Fortive Corporation (FTV) Earnings Call Transcript & Summary

Thank you, everybody. Chris Snyder, U.S. multi-industry analyst at Morgan Stanley. Very excited to have Fortive up with me today. We have President and CEO, Olumide Soroye and CFO, Mark Okerstrom. So thank you, guys. Olumide is going to start off with some opening remarks before we get into Q&A.

Thanks, Chris. Thanks for having us, and it's great to be here, as always. And we are right into our first quarter as new Fortive. So I thought I'll provide just a few highlights as context for the Q&A. And really kind of three main things. The first one is we are diligently executing the Fortive Accelerated strategy that we laid out at our Investor Day. And our team is really excited about the progress we're making. I would say that the goal for that strategy is to accelerate profitable growth. And in that process, we also accelerate shareholder value creation in the next few years. And we laid out 3 key pillars for driving faster growth, innovation, acceleration, commercial acceleration and recurring customer value. And as we laid out on our last earnings call, we're making really strong progress on those, and it continues. The second key point is based on what we've seen so far in the second half of the year, we are right on track with the guidance we provided on our Q2 earnings call. And that is really credit to the laser focused execution by our teams. Nothing has been surprising compared to what we said on the call. At the same time, we remain confident in the medium-term financial outlook that we laid out at our Investor Day 13 weeks ago. And that, as you recall, we talked about '26, '27 financial framework. We remain very confident in that for a few reasons. One, in new Fortive, we now have this portfolio of 10 brands that are market leaders in really attractive segments with great circular trends. They come into 2025 with a demonstrated track record of delivering at or better than the financial framework that we laid out for '26, '27. So we know these businesses have the capacity to deliver that. And again, execution on our growth acceleration strategy gives us a lot of confidence as we come out of '25 to really accelerate. And in many ways, the subdued growth in '25 provides a great comp actually going to '26, '27. So we feel great about that. And then the final point I'll make is on capital allocation. And we continue to really stay within the exact parameters that we laid out, which is a more-balanced capital allocation strategy. At this point in time, that's all about shareholder returns and maximize shareholder returns. We believe right at this moment, buying back our shares is attractive. We are looking at small attractive bolt-on M&A, but we hold those to a very high strategic and financial criteria but we feel no pressure to do any bolt-on deals at all. We've also been really clear that we are not looking at large transformational deals. We like our portfolio. We like to have a runway to show the value we can create from that. So we're not in the business of large deals at this moment. We'll maintain the regular dividend. We did a reset on that just consistent with the spin-off that we did. We'll continue to invest in attractive organic growth ideas. So that's really our story. We've got a class strategy we're executing. We're on track with what we talked about on last earnings call. And for '26, '27 on track with the financial framework we laid out. And our capital allocation plays exactly what we've talked about.

Well, I guess it's been 3 months post spin. I guess what does the separation mean for Fortive? And what opportunities can arise by being an expand alone singularly focused company?

Yes. So I mean, I think it starts from simplicity. So by having the 10 brands all about keeping the world safe and productive, that gives us just a singular focus on what we're about. And these 10 brands are also all consistently #1 and #2 in the markets that they play in attractive markets. So that simplicity and our focus on a high-quality portfolio is very attractive, and that's a big opportunity. The second thing that comes out of that is the chance to be a more consistent grower and a faster grower. And we really do believe that each of these brands have a strong runway ahead of them. And so we're laser-focused on capturing that growth potential in the businesses. And then I would say just finally is capital allocation. In new Fortive, we have a business that really has a portfolio that's been fine-tuned for what we need. So we don't need any dramatic activities from an M&A point of view, which means our capital allocation becomes really about -- we generate about $1 billion of free cash flow a year. We can really, at every point in time, put that in the best use that uses the best risk-adjusted returns for shareholders. And if that's share buybacks, we'll do that all day long. and we'll keep a high bar on bolt-on M&A. So I think on simplicity, growth and just the ability to focus our capital allocation, that's a very different play than before the spin.

Yes. And maybe you specifically, you've obviously been at Fortive for a while, but first quarter as CEO, are there any changes that you've implemented as you took over that role? And are there any insights or any new perspectives that you've gathered maybe with some fresh eyes?

Yes. We try to keep it consistent with the key value drivers. So my focus really with our team has been three things that probably wouldn't surprise you. First one is customer intimacy and growth. So we really do believe that the 100,000 customers we already have across Fortive provide the best opportunity for us to grow. And there's a great runway ahead of that. So personally, I've been spending a fair amount of my time with customers, which then means our whole team is also doing the same thing. So this idea of just spending more time with our customers so we can understand what innovation they need, ways to accelerate value for them. And the insight coming out of that is, I'll tell you from the last few months, I am incredibly excited about how much our customers trust our teams, how much they look to us to help them unlock value from a range of things that only Fortive and operating brands can do. So that's been a change for the company. And I think in the end, growth comes from being closer to your customers. And that's a culture shift for us that we've been driving. The second one is on capital allocation. So with Mark as my partner here, we've revamped our M&A engine completely to be a lot more focused on bolt-on M&A rather than bigger deals, really much higher strategic and financial criteria that we pass them through. I think that means the funnel has become much smaller, but the higher quality prospects and there are things that if we were to do any of those would be incredible returns similar to before we talked about that would be in the second half of '23, which are now double-digit ROIC in the second year. So it's been a lot of kind of change in the mindset of the company around the role of M&A in our strategy that we have a formula for value creation that does not require heroics from an M&A point of view. So that's been a change for our team. And then the final one is on the Fortive Business System where we've just done a lot to infuse AI into what's a secret weapon as a operating model and also to infuse small growth tools into FBS. And I think the insight coming out of that is our teams are energized by that. Our teams want to grow faster because that's the -- that's where the flywheel stats for everything else. And so it's been a great few months.

Yes. So while maybe M&A is not as big of a piece of the capital allocation profile, it's still a piece. And it feels like it could be a regular piece just that the deals are smaller. So I think on the last conference call, you -- I think the quote was open for business. I guess when could we start seeing bolt-ons come through? Like any sort of like cadence to that? And did the open for business refer to only buying? Or are there maybe small businesses within Fortive that could be thought of to be divested?

Yes. So I think the open for business comment really is about within the frame of our balanced capital allocation. So going forward, again, we will do share buybacks where it offers the best returns. Any M&A thing we do, which would be focused on smaller bolt-on deals, we'll have to compete from a return point of view, risk-adjusted with buying back our shares. And so we're always looking. And the way I'll describe it is, you're right, we have a great focus area of potential bolt-on deals that are attractive. And at this point, there is a really high bar that we just introduced into the system. So there's going to be a period of time where we're kind of refining the funnel to get it to things that really pass muster under this new higher bar. And then we'll play that through over time. So it is the case that targeted bolt-on M&A that help reinforce our growth capacity in our existing businesses will be a part of our formula over the medium term. But we're just not -- we're not in a rush at all. And when we do those deals, there will be great deals because we're not -- we don't feel the desperation to do a deal if we don't find great ones.

Yes. I wanted to ask about what AI could mean for Fortive because on one hand, I could see that you guys sell productivity solutions. You guys could use AI to sell better workforce productivity solutions. But the other side could be that could AI be a competitor to some of the products that you guys have? How do you think about AI in that context for Fortive?

Yes. I think overall, the AI theme for us is just an exciting opportunity because in the end, if you think about what we do at Fortive, there's 25% of the company that's kind of software type of product, but they're vertical software with the proprietary data. A lot of them have 2-sided networks to them. And a lot of them are deeply embedded in customer workflows. So these are really important connections that we already have with customers. And so the conversations we're having with customers is -- and we have 100,000 customers. They're saying you're already in our system. We already trust you. Can you help us unlock the true business value from all these AI capabilities by embedding them as use cases within your solutions. And that's what we're doing at scale across all of our operating brands right now. And it's exciting. It's exciting for our teams. And as you might recall, Chris, we had the foresight of starting our AI center of excellence almost 7 years ago now before GenAI became fashionable. And so we've had a chance to really have a leading position in introducing some of these use cases with our customers across our businesses. And that's what we see the most separate from how we deploy it for internal productivity. We are not -- the productivity work that we do is not something you can abstract and do with AI because it's really about delivering decision insights for customers at the right point. And so the more important thing is the connections than at some level, the insights themselves. So that's why we're excited about it.

I appreciate that. You guys at the '25 Investor Day targeted a 3% to 4% organic growth profile, modestly lower versus the mid-single digit that I think the company targeted at the '23 Investor Day. Is that a function of where we are in the cycle? Is there more prudence? Are some verticals lower growth than we thought previously?

Yes. Well, so I think if you kind of step back and look at the storyline on growth for this portfolio, so this portfolio that's now new Fortive. And if you just kind of take that out of how Fortive has existed before this, it's a portfolio that's delivered 4% compound annual growth rate organic for 5 years coming into 2025 and pretty consistently with a narrow band around it. So we know it has that capacity. We are executing a set of strategies I talked about in the beginning around product innovation, commercial acceleration and customer value that we believe can increase that growth rate over time. So if you step back, we certainly feel like the potential for this portfolio is exciting and the history is very strong. What we did with the financial framework we laid out is we know we're in 2025 right now that's a little bit noisy and growth is a little bit subdued for a variety of reasons that we've talked about, macro reasons in '25. And so what we really did was based on the history, based on what we're seeing in '25, allow kind of a gradual ramp in that growth as you look at '26, '27, which is what we said was kind of 3% to 4% in our framework. And then we said it gets better after that. So it's really more -- if you think about the time series, nothing changed in a sense of the capacity for growth of the portfolio, but we really were just being balanced in the time series.

Appreciate that. Maybe last one on strategy. You changed the guidance approach and you're only providing full year guidance for adjusted EPS. I think there was a lot of people in the market that wanted more organic growth or kind of some more numbers around that. Has your perspective on this evolved at all since the call? And are you planning to provide more going forward?

That's Mark's favorite.

So listen, I think we feel good about where we are right now. And I think as you called out, we did two things. One was we went to full year updated quarterly as opposed to specific quarterly guidance. And secondly, as we did reduce the number of metrics that we're guiding on. We did that at the same time as providing modeling help so we could make sure that the sell side and the buy side knew the cadence of how the year would unfold and some directional guidance on core revenue. We did it really to align with how we're thinking about the value creation formula of this business, which really is a multiyear story that's punctuated by years, not by quarters. And I think this gives us the ability to have the flexibility to make the investments that we need to make to drive towards our goal, which is benchmark beating returns over the course of the next 3 or 5 years.

I appreciate that. I guess kind of moving more towards the operations a little more near term. You guys called out 3 headwinds in Q2, some fluke channel dynamics, government and health care. Could you provide some color on each of these headwinds and when we could expect to see some of that alleviate?

Yes. So I think the headline on it is it's all playing out exactly as we anticipated on our Q2 earnings call. And just maybe to start with the first one, which is really the tariff uncertainty for some of our short-cycle businesses in the latter part of June, especially, had some customers that had big orders to place saying, you know what, I'm just going to wait a few weeks and see what comes out of that early July, July 9 time period that people were expecting there might be some change. And like we mentioned on our Q2 earnings call, that the order pattern is normalizing already, and that continues to be the case. So -- and part of what happened is we really just had kind of a backlog build in Q2. So that's -- that's playing through just as we expected, and we'll be fine on that. The tariff overhang and what happens with APAR and what the Supreme Court does with that, that's obviously still out there. But we think at some level, the system has embraced the uncertainty. So we're not finding that to be the headline news at this point. With respect to, if you want to touch the other two, the second one was on health care with some of the changes in reimbursement policy had hospitals really just -- especially for capital equipment purchase, where they were trying to buy a new piece of sterilizer saying, you know what, I'm just going to wait a little bit and see how this plays out. Again, this was in the context of June, where they were waiting to see what Bill was going to get signed on July 4. Like we mentioned on our earnings call, we're beginning to see customers emerge from that period of kind of hunkering down and things are beginning to flow. Like we said, all of the deals in our funnel for those capital equipment are still there. So it's just a matter of timing. And that will continue to flow through over the quarters ahead, just exactly like we presumed in the guide that we provided. And then for government spending, the same thing. It was a June year-end for state and local agency question. They didn't spend as much as they spend the last few years. keeping in mind some of those last few years, we were growing 20% plus in that business, so a pretty tough comp. Those are essential projects that have to be done at some point. It's all of our communities. Those -- the infrastructure maintenance has to happen at some point. So that's beginning to flow through. It will take some time. But again, just exactly the way we presumed in our guide.

On your comment about, I believe it was Fluke effectively just built backlog during the quarter. I guess, any sense of how long or how quickly that excess backlog will be worked through and brought down?

Well, we've been through that a lot, as you can imagine in the last few years. So we certainly know how to run backlog. And I think we're right on cost. It's not exceptional. We've been through periods of bigger backlog build. So I think it's within the normal range from my point of view. to Mark's point, this was more of a quarterly blip thing than anything of note

I appreciate that. I think a lot of the companies that are at this conference, they're driven by industrial production, and we can model that because we can tie it together. Fortive is harder. So one thing I've always felt like I think from the outside looking in, it's sometimes hard to realize like what is making things better or worse. So I guess, is there anything that we should be monitoring to kind of help us understand the status, the health, the trajectory of some of these business lines?

Yes. And that's something we continue to put a lot of thought into to make sure we're as helpful as we can be. Obviously, for us, it feels simple because we see all of it, but we'll keep working on that. And I think while to your point, we have these two segments and they have slightly different drivers. In the end, the industrial part of Fortive, I think the PMI is a good index to look at. Now you've got to translate that because we've been doing much better than PMI for a long period of time. So you have to do some kind of adjustment to PMI. But there's some correlation, maybe separation in time. We may always do a certain number of basis points better than PMI. But -- so that's a good index to watch on the industrial side. And I think on the health care side, hospital procedure volumes and hospital CapEx are certainly relevant indices because that tells you how much operational activity is happening in hospitals, which drives some of our businesses and how much capacity expansion is happening, which the CapEx would tell you. So again, while those may not be -- if this goes up by 10%, we're going to go up 10% in the same quarter, those are kind of a few metrics that might help. Another one is kind of construction index, if you look at that for state and local agencies, especially. And I think between -- across those 4 PMI construction index for state and local, hospital procedure volume and hospital CapEx, that's probably a good kind of set of metrics to get a sense of is the underlying kind of market for Fortive is getting better, getting worse.

That's really helpful. Maybe talking about facility asset life cycle specifically. Industry leader there for you guys. Can you talk about -- I guess, what really drives that business who is Fortive competing against to win that? And why does Fortive win there?

So we have three operating brands. What we do is really help organizations and government agencies manage the kind of the life cycle of their built environment. The important thing is we've selected vertical specific plays. So instead of trying to do a horizontal play that manages the built environment across everything for everyone, we've picked areas where we believe we have the #1 businesses, the deep profit pools and the circular trends that suggest it's a good place to be in. And those few areas that we've picked One, in the case of ServiceChannel is helping organizations with multisite retail manage their billions of dollars of RMO spend. That's attractive because it's a lot of money they spend there. There's a lot of value a customer can get from really being good compared to benchmarks on how they manage their RMO spend. And we happen to have a business that has the deepest 2-sided network, so 100,000 contractors on one side and a whole list of the leading multisite institutions on the other side. They meet on our platform every day to decide what's the best place to execute any particular repair and maintenance activity in their facilities. That's a very specific thing. It's surrounded by proprietary data that we've had for decades. It's surrounded by AI use cases that we've built on top of that data. It's surrounded by this 2-sided network that nobody else really has. And so that's an example of a very unique play that we've picked. Competitors, it's kind of hard to define because no one does exactly that. There are other companies that do something, but they don't have 2 out of the 5 things that we have. And then if you look at what we do in our Gordian brand, which, again, very focused, and there's a few elements of that, but the biggest one is helping state and local government agencies to execute their community construction projects in a way that complies with some of the regulation on how they need to procure projects in that particular jurisdiction. So it's written into law that if you want to do job under contracting, this is the way to do it. And we happen to have a platform for them to execute that. And if they spend less, we may make less money. But otherwise, it's a great business. That's why we grew 20% plus for a couple of years. So again, competitors, it's just -- it's a different -- there's other players that do pieces of it, but it's a different bundle that we have. And then the other one is Accruent, which really has a number of different pieces to it. And that's probably the one that has the most observable kind of universe of other players that do the same thing. So it may be slightly less differentiated than the other two. But the same idea applies, they're deep leaders in the categories they play in. And I think in many ways, the reason we continue to believe that, that file platform has more growth potential is because of the quality of those brands.

And then facility asset life cycle collectively, it's a highly recurring business. Can you talk about how the company gets paid? Maybe throughout the life cycle of a building, obviously, construction, but then beyond that, how does that work?

So if you look across FAL, 65% of it is just software businesses, where the customer signs a multiyear SaaS license and they pay us something each year and it escalates over the years. So that's pretty straightforward. There's another 25% or so that is we call reoccurring, which is really this piece around helping state and local government to execute their construction projects. So the math on that is they spend $1 billion. And if they do it on our platform, using our data, using our software, using our network, we get a percentage of that spend. So that's -- so as long as it keeps spending, we keep getting the percentage of it. And then the rest of it is just professional services that tend to be linked to executing some of the software projects that customers procure from us. So that's a simple way to think about it.

I appreciate that. And then maybe turning over to Fluke. So I guess in Q2, it wasn't a destock headwind. It was more that orders weren't effectively converting to revenue, if I understand that right. I guess kind of two questions on Fluke. I guess how long can those stay disconnected? And then the follow-up is, can you just talk about why Fluke is such a durable business? Because I think from the outside looking in, people say, short cycle sells into distribution, obviously, you guys have a different view. I just like to hear that.

Yes. So I think on the first part of your question, Fluke's continued to, from a point-of-sale point of view, order point of view, really maintained -- we're really happy with how it's continued to perform. And I would really say the Q2 event was a few -- some big orders getting delayed a few weeks. So I think there is really no disconnect in Fluke. I think it's really shown itself to be really durable. And then on your point on why is it durable and why it's different. I think a number of things. Fluke today is different than it was 6 years ago. 15% of the business is now recurring models. So software, AI use cases, service plans for customers and high-value professional instruments. So that's certainly -- and that's growing double digit a year very quietly. So that provides a bedrock. And then if you think about the Fluke brand, it's -- it's global. We've got a set of solutions. Some of the business is $100,000 price point products that are going into some of the leading institutions. And then you've got $600 digital multimeters for your local electrician. So it's just a really -- it's a terrific diversity of offerings that all connect because the person that's buying the $600 instrument, they trust your brand because they know you do the $100,000 stuff for the person that sets the standard. And it just has this beautiful aspect of it that we built by cobbling those pieces together over time that makes it more durable. People always say, well, PMI has been in contraction for a lot of time in the last 5 years and Fluke orders keep growing. Is that ever going to stop? And I'm like it hasn't, and I don't hope it does anytime soon.

Yes. I mean it feels like there's a lot of benefits of productivity, particularly with kind of the demographics that we see on labor. So that really resonates. Maybe turning over to health care. So the AHS segment, organic growth turned negative in Q2, down about 2%, 3%. And you talked about second half kind of being similar to that. Obviously, Q3 is a tough comp. But can you just kind of walk us through the dynamics impacting the AHS segment and how you kind of see the rest of the year playing out?

Yes. So again, I think if you step back beyond '25, we like the AHS kind of trends over time. I think we feel good about the things our team is doing to keep the growth up. A few things I would observe in '24, the AHS segment grew about 6.1% organic growth. That's a little bit faster than kind of its normal pace. And to your point, Q3 especially was a particularly high comp. So some of that factors into it. And then like I mentioned on the health care reimbursement environment, there was something that happened in Q2 with respect to these hospitals holding back, especially on capital equipment purchase. And we just expected that would take some time to unwind. And that's what's playing out. Some hospitals are now like, okay, I have to place this, so let's go. And so we're beginning to see that flow because we have the funnel, we didn't lose a single one of those things. So it's going to flow through over time. What we don't know is how quickly that flows through. But once it all flows through, the medium-term growth capacity hasn't changed. It's just customers getting through this period of uncertainty. And so we feel good about the financial framework we have for '26, '27 and the role that AHS plays in that. Again, keeping in mind that '24, that segment was actually above our fleet. It was kind of 6.1% growth. So this year is a little bit of that comp factor playing in, and then we expect that normalizes over time.

One thing that's kind of been flagged in the market is that STERIS, a key competitor to ASP, strong Q2, guiding to, I think, even better growth in the back half. So they don't seem to be facing some of these pressures. I guess can you just kind of talk about what could be driving that disconnect?

Yes. Well, I think -- so first of all, we're always curious. And we're the same question I'm asking our team all the time, like what's going on? So it's a question, as you can imagine, we spend time on. I think a few things to keep in mind is these businesses are all very different. So we have a lane that we've picked that we really like, which is low temperature sterilization. And we are the leaders in that lane. And some of these other companies do a lot of other things that may be going well at any point in time. So just keeping that in mind is important. I think comp is also important. So especially if you look at capital equipment, I think we did really well last year on that. So I think keeping that comp factor in mind is important as well. And then again, the thing we know is what we see with our customers, which is we have a great funnel of opportunities. We're winning even more than we used to win. So from a success point of view, we feel -- we like the trend line, but it's just a list of very specific things that are delayed. So we have clarity on what we're seeing. I think for some of the kind of other companies, it's just different mix of businesses, different comp, different backlog kind of scenarios that people start the year with. So I think there's other things that just get noisy, but we're always pushing to learn what we can from it.

No, I appreciate that perspective. Obviously, this year, we faced some headwinds. You called them out. As we look into 2026, do you feel like those normal targets are in scope, 3% to 4% organic with a 50-plus bps of margin expansion?

Well, we remain confident in the financial framework that we laid out for '26, '27. And when we get to Q4 earnings, we'll have more guidance on '26. But from a financial framework point of view, for that '26, '27 block of time, we remain really confident that kind of 3% to 4%, call it growth, 50 to 100 basis points of adjusted EBITDA margin expansion. I think we said high single-digit plus EPS growth. That's still well on track for us. And we also importantly had this plus-plus sign after '26, '27. And our confidence remains that these businesses have a chance to do much better than those numbers for '26, '27. And again, if you look at historically for the 5 years before 2025, the businesses we're talking about all delivered better than that '26, '27 framework that we laid out from a core growth point of view, margin point of view and any way you think about kind of effective EPS growth point of view. So we feel confident about that. And the reason we feel confident about it is we're doing the right things. We're executing on innovation acceleration, commercial acceleration, trying to add more value to 100,000 customers. We believe these businesses have positions of strength in markets that are attractive. in many ways, the noise and subdued growth in 2025 is good comp as we go into '26, '27. So I think there's a lot of factors that go into giving us that confidence on the framework.

Well, I appreciate that. Well, we're up on time. Thank you, Olumide. Thank you, Mark. Really enjoyed the conversation.

Thank you.

Thank you. Good to see you.