Fortive Corporation (FTV) Earnings Call Transcript & Summary

[Audio Gap] Hardware as a service type offerings that we have and it's software subscriptions. And we've continued to see the strong performance across those. To give you a few examples on iOS segment at Fluke, which is again our biggest brand. We've just had great success in attaching service plans and subscription software to some of our products at Fluke. And this has really taken the experience that our customers have with our advanced professional instruments and saying, how can we make that better over -- beyond the time they're buying the device from us. And that's going really well and continues to provide upside. And then on the software side and the health care consumables side, it's really about driving utilization of equipment we have in health care and then attach for our software businesses. In health care, as an example, again, we have tens of thousands of equipment out there. Everything we do to help our customers run more devices through those sterilization machines that's recurring revenue growth. So we talked about the recent FDA approval of a 50-pound weight claim for our sterile machines. That means our customers can put more robotic equipment and devices through those machines, which means the utilization rate on those machines go up, which means more consumables and more services. So those are -- it's a very, very targeted approach at looking at all the 100,000 customers we have and ways to do more for them on the hardware side and on the recurring revenue side to deliver more value and the best place to grow is with the customers you already have.

Yes, that makes sense. And on Fluke specifically, you highlighted that you're offering now more software recurring revenue opportunities to products you have. Currently, recurring revenue is 15% of Fluke. What now essentially the product portfolio, what percentage now has some software option attached to it that you can now bring to the marketplace? And how high can that go?

Yes. So Fluke is just a terrific business for us with a lot of growth vectors. And one of them is this attaching service plans and software to our Fluke portfolio. We talk about a 50% of our revenue at Fluke being recurring revenues, and that continues to grow at a really strong rate. So if you play that through over time, it's going to -- it's just an exciting frontier for us for growth. The power of that in the end is that as you get into higher-value equipment, customers need more service plans around them to calibrate them and to keep them functional. And as you think about AI and what's possible with AI, it gives us a chance to add more value that customers are actually willing to pay for as upsell on those devices. So lots of runway ahead of us.

And speaking of AI, how are you using AI to enhance product value on both the hardware and the software side?

Yes. It's a great way to frame the question because it is on both the hardware and software side. And just as context again for everyone, we have the benefit of having started our AI journey with our center of excellence in AI launched 7 years ago. And so we've had time to mature this capability and didn't start it with Gen AI a few years ago. And what that's given us a chance to do is really be focused on real customer value, right? Because we were not trying to learn the technology, we were focused on use cases. And I'll just give you a few examples. On the hardware side, we took the approach of looking at every technician that uses our devices and trying to think through how we can leverage AI to help them do their job faster, make better decisions, better reliability and uptime. And we're doing that systematically across our portfolio. A perfect example is our Fluke optic car automated visual calibration product that we released recently. Think about this as a way to take the activity that technicians do of checking measurements on multiple devices and having to interpret those measurements. We now have a computer vision system that can capture those measurements and with AI can translate them into the implications and then some agentic workflows for some of those to actually take the actions needed. So it's gone from selling them a set of devices to now having this upgrade service that can actually, instead of a new technician trying to figure it all out, do 80% of the task and just help them get more done. So that's an example of AI delivering real value for customers on the hardware side. And on the software side, we've talked on many of our earnings call about a range of AI enablement that we put on top of this incredible data-rich systems of record with multisided networks around them. ServiceChannel, [ Vocode ] AI intelligence platform continues to see great adoption. At Gordian, our Flash AI solution, which can help people do estimates in minutes that used to take them days and weeks to do. And we've also talked about probation and our voice documentation capability that helps surgeons now not have to handwrite everything or dictate everything to a nurse practitioner, but they can actually, in an automated way, capture content with their voice rendering. So just a great set of real use cases, again, enabled by the fact that we've been advantaged because we built this capability a long time ago.

Very interesting. A little bit on the cost structure now that you're sort of a leaner stand-alone company, how are you progressing on your structural cost saving initiatives? And how much progress is there left to make?

Yes, great question. So we talked at the time of the spin-off of there being about $50 million of stranded costs. We were able to take that out between the second and fourth quarter -- third and fourth quarter of last year. We also went beyond that and took out a fair bit of cost, particularly at the segment level and the corporate cost structure. And we used that capital essentially to reinvest in the initiatives backing the Fortive Accelerated strategy, and it's early days, but we're seeing great progress. I would just say that we're not done now. The Fortive Business System is all about continuous improvement always about looking at ways to do things more efficiently. We certainly see that in the operating companies, but also at corporate. We're on the hunt to do things with less. And even though the big chunk is behind us, I think we're going to continue to drive efficiency through the business.

And can you talk a little bit more about those investments and where those dollars are going? And how long do you expect before you see the return on that investment and where that's going to show up?

Yes. Well, I mean, the good news is we're already starting to see returns flow in. And the investments have really been across the portfolio and across those 3 initiative groupings that Olumide mentioned, which is accelerated innovation, accelerated commercial activity and recurring customer value. Just to give you a few examples. For Fluke, we really beefed up their engineering resources. They've launched an industry-leading data center tool called the CertiFiber Max. Order volume is way ahead of our expectations. We can't keep up with it. And that wouldn't have happened but for the investments that we are making. On the commercial side, we've been putting more boots on the ground in places like Latin America, places in Europe, places like the Middle East, India. We're seeing the returns on those sales heads, again, across the portfolio, advanced sterilization products, Industrial Scientific, Fluke. And we've also put more specialty commercial expertise into Fluke in both defense and data centers. Again, we're starting to see the returns on that. And then on the recurring customer value side of things, we've been working on some of the innovations around the software products that Olumide mentioned and then also working on making sure that our service center infrastructure for Industrial Scientific and Fluke and advanced sterilization products in places like India or the Middle East is fully built out with the view of getting more of those great service plan subscriptions that will help drive the recurring revenue EBITDA.

Switching to capital allocation. You guys generate a lot of free cash, which is a very positive piece of the business. How do you make capital allocation decisions between M&A and buybacks?

So we do generate a lot of free cash flow. We love that part of the business. It will be about $1 billion or more of free cash flow this year, and it's growing very nicely. It's not a capital-intensive business, and we've got a free cash flow conversion on net income -- adjusted net income north of 100%, and we would expect that to continue. We really look at capital allocation across 4 primary categories. And we look at them broadly speaking, based on best relative risk-adjusted returns. First and priority is organic investment, and that would include things like building out the service center infrastructure that we mentioned. Second and third, which we look at interchangeably, are share repurchases and M&A. We've leaned in heavily into the share repurchase since the spin-off. Again, $2 billion spent at the end of the last quarter. 11% of our share capital retired. And really, that's just been on the basis of the attractiveness of the returns on a relative basis. But while we've been doing that, we've rebuilt our whole M&A engine, new leadership, new process, new analytical suite to assess relative returns of deals and a focus on predominantly bolt-on acquisitions where we believe that we can buy companies and make them worth more under our ownership and have them make Fortive be worth more as well. And again, we look at buybacks and M&A interchangeably based upon best relative returns. And then the last is our dividend. We've got a modest dividend, and it's growing. We're very happy for payment in the third quarter here to announce an increase in our dividend of over 16%. And that's just going to be a recurring feature of the capital allocation palette, if you will, over the years to come as well.

On the M&A piece, can you talk a little bit about some of your recent bolt-on acquisitions and what they brought to -- they bring to the product suite at Fortive?

You want to take that one.

Yes. So I mean our bolt-on M&A has really been very focused, as Mark mentioned, on a few ideas. One, we only do things that are going to strengthen our existing platforms. Second, they have to bring in some differentiated technology. And third, they have to meet our rigorous strategic and financial criteria. And those are very clear gates that we've set in place that guide everything we do. And you see that in the few examples that we've talked about over the last several months. And one of those is UV Smart, which is this company based in the Netherlands, and we did that acquisition in our ASP business. And you think about a few things there. One is that technology is very differentiated. It gives us an expansion in addressable market at ASP that's about $0.5 billion in expanded market. And it gives us this ability to bring this ultrafast chemical-free UV-C technology that's really important for disinfecting some of the ultrasound probes and endoscopes that are going to be a growing market for years to come. And we had -- importantly, not only do we like the asset, we had a really clear value creation thesis. We knew this was a technology in the Netherlands that with the commercial and the global presence that ASP had, we could significantly speed up the growth rate and the adoption of the technology. We also knew that while it's been approved for some use cases by the FDA in the U.S., there are a lot more use cases that this technology can apply to. And we knew that our ASP team has the regulatory process to speed up that process of getting more and more categories approved, which will further expand the addressable market. And we knew that we could significantly improve the manufacturing efficiency of the operation and drive cost productivity with our Fortive Business system. So really clear, really solid value creation thesis that's tracking very well right now. And the same thing at Aeroqual, that's another of the small bolt-on acquisitions, this one for Industrial Scientific, brought in a differentiated technology around air and environmental monitoring, something that connects really well with our worker safety solutions at Industrial Scientific. We had a clear value creation thesis. In this case, we knew we could take out the entire manufacturing operation and facilities footprint of this company and just replicate it within our existing factory at Industrial Scientific. And that was a big part of the value creation thesis. And at the same time, we could take the product they had, improve the distribution with our industrial scientific channel and customer relationships and drive faster top line growth while you're taking costs down strong clear value creation thesis and the team is off to just a terrific start on making that happen. So you'll see us do those types of focused bolt-on deals. They're not large in magnitude, but they play a really important role in giving a booster shot to our existing businesses at Fortive.

That's great. Shifting to some more near-term dynamics. Like you said, growth has been strong to start the year, 6.7% core growth in Q2. What are you seeing across your end markets today?

We feel really good. We talked on our Q2 call about what we describe as kind of broad-based strength across all of our platforms and end markets that led to that 6.7% core growth in Q2. And we continue to see the year play out as we expected and feel really good across all end markets. We talked about North America being the strongest region. That's -- I mean, that's held up really well. The other regions are holding up nicely, but North America continues to lead the pack. And then across all the pieces of both segments, we talked about the broad-based strength in terms of product categories, and that trend continues as well into the second half.