Fortive Corporation (FTV) Earnings Call Transcript & Summary

[Audio Gap] senior analyst at Baird that covers advanced industrial technology. Next up is Fortive. I've often said Fortive checks all the boxes of the types of companies we seek out in our coverage in terms of delivering productivity, quality, safety to its customers. We try to seek all of those drivers, if possible. Very happy to have Olumide Soroye, Fortive's President and CEO, with us today. Olumide is going to start off by a few opening remarks, then we'll go to Q&A and can take your questions at that point. So if you do have any, again, remember to send those up on the iPad, we'll work those in the conversation. So Olumide?

Excellent. Thanks, Rob. It's great to be here, and thank you all for your interest in Fortive. Just to set the stage for our conversation, I thought I'll provide reminders on 3 key points. The first is following our spin-off of Ralliant at the end of June, Fortive is now a simplified focused company with a terrific financial profile. And that's enabled by our leading operating brands in a number of attractive markets. The second key point is that we are poised for acceleration. We are in full execution mode with our Fortive Accelerated Strategy, which we were pleased in our first full quarter as Fortive in Q3 to show some tangible evidence of progress. And then the last key message is that our value creation thesis is on track. The financial framework that we laid out at our Investor Day last June remains firmly intact. Let me just provide a bit of color on those 3 points, and customary forward-looking statement and non-GAAP financial measure caution applies to this conversation. So if you think about Fortive today and what it is, the financial framework really stands for a great revenue profile. So we're just over $4 billion in revenues, we've grown revenues on a core basis, about 4% in the last 5 years compound annual growth rate, with growth -- organic growth every single year since the pandemic, that's partly enabled by a 50% recurring revenues. It also stands for a terrific profitability profile. Adjusted gross margins of 65%, adjusted EBITDA margins of almost 30%. It also stands for great free cash flow generation. We generate almost $1 billion of free cash flow a year, adjusted net income to free cash flow conversion of over 100% and a very strong balance sheet. And that financial profile is enabled by the leading brands that we have in these attractive markets that benefit from a range of favorable circular trends from electrification to industrial reshoring, to the expansion in data center capacity that's installed and operating that will continue to grow, to aging demographics, to the shortage of providers in the health care space and the $1 trillion of deferred maintenance and infrastructure in the U.S. alone. So just a range of markets that will benefit from this trend for years to come. I tell you, as we sit here as a new management team at Fortive, we feel like we're at the beginning of an exciting chapter in the history of the company, one that's defined by growth and exceptional shareholder value creation. And the reason we believe that is our Fortive Accelerated Strategy. And let me just remind you of the 3 key pillars of that in the next slide. And I'm also going to provide a few examples from Q3 to make the progress we're making intangible. The first pillar is faster profitable organic growth. Putting it simply, we believe we can grow this portfolio much faster than it's done before. And we're going to do that in 3 ways: accelerate innovation, more new products for customers; commercial acceleration, we're going in very surgical ways invest in sales capacity, both for high-growth markets, geographic wise and end market-wise; and recurring customer value, we've got 100,000 customers and we're going to do a lot more for those customers to deliver impact to them. In Q3, which was our first quarter as new Fortive, we continue to see acceleration in our new product innovation, some success in North America and Southeast Asia on the commercial seeds that we're planting and great growth in our recurring revenues, which continues to outgrow the overall company. So great progress on that first pillar. Early days, a lot more to come, but we're incredibly excited about that. The second key pillar in our Fortive Accelerated Strategy is a disciplined capture allocation approach. That's very new. And we've been very clear. We don't need M&A to deliver the value creation thesis that we have for the company in the next few years. And we've also been clear, we are not interested in large transformational M&A. Our priorities are very clear for capital allocation: We invest in organic growth ideas that are high quality, we will look at M&A that are small, bolt-ons and accretive and meet our criteria and are able to accelerate the go-forward organic growth rate of the company. So that's a very tight filter for the bolt-on M&A that we do. They're smaller, they help growth going forward and they meet our strategic criteria. And we will continue to do share repurchases at scale where it provides a compelling return for shareholders and maintain a modest growing dividend. All of that is going to really be around this frame of the best relative returns and maximizing medium-term and long-term shareholder value creation. Q3 was a great manifestation of what we mean by this new approach. In Q3 we did $1 billion of share repurchase. That's the biggest single quarter of share repurchase in the history of Fortive. And with that, by the way, in that process, kind of bought back 21 million shares, which is about 6% of our fully diluted outstanding shares. We did that because we had a high conviction that given the equity valuation of Fortive in the quarter, this was a remarkable return proposition for our medium- and long-term shareholders. Now where that condition exists, we will continue to take that approach. And the third main pillar in our Fortive Accelerated Strategy is maintaining and building investor trust. And this is an important one for us. It means we want to set clear expectations and meet and deliver those expectations consistently. It means we want to be clear in our communication, simple, including with guidance and disclosures and make sure that we really translate the company with the excitement that we feel to our investors and prospective investors. And we do what we say we'll do. Again, Q3 was a great example of that. I think our share repurchase program, hopefully, was a clear manifestation of what we've been talking about on the difference in our capital allocation strategy going forward. We also outperformed on all the expectations that we set, with 2% revenue growth in the quarter and also 10% adjusted EBITDA growth and 15% adjusted EPS growth. So that was a good stat and a lot more to come ahead of us. We also raised our guidance for the rest of the year. So that was, for our first quarter, I felt really good in terms of doing what we said we would do. So that's the frame for new Fortive. You've got this great company with a great financial profile, great leading brands in key markets with favorable trends. We have a clear strategy to go even faster than we've ever gone, and the value creation thesis we laid out is intact. Q3 is just the beginning, and we feel good about that stack and a lot more to come. So with that, Rob, well, turning to you for questions.

Perfect. Yes, absolutely. Again, if you have any questions, send those up or just raise your hand, we'll work you into the conversation. Olumide, maybe just to start, I mean, again, it's kind of like we're starting anew year post-spin with reframing the strategy, you're stepping into this role as CEO, you're not new to the company necessarily. But as you do step into the role and maybe investors taking a fresh look at a different-looking Fortive, what should they know about your background and the way your leadership style and how that meshes with the strategy that you've just laid out there?

Yes. Thanks. So I mean over the last 3 decades, I've had the privilege of being involved in a lot of terrific growth and shareholder value creation story in technology and industrial space. And my last 4 years at Fortive has been a terrific way to actually get to know this company and understand where the levers are to create a remarkable story ahead. And I think those set of experiences and the purpose-built team that we've put together is really what gives me excitement about the fit with our strategy. And just to give you a few examples of how those -- that intersection works. We talk about accelerating profitable organic growth. My orientation in general is just deeply customer-centric. So a lot of how I spend my time as CEO is time with our teams, engaging with customers directly because that's where you find growth ideas. And we're driving that mindset across Fortive now over the last 120 days, we have a business leaders spending more time with customers than they ever have before. And so I really do believe that when we talk about innovation acceleration, commercial acceleration and recurring customer value, the underlying driver of that is you have to have really deep insights about customers. And that's just fundamental to how I view business, I've had a lot of success with that approach and that customer intimacy. So that's something you should expect and connects really well. With respect to disciplined capital allocation, I'm really -- I'm a real fanatic about being judicious with every dollar of free cash flow and getting the best returns for it and deploying it in a way that generates the best return with the lowest risk. And so you will see that translate into how we approach capital allocation. We're not going to do anything dramatic, we're going to do simple things and do them really well. And if that share repurchases, we're going to do them big and bold and really well. And I couldn't be more excited to have, as part of our team, Mark Okerstrom, as my CFO partner for this, who shares the same mindset around capital allocation. So you're going to see that intersection of my experience and what we're doing. And building trust is with every one of our stakeholders, customers or investors or competitors or our employees and teams, trust is the currency that I believe is fundamental to success. And so you're going to see that intersection as well, we'll be simple, we'll be clear about what we're going to do and we're going to do what we say.

Yes. I appreciate that. You mentioned, again, first quarter out of the gate, nice results, better -- a little bit better than expected. Maybe talk about what drove some of that upside, why you were able to carry that through into the outlook for the year? There's also some, as you noted, just right at the spin-out, few challenges midyear with all the tariff dynamics and government policy changes and how you're managing through those challenges as well?

Yes. I mean we were quite pleased with our first quarter and the ability to, despite the dynamic macro environment, have both of our segments perform better from a core growth point of view, have the kind of margin expansion that we delivered and 15% adjusted EPS growth and also the fact that the $1 billion of share repurchase. So we felt really good about that. We also are pleased but not satisfied because in many ways, we really do believe that each of this segments have a lot more growth acceleration runway ahead of them. And we look at the macro and it's interesting, but we're really focused on the things we're doing on innovation, commercial and recurring customer value to unlock that growth acceleration. The macro factors that we talked about mostly in Q2 are all receding like we expected. The tariff environment is getting settled. It's less about the tariff, it's more the certainty that we really find conducive for normal demand conditions. So that's settling. The health care space is settling now that the OBBBA Act is passed, that legislative certainty is helping the market sort of move on with it. And federal spending and still local spending it's kind of set at what it is. We're not counting on it getting better. So we really feel excited about the first quarter, but we are not satisfied because we know there's a lot more from this business is to be had.

Yes. If we look at your largest business, that being the Fluke business inside of IOS, I mean certainly, a history as a great business, really strong brands, culture of innovation as well around products there. As you, again, take the new strategy and apply it to the Fluke business, what were some of the key areas that are going to receive some of this investment around accelerating organic growth? What are some pockets there that you've identified that you think you can raise the growth rate?

Yes. No, and Fluke is a great way to test out the strategy for sure. And it's -- Fluke is just an incredible business, a great brand like you said, just a very profitable business. It's just really customer loyalty -- when I talk about customer centricity, there's no better example of that than our Fluke business. And the way we're going to drive faster growth at Fluke is those same 3 things. So product innovation wise, we've been dramatically increasing the funnel of new products at Fluke over the last 4 years that I've been part of the company, and we've picked that up even more. So you're going to see the Fluke team unleash a set of innovation that transcends a really impressive history of 76 years of being a leading innovator and the best is still ahead of us. And the set of new products that the Fluke team is working on are things aimed at operating and maintaining data centers, managing the EV charging station infrastructure that's out there, managing solar installations that are out there, aiming at really attractive geographic markets. North America is a really strong one right now, so is India and some markets in Southeast Asia. So you're going to see the Fluke team innovating in a very surgical way to get after some of these high-growth teams. And we have that fun of working. And then you're going to see the Fluke team from a commercial point of view really expand our capacity in some of these high-growth markets. So I'll use data center as an example again. That's an area where a lot of focus right now on the build-out, but the fact is, once the build-out is done, you got to maintain and operate this data centers for decades ahead and that's where the Fluke team really kicks into high gear with the instruments that we provide. So you could really expand our sales team that's focused on that. You could expand our sales team that's focused on these attractive geos. So we're doing those surgical sales capacity expansion to help Fluke capture more of this incredible opportunity, and that will show up in volume growth for that business. We've done really well from a pricing point of view. And recurring customer value, Fluke is now 15% recurring revenues. We continue to see that piece of Fluke, which is service plans on the high-priced professional instruments, these software components that we bolted on to some of our instruments as well. We're going to continue to invest in those and drive faster growth there. So those 3 vectors provide just a really exciting outlook for that business for years to come.

Yes. Just on the data center effort itself. Is that required new product innovation or is that more a commercial exercise? I'll blend the question a little bit. You look forward, there's maybe high voltage starts to enter the equation on the data center side. Does that change the insertion points for Fluke, if that's the case?

Yes. I mean that's an exciting one for us because -- and I'll just expand your question a little bit. So the passion around data centers is obviously at a peak right now. And I think a lot of times, we focus the conversation on the build-out phase, the CapEx phase because it's just so much money going into it. And for us at Fluke, we participate in that because for each of these hyperscale data centers, you have thousands of technicians that are involved sometimes for multiple years to actually build it out. And a lot of them in the installation and certification toolkit, there's a lot of Fluke tools in there. So we're seeing some demand from that. You can't always trace what's exclusively data center, but we can see the demand from that. The more exciting thing for us is once the data centers are built and this incredible capacity out there, you actually have to drive uptime and performance from data centers, and the set of tools that Fluke offers fit really well with that. To your point, it starts from things like just power quality analysis and monitoring to high-voltage diagnostics, to high-density fiber testing, to electric ground fall detection, to power calibration, and it goes on and on. But there's this unique set of instruments needed to actually run and maintain a data center that fit really well. And we're working with some of the hyperscalers already to say, can we just help you define your standard tool set for operations and maintenance for your data centers? And I'll give you an example from one that we worked with recently. They came up with a list of instruments for running their data centers, and this is one of the biggest ones in the world. And 1/3 of the instruments on the list are referenced as Fluke tools. So that means Fluke tools that is standard for that. And so for us, the data center tailwind is not just this onetime surge, it's the next 10 years of really getting value from these incredible investments that have been made.

Yes. Excellent. Your the software business is the FAL businesses within the IOS portfolio, I mean those were inserted into the portfolio over several years via acquisition to bolster that recurring value that you talk about. And I know that you've spent a lot of time being intimate with those businesses. Where do you think they are on their maturity curve in terms of being able to deliver to the objective? I know they have some macro events just -- but on a go-forward basis, where do you think those are today kind of 3 businesses in there on that curve in that journey?

Yes. So I mean if you think about what the facilities and asset life cycle businesses have done for us, they've continued to grow faster than our fleet average. So we've been pleased this -- even this year with all the dynamic macros, it continues to grow above our fleet average. So we like that performance. But to your point, I think we're still very much in the early innings of the full potential of that platform. And it's the same drivers that I talked about for Fluke. So I'll give you an example in that business is one of our really just impressive data reach, network-enhanced software businesses in service channel that really takes this idea of you have 100,000 service providers and facility owners that are meeting on our platform to match the right job to the right service provider. So this is not just a workflow software, it's actually -- it's a marketplace as well, and it's enriched with data. And so we're doing things like deploying AI use cases on top of that data to help customers make decisions that get work orders coming in to benefit from the intelligence of the last 10 years of work orders and what they've experienced. So that's just one example, but there's a whole range of innovation that we will deploy on that facilities as a life cycle platform to drive even faster growth than we've seen. The same thing on the commercial side. It is a business that it's really very much U.S.-centric right now. Some of those assets transfer beyond the U.S. And so from a commercial expansion point of view, we have a chance to build capacity in some markets outside of the U.S. and drive growth. And from the recurring customer value point of view, that's classic net dollar retention drive in the software businesses. We like where we are right now, but we still have a lot of room to go across the board in your NDR waterfall. So it's a great business, it's doing well, but we're still in the early innings of it.

Yes. As you think about taking some of these capabilities to other countries, which regions would be higher priorities for that?

Yes. It varies quite a bit depending on which asset. I think the places we typically look at first for the software assets are targeted markets in Western Europe, sometimes Australia and New Zealand, Canada is an obvious one. And what do you know well is when you're trying to do that, you have to be really surgical because you really want to build scale in one market instead of fan out too much. So that's how we've been. We've been really selective in picking a few markets at a time and really getting that right.

Yes. Shifting over just to the health care side of the portfolio, AHS, ASP being the larger business within that. Just kind of update us on where you think demand is right now, some puts and takes in there around -- some around the equipment decision-making, you think that started to playing out a little bit? But just what are you seeing inside of that business, both domestically as well as on the international side because that does have an international footprint already.

Yes. No, absolutely. And the way I will kind of framed that is keeping in mind that this time last year, that business was growing high single digits. This year, it feels unusual in that sense, it's been much tighter. And June was sort of the epicenter of that tightness, where especially in the U.S., some of the uncertainty around the OBBBA Act and reimbursement and in shifting policies around health care, really caused these big hospitals to slow down their capital equipment purchase. And since June, especially the last several weeks of June, when they were waiting for OBBBA to get signed on July 4, since then, it's just kept getting better. We have a funnel of those capital equipment. And every month, we're seeing more of those. The orders get placed and it's getting shipped, and we continue to see that improvement play out. So we feel good about the trend line on that. Hospitals are under a lot of pressure financially from a range of sources. And we're working closely with them. We actually like the seeds we're planting to be strategic partners with them for the long term. So it's getting better, will keep getting better. The federal government sort of shutdown and the hospitals that are driven by the federal government, that's another factor that the hospitals are dealing with. But all of those will fade. The underlying drivers of success there is aging demographics, almost over 20% of the U.S. going to be over 65 in 5 years from now. Think about that. A lot of the over 65 have multiple chronic conditions, they need medical intervention. And you have the middle class expanding, you have a shortage in provider workforce in health care. And those are the things that we solve. So the underlying tailwinds are there, they're going to [indiscernible] quarter-to-quarter, there may be ups and down, but we like what we're doing with customers, we like what we're doing with innovation from a commercial point of view, and we like the business. And again, it was high single-digit grower this time last year. So we know what it can do.

Yes. Any update on some of the new product -- newer products, some were introduced last year in terms of how they're gaining traction as well as you kind of expanded the catalog, I guess, inside of the ASP business, in particular?

Yes. No, they're doing really well. I mean we talked a lot last year about all those things we launched, and they've continued to gain really good traction. So we like that. And more importantly, just like I talked about for Fluke, the funnel of new things coming soon that, that team has is the biggest funnel they've ever had. So as I look ahead, that's really what I'm looking at to build confidence for the future.

Very good. Just step back and speak about the margin objectives of new Fortive, if we'll call it that, and kind of steps that you're taking to make sure that you can protect the investments that you want to make and accelerate the strategy and also deliver the kind of margin and leverage opportunity that investors are somewhat accustomed to with the Fortive portfolio?

Yes. So I mean the financial framework we laid out at our Investor Day had over '26-'27 50 to 100 basis points of adjusted EBITDA margin expansion every year. Complete confidence that we will deliver that. As you saw in Q3, we way outperformed that in the quarter. And the reason for that is we've got operating leverage built into the business. When you have a business that's 65% adjusted gross margin, so that's a good place to start. And what we've been able to do as we grow, especially on the recurring revenue side, is we're growing with our higher-margin revenue streams. So that just provides a tailwind. At the same time, we have this deeply rooted cost discipline, that's just part of who we are, and we will continue to drive that. You saw some of that in Q3. We streamlined the organization, taking a hard look at corporate cost structure and getting that tighter. So we'll continue to free up space. And the way we look at it is we have more than enough space in our $1.5 billion of operating expenditure to create the space we need to invest and still deliver very, very attractive margin expansion. So we feel quite good about that. We will continue to examine that. As we mentioned, in Q3, the margin expansion in the quarter for Q3 was outsized, and we may put some of that in growth, that's why we're not banking it all in, looking out into Q4. So we'll make those choices. But in the grand scheme, we feel completely confident that we can invest what we need for growth and still solidly deliver that framework that we laid out.

Yes. Anything that you would want to call out at this point in terms of where you are going to direct some growth investments that we would want to be aware of? You made mention, I think, maybe of India. And obviously, just -- there seems like there's a number of areas on the commercial side that you can pull some levers in and start to expand, but anything that we should be watching in particular?

Yes. And I mean, first of all, I'd say it's all within our envelope. So there's nothing we're trying to do that's a dramatic level of investments that will get outside the envelope that we've laid out. And it's those areas I've talked about. It's -- there's some targeted new product development that we want to go faster; eg, data center operations and maintenance is going to be big, and we're working with these big hyperscalers. They may have things that we've got to go build faster. So you see us do some of that. The surgical investment in capacity in a few markets, India, we mentioned, we're doing that already. That the India market for us in both segments grew double digits in Q3. So we have momentum there, and we're going to continue to kind of build on that momentum. And it's sales teams, it's local product teams that can really help us win more there. So it's really seeds like that. It's nothing dramatic.

Yes. I think you've been pretty clear on the capital allocation side, where M&A fits within the range of opportunities for free cash flow redeployment. How should we look at how you've retooled that organization to suit that newer strategy, refined strategy around M&A? And what maybe the current pipelines look like? Were they already well populated, do they need to get repopulated? Kind of recast through different filters, I'm not sure, but maybe just comment on where you think that status is right now?

Yes. No, I think the headline is we've done what we said we'd do, which is we're not trying to do the big M&A anymore. So we've changed the process. We've changed that funnel. A lot of things we use to have in our funnel, we've flushed it out. The funnel is now much smaller and much leaner. It's smaller deals that meet our criteria that help us grow faster going forward. We're not going to be doing a lot of deals because we don't need to do deals for our value-creation algorithm. And so we've scaled that team accordingly, we've changed our processes accordingly. I'm delighted to have Mark Okerstrom as a partner on this. He's been really crucial to help with that new pair of eyes to really reshape and rethink things based on what we're trying to do, which is different than what we did before.

Yes. Very good. We're getting flashed here. We're at time, so we'll break. There is a breakout session in Salon A out to your left afterward, if you have any follow-up questions for the team. Thank you.

Great. Thanks, Rob.

Thanks, Olumide.