Fortive Corporation (FTV) Earnings Call Transcript & Summary

Okay. Great. Day 3 here, our last fireside chat. We have the guys from Fortive, Olumide Soroye; as well as Jim Lico. And I was just informed, this is his last sell-side conference as the company breaks up and you guys move on to bigger and better things. So guys, thanks for joining us here today, and congrats on building the business over the last, I don't know, it seems like only a few years, but it's actually been about 8 or 9 -- yes, yes, 9 years. Time flies.

So we always just like to start off with a bit of an update on what you guys are seeing and a bit of commentary on just the near-term trends in the business.

Yes. Well, I -- we have, obviously, a long-standing -- never comment necessarily specifically about inter-quarter. But I think, Steve, what we said coming into the year was from a geographic perspective, the U.S. would be our best market. Some of that has to do with -- it certainly has to do with the fact that some of our businesses -- some of the great trends that we have in the business have more exposure to the United States. Europe would be mixed, and I think that's playing out, health care being the best. Closer you are to sort of the industrial environment in places like Germany, you're probably going to see a little bit more uncertainty. And then high-growth market is good, but with the exception of China. We said China would be a market where we would certainly be in a position to -- we said down mid-single digit for the year in China, but the first quarter would be our toughest quarter. So certainly, as we see things, that's certainly how we -- it's certainly going to be a year of uncertainty. I don't think that was determined last week or this week. I think we came into the year thinking this is going to be a year of uncertainty, customer uncertainty, those kinds of things. Some places, we're going to plow right through that. Other parts would be strong and -- or some parts would be continued strong and some would maybe have to deal with some of the customer uncertainty or in some cases, our customers' customers' uncertainty.

And are you seeing in your, I guess, in the short-cycle businesses, the ones that are the hardware businesses, some of them go through distribution. What are you seeing from an orders to sales conversion perspective? We had a couple of companies here this week who talked about orders being okay, but a bit of an elongation of the sales cycle. So are you seeing anything on that?

Maybe a little bit of a Tale of Two Cities when you think about it. What we said on our earnings call was we had strong orders on the PT side or the Ralliant side, we have a new name. So that -- and those orders were good in the second half, but a lot of those orders were really for the second half of 20 -- of this year. So maybe that speaks a little bit to -- maybe a little bit more customers being confident, but also saying that it's more later in the year. But on the -- as an example, on the Fluke side, U.S. POS is good, point of sale is good. So it kind of -- it's a little bit of a Tale of Two Cities, and it really kind of matches up with the comment I made before, which is in some -- you've got some markets that are sort of moving through it and some that are dealing with this uncertainty. We're seeing some pushouts on the PT side where customers still want things, but they maybe want it a little bit later in the year.

And on that PT side, which verticals would that be in? Would that be in semiconductor verticals, EV verticals? What types of verticals?

Certainly, I would say, if we look at PT, what's been strong is our -- anything tied to our utility business, that's been really strong. High-performance compute has been strong, but the rest of semiconductor has been weaker. And so I would say that's sort of a characterization of the semi market. So high-performance compute is really strong, but it's not the biggest part of the semiconductor market. And so -- and I would say defense has been mixed on -- our EMC business, which deals maybe more on the defense production side has been very good. In fact, we've secured a number of large orders in the quarter. So that feels good. But on the other hand, when we look at maybe -- and we saw this in '24, the sort of technology investments that we might see from a Tektronix as an example, those might be a little bit more delayed.

As far as Fluke is concerned, you said the POS is pretty good. How about your orders and kind of how the channel is positioning itself?

Yes. I mean Olumide will probably talk about certainly some of these things as it relates to IOS. But I would just say from a high-level perspective, when we look at Fluke, U.S. being pretty good. And some of the characterization I had about Europe is, Europe is probably a place where it's a little bit more mixed even relative to Fluke.

So just as a -- you've been around for a while. Obviously, you're not going to be managing the business over the course of the next year. But how are you guys at Fortive reacting to all the headlines? And what's the boardroom conversation like? Are you guys dusting off a restructuring or a recession playbook? Or are you kind of powering through what you need to do given, look, you don't really know in the first place, right, so how do you react and handle this situation?

Well, I would say, first and foremost, when we think about uncertainty and we think about the Fortive Business System, the Fortive Business System is really -- is meant for those kinds of times even more. It's a time when we can distinguish ourselves better competitively. It's a time where we can distinguish ourselves better financially. Free cash flow as an example -- is one example of that. And so I would say we came into the year with uncertainty. So we did some restructuring at the beginning of the year with the idea that some of these things would be happening. And certainly, that was certainly our base case. So I wouldn't say -- you're always going to see one thing that's maybe a little bit worse than you thought, but you also see some things that are better than you anticipated, and we'll manage accordingly. And I think the ambiguity or uncertainty that's in there -- that's out there today has been anticipated. And so our conversations with the Board and our conversations internally have been, let's not roll out a new action plan, but roll out the action plan we set at the beginning of the year and execute against that action plan.

We'll maybe delve back into the businesses a little bit, but want to get the tariff question out of the way. Can you just give us a bit of color around your -- remind us of what your cross-border exposure is and where that would be most acute? And then what do you see here when it comes to Mexico and China and maybe Canada as well and Europe and Asia?

Those are tariffs from yesterday or the day before?

I don't know. I've lost track.

Or the morning or the afternoon? I would say we've roughly sized our tariff exposure here, about $25 million or something like that. Most of that's China related. We don't have a lot of exposure relative to the Canada and Mexico situation. So we've countermeasured those. Some of that is countermeasured, things we decided to do at the beginning of the year in anticipation of some things. And there'll be some other things that we're reacting to now, and we'll countermeasure appropriately through a combination of -- it's the playbook we started in 2018, which was when the tariffs first came out, which was supply -- globalizing our supply chain, globalizing our manufacturing, been doing that for several years. And so it's that part of the playbook that has really been being executed over a several-year period as well as pricing and things like that to be able to where appropriate.

Nothing in Mexico?

Very little.

Okay. So there really isn't much to say for you guys from a tariff perspective. I mean...

It's the China tariffs, really, is where our exposure is.

Right. But is there anything incremental? No incremental risk that you see from what we know today?

I think it's where we stand today, we've got those things countermeasured.

Yes. Okay. Great. When it comes to the separation, maybe just give us an update. And any updates on timing, structure, just maybe walk through what your thinking is on that front.

Well, I think number one, we announced, we've got a new CFO, Mark Okerstrom. Olumide can certainly elaborate on Mark. Excited to have him as our new CFO. He's a great talent, and excited to have his contributions. The spin, as we said in the earnings call, we moved up the date to early third quarter. We've got a -- we now have a chair. So we've got a number of Board -- the Board is really structured now today for what we need. We're continuing to hire, so to build the team, and that's on track. And then we'll file the Form 10 in May. And a number of the other regulatory hurdles that we have to go through are very much on track. So we feel really good about where the spin is at today. And Olumide and Tami are -- we don't have new CEOs here, so they're running the businesses the way they've run them. And we're in a really good place to execute the spin here.

And Olumide, I guess, looking ahead and thinking about strategy a bit, what are some of the different ways you may attack to approach portfolio management, investing in the business? What's top of your mind as far as how you -- where you take this new company and how you manage it?

Yes, no. Thanks. And it is a new company, I guess, as a starting point. So once we're done with the spin, Fortive is going to be just entirely focused on innovating essential technologies to keep the world safe and productive. And everything we do will be about that. In IOS, we'll do that in industrial. And in AHS, we'll do it in health care operations, which you could almost call it industrial health care. It's the part of the hospital that's most like a manufacturing plant. So there's a unity in what we do across the company. All of the brands we have will be market-leading brands like Fluke and Gordian and ASP. And I mean, essentially, they're really advantaged positions in all their markets and a lot of growth headroom ahead of them. So we feel excited about that. Only 3 of our operating brands will make up 80% of the company. So from a focus point of view and knowing exactly what you underwrite and it's just a dramatically simpler company. And our value creation algorithm is very clear too, and that will drive our strategy. The first piece of it is our organic growth engine, which we talk about as mid-single-digit growth and feel like we will deliver that consistently as we've done the last 12 quarters straight. We've been at least mid-single-digit growth in the company, the way it's going to be configured. So that's the first piece. So we'll invest in organic growth and continue to accelerate that, maybe a little bit more than we've done historically. At the same time, we embrace the [ ayrn ] principle. So we're at 65% gross margins and 31% adjusted operating profit margins in the business coming out of 2024. And we continue to expand those margins, and we'll keep doing that, partly because we're growing in ways that are very accretive to margins in our consumables businesses, our software businesses and even Fluke, the way we're growing. So we have just an amazing free cash flow generation engine that will continue as well. So in many ways, the portfolio strategy is a lot more focused. We're going to have from an evolution point of view, more evolution than revolution in our portfolio going forward, partly because we've done the hard miles of creating what we now have. Going forward, our capital allocation will be a lot more balanced between share repurchase, and the M&A we do will be bolt-ons and very low-risk, things we know exactly how to plug in and how to cross-sell and upsell. We've done that before. We know that recipe. So I just look at it as going forward, we're set up to be a really high-quality kind of accelerating growth compounder for Fortive, consistent with, frankly, the performance record we have ex PT.

Maybe just, I guess, on those bolt-ons, should we think about those as still a lot of the activity has been focused on software? You guys have said you're open to doing hardware as well. Where are the particular work streams that you're focused on? Are there any that are real hard targets?

Yes, no, I mean, again, it goes back to the simplification of the portfolio. So the fact that we will now have a company that's 25% software, $1 billion or so of revenues, incredible businesses; 25% consumables, incredible businesses; and 50% in kind of industrial short cycle, but it's Fluke, that's incredibly durable. And we've had 15 quarters of order growth in the last 17 quarters since 2021 with all the PMI. So these are really high quality. And those 3 areas make up 80% of the company. So from a bolt-on point of view, we'll be bolting on to those 3 areas of strength in a very focused way. And some of those may be hardware deals that are incredibly durable and we can create a lot of value out of. Some of them will be software, some of them will be data. But the key is they're bolt-on, so they're much smaller deployments. They're not mega deployments, so you're able to really manage the portfolio. So in the end, it looks like the 4 we did in the second half of 2023, which those are double-digit ROICs not even the second year yet. So we have the focus on the 3 platforms. We know exactly the kind of deals and the return profile we're looking for. And I think that's going to help us really be focused.

Any pruning to do in your portfolio? I know a lot of the companies now are kind of doing a little bit of a version of 80/20 where they're walking away from some lower margin, lower growth products. You guys obviously have really high margins. So I can't imagine there are that many lower-margin products. And the way you guys run the business, it's not like you leave nickels around the factory. So any pruning that you're looking to do?

Nothing major. I mean, like you said, it's a continuous process for us. So part of our innovation and the reason our NPI is sped up is, in some cases, we're shedding the old legacy products and building new ones to add more value. So we're always doing that, and we'll keep doing that, but nothing at a big kind of portfolio, kind of divestment point of view because we've done a lot of that. And part of the theory of the spin is things that are not consistent with the thesis of Fortive going forward, a lot of those will now be on their own and thriving as part of Ralliant.

So just digging into Fluke a little bit, you talked about the growth record there. I mean, it's really hard to put our finger on sometimes what's so great about that business. What do you think has been the key to sustaining that growth? And is that just -- as far as the eye can see, this thing is going to be an outperformer relative to the economy? What is -- what's been the GDP plus type of -- what's been the plus, driver of the plus for Fluke, do you think over the last several years or the last decade, really?

Yes. So I mean, I think a couple of things. First, starting from the fact that it's just an incredible brand. It's a 76-year-old brand, iconic inventor brand in the industry. And it stands for the highest quality, durability, and it's essentially kind of the pricing leverage we have is enabled by that. So that -- it's just a great starting point. The things that have added the offer, from my point of view, Steve, one is the NPI velocity, we've been speeding up very gradually. So last year, we had 20 new products at Fluke that added 200 basis points to our growth, and we expect at least as much this year, and we're still ramping that. That wasn't the case at Fluke 10 years ago. And then we've also been gradually building a recurring piece of Fluke. So now 10% of Fluke is in recurring models. And it's a range of things from software add-ons to some of our products in calibration and on the IG side. But also, it's service plans for some of our high-end products where customers want kind of a subscription to make sure we can help them keep those things functional and active. And the team has a really strong mindset of customer value and life cycle that's driving innovation around those 2 topics, software services all the time. So you take that NPI velocity, you take that service recurring component of it and frankly, you take the quality of the brand and the price capture that, that enables. That gives you that alpha on top of a really strong foundation.

So when we think about a new Fluke product and putting aside entering a new vertical like utility or solar or whatever you guys did a couple of years ago, which is obviously a winner, that's more probably applying like what you have to a new vertical. But what is the key to a really good new product at Fluke? I go to these conventions and it's a yellow handheld with some like wires and a little clip at the end and some dials and things like that. What is the -- you mentioned software. Is it the user interface? Is it -- AI a part of this? What is the -- what do you think is like the most exciting thing about these new products that keep that -- keep them chugging like this?

Yes. I mean I think thematically, Steve, there are 3 types of product innovation that we're doing at Fluke. There's one that is really thinking about the user experience of our products. Keep in mind, there are millions of deployed kind of Fluke tools out there. And there's a next generation of technicians coming on board. So there's one stream of our innovation that's just taking our portfolio and creating the next version of them that are much more like the interface you expect in your consumer devices. And that's driving a refresh cycle on these millions of deployed tools out there because then you have new technicians, you want to have the new stuff. So that's -- on the platform we have, that's a big installed base to do that on. The second mainstream is what you talked about, which is taking data and software and AI enablement on some of our tools that are connected and capturing data and beginning to give customers an experience where instead of taking 20 measurements on 3 different devices, you can do it with an integrated device that captures the data and helps you make decisions on it. And so that's going from kind of discrete tools to integrated decision engines for customers. And that's a big trend that is and in some of the markets you mentioned, it's powerful because you have people going up 60 feet on solar kind of installations with 6 different tools. And being able to put that in a single small tool that is safer to carry and they don't have to handwrite the results, but it's captured, that's a powerful value prop for this customer. So that's a big swim lane of innovation. And then the third one is kind of end market focus. So there's things we're doing aimed at, solar, you mentioned, EVAC infrastructure, you mentioned, data centers, right? And it's really kind of installed base management and data centers. And regional to -- in terms of Fluke, it's one of our most global businesses, so we're adapting to for different markets. And those are the 3 main swim lanes, kind of refresh our installed base with new UI/UX, add some of the data software components to go from discrete devices to solutions and then go after some of these high-growth markets. And I'm just impressed with the work the team is doing.

Yes. We've been impressed over the years. I mean, it's a part of the portfolio, you'd think it would be more cyclical than it actually is.

Yes. I think a decade ago, maybe a little bit longer, you could correlate Fluke pretty closely with industrial production. But now I think if you look over the last 3 or 4 years with PMIs and industrial production, what that's been mixed around the world, net Fluke's continued performance just speaks to the capability that Olumide just described.

Now how about the other businesses on the software side? It just seems to be pretty steady state. Anything there that you're seeing that's interesting? And is there any risk that as more niche vertical software businesses that -- AI can come in and disrupt some of this?

Yes. No, we love the businesses and the trends. It's about $1 billion of software revenues. And as you described them, we've picked very focused markets and frankly, built #1 in the market businesses in those markets. And they're all doing well, partly because they have deep proprietary data and networks that provide a moat around those businesses. And what we're doing is because we started the AI journey 6 years ago with a thought, we're actually getting ahead of the market in terms of incorporating that into our offerings. And I'll just give you a few examples, Provation on the health care software side, we grew our sites in Apex, which is our SaaS version of the product, 6% to 7% last year. Over the last few years, we've more than quadrupled the kind of site count we have in that business. And that's because we're adding insights to that workflow, leveraging the data we have in the system installations we have for customers. So that's a great business. We're using AI already there. Now another one is kind of ServiceChannel. That's back in teens growth at this point, now that we've lapped the kind of pass-through revenue that we're trying to migrate out a couple of years ago. But again, the same idea, there's great data. There's a 2-sided network where we have over 90,000 contractors that are connected to that network. So you can't replace that. So what we're doing, again, is deploying AI to give customers more value, and we're capturing the share of that in pricing and upsell, which is driving NDR in that business. I think you go again to Gordian, great business. It's got a software piece. It's got a pass-through piece to it. And we had a couple of years of 20-plus percent growth in '22 and '23. It's normalizing a little bit right now, but it's a great, great business that really drives efficiency in those workflows. So across -- and the tail of it is Accruent, which we've talked about quite a bit. And that's also been a great story of just pruning to your point the pieces of it that were holding us back. We now have a company that's kind of ramping towards what we expect to be, a kind of -- it's the tail end of our software, and we expect it to be tracking to mid-single-digit growth.

What are you seeing in terms of customer IT budgets? And there's obviously a lot of focus on building out AI and maybe that's taking a bit of a chunk out of what would have been more niche vertical software applications. Are you seeing any of that? We've seen some of that in some of the other larger design software companies out there.

Yes. Not very much, partly because of the way you started, our software businesses are very focused on specific kind of markets that are mission critical. So for example, Provation, you kind of need to run GI procedures and capture the case documentation. So you're not going to not do that because you're trying to do AI. If anything, the best way for you to get the value from AI is put it on top of a workflow, software workflow. So in many ways, it's actually beneficial to us. Same thing in ServiceChannel, right, you're going to need to actually have a workflow to infuse that AI insight into. So we're not seeing that affect us that much in terms of IT budget decisions. And again, like I mentioned, a lot of our customers, whether it's in health care and industrial, they're looking for help with how to get value from AI and get returns from it. And one of the things we bring to them is, hey, we're deployed at scale in your operations already. So any AI we put on, you can -- your time to value is so fast on it. And so if anything, it's pulling spend towards us right now.

And then just lastly on AHS, I guess -- all right, I'm not sure who to ask on this one yet, but it's you. Okay. Maybe you're not out the door yet. Maybe I'll throw this one your way. What are you seeing in the trends there? Anything moving around in the distribution channel for consumables or pretty steady state?

No, we're really excited about the year they had last year. Obviously, they grew 6% last year. They'll come back to maybe more closer to mid-single digit, right in the mid-single-digit range. But no, really good execution. Olumide talked about Provation and the strength of Provation. We got a few less days in the first quarter. So that has a little bit of impact on the growth in the first quarter just on the consumables front, but we're in a really good place in the business. And I think the channel transition that we talked about is very much in place, and the business is executing. So we feel really good. And I think if you step back and think about the sort of -- in a time of uncertainty, this is a set of businesses that, quite frankly, is really, really stable. And I think now with the continued margin expansion and the good work that we've done from an FBS perspective, it's just going to be a super -- really great important part of the portfolio going forward.

As long as there's no pandemic, which we don't need.

Yes. We don't have a pandemic case.

Well, you never know what can happen here these days. So just on the margin front, you guys have put out longer-term margin targets at the Investor Day. Is that -- are those your targets as well, kind of the next leg of the multiyear targets? Or are you -- will you take an opportunity to put your own stamp on things when you guys come out or when the split happens?

Yes. The good news is we have our Investor Day set for June 10. So you can be sure that I'll have a point of view laid out at that session. But the thing I would say, Steve, though, is that we have a deeply rooted practice of driving kind of growth in margins over time, and that will continue. I think going forward, it starts with very margin accretive top line growth. We really think we can grow the company faster in businesses that are inherently kind of higher incremental margins. So we think that's going to contribute to our margin journey going forward in addition to the convention we already have of just productivity as a way of life. That's deeply rooted in our company. So we're excited about our margin journey. We're going to come out with new Fortive, last year with 31% adjusted OP margins, and we got 120 basis points of margin expansion. OP has grown 12% CAGR the last 3 years. So we're starting from a really strong trajectory. And so what you should expect to see is through a mix of really smart ways to grow in ways that help margins and free cash flow as well, we'll continue and accelerate that journey. But we'll have that laid out in a few months here.

Okay. Looking forward to that. And then just on the PT side, any updates there on the positioning of that business? Is that also going to have a new kind of margin target? And what do you -- what's the story with Tektronix and the trends there and strategically kind of how you guys are approaching that business for this?

Yes. I mean, I think the way to think about it going forward, and again, we'll wait until June 10 to get a lot of specifics out from Tami and the team. But Steve, I think past this prologue and the fact that these businesses have deep-rooted FBS skills, and so the margin ability and free cash flow, as you know, while the revenue has been cyclical, the free cash flow and margins have been very stable in the business. We've been able to continue to drive -- these are some of our best businesses for working capital management as an example. So I think it comes with an incredible foundation. And so probably doubling -- if we think about a growth rate, probably the OP growth, the annual OP growth is probably 2x that. And that's probably how we'll think about it. They'll have a good margin story as well. And then the growth is going to come, as we've talked about, 30% of the -- over 1/3 of the business is in some really strong growth categories right now, whether it's utility infrastructure investment, whether it's some of the defense pieces that are really strong in our EMC business or even at tech, which has had some struggles in sort of the broader end markets, it's been really strong in high-performance compute, particularly around the semiconductor and data center side of that. And so those will be the growth drivers that will really drive the business. And then we would anticipate the market starting to come back a little bit. They're going to do a lot on the self-help front, but we would anticipate some of these markets coming back towards the tail end of the year.

Okay. Any questions from the audience? None? Okay. How are you going to integrate AI into FBS? How do you -- I know you guys have already been doing that. But going forward, what are you seeing as opportunities to integrate AI into FBS?

Yes. No, it's a great question. I mean, we have a journey on AI that started 6 years ago with the creation of FORT. And that team has been -- think about it as our center of excellence and armory for kind of AI best practices. And we've been deploying that across all of our companies and have 50-plus different use cases. That's now developed enough that, to your point, FBS is a great way to make it not just something we've done in the last 6 years, but something that's really deeply rooted in the fabric of the company. So we are beginning to connect those teams, our FORT team and our FBS team and building it into FBS. And that means it affects innovation for customers. It affects internal operating efficiency. It affects kind of customer service. It affects our development teams that are all now using copilots and the work they do. So we're very much making that connection right now to use FBS to scale.

And then just one more question for me. Are you guys -- are you reaffirming guidance today? Or is that implicit in your commentary that things are on track?

We've never affirmed in a quarter -- mid-quarter commentary. So I think what we try to do is give color that's pretty consistent with what we've talked about at our earnings call and try to give some color that sounds very consistent with what we talked about a few months -- a month or so ago.

Okay. Anything else? Jim, thank you so much for coming, and congrats on a great run.

We're in a great place. And I think where we stand today, I couldn't be more excited about where we're at right now. Obviously, uncertainty in the market, it's sort of easy to pick up the news every day and see what's going on. But I think at the end of the day, as I mentioned, our culture and our organization is built for uncertainty. And I think going forward, as you heard from Olumide and certainly, we'll hear -- continue to hear from Tami, and certainly, on June 10, when we have the Investor Day, I think what you're going to hear is 2 really great businesses with 2 really great growth stories that are going to be incredibly exciting for investors.

When do you officially leave the building? What's...

Well, I've got work through the year. So I'll -- we'll hand the reins at the time of spin, but Olumide has asked -- and Tami have asked me to do a couple of things for them, and I'll continue to do a few things for them.

Yes, no, Jim is going to be a part of the story as we develop it here. And I know we mentioned Mark Okerstrom earlier joining as CFO. And I look forward to, Steve and team, having you meet him as well. As you know, that was an important hire for me, and we invested a lot of time in a thorough search, and we're excited about his record of shareholder value creation and over 200% TSR in his 6 years as a public company CFO. So we're excited to have him -- have his coming out party at the Investor Day.

Well, and congrats to you, and best of luck on this new endeavor.

Thank you.

Thanks, Steve.

Thanks, everyone.