Fortive Corporation (FTV) Earnings Call Transcript & Summary

Good afternoon. Thanks so much for being here. We saved the best for last. We have the team from Fortive, and Fortive is going to be spinning off its Precision Technologies segment as Ralliant by the end of the second quarter. And we have Tami Newcombe, the CEO of Ralliant, the spin-off here with us today. We have Jim Lico, Fortive, CEO; and Mark Okerstrom, Fortive, CFO. So I think I have everybody. Yes. And we're going to have -- we're likely to have both management teams on stage.

And I have set of prepared questions. Thank you. Well, first of all, thank you so much for making it here. We really, really, really appreciate it. So maybe -- so I sort of the question are Ralliant questions on Fortive. So I'm going to start with Ralliant question to Tami. So sensors and safety makes up what 56% of revenue. Can you walk through what you're seeing in the key end market or sort of utilities and DE and broader industrial?

Yes. Thanks, Andy. So in sensors and safety systems, there's a couple of ways we think about the business. There's 2 really strong growth vectors that we've seen multiyear growth vectors that we expect to extend for the coming years. The first being in the utility space, where there's 2 things going on. There's an expansion phase going on, where there's more demand for electricity than the utilities are able to keep up with and there's a refresh going on, because it's aged infrastructure. And both of those are good signs for our business that is sensors on those critical assets, namely transformers in the electric grid. The second growth vector is around our Defense Technologies business. This is -- for those that have followed, this would be our PacSci EMC business. They do electronics and energetic materials and just a lot of replenishment going on around the globe of production programs that have been 5, 10, 15 years in the business. This is a business that we've got a really nice backlog on and continued strong. Then the third piece, I think of, are sensors that are very niche applications, harsh environments, regulated environments. And that business has been slow. We saw some signs of some resilience in Q1.

So look, maybe digging down a bit on the utilities, you sort of talked about Qualitrol is the brand. It's very strong there. How durable is the strong demand trend there? What are the customers telling you?

Yes, customers are -- so we have 2 sets of customers. One is direct into the utilities. The other customer we have is the manufacture of the transformer. And in both cases, they're struggling to keep up with demands in that space. And we have not seen an end to that right now. Demand is really strong. Where we're spending a lot of time right now is ensuring we've got the capacity on the supply chain to keep up with that.

That was my next question, but you think you'll be able to hold you on there.

We just -- last week was a big week across Fortive, I'll boast a little bit about Ralliant. We had 42 different Kaizen teams. Several of them were in the politeral facility, figuring out how do we get more capacity and the footprint that we have.

Excellent. So maybe in Test and Measurement, 44% of revenue. Can you walk through what you're seeing in the 2 largest markets of communications and semiconductors. And I think [ auto ] -- is auto electronics, the third largest there.

Yes. So the largest end market for the Test and Measurement business is diversified electronics. If you get underneath diversified electronics, the 3 next biggest pieces inside diversified electronics are automotive, industrial and university in research and then probably next would be medical consumer computer in diversified electronics. So that, that segment right now is down due to EV and battery energy storage being soft. In the semiconductor space, we continue to see strength and anything tied to the data center, whether -- so anything, any computer chips, memory chips, things that are going into the data center are still quite strong and then our communications business, communications is -- so semiconductor is the smallest. The next is communications. And for communications, it's predominantly mil/gov in that space. And the real -- we saw softness in Europe in Q1, very soft. We still are expecting a decent season, buying season in Q3, which is typical for the Test and Measurement business.

And communications softness in Europe was government.

Yes.

And it's just timing of the contract.

Well, there's 2 -- 2 reasons for softness. But the surprise to us was the government business being soft. What we weren't surprised about we saw going into the year was that our EA business had a really tough headwind because the prior year, we shipped a bunch of backlog.

Yes. All right. Got you. And then maybe on the semi exposure. We think you're broadly more R&D the production test, but how should we think about the U.S. semi fabs and fabs coming back to the U.S.? What impact does it have on you? .

Yes. Two parts. If you were to go into any of the build-out of semi fabs, you'd certainly find equipment from Tektronix in the production phase. But it's -- from a revenue standpoint, it's a small piece of the revenue footprint for us. But coming back, there's still -- it spurs more research and development here in the U.S., and that's a very, that's a place where we play really strongly.

So it's just a build out of Arizona ecosystem, you're just generally holistically benefit from that.

Yes, absolutely. .

Okay. Got you. And what does product vitality stand at tech, the percent of revenue from products introduced in the last 5 years.

If I think about the industry, the Test and Measurement industry, we've always said 25% to 30% is really healthy in that industry. If I look at where tech is today, it's light on that today. We had -- if you go back to the supply chain disruption, we converted a lot of our engineers into ensuring revenue, which meant we had to qualify new suppliers in that business. And what that's led to is we've got a really nice lineup of new products coming out here in 2025. And I'm not going to steal the thunder from Investor Day, because that's going to be fun for us to talk about at Investor Day. But that will start us back on the right path to get back to that vitality that we like.

Excellent. And a key part of the thesis around the electro automatic acquisition was the ability to put these products in the chronic Salesforce's toolbox. So how much progress have you made on that cross-selling opportunity?

Yes. I think there's 2 places that we have made progress on EA. And the first is just making it truly a part of Tektronix. So November, December time, we did some restructuring, took about 30% of the head count cost out of that, made it a product line for Tektronix, so that as that market starts to come back, we'll get to see some of that operating leverage. The other piece about EA is getting it in the hands of our salespeople. And we are continuing to see funnel build there and probably buffered about 40% or so of the downturn that we saw in EV and battery. We've been able to buffer by the expansion back into the R&D labs and new sets of customers that [ EIA ] never sold to. So you can go down through the funnel, and you can see where they are today and it maps very closely to where our tech sales team is really strong.

Got you. And then the last one for you, for now. Alan is coming out with 22% pro forma EBITA margin, and that's including $45 million of stand-alone costs. Test and Measurement segment is low teens margins, Sensors and Safety is high 20s. How would you frame the margin opportunity for both.

Yes. I think if you look at the historical average for T&M, it's high teens, not low teens, so it's high teens. And the opportunity for both as we -- in Test and Measurement, we talked about the market is a little soft right now in Q1. But as you see that build back, it's -- we get great flow-through in that business.

So it's just volume leverage.

And we'll get the leverage back and we'll get back to where we need to be. We made a conscious choice here at the start of the year knowing we had a great lineup of products coming out in the second half that we wanted to be sure to continue that investment with the sales teams and the R&D that we needed to deliver in the second half here.

Excellent. Now Jim and Mark. So new Fortive had a pretty solid first quarter, it was 2% core growth, 80 bps of year-over-year margin expansion. What people may not know is that software is about 20% of new Fortive, how first quarter revenue trends different in that software hardware split?

Yes. So I would say a couple of things. One, we've sort of new Fortive, if you will, came in right where we thought it would come in. And we always knew we had a little bit of an impact of days and some other things. As you mentioned in the question, software was strong, mid-single-digit growth. And we really have 2 big software businesses, our health care software and then our facility and asset life cycle software, those 2. Our total software for the new Fortive will be about 25%. So if we think about 50% recurring revenue in new Fortive, about half of that is going to be software, and about half of that is mostly health care consumables. So that makes up the recurring revenue. And we had a good quarter. We certainly saw a number of really strong. Our health care software was very strong. We continue to, I think, see the benefits of FBS, Fortive Business System in accelerating growth and providing opportunities on the innovation front. So I think just in general, software comes in mid-single-digit growth for all Fortive ARR was high single-digit growth. So -- so again, I think, bodes well for the year. Some headwinds, I think we did see some customer uncertainty, some, particularly on the government side, Gordian is an example, we did see some places where there's a little bit -- a little bit of a change. But overall, strong, strong set of dynamics for the business for the year.

And you're the largest player in the facility asset life cycle software space. What are the sort of the ways in which you can leverage that position?

Well, I think we've been leveraging the position over the last few years. A couple of things we've done is moved product lines around in terms of offerings, we moved some product lines over from a current to Gordian in order to sort of take advantage of the market presence that Gordian had in their particular customers. So we've got a -- we really have a strong position. I think the opportunity here going forward is to continue to elevate our innovation, continue to build on the strong capability we have to start to think about more data offerings as well, given the magnitude of real estate that we see and facilities we see and equipment and assets we see. The opportunity then to take that data and analysis that comes from that and convert that into solutions is still an untapped opportunity for share in the business.

And what keeps you up at night around advanced health care solutions, would seem less tariff risk, less economically sensitive, et cetera?

Yes. Great segment. We'll certainly give up. I think when we get to Investor Day, we'll unpack that a little bit, would that be exciting. But I would say this, Andrew, when we think about our health care business as industrial health care, it's really helping the back of the hospital becoming safer and more productive. And when you think about the long-term trends, the secular drivers that have been in that business around the thesis of our -- the whole time of getting into the business, it's really around a couple of things. One is that the developed world with more people getting older, they require more health care. On the developing world, they want higher -- better access to high-quality health care. Those long-term secular drivers are very much there. We feel really good about it. And I think it may be the nature of your question. A little bit of noise in the first quarter, around days in consumables, but we think the business can be good. Profitability is strong. And we said, we've got a great equipment and consumables business in ASP. We've got several good software companies. We've got a good portfolio in which to go forward. And what keeps you up at night? Well, we've got VA as a customer, right? We've got the short-term dynamics of what's going to happen with Medicare and Medicaid reimbursements. There certainly are some headwinds that we'll look through or look at to see what happens. But I think the strength of the market positions we have in the business and the ability to sort of take things forward in terms of combining what we do at Censis and ASP as an example. Those are really strong opportunities for the business going forward.

And maybe sort of you talked about provision, but question provision. How much should upgrade to Apex, the SaaS version contribute to '24 growth or planned '25 growth, because, I mean, our understanding that there's like a very multiple sort of revenue uplift Apex.

Well, when we bought the company, we always said the majority of the growth would come from that SaaS migration, because our installed base is so large and hospital customers would really want to move to SaaS solutions. I think we always said we weren't going to necessarily drive that adoption of SaaS. The hospital will be making that cloud decision on a broader set of their network infrastructure. And as they did, our strong presence and the offering -- SaaS offering we have would be a perfect fit to their next level of technology, and that's what we've seen. So we've seen really good growth on the SaaS front. But -- and it really gets back to the original thesis of the deal, which was SaaS conversion would really be a growth driver, and that's what we've been seeing. SaaS growth has been very strong.

Can you quantify the contribution to provision growth.

It's all their growth. Really all the growth. Yes. It's really -- I mean, we really think about that. That's really -- it was the original thesis, and that's really where we're getting the majority of the growth. There's a little bit of new logo, but we have such a strong market presence that the real opportunity there is around converting current customers.

Once again, I'm sure you're going to say that it's going to be at the Analyst Day. But how excited should we be about the start of the innovation flywheel at ASP, the team biological indicator that launched last year, for example, what could that add to ASP's growth rate?

Well, yes, I probably will punt it a little bit in part because the team is going to be there, and I want them to share their successes. As we said, a number of FDA 5 -- FDA approval projects consummated in the back half of the year. And Andrew, you've known us for a long time, so you know. We knew it was going to take a little while to get the innovation flywheel guarded -- but our -- I think the set of compelling solutions, the presence we have, we're just in the very early days of thinking through that. And I think it's -- at this point, I wouldn't necessarily say it's going to be the biggest growth driver at ASP. But certainly, if you take a 2- to 3-year time frame, that acceleration is going to continue. Obviously, a lot of these things aren't consumables. So the consumables stream is just going to take -- it's a lot like SaaS revenue. It just takes -- once you get that flywheel moving, though, then the flywheel just continues to accelerate. And I think that's really what you're starting to see at the start of the capability of ASP.

A question for Mark. You've been in the seat now for a month.

Just little over a month. Yes.

Yes. So one of the maybe 1 or 2 opportunities that you're looking at.

Yes. Well, there's a few. And I think first of all, just to recap for those who didn't hear the earnings call around the reasons why I joined Fortive. And good to see a few of you from the old Expedia days. Really, for me, there was multi-parts to it. I mean, first of all, just from a learning perspective. I learned a lot about the Danaher Business System and seeing a lot of what that could do. And I was super curious about what that looked like from the inside. So I wanted to learn that. But at the same time, I saw there a real opportunity here for not only the stand-alone business, great secular tailwinds behind health care and industrial, occupied by leading brands who have strong market positions and great moats. But I also saw the personal opportunity to step in and drive shareholder value actually from the inside. And last 1.5 years or so, I've been working with Advent being really just around investments and doing diligence front deals coming up with deal thesis. And I saw this to be really compelling. Three areas of value creation that I felt like I could really move the needle on. All of them important. Some of them easier to get than others and on different time horizons. First of all, it was just the opportunity to drive organic growth. If you look at these businesses, there is so much opportunity because of their market-leading positions, because of their pricing power to maybe invest a little bit more in new product development, which may hurt a quarter. But if we can invest $10 million this quarter and get $40 million in the fourth quarter, or in Q1 of the next year, we should totally do that. And I think that's where Luminiz heads at. Jim and I have been talking a lot about this. I know this is Tami, you've been thinking about that as well. I mean that is goal number one. And we see a lot of opportunity there. That was a lot of what we did at Expedia during the huge growth spurt. Second one, I think, will be easier. I don't know for sure, but it's really just about earning and keeping trust with all of you and making sure that we are setting reasonable expectations that we are delivering on what we say. And at the end of the day, we want to create a huge amount of shareholder value. And you should judge us on what we do, and the best thing we can do is tell you what we're going to do and then deliver it. That may mean that in some cases, we're giving more narrow guidance, a little less granular guidance, and we're going to work that out between now and Investor Day. What we want to do is give you enough to be able to understand where we're going, when we have to change course why. And at the end of day, we want you to look back 2, 3 years from now and say, wow, those incredible investments. So that's number two. And then third, extremely important, it's starting now. It started actually a while ago at Fortive and this is all around capital allocation. We really have an opportunity with new Fortive where spinning off $1 billion of free cash flow a year. If you look at where Fortive stock is trading right now, you're like, "Hey, that looks like a pretty good return area." That may not always be the case. But we also have these incredible businesses that can act as platform businesses; and two, pretty big pond areas of industrial productivity and safety, software and hardware, and a same thing in health care, where there must be opportunities for us to do great deals. Great deals that are good stand-alone businesses where we feel like we can integrate them and make them more valuable under our control than it would be someone else's where we can pay fair prices and we could integrate them in kind of the Fortive way, which is incredible discipline. And I think there's going to be a lot of opportunity there. And we'll look at those opportunities really on a relative basis and what's the best use of capital at the moment. And I think that's just another sort of kicker on top of the story here.

And then another question maybe Mark, Fortive act quickly to rightsize the corporate overhead after the Altra deal and the Vontier spin, any view on magnitude and time line for the stranded costs? .

You want me to take that.

Yes, go ahead.

Yes. Well, I think Fortive act pretty quickly, I mean, the spin is not a surprise for them. So they take a lot of actions in Q4 of last year. That continued in Q1 of this year. And part of the job was almost easy, because there's a lot of Fortive employees that want to go to -- 75% of the rules we created actually were Fortive employees. That makes your job a little bit easier. I won't say there's not more to come, because I don't know if it's #1 on my agenda, but it's the top 3 is really understand the cost structure of this business and look for opportunities for us to be more lean to reallocate capital from somewhere in G&A, the sales and marketing and our product development. And so we'll be looking at that on a go-forward basis.

Excellent. So maybe we have a couple of conference wide questions that we are told to ask.

Probably tariff-related tariffs.

Tariffs. No. Do you expect to shift incremental incrementally more of your own production or supply chain to the U.S.? And do you expect your customers to source more from the U.S?

Well, number one, I think in all of our tariff mitigation strategies, fundamentally, there's a kind of a threefold set of strategies, right? One is dual sourcing amongst a number of places. That's not necessarily any one country. It's just having sources in a couple of places. Same in true manufacturing and having that same capability. We essentially changed our supply chain by about 70% since 2018. So really doing that capability. And then the third piece is continuing to look where there might be new opportunities for locations as an example. So that's the broad set of strategies. I would say -- from a customer perspective, we're -- I think our ability to see what's going on in the movement over kind of is in a number of places. But the thing where we're going to benefit the most is once those facilities are up and running, and then they need software to run the facility, then they need fluke equipment, then they need -- that's going to be -- I think we're still very early days in seeing people actually -- those facilities.

But you think it's actually going to happen. .

I think without a doubt, there will be some that will happen, yes. I think it's -- whether or not it's to the extent that there's -- as you know, a wide range of beliefs in that regard. I would probably be more in the -- it's probably going to be some .

For sure. .

I mean we're moving some of our manufacturing, some. Yes.

Like what would be an area that would lend itself to.

I would tend to think where we see opportunity where either the -- we don't -- where we have a product that probably has a little bit more low volume and where the demand cycle is a little bit more varied where being to the market -- it's a little bit more helpful.

I would just add to that. Sorry, didn't want to cut you off, but we're actually seeing a little bit of everything in the portfolio, people wanting to move to the U.S., people wanting to move outside of the U.S. and you like Charlie Munger has this great concept of Lollapalooza which is when you change too many things all at once, you get unintended consequences. And you saw this what has happened with these tariffs. And we've got a great company based in Pittsburgh, who is supplying products all over the world. And they're like, we might have to move this to Edmonton. And they're a big employer in Pittsburgh. And so we see that. I think any place where you've got businesses that have access to the U.S. market who are producing, I think you're going to see stuff.

No, no. We had a company up here, and they big U.S. manufacturer export to China. And we should probably not be making the stuff in the U.S. I think one of the things you've seen even regardless of what happens, like would better be safe than sorry.

Well, I think the other thing is one of the things we didn't do is we didn't move to Mexico. So when you look at the Fortive footprint, and this includes Ralliant. We never really had a big move to Mexico. So when those first tariffs on Mexico came out, that was sort of a nonissue for us, because I've been really worry about it. Because of lean and because of FBS, we've been able to maintain a U.S. footprint, right, pretty strongly. The reality is the tariff impact that is hitting us from U.S. into China is less than -- is about 1% of our sales. So it's a really small number. It's when you tack on 125% to that, but it obviously starts to become a bigger percent of our sales.

Got you. And does Mexico look any more attractive for supply to some extent.

We have suppliers in Mexico today. There may be some opportunity. But I think, again, we -- our team has done such a good job since 2018, right, that we've done -- and we feel really good about what they'll do from here.

And then the tax bill is expected for many bonus depreciation, domestic manufacturing incentives, will any of these be important? Will any of these be important. Will any of this change your behavior -- sure you get in tax rates is important.

Well, whenever something comes out, that's a legitimate long-term decision, we'll build that into our decision.

We've got a great tax team. They're on it.

So we did cost -- we actually did talk about China. So maybe let's talk about orders in the remaining time. We recently got the government to import stats -- and first quarter '25 industry imports were up 13% year-over-year. Those prebuy some were in industrial land, but now publicly well, actually, it's not true. We've had a couple of this show at this event sort of say that they have seen it. But most publicly traded company have not seen it if, there was some prebuy at Fortive, where is the most likely place it would have been?

Well, I think 2 things. One is I would on balance say we didn't see much. We might see a little bit of price, when I'll call tariff avoidance, price increase avoidance, a little bit that, that's going to tend to be in your channel businesses, maybe a little bit with the order of magnitude. Somebody is maybe at a higher end purchase price, that's been working on a longer cycle project. They're not necessarily going to go do 3 years worth of projects in 6 weeks and already get the advantage. So I would say it's pretty light. And if it happens, it's going to happen in our channel businesses, like a Fluke is an example. Right. But again, I would say it's a small impact and to this extent, we saw a little bit of it first, but I would say at the end of the day, nothing out of an order magnitude.

And then maybe on Europe sort of Eurozone manufacturing PMIs. I think PMIs have been improving. Industrial production actually trending up year-over-year for the first time since mid-'23. Are you seeing any green shoots in Europe? .

I would say it's still too early to tell. We've seen -- health care has been pretty good in Europe across the rest of our businesses, and I'll say, Fortive and Ralliant. It's still too early to tell. .

And what are your expectations? There was a lot of excitement about what's happening in Germany -- and people are just sort of more pessimistic about just how long it's going to take, given that Europe is not known for being very fast. What's your expectation. When will -- if Germany does turn out, right? When do we see that? Is it a -- are we going to see it in '25 or you need to wait until '26.

We don't have a huge exposure in Germany.

West Germany being also being the flywheel.

Yes. I would say -- well, we could talk a little bit about the 2 businesses independently here a little bit. But my own view of that is that feels like a later '25, '26 story for a bunch of reasons. We certainly think defense probably ramps up to some extent, right? And that will have some downstream effects to Tier 2 and Tier 3 suppliers of that industry. That just feels like longer time than anything near term.

I would just say, I mean, Germany, we can [indiscernible], but in of all the European nations, they're industrious, they're efficient, they've actually been pretty innovative, I think what they've done in Berlin, for example. So if I was going to put money on a country to like power Europe ahead, it's probably not Greece or Italy. It's probably Germany.

And then maybe a couple of sort of modeling questions. So well, a question number one, did you guys do -- and maybe a separate question for Fortive and Ralliant, did you guys mostly do price increases or surcharges for tariffs. .

About -- I think we said about 2/3 of our total tariff mitigation was priced, but that's got price and surcharges in it. So I would say 2/3 price, 1/3 surcharge sounds like a good number .

2/3 price and surcharges 1/3 cost. And we didn't give the split between surcharge and price.

It's pretty -- we try to do price whenever we can.

Right. Well, -- so that's the question. So I think we calculated tariffs like $0.06 of a drag in '25. But just as you keep the pricing, does it actually become a bit of a tailwind in late '25-'26. or just having one more quarter of tariff cost just uses some of this?

So I would say 2 things. $0.10 on the full year, $0.06 in the quarter second quarter -- and that's -- most of that impact is really the timing. And remember, half the quarter is already done. There's no retro tariff, you rated last week. We did. Yes. So unfortunately. So -- and then you get into the sort of thought process, how do we -- now we go back and renegotiate it with customers and all that. So I think the 6 and 10 is a good number for now. We're 48 hours into this. And quite frankly, I think that not knowing what it will change or what if in the third quarter as well, 90 days from now, I think the hypothesis we have is to be really good mitigation, work super fast, be done by the end of the year, have mitigated things so that our launch point in '26 is strong. And that's what we said on our earnings call, and I think that's the right way to think about it. .

I think, it was really good. The only thing I would add from -- if you're talking about from a modeling perspective is that what we saw from -- or what we will see from an operating income perspective in terms of net cost of these tariffs was really driven by the delay between when the tariffs hit and cost hit from suppliers and we were able to put pricing -- by the time we hit Q4, we're going to be -- our expectation is we're going to be run rate operating income neutral. So what that means for 2026 is we're going to be neutral. We're not going to have that hole that we created in Q2 and part of it. So that's a tip.

And just last question, we have 15 seconds. Is there any demand destruction baked into your guidance from .

From the tariffs? .

Yes.

I would say a little bit in the China -- U.S. to China, We did think a little bit of, "Hey, there might be a little bit of demand destruction in China." And maybe a little bit elsewhere. But certainly, as we think about we have certain product lines in certain businesses that can -- that do have price capability and can get price increases -- but in other places, there might not be, and that might mean they choose another supply.

And I would imagine some of your products would be exempt from tariffs .

We get a little bit of exemption, but it's not big number .

We are right on time. .

All right. Great. Thanks. Good to see everyone.

Thank you. .