Vontier Corporation (VNT) Earnings Call Transcript & Summary

Great. Well, next up, it's my pleasure to have Vontier Corporation, Mark Morelli, President and CEO; and Anshooman Aga, CFO. So I appreciate both of you coming down here. Maybe start off with a topic that's generated a lot of discussion in the last sort of month or so, in particular, around your software exposure, maybe kind of frame for us the scale of that software business in the overall sort of Vontier revenue mix? And help us understand why you think AI-related concerns are probably not merited in this case.

Yes. Julian, thank you for having us. I really appreciate getting this question because it's something that we're really happy to talk about. Look, we are not a generic enterprise software company nor are we -- do we have thinly -- thin capabilities in SaaS. Our total software as a percentage of sales is between about 10% and 12%. And the important thing to think about our software as we have industrial software that is tightly linked to equipment. And the best way to think about this, our software platforms is that they control, automate and optimize the physical layer. In fact, they're actually sold with hardware. They work in conjunction with the hardware. And more importantly, this forms a critical application layer that is mission-critical for the people to use it like convenience store operators or fleet operators as an example, or ChargePoint operators, this is how they're doing business. They're doing it through this is actually where the payments are flowing through it. And so that type of application requires multi-levels of certification like our FlexPay 6, in fact, requires 3 levels of certification. And when our system goes down, you're bringing down all stores that have that capability. So you can imagine how carefully that is guarded and that's the kind of software we do. More importantly, this physical application layer, this foundational layer, what we call it, is also where we aggregate data. It's enabled by AI. We can either embed those in and we have great applications that manage uptime or preventive maintenance like in the hub as an example. But also the -- it's an open system architecture where you can enable applications from AI to tap into it. Of course, you charge an API fee and that enables a very robust innovative environment, but it's not something that's going to be disintermediated from AI agent taking over your application and commoditizing it.

And maybe remind us kind of what are the specific kind of pure software applications, not what's embedded inside the hardware, but that stand-alone 10% to 12%. Where does that sit in terms of the different brands inside the company?

Yes. So one of the areas that we're talking about that you saw in our Investor Day last fall at the NAC show, the National Association for Convenience Store owners show was unified payment. Here's a great example of a LEGO building block of typically it's FlexPay 6 and NFX that enables this backbone of a payment to be enabled whether you're inside the store, doing a transaction, whether you're at the dispenser or the fuel dispenser doing the transaction, whether you're at the car wash or the EV charger, whether you can enable ordering at the pump through food, as an example. It enables media and also loyalty where it's a connection of loyalty. So all of that's software-enabled, but once again, it's just durable software that's part of this backbone that is their critical infrastructure and how they do business. That's an example. On the fleet side, we have the vehicle identification system, which is a security of payment application system that is a tight linkage between the vehicle and fleet depot. And they -- that -- through that transaction, it's very difficult for that to get hacked. So can you imagine if you want people from the outside just with an AI agent in there running that application on security of payment. The whole reason why they have it and they pay for it is because it is a more secure payment way to get things done. On the drive software side, this is a deeply embedded software platform by which the operators are now experiencing nearly 100% uptime for the adoption of that network. And about 1 terawatt of energy is going through that and about 20% of all drivers outside of China are using that network, but it enables payments, enables customer interface. It manages the how it backs into the grid, it pays taxes. This is all like a really difficult thing. And the reason why we're getting more customers on it is because it's so difficult to get right. So it's really this foundational layer that -- and by the way, is being AI-enabled for uptime. So we're embedding that into it as an example.

And how you kind of -- you mentioned the AI-enabling aspect. How are you kind of pushing that across the various businesses to make sure that they're helping out customers or getting some value from it in the selling process?

Yes. There's 2 layers to it. The first 1 is certainly how we can enable a better customer experience. I'll just throw another 1 out. In DRB, we have something called no pile-ups where you get into the car wash and you can run a very fast throughput through your car wash and it prevents vehicles from knocking into one another, which is actually a thing. So be careful, Julian. If you're ever in an accident in a car wash, it's actually your insurance that pays but you can actually increase the throughput there. And I wouldn't get into a car wash without that, but it's definitely AI-enabled. We have the hub, which is for underground equipment. We call that environmental that is providing remote diagnostics, and those are a couple of other applications. But we're also getting a lot of cost benefit and pickup. Anshooman, you want to talk about that?

Yes. Especially in our R&D organization. We have over 1,200 software engineers that are 90% plus are using AI as part of the standard work process. We have seen that the velocity of our Sprints or EPX series of Sprints has gone up well into the double digits as we've used AI for cogeneration of code, and we're also using it for automated testing. So as a result, when the velocity of the Sprints goes up that significantly, you have, one, an option to increase the amount of R&D you're doing. But second you can start lowering your costs. And so we are actually going to be reducing cost in R&D, which is part of a $15 million in year savings that we've talked about, where the cost is actually coming out. Another quick example is for our internal IT organization. We're rolling out AI for answering, help desk tickets. So we expect very conservatively -- over 30% of our tickets will be handled via AI without human intervention. And even where human intervention is needed the analysis that you can pull through that used to take 4 to 8 hours can be done in less than 30 minutes. So it really helps with the productivity out there. We're using AI for cybersecurity, for monitoring, looking at unusual data patterns et cetera. But the next opportunity for us is around our customer service. We have a large customer service organization and using AI enablement for basic Level 1 helped us support for our customers is not only a good benefit for us from a cost perspective, but will also lead to higher customer satisfaction if you can get an instant answer. So there are multiple layers. Some of them are already embedded in our guidance and execution as we speak and some are to come, and that's why we feel there's a runway of opportunity on self-help ahead of us.

Fantastic. And maybe on the very near-term, switching to the sort of overall Vontier company-wide. Since the guide looks a little bit back-end loaded at first glance, whether on the top line or the EBITDA margin progression. So maybe help kind of flesh out why that's the case and the sort of confidence in that improvement?

Yes, Julian. There are a couple of ways to break down our guide for Q1, and we kind of gave an implied model for Q2 in there at our earnings call. One is obviously the traditional way, if you look at it year-on-year, and we do have harder compares in half 1 because of a couple of larger projects last year that drove revenue earlier in the year than typical. The second way is, if you just look at our traditional seasonality, Q1, Q2, Q3, Q4. And if you really look at 2021 through 2024, those 4 years, we did roughly a little over 48% of our revenue in half 1, which is what we guided to for half 1 of this year. If you back then in those 4 years, Matco Expo used to be in Q1. So if you physically moved it from Q1 to Q2, which is where it has been in 2025 and now in 2026. We typically did 23.5% of our revenue in Q1, which is exactly squarely where our guide is at the midpoint for Q1. Margins also last year was a little atypical where margins in Q1 were the highest all year. That's -- as volume develops this year, normal seasonalities, we get some of the benefit of that. Additionally, the $15 million in-year savings, we're in process of executing those right now. So there will be some benefit in Q1, but most of the benefit starts in Q2 and fully ramps up in Q3 into Q4. So you get some tailwind from that. And then the additional comfort, I'll say is if you step back to how our end markets are performing and jumping from the segment view to the end market view the 3 end markets we serve. Convenience Retail, our exit rate was pretty attractive. The market remains constructive and innovation is really reading through. And that's why we're growing above market and taking share. So that we expect will continue. Fleets where we have the vehicle identification system, what Mark had also referenced. We had a very large project there last year in the Middle East in half 1, both Q1, Q2. We won another project in vehicle identification system. That delivery will start in the back half of this year. The reason is we have to deliver the proof of concept, the customer pilots it. They go through their certification and then you start a rollout. Again, these are handling payments in a very secure fashion. And if payment isn't working, your store isn't working. So it takes a little bit of phase, but we have a track record of delivering these projects on time. So we feel pretty good about those end markets. On repair, we saw stabilization of that end market. And we have initiatives in place that we're doing to really help ourselves in that from a volume perspective, and we're guiding to roughly flat for the year in there.

Perfect. That's very helpful, Anshooman. And maybe sort of dial into Invenco a little bit. It's been a very strong growth. How do we think about the sort of trend growth ahead? What's the pipeline of wins looking like in terms of sort of projects that you're going for?

Yes, let me start off with just a little bit of background on what you're seeing currently in the business. So Invenco is doing a great job, particularly in 2 areas, but both of them are thematically around the same thing. We are essentially making investments, solving customer high-value problems around people that are trying to scale the infrastructure, whether it be inside of the convenience store operator, where the large regional, national, multinational oil companies are building out their footprints, buying up smaller players and they're having to manage that network and doing it in a more effective way unified payment that we talked about is a great example of them being able to do that or when we talk about FlexPay and NFX, working for Costco, as an example, to speed up their transactions, those are great examples of that. The other one is on the fleet side and fleet operator that we also discussed. And so what you're seeing happen with the business is a result of us putting development in place a couple of years ago, and you saw an increase in our R&D expense, but now you're beginning to see those green shoots coming through. And these are also mission-critical capabilities that we're talking about and folks take a bit to digest what -- how they want to go after it and then they roll it out. So it's a little bit difficult for us to tell exactly when in our guidance that some of these rollouts will occur. But I think what you should take away from what you've seen, particularly in things like Q4 is that there is a great runway of these opportunities. Another thematic around this that shows up in mobility technologies as DRB and Patheon. So all of this is innovation-driven growth. All of this is at a relatively early stage in terms of the penetration in the industry for these kind of applications. And it's also indicative of our differentiation where you look at -- we're providing solutions from being either #1 or #2 in our brands in these siloed ways that are now coming together, and we've reorganized around this last year. We've an organization around convenience retail, where we have a head of sales for Convenience Retail, Chief Product Officer for Convenience Retail, Chief Technology Officer for Convenience Retail, same thing for fleet. And so we're bringing these solutions to market also in a more concerted way so they can also work together. And I think you're seeing that growth uplift as a result.

And so I think sort of what double-digit revenue CAGRs are realistic?

Yes, I think for 2026, we think Invenco is more mid-single digits after 2025 being north of 20% and 2024 being anywhere similar to that. So -- but I think longer-term, this should be a high single-digit kind of growth business because of the innovation we're bringing and the high customer pain points we're solving that are really driving productivity and automation. And the interesting thing is it's like LEGO building blocks that take a slightly different shape and solve different problems for our customers. We talked about Shell and Chevron in the past where they did a countrywide adoption because it helps them manage their payment complexity. Costco Canada was a slightly different use case for them, where we significantly improved the throughput by speeding up the transaction. And there are other customers where we have a large national account, which is looking at the same payment terminal across to simplify their complexity, but also improve the consumer experience, you can drive down media, you can drive down loyalty and start steering the consumer at the end of the day. So all of these are playing out as we speak.

One of the things that maybe what people miss in this is one thing that is very helpful is that we have a very extensive service network of technicians that know how to work on our products. And in fact, that's best-in-class what's available. That happens through our partnerships on our 2-step distribution model, even though these sales are made direct. And that's also a really important part where when you do these rollouts, they want to see that you can stand behind this with a really strong service network. And because it is like we're seeing that foundational layer that we're providing is so mission-critical. And so it's something as we build this ecosystem out that we can continue to add to it and particularly because we have such a strong service network.

And then drives and telematics came up a little bit at the beginning of our discussion. How satisfied are you with the sort of turnaround effort as it was telematics? And is that kind of steady state and growing decently. And then drives, what should we expect there kind of medium-term top line growth?

Yes. So on the telematics side, we had to get out of some technology debt. We've launched TN360. Then we also ran into some countrywide transition from the 3G to 4G network and when telecom companies were cutting over on a countrywide basis, we had some churn as a result of that. And I think all that's behind us. Last year, we grew operating profit by 50% for the first time, cash flow positive. Churn rates have dropped. We had a really great bookings in Q4. We started this year really strong. So I'm glad that those things are beginning to come together. It's well below fleet margin. So we have real opportunity there for uplift. On the drive side, this is -- when we bought it at its infancy, we've really moved that into the #2 player worldwide with plugs under management. We're seeing some really steady growth. It's still -- if you look at EVs, they're still relatively in their infancy in Northern Europe, Nordics, clearly, U.K., it's -- we're the market leader there and adoption is going really well. But in the U.S., it certainly had a slowdown. But we believe EVs are here to stay. We think this is a very sticky way by which operators of charging networks have to be able to manage their networks and we continue to get really good growth out of that business. And as a consequence, if you look at also what's going on in fleets and convenience retail, particularly on the convenience retail side, a lot of these folks sit on the right street corners and for them to incorporate EV into that into their offering is kind of a no-brainer. We saw this actually in areas which are more mature on EV charging and they want to have the benefit for the consumer to accrue to the people that own that property, not necessarily just the ChargePoint operator. So we've definitely seen a trend where the convenience store operators are also getting into that business. So I think it's got a long road for EV. I really like the position that we're in because we don't have to play political football when it comes to our guesswork, whether we know who's going to be in favor and which incentives are going to be in favor. We're selling a lot of high-flow diesel pumps right now because contractors are using those kind of trucks and they're servicing your neighborhoods with plumbing contractors and yard contractors, and they're driving a lot of diesel vehicles. But at the same time, we're advancing our EV charging network in areas of the world that appreciate that. And I think the important thing, Julian, is not to be able to guess what is going to be in favor, but to have the right portfolio and do it at the right return on capital. I mean, we're doing this in a way that we're in the right profit pools that I think are sticky for the long-term, and we couldn't have said that about the portfolio 3, 4 years ago.

And you mentioned the aspect of some good revenue synergies across the business. If you think about the total kind of gas station pad and C-store attached there and so forth, how are you thinking about the Vontier firm-wide dollar that's addressable or dollar content per station?

Yes. So I think our -- the way we organize in the back half of last year really gets to your question because we see a lot more synergy by bringing our siloed solutions together and selling a lot more share of wallet. We know that after a couple of hundred thousand dollars we might have by selling dispensers and underground technology can be enhanced a lot when you look at all the other offerings that we have around car wash, point-of-sale, unified payment, new offerings on the hub. And we can get a couple of hundred million dollar uplift by fully exploring our share of wallet opportunity there. And our new organization structure really helps us get at that. We have a similar kind of opportunity on fleet and fleet operators. And now we've organized around that. And then there's a third dimension is go look at developing countries versus developed countries. A lot of developing countries have a fueling kiosk. They might have 2 dispensers. They have a person with a long stick, Julian, that tests the level of the fuel with a long stick. I mean this is far from the modern convenience store experience with automatic tankages and having a convenience store experience. And when you start measuring the dollar content uplift, now I don't think this is a 2-year thing. I think this is over a 10-year plus thing. There's a major uplift in the content. And by the way, it's more sustainable. Governments are very interested in the sustainability of this. I don't think leaching fuel into your groundwater is political football anywhere. I think pretty much across the globe, governments are really interested in that. And the other thing that is really tied to is payment security. Governments and people are really interested in that because fuel theft is a really big thing on a global basis and that is responsible for a lot of illicit crime rings that are involved with that kind of thing. Governments want to break that down. They also want their share of the tax revenue and so none of this is -- what we're talking about is political football. It's all about providing better, more sustainable solutions that the public is really interested in, and it creates great uplift for us. There's great regulatory drivers that we can able to latch on to, great margins provided and I think great business model for the long-term.

Fantastic. And then on the repair side, you had very high margins, just a few years ago, sort of bottoming out at 20% plus right now. What do you need to get the repair margins back to those prior levels?

Yes. Let's break down the margins from the mid- to high 20s down to the low 20s right now. So if you look underlying, the gross margin was around 50%, it's still the same. So it's not that we've discounted or we've lost price or cost has gone up, our gross margins are intact. If you look at our SG&A at that level at those years earlier years, it's relatively flat despite inflation. We managed that. So really, there's 2 aspects that's impacted profitability. One is the volume deleverage as we've had 2 years where volume came down. It came down at that roughly 50% gross margin. And the second was post-COVID when the amount of stimulus that was put in and with people don't have anywhere to go, personal savings went up and the delinquency rates were at the lowest they've ever been and write-offs were the lowest they've ever been. We've seen delinquency and actually the write-offs move to the higher end of the range, but they're stable 2024 to 2025, they haven't gotten worse, and we're managing that by having a better book of portfolio, more stringent underwriting standards. But over time, they'll start shifting back. Really for us, as this business starts growing, the drop-through or the leverage on that is going to be pretty darn good because the infrastructure doesn't need to grow to scale that. And then also with time as we continue to focus on improving our underwriting standards, be a little more stringent and that starts leading through the portfolio as the portfolio mix keeps shifting. But also as ultimately, we aren't counting on it, but ultimately, as the economy for the lower -- the working class consumer improves, we'll see some benefit. But really for us, right now, it's -- we're excited that we're seeing this year, we expect will be relatively flat from a volume perspective and that should hold margins also relatively flat.

Great. And so lastly capital deployment, how are we thinking about priorities there?

Yes. So our capital allocation policy is unchanged. We say it's dynamic because we will always go to what the highest return option for our shareholders. At our current valuation, stock buybacks are very attractive. And we have an internal model where we look at our high confidence plan over the next 2, 3 years and say, based on that, even keeping the same multiple, where should our stock trade and what's the return, and we compare that against acquisitions. So buybacks remain very attractive. At the same time, our M&A pipeline, we continue to work. We have -- it's strategy driven, but it's also very focused around making sure we get the returns. So it's -- usually, you have to get the seller and the buyer to mind to meet and sometimes we take a shot at the goal, but the deal doesn't close because of that, we're very disciplined, and we're committed not to overpay for acquisitions by doing right.

I think, Julian, about the only way we can truly demonstrate, we believe that we're trading at a discount multiple is by really committing to buybacks. And I think we've done that. We'll continue to do that as we feel there's a real opportunity for our multiple.

Fantastic. And with that, we'll switch to audience response survey questions. So the first 1 is around sort of current ownership. Sort of fairly even. Secondly is around current bias or kind of attitude to the stock. That's the next question. So neutral-ish. Third question is around EPS growth for Vontier versus the sort of multi-industry average? So in line-ish. Next question is on usage of excess cash? Sort of bolt-on M&A. And then last, penultimate question on the valuation multiple. Where should the stock trade on kind of year 1 PE? Sort of mid- to high teens. And then last question, what's the biggest anchor on the valuation today. Organic growth. Good. Well, with that thanks so much, Mark and Anshooman. Thank you for being here.

Thank you for having us.

Thanks a lot.