Vontier Corporation (VNT) Earnings Call Transcript & Summary

Good morning, and welcome to -- certainly, welcome to the second day of Baird's 50th Annual Industrial Conference. We're very pleased to have this session with Vontier Corporation. Again, I'm Rick Eastman, Managing Director and Senior Equity Analyst here at Baird. And with my wingman, Rob Mason, I do head up the advanced industrial equipment sector here for Baird. So let me introduce Vontier very briefly. Vontier is a global industrial technology company focused on smart transportation and mobility. Their portfolio of 5 operating companies offer innovative solutions to advanced safety, security, efficiency and environmental compliance worldwide. Vontier was 80% spun out from Fortive on October 9 of this year and carries with it a proven business system, an experienced leadership team and a culture of continuous improvement from both Fortive and prior to that from Danaher. So with that, I'd like to introduce Mark Morelli, President and CEO; also Dave Naemura, SVP and Chief Financial Officer. And Mark is going to lead us through some overview slides here and get us oriented. We'll then have time for fireside chat questions from me. And if you have some question or 2, please send it to reastman@rwbaird.com, and I'll work it into the back end of the fireside chat. So with that, Mark, I'll hand off to you for the introduction. Mark, I don't think -- I'm not hearing any sound here. You may be muted. Here we go.

Okay. Yes. Thank you, Rick, for the introduction. We're certainly happy to be here. You can see here our safe harbor statements. I know folks will review them at their leisure. And just as a reminder, our slides will be uploaded onto our website if you want to access them. So turning to Slide 3. Vontier is an industrial technology company, a portfolio of market lead brands and technologies. And we have a large global installed base with low cyclicality. As you can see here in the lower right-hand portion of this slide and that pie, about 30% of our portfolio is tied to retail fueling hardware. About 20% is for auto repair. And then about 1/4 of our revenue is recurring revenue, and that's represented with a split between SaaS and service businesses. And then the balance of the revenue comes from environmental and retail solutions with smaller contributions from e-mobility offerings as well as smart cities. We have also excellent financial profile. And if you can see our strong margins here on the right and our strong free cash flow conversion, all of Vontier's financial characteristics are top quartile or in line with industrial technology premium peers. We have an investment-grade style balance sheet and strong cash generation and this gives our ability to -- an ability for us to drive both our growth and accelerate our growth as well as our ability to do M&A. And we have a Vontier business system, and that's something we call VBS. It's the foundation of our organic initiatives to enhance our growth profile and continue to expand already strong margins. And as you'll see, we have a proven track record of strategic portfolio transformation. Turning to the next slide, please. This is Slide 4. We have 2 major platforms: mobility technologies and diagnostic and repair technologies, and we serve an attractive $27 billion market TAM. These are excellent platforms for longer-term growth and the opportunity in each is to move up the technology stack. Our mobility technologies platform, or MT, consists of Gilbarco Veeder-Root or something we call GVR, Teletrac Navman in the telematics business and GTT, which is global traffic technologies, which is a toehold in smart cities. Our installed base positions us well to expand into attractive market adjacencies. This gives us the ability to leverage into e-mobility, smart cities and logistics and supply chains. Our diagnostic and repair technology platform, DT, it consists of Matco and Hennessy businesses. Our businesses leverages increasing miles driven and aging car park and increasing complexity of repair. And this gives us the opportunity to leverage workflow solutions and diagnostic solutions. Turn to the next page, Slide 5. This is something we call the value creation flywheel. We are well positioned with our business model to create value through reinvesting strong cash flows to compound earnings through M&A. Our longer-term model is for core growth of GD plus -- GDP plus in revenue as well as margin expansion. And as Rick said, the separation of our 5 operating companies really gives us an ability to enhance focus and this gives us a significant runway for improving profitable growth. Our strong balance sheet at separation is investment-grade style, and it sets us up to accelerate growth through M&A and compound earnings and the Vontier business system, VBS, has its roots in the Danaher business system and the Fortive business system, and this is a heritage that few can lay claim to. Turn to my last chart, Page 6. In summary, Vontier is a high-quality, low cyclicality, industrial technology company serving a large and attractive market. VBS is the foundation of what we do, and it enhances our organic growth profile and further expands industry-leading margins. Our capital deployment will be focused on strategic and financially disciplined M&A, and we have an excellent runway of improvements ahead. We have the expertise and leadership to execute a transformational compounding strategy to unlock shareholder value. And we think we have a great business with lots of runway for improvement. So thank you for your interest. We're excited to mobilize the future and create a better world. With that, Rick, we're really happy to take your questions.

Okay. Excellent. And as mentioned, if you have any questions and you're listening in, please e-mail to reastman@rwbaird.com. And we'll definitely work those in. Hey, Mark, I wanted to just kind of lead. We're just kind of pulling all of our companies here at the conference. But given the recent transition here in the administration, I think we can call it that in the U.S. Any thoughts around -- any impacts that might be hanging out there, either maybe easing of tariffs as a positive or just any -- should we -- at Vontier, are we kind of leaning into this change in administration? Or leading the way?

Well, I would definitely say we're leaning into it. But the tariff aspect you brought up was not a big impact on us. We used VBS and we've kind of mitigated that impact a long time ago. So that really won't necessarily break our way either because I think we've already mitigated it. However, when you talk about things that we love, it's about regulation because that drives many of our industries. And if you see what's going on in terms of a possible $2 trillion investment in clean energy and also infrastructure build-out, these kind of things can help in smart cities. So these are great things for our business. And so we look forward to seeing that. And that -- by the way, that kind of regulation drives our business today. So more regulation in terms of where we're headed, can definitely provide some stimulus and help.

Okay. Yes. No, good points. Yes, we in the financial services industry, don't like regulation. So I'll put you over there as a beneficiary of more regulation. You could be my trade, short the financials.

We'll take that.

So Mark, I mean, now you were recruited in as President of Vontier back in January of '20 and have been really shepherding Vontier through the spin-off process, lots of work, I'm sure, on your part to get up the curve on the businesses themselves. As you sit here now, largely spun off, what would you define as maybe your 3 top, I'm going to say 12-month priorities here right through the spin?

Yes. So I think it's a great question because it really gives me an opportunity to talk about where we're focused. So as you may know, our business has been benefiting from one regulation, which is the Euro, Mastercard and Visa chip-reading technology in the U.S., and that's something called EMV and that tailwind will abate as we go into next year. So the key is that we get other engines of growth up, both in terms of organic growth as well as also start working on M&A as well. And also, there's an excellent runway for us to improve the profits on that. I think the second one is working on the portfolio strategy. We talk about transforming this portfolio. So very attractive spaces, but working out exactly the portfolio transformation over the next 12 months will certainly fare prominently. And then, of course, leadership development, part of staying up a company is a unique opportunity to launch a purpose-driven value-driven organization where we can leverage from the past, but also build into our future. And so part of this leadership development, it's a really unique opportunity, and I'm very excited about that because I think we can derive a lot of value from that.

And does the structure here -- as you see it emerging around Vontier, is the -- do you have all the leadership in place that you need for the various businesses? Is that pretty much done at this point? You're comfortable there?

I've been here 10 months, and the team has worked very hard from sort of the announcement of the separation by Fortive more than a year ago. So we've definitely had time to work on that. We've built out our management team. I couldn't be more pleased with the talent that we've been able to attract to the company, both the folks joining us with a Fortive and Danaher background, and there's many executives that have that as well as we're standing our headquarters up in Raleigh. It's been a great place to also hire and attract new talent, too. So very happy. I'll tell you one of the things that I've also learned here, Rick, in my last 10 months is I couldn't be more impressed with the folks that we have here in the business. You're always sort of surprised by certain things, and this is one real pleasant surprise, hardworking, performance culture people with a deep, rich heritage, particularly in the Danaher businesses, because many of the businesses came from Danaher as well as Fortive as well. So that's deeply rooted in our culture, and it's an excellent thing for us to be able to carry forward.

Okay. Okay. Fair enough. And then I did want to just touch on this issue. Over the next -- and I kind of prefaced that a little bit with 12-month priorities here given you're now independent. But when you think about Vontier's portfolio, do you think in terms of portfolio transformation? Or do you think more in terms of migration? I mean, we've got our balance sheet. We've got capacity. But over the next couple of years, is this a function of kind of migrating the portfolio towards more interesting areas or -- and taking care of short-term issues? Or is there this -- is this a portfolio transformation on the horizon? Is that the right way to think about it?

I think when you think about a 3 to 5-year horizon, I do think that, first of all, we have some great near-in adjacencies. These are not far adjacencies, the ones that I talked about, in my remarks here, they're all pretty near-in, but they do, I think, represent a good opportunity for us to -- over that longer-term horizon to be able to transform our portfolio. And I think you've seen other companies that we have a real tension for this in our own business. If you look at the acquisitions and transformation that we've done through this portfolio over the last 10, 15 years through M&A and also through organic growth. And I think with the age of mobility is changing more in the next 10 years than it is -- has in our entire lifetime. So I think it represents really great growthy near-in adjacencies for us to be able to pick through and to, over a longer period of time, transform the portfolio.

Yes, fair thoughts. And then when we sit here now as a public company, and we're going to push into '21 here, talk a little bit about your incentive programs for your senior management, also the operating management and maybe what those metrics start to look like for '21? I mean, are they a profit-focused, growth-focused, maybe you could kind of speak to where the emphasis is for '21?

Yes. Well, I think you should expect something pretty similar to what you've seen in terms of Danaher and Fortive. There's a very a regimented way with annual reviews. And when you look at each of these operating companies, there's an element of core growth, that's part of the incentive. There's an element of driving profit, and there's an element of driving -- excuse me, strong free cash flow through working capital management. And I think there's a real ability here. I think you see that in our numbers that we've been able to take outsized growth opportunities in EMV. We've positioned ourselves exceedingly well for this. I think you're seeing that flow through our P&L now. And then as we continue to work forward into the next year, I don't view that you'll see very dramatic changes there. It will be more of the same.

Yes. Okay. Okay. Fair enough. And then I'm going to start -- I usually like to start with the big time positives here. And I guess you can -- we can make this into a positive here, perhaps on the cost side. But I'm going to just kind of start where I have to start when I pitch Vontier. But when we talk about this, the EMV sunset at Gilbarco, maybe I think what's out there in the marketplace is kind of this $150 million to maybe $200 million revenue decline off of kind of a peak number. But maybe just define what's out there and then speak to me about is not -- what's the bull-bear case around the revenue fall off on the sunset side -- on the back side of this?

Rick, it's Dave. I'll take that one for us. So the $150 million to $200 million that's out there was, frankly, what we put out is our best view at a point in time when we went through the road show associated with the spin transaction. And we see that as the -- not a peak to trough number, but the 2021 decline over 2020 from what we kind of know now. Now we also present that with the caveat, the understanding that Q4 is an incredibly important time for us to continue to get visibility. We have a lot of -- a little more market share, I should say, at the larger customers. And as EMV adoption continues to progress, as you know, it's been evolving for the last 5 years or so or 6 years. And so we see some of the larger customers adopting earlier. And then we see the average size of adopting customer we believe will continue to come down over the coming quarters. Very important for us to see what the behavior is in the fourth and also get a feel for people's capital plans for next year. So we think as we move through the fourth quarter, understanding people's capital plan spend and really get towards the deadline will continue to refine our view of what next year could look like. It's all about the shape of the tail. We think the tail goes well beyond the adoption deadline, but it's harder to predict for the smaller customers, of which we have thousands and thousands. So much easier to predict a few hundred larger customers, but much more difficult to predict thousands of smaller customers. So we would anticipate getting through this. Updating our point of view, we've tried to be very transparent. That's where -- that was the reason for putting the number out there. We want people to understand what we're seeing, and we'll continue to do that when we have better information. And then really based on that understanding we have today, that's a serious top line headwind for next year. We wanted people to understand that. But also then working to build a path towards how do we hold maybe not OP, but operating margin next year, and that's what we're working on trying to build a path towards right now.

Yes. Yes. And so in your context, Dave, again, as we annualize on that sunset, one could expect at this point to pick up second half might be this $150 million to $200 million, first half of '22 until we annualize, there's a number there to think about as well?

Yes. I think, look, inherent in that is, ultimately, we got to see what the shape of next year is, and it really comes down to this adoption time line behavior. But I think it's logical to conclude that the deadline in Q2 remains a bit of an event out there. So we'll see -- and when you roll through to 2022, that the first half compare will be more difficult than the second half compare in '22 until we get to a little more normalized state.

Yes. No, I think that's fair. And for what it's worth, I mean, we have about $400 million in with half of that in the second half of '21 and half of that in the first half of '22. And again, that's our approach on this thing, but it does capture the lack of growth split over 2 years is kind of what captures and kind of creates this as a priority question with people. But anyway, that's why I kind of raised it early in the conversation here. And is there a path, again, on the back side of this, we're going to have, in theory, a structurally smaller business, maybe we have an elongated replacement cycle for dispensers. Does -- how much of the -- is there a path to perhaps manage the decremental on this business to a 30%, if I assume a 30% incremental on this business, the EMV business at Gilbarco? Is there a path to managing the decremental to 30% or less? I mean is that conceptually the process that you're thinking through? Or...

Conceptually, that is the process we're thinking through. So when -- we've always talked about this business as being kind of a 30%, around 30% incremental decremental business. In fact, in the second, which was a very tough quarter, you saw us hold on to a decremental that, I think, was right around 30%, maybe 32%. Now that included a number of temporary actions, which will come back at us next year, but we'll also have significantly better compare in that second quarter where we had where those temporary costs were taken out and fundamentally came back into the business. This business has a reasonable amount of variable cost. So I think the idea of being better than that 30% is, of course, possible, but I would say not probable. The EMV revenue is pretty strong margin revenue, given what it is and where it is and it has a higher kind of electronics kind of component to it. And so it comes off at a little better mix. But the work we're going through and some of the things Mark outlined on the roadshow around, look, as volume comes out, we got to make sure that some associated cost comes out as well. And that's kind of inherent in the way we go about kind of running the business, if you will, Rick. Beyond that, as we have been pursuing this revenue for the last number of years, we believe there's also a number of productivity opportunities that we've foregone to make sure that we captured our fair share of this regulatory super cycle, we'll get back to those items as well. Also, we've talked about a couple of businesses that we think have opportunity for -- that are operating right now, well below kind of the fleet average here. And we think there's opportunity to improve that. And so we talked about Teletrac Navman. We'll talk about Hennessey as well, we think we've got a good path on both of those businesses. And finally, we run a large global business, and the opportunity of focus, kind of the basis of the separation allows us to get that much closer to it, and we think there's opportunities in the business to continue to drive simplification that should accrue through the productivity. So those are the types of things we'll pursue to make sure we try to manage the decrementals to our expectations.

Yes. Fair enough. And not to stick on this one point. But again, we will come through this with a leading share in terms of the EMV updates -- upgrades, we do come through this with a large installed base. I mean a pretty impressive installed base. And other services that can be sold into that installed base, could you just speak to that opportunity?