which may be a bit of a data point of view. When we brought in ASP into Fortive, it hadn't had a lot of focus historically. It's been a business that didn't have the push and the priority with the previous owner of it. That's changed now. The team has done an incredible job with the Fortive Business System to getting that business to a point where it's now growing mid-single digits. And they've done that really driving growth outside of the U.S., making sure we're keeping our installed base stable in the U.S. where we already have a really high share and then growing really quickly on consumables and the utilization rate of the capital placements that we do have. And at the same time, our software and radiation monitoring businesses, which are very heavy recurring content, have been growing incredibly fast through innovation and all of that. So overall, the segment, we think about a really clear growth algorithm for it. That's 1 to 2 points of price a year, 1 to 2 points from incremental capital placements, installed base growth, 1 to 2 points of utilization of sort of just procedural volume growth and 1 to 2 points of new product introductions, which we talked about the increasing velocity of that, including at ASP, where we had 6 new products in 2024 alone with 510(k) approval. So we feel really good about the platform. We feel good about position versus other players that may be more broad, but not as deep. We think about ourselves and ASP as really deep and clinically differentiated and for low temperature sterilization and sterile monitoring, the customer loyalty we get because our technology is better, our service and support is better. We think about ourselves as trusted advisers for our customers, and they see us as that, it sets us apart from other players that may be broader, the lower margins. So if you think about the financial profile, that's the reason we have a much higher margin business in AHS than maybe some of the other players it's because we run a different play.

Got it. And Fortive generally has versus most companies at this conference, higher R&D, higher gross margin, higher cash and operating margins. On the R&D front, how do you make sure that you keep getting a very high return on those investments, particularly as the new Fortive, there are some slightly -- they will have high recurring revenue, but they are different businesses in a sense, Fluke, AHS and FAL.

Yes. No, absolutely. And we've -- just our mindset at FBS is all about getting more out of what we spend. And in R&D, it's been no different. So we've built a mindset and a tool set focused on R&D productivity as part of the Fortive Business System that all our companies are adopting. Over the last 2 years, we've infused kind of AI-enabled tools into that. So as an example, we've talked about this. We now have just about all of our R&D teams using kind of AI copilots and other tools, that's driven 25%, 30% increase in their productivity by using those tools. And these are the things we do first before we put more dollars into R&D. And so I think it's just so deeply rooted in our culture. So even though these businesses are all slightly different in terms of the R&D intensity, they all manage to industry standard benchmarks for their particular space. And we hold ourselves accountable to that. So I think that culture would [indiscernible].

And when and we think about the operating margin entitlement of new Fortive, AHS, I think, is still a little bit below the medium-term margin guide that was set out a couple of years ago. IOS is there already, I think, this year. So how should we think about kind of the total entity of new Fortive? What kind of operating leverage do we see the health care margins get to that target on schedule?

Yes. So I think if you think about 2024, for this new Fortive constitution, we're about 31% adjusted operating profit margins. I think 33% for Q4. And like you pointed out, Julian, the AHS segment continued to increase, and that increase is from the growth and kind of the high incrementals and growth. And IOS as well, even though we've gone to the target, we've kept improving every same year. So for both segments, we don't think we're done in terms of continuing to improve. And so you will see that play through over time. We really like our starting point. We think in terms of entitlement, we have a chance to do a lot more for customers that create value and that's how we think about entitlement for margins as you do more for customers and you get to capture more of that. And so we feel quite good about the trajectory to keep improving and the AHS segment, especially has a lot of headroom still ahead of us by executing the growth formula I talked about. Because if your growth is coming from pricing, and it's coming from high gross margin NPI and high gross margin consumable growth that's 75% of the growth and those are inherently just very high incremental kind of growth contributors. So that's the -- we've got a flywheel built in for not just growth but also margin improvement.

Got it. So overall, new Fortive, when we think about the earnings algorithm, if you like, it's sort of mid-single-digit plus organic growth and then sort of I don't know, 75 bps plus of operating margin expansion annually and then some capital deployment on top. Is that the right way to think about new Fortive after the split?

Yes. And at the Investor Day, once we have a firm date on the spin, we'll kind of expand on that a lot more. But I think that's roughly right. We like the mid-single-digit growth expectations, and we'll reinforce that with the bolt-on M&A that we do. And we like the fact that we are -- inherently the way we run the company, partly because of the nature of how we grow, but also operating leverage. We'll continue to grow our operating profit much, much faster than our revenue is growing. So that has built in margin expansion in it. And free cash flow has been an outstanding point for us, and we intend to continue that as well. I think we've cut net working capital to sales in half, to 6% of sales over the last 5 years. And we think for new Fortive, it'll be lower than that 6% fleet for Fortive today, and we will continue to improve that over time. So we feel quite good about the path ahead for new Fortive.

And when we look at the portfolio for new -- Fortive in total has had a lot of portfolio change in the last 9 years. New Fortive, I suppose, will be more settled, perhaps at least initially. When should investors expect if you start to see more meaningful divestments or acquisitions. How far out is that kind of activity?

Yes. So we absolutely like where we're starting from. And I think like you pointed out, Julian, the hard work over the last 9 years to do all the big acquisitions, and some of those were risky, and it's in the nature of some of these big deployments, is now giving us the entitlement to play a different game. And a different game we're now playing is we know the organic engine works. We know that mid-single-digit revenue growth and earnings high single digits just from that organic engine. The capital allocation strategy is very intentional in being balanced, right? So share repurchases will be a more sustained component of how we allocate capital, all solving for at any point in time, what gives us the best risk-adjusted returns. And the M&A that we do will be a bolt-on, so they would be connected to our existing positions. They will be accretive to our top line growth and our recurring and durable revenue mix. They will be things that can benefit from the Fortive Business System's ability to unlock value. And they tend to be terrific accretive cash return type of deals. As I pointed out in my opening remarks, with the example of the 4 we did before. So we don't expect for the next 3 years, a need for any major shifts in our portfolio composition. We like the kind of a singles and doubles on M&A, share repurchase game plan and our organic engine. We think that gives us what we need. And 3 years from now, we'll have conversations with all of our stakeholders and see if we need a different play.

Fantastic. Well, with that, we'll switch to the audience response survey questions, please. So the first one, do you currently own the stock?

My favorite part of the program.

So 80%, no. Second question is around sort of what's your kind of bias towards it right now. So generally sort of neutral to positive. Third question is around earnings growth expectations for, let's say, new Fortive versus the multi-industry average. So in line with the group. Fourth question is around kind of excess cash usage for new Fortive. So mostly share buybacks. Penultimate question is around valuation. What kind of PE should new Fortive trade at. So sort of a slight discount to the market, which is a bit strange. And then the last question would be sort of why should it trade at a discount to the S&P, I suppose. So core growth and then execution. So great. Well, with that, thanks so much Olumide and Jim.

All right, thank you.

Thank you.