Vontier Corporation (VNT) Earnings Call Transcript & Summary

All right. Good afternoon again to everyone. We're delighted to be joined by the Vontier team. With me, we have Mark Morelli, CEO; and Dave Naemura, CFO; Lisa Curran of Investor Relations is also here. And what I'm going to do now is kick it over to Mark for a couple of prepared remarks, and then we'll jump into Q&A.

Yes. Thank you, John, for having us. Really happy to be here. If we've got a couple of slides that you can follow along with. You can also reference them on our website. You can see our safe harbor statement, which you can certainly reference at your own proposition and then go over to Slide 3 because that's where we're going to start off on. And -- so Vontier is an industrial technology company at scale with a portfolio of market-leading brands and technology solutions. We have a large global installed base with low cyclicality. If you look at our revenue profile shown here in the lower right, about 30% of our revenue comes from retail fueling hardware, 20% from auto repair, and about 1/4 of our revenues are recurring revenues. And this is split between SaaS revenue and service revenue. And then the balance of our revenue predominantly comes from Environmental Solutions and retail solutions. Smaller contributions of our revenue come from smart cities and e-mobility. We have an outstanding financial profile and strong margins and free cash flow, shown to the right-hand side of this slide. In fact, we're top quartile or in line with premium industrial technology peers. We have an investment-grade style balance sheet and strong free cash flows, and this gives us an ability to invest in our business and to accelerate growth through M&A. VBS, or the Vontier Business System, is the foundation of how we get things done. It's our business systems. It's also the basic or organic initiatives to enhance our growth as well as to continue to expand already strong margins. And we have a proven track record for strategic portfolio transformation. If you go to Page 4, we have 2 major platforms: Mobility Technologies, or MT, and Diagnostic and Repair Technologies, or DT, and this represents an attractive $27 billion market that are fragmented and growthy markets. This is an excellent platform for long-term growth, and then gives us the opportunity to move up the technology stack in each of these platforms. Let's take a look at MT, or Mobility Technologies. This consists of 3 businesses. Our largest of which is GVR, or Gilbarco Veeder-Root. We have a smaller business in GTT, or Global Traffic Technologies, and we have a fleet monitoring managing business called Teletrac Navman. This is an excellent installed base, and it allows us to expand into attractive adjacencies, such as e-mobility, smart cities, and logistics and supply chain. Diagnostics and Repair, DT, as I mentioned, consists of our Matco and Hennessey brands. And there's great drivers here, like increasing miles driven and aging car park and an increasing complexity of repair. And all these are great backgrounds to drive our businesses. And this platform gives us opportunities to leverage into workflow solutions and diagnostic software. Let's turn to Page 5. This is what we call our value creation flywheel. And we're well positioned with our business model to create value through reinvesting strong cash flows to compound earnings through M&A. Our longer-term model here is for core revenue growth of GDP plus and to continue to expand already great margins, and we're looking at expansion of 25 to 50 basis points of OMX. Through our separation from Fortive, we have an enhanced focus on these 5 operating companies I showed you on the previous page, and this gives us significant runway for profitable growth. Also, part of our business model is leveraging a strong balance sheet at separation, its investment-grade style that accelerates growth through M&A and compounded earnings, as I mentioned. It's rightly represented here, too, because VBS is at the center, it is what we do, it's how we get things done. And it's got roots in the Danaher business system and the Fortive business system, and it powers our business model. This is a heritage that a few other folks can really lay claim, too. If you go to my last chart, in summary, Vontier is a high-quality, low cyclicality, industrial technology company serving a large attractive market. VBS is our foundation. It's the business system by which we enhance our organic growth profile and further expand already strong margins, and we have an excellent runway of improvement opportunities ahead. Capital deployment will be focused on strategic and financially disciplined M&A, and we have the experience and leadership to execute a transformational compounding strategy to unlock shareholder value. So thanks for your interest. We're excited to talk about our business today, and we're excited to mobilize the future to create a better world. With that, John, we'd love to take some questions.

Great. And thank you for that introduction there, helps set the stage for sure. We've been asking everybody. And first, I'd like to say thank you for having a guidance framework out there for Q4. But as we stand here in December, anything that you would either highlight as it relates to the guidance you laid out on the last quarterly call, I just want to give you an opportunity.

Yes. Well, we appreciate that. There's no update from our third quarter remarks that we made. As you may remember, third quarter outlook already contemplated some uncertainty in the market related to the pandemic. At the same time, what we've also talked about is leveraging VBS, which I talked about in my prepared remarks as well, and that's served us exceedingly well, as you can see through our performance through last quarter, and we're optimistic that we continue to pull the levers that we are able to manage accordingly. And just from a macro perspective, we believe that China continues to be soft, and the national oil companies in the United States have had continued to buy through the EMV cycle. And these kind of trends that we talked about are still in place today. And then we continue to see healthy demand, too, and serving that demand is our job to do in these difficult times, but we're pretty happy with our performance so far and continue to be optimistic through the launch of Vontier.

Great. And then I guess as you think about the launch of Vontier, right, so you spun out from Fortive right here in the midst of COVID, obviously, only a couple of months here under the belt. But what have you either had to accelerate or maybe push to the side as you're dealing with the pandemic relative to that initial strategy you laid out for investors?

It's -- we're certainly living in interesting times and separate in a company in this environment brings its own challenges. At the same time, it also brings some unique opportunities, to launch a company in this kind of environment, really brings the management team closer together. We've had to do a fair amount of hiring, bring the team closer and dealing with some of these issues. In the intensity of having to manage the business has really formed strong relationships. And we think this has not only given us a great ability to manage what we're able to do now, but also it's going to set us up exceedingly well for the future. So managing through adversity is one way to form good teamwork, and we're kind of taking advantage of that opportunity, if you will. At the same time, I mentioned VBS now a couple of times, but it's an excellent time, too, because we're able to deploy quickly, while part of Fortive, the business system, which was FBS, and we've taken that directly into VBS and into daily and weekly KPIs and how to manage that and deploy around what we need to deliver on, and that served us exceedingly well. We've had to do some shifting of resources. We call that DRA, or Dynamic Resource Allocation, and we've obviously taken advantage of that as well. We've had to deploy online Kaizens. If those of you that are familiar with that, it's typically an in-person, pretty intense process. And -- but it's worked really well online. And so we've deployed digitally many of these tools and capabilities, and we're actually surprised on how well they've worked out for us. So I think some of the thing is that we also have to work through, too, is we're pretty happy with where we stand on the M&A front. But as you know, this -- the Bid/Ask spreads have widened kind of through this pandemic process. But we're pretty happy with seeing where we are and look forward for good things to come.

Great. So maybe we could talk about GVR first, right? Largest business. You are selling multiple different products into that retail fueling station, whether it's the dispenser, point of sale, et cetera. One, I don't know if you could put a number around what is that actual opportunity per retail fueling station as you see it, if somebody took all your complete solution? And then a follow-on to that is, I think the dispensers, the largest part of that number, as I understand it. Does that pull through other stuff? Or is it a bundle, I guess, is kind of another way of asking the question, but just trying to understand a little bit better about how your customer buys your solutions?

Yes. Let me describe that to you. So first of all [Technical Difficulty] the most sophisticated C-store format that you have out there. And typically, the content is anywhere between $75,000, $100,000. And and it's not only the hardware in the forecourt, which is what you see as you refuel your car or your truck and then also below ground equipment as well as the point-of-sale system inside their retailer head office system, how the fuel might be managed and delivered to the site which is the back office systems. So there's lots of software that's also part of that. So a lot of automation, if you will, of what you sort of see in that whole operation and really a strong linkage to how that retailer makes money to the pure point-of-sale, some even including advertising. And so that's a pretty sophisticated offering, which includes environmental regulation and compliance to safety compliance to, obviously, how they make more money. When you look at outside of the United States, that content is very different in a refueling kiosk in a high-growth market is mostly about refueling operations, that might only be $25,000 per footprint. But what's happening is there's a trend for greater automation because of the need for greater security. And one of the reasons is security of -- are you making sure you're going to get a gallon or liter of gas? And so how you do that through automation and more software? So they are typically going more higher end. And as they go more higher-end and offer more automation there as well as for compliance reasons, for environmental issues and for safety, the developing countries want all these things, too. So that adds to a capability to move up the food chain, if you will there as they build out their refueling infrastructure as well. Part of you -- what you asked for is the bundling question. And it's a little bit different. In the smaller -- in the United States, the smaller network folks, there's typically not a bundling. But in the -- more in the national account-type footprint in the United States, there might be a bundling of the product. But it's interesting while dispensers might represent 45% of the sales, we're actually using bundling what those national account folks more with the point-of-sale system because that's their point of actually reference for making money where you can add the most value to them, and that actually can pull the rest of the sales, such as dispensers.

Great. That's a very helpful answer. So then I guess the follow-on question to that is if we -- and maybe it's too soon, but if we were to look into the future more around an EV-type station, or maybe you can answer this today, does that dynamic change versus a liquid pump dispenser versus an EV dispenser?

Yes. So I think you answered a little bit there yourself. It's pretty early innings. Keep in mind, the carpark itself, less than 1% of the global carpark or 1.2 billion vehicles is electrified. And that will certainly grow at a rapid rate. But even by 2030, it's still going to be less than 10% of the global carpark. But as that builds out, we're currently very involved with how decisions are being made and how that might play out. In fact, that's why we've done 2 investments in the Tritium and Driivz because that really gives us a front-row seat there. But we're pretty convinced about is that retailers are in it to make money and we're in it to help them do exactly that. And through things like our point-of-sale system, our head office system, our software solutions, is something that's going to be pretty integral regardless of whether they're selling beer, making sandwiches, doing refueling operations or doing electric charging. So I think being part of that, and being integral to that predominantly where we do that in the United States today, and obviously, we look to expand that is an area, I think, of interest pretty much for every retailer.

Yes. Maybe shifting gears a little bit here, but I think you guys have been very public about the EMV headwind that you see for next year in the U.S. I think you also noted a little bit of a potential headwind out of Mexico. There are some things to offset that, right? You have I think some growth maybe in India coming depending on COVID, but what are the sizes of some of these offsets to that EMV headwind that you see today?

Yes. John, I'll take that. Your point is right. So first of all, EMV is just North America for GVR. Granted, it's been a great tailwind. And we will hit the adoption deadline in April of next year. And how that exactly plays out is something we're going to continue to update folks on. We're taking our best estimate and share that with folks at the time. We've also got a little bit of a headwind out of Mexico. There's been a strong fiscal regulatory driver down in Mexico that we've seen some benefit from beginning in the third and kind of continuing through the fourth. But we would anticipate seeing recovery for the rest of GVR, not -- as well as kind of North America, non-EMV, but more rest of world as well, including high-growth markets. We expect to see a rebound in both China and India. Probably a little more confident with India on the back of some secured orders. A little more uncertain environment in China as the national oil companies have profitability that gets impacted by lower oil prices. So we'll see the degree to which that recovers, but we do anticipate return to grow sort of, kind of mid- to high single digits in emerging markets. When we get into next year in those areas. At this point, we'll see how COVID plays, but we don't think COVID will be a big impact around year-end or pushing demand out of the year. We've talked about strong EMV as we come through the back half of this year and continuing into next year, and we anticipate that's what we'll continue to see. Also, our diagnostics and repair platform has historically been a very nice low single-digit growth business. And I would add that this year, there will be a bit easier to compare, particularly in the second of that business. Now some of their events might might change when things happen depending on COVID availability and some of those things that historically have been a little more seasonal in nature, but we anticipate that being a tailwind for us next year as well, kind of returning to that steady growth and aided a little bit by by the easier compare. And that would also include continued franchise growth at Matco, where we talked also very publicly about having about 30% of our territories unpenetrated in that business and continuing to sign up new franchisees. And then John, aside from revenue, of course, we're pursuing -- leveraging VBS to pursue a number of activities to help operating profits, both in terms of simplification, as EMV rolls off and not just from EMV volumes declining, but also we have a very large, very global business. And I think we have opportunity to drive some simplification there. We have a couple of operating companies. We've been public about saying, "Hey, they're -- they're below the fleet average op levels, and we think there's an opportunity to bring those up." So we'll be concentrating activities on those as well. And then finally, you saw us announce the beginning of some restructuring here in the fourth. And that is really restructuring that kind of facilitates some of these activities, but there's a little more permanent cost takeout, whereas most of the actions we took in the midst of the pandemic were very temporary in nature. And then the last thing I'd say, of course, all of that is before M&A, which remains a capital allocation priority for us and a lever, which, of course, will be episodic in nature. But something that we see as a growth opportunity in the future as well.

Very helpful. I guess, since you touched on -- or both of you touched on M&A, always difficult to know the timing of anything, but how are you feeling about the pipeline? You did comment on the Bid/Ask spread earlier. And then anything around some of the -- maybe the return metrics that you use as you evaluate potential transactions?

And let me talk to the return metrics, I'll let Mark maybe talk about pipeline. I think you'll hear from us return metrics and thresholds that you -- that we sound very familiar from our predecessors. We use ROIC as our primary valuation return metric. And we think of a 10% ROIC in year 3 for things a little more in the core, definitely for a bolt-on, and we hope to exceed that. And for things that are more adjacent, a little more strategic in nature, we would see maybe that 10% threshold, pushing out to say, a year 5. We have a variety of deals that we'll look at, things that are adjacencies versus very much in the core, an existing funnel today, and I would anticipate you'll see a wide variety of deals from us, probably a little closer down in the middle of the fairway in the earlier days. As far as markets and pipeline, I'll -- maybe I'll let Mark comment.

Yes. We're talking about sort of a Danaher heritage a little bit earlier. And Danaher and Fortive have always said it's difficult to predict the timing. But also one of the legacies here is that we do have a process in our operating companies where we have a robust pipeline and cultivation is sort of key to what they do. And so while the Bid/Ask spreads have been widening, we're pretty -- we're not surprised by that, but we're pretty happy with the position that we're in. As Dave said, too, we're looking at a variety of things, both bolt-ons, larger acquisitions, near-in adjacencies, for sure, are very attractive as well as many of these folks are in the hands of private equity companies today. So obviously, I think our approach there is probably not going to surprise people a lot. But our M&A capacity, I think, is significant, about $1.5 billion in cash over the next 2 to 3 years, driven by also strong free cash flow generation. And just keep in mind that our approach is that a disciplined approach, as I said in my prepared remarks that it's led by doing our strategy, how can we accelerate our strategy. It's something we're also spending time on, as you can imagine to make sure that it's strategy led and that we'll get to the right decisions based on that being out front for us. So happy to engage further and update you as we make progress.

You touched on earlier about the strong free cash flow margin of the business. We can clearly see that in what you've reported thus far as an independent company. I think you're going to have a very strong free cash flow quarter here in Q4 is what we're all anticipating. I guess the question is, as we look forward, is there anything just to be mindful of in, I would say, more near-term headwinds or tailwinds? Because I think you've -- over the longer period, you've demonstrated a very strong, consistent free cash flow margin. So just -- I guess the question really is, is there anything to be aware of near-term in terms of the absolute free cash flow generation of the company and then kind of the confidence that over the long term, you can maintain that strong free cash flow margin we've seen.

Yes. Great. You're spot on. The conversion ratios we've seen on a year-to-date basis have been extremely strong. And they've really been on the backs of -- through the third quarter of really unprecedented -- historically unprecedented working capital performance, and we leverage VBS early and often here to really get out in front of some of the potential headwinds in the teams at the operating companies have done an incredible job in managing working capital. We see some of that normalizing here in the fourth, but we'll still be at historically low levels that we hadn't seen. So I think, of course, we'll manage it, I think, as well as it can be managed. But ultimately, being so far below historic levels, I think things will normalize when we come out of the pandemic and kind of business activities normalize. So I think that could be a headwind next year, $50 million to $70 million depending, maybe 2% to 3% of LTM sales. We'll see how that goes. Also, there's a little bit of noise in the year around federal income tax payments as a nature as a function of the split. So by the time we get to year-end, we will -- our free cash flow represent 3 payments in 2020, whereas next year, we'll have 5. And so 2 more next year will be about a $60 million year-over-year headwind. But obviously, this year, we're looking at conversion rates that are well above the 100% kind of rate we talk about is kind of more of a long-term normalized rate for this business, and we think we'll normalize back once we get to a more normalized environment and also through some of the dynamics impacted by the spin, but I'm glad you brought that up.

Thank you. I guess, maybe this is kind of a capital allocation and an end market question wrapped into 1, but 100% appreciate your comments around the carpark. As we look forward, right, you have these investments in Tritium and Driivz, which you noted earlier? I think they've -- you've highlighted they have pretty strong positions. But how should we or when should we think that we're going to know who is really positioned for this transition to EV when it eventually happens, right? Do we know who is going to win today yet? Or do we need more time because there are still people entering the market potentially?

Yes. It's a great question, John, because the ICE carpark is going to continue to grow and will continue to give us strong free cash flows for a good time to come here. But at the same time, this is a really interesting evolving trend, and we consider this an and-opportunity, not an or-opportunity, which is obviously why we've done investments in companies like Tritium and Driivz. And we've really done that because it is so difficult to figure out this changing landscape and how is it going to play out? And who are the players going to be? And where are the legitimate places for e-mobility should we play to not only capture growth, but also capture margins. And so these investments, it's not just about studying the market and doing strategy work and doing VOC. It's about how you can participate in it through these minority investments. It gives us that front row seat, which is an excellent opportunity for us to engage also in the business as it's beginning to evolve and develop. And it's a pretty dynamic situation. And it's early innings. So we're really happy with our position that we're in right now, so we can continue to learn and continue to pick through that. And of course, our customers are asking us questions as they're beginning to figure things out. So I think a lot to come as this market evolves. And there's many players that are obviously involved in it, too. But we're really excited about what we have to leverage to, which is an excellent installed base already in terms of either the footprint, in terms of the number of intersections we're on or the number of refueling stations that we're at to the amount of 0.5 million vehicles that we monitor. So there's a lot that we have out there already in this space that we combine with these investments and continue to learn.

Great. So I think we covered a lot around Teletrac Navman in the last couple of earnings quarters, but maybe one company that doesn't get as much airtime is GTT. And I would say smart cities is a kind of a really big word, right? It catches a lot of different opportunities but what should we be excited about with that business? And what are you thinking you can do longer-term in that space?

Yes. GTT, or Global Traffic Technologies, is really a toehold in that space. It's a small business and a very large market, $7 billion market with really good growth rates of mid-single digits. We think pretty attractive from many dimensions. So the secular drivers there, I think, are pretty significant, but they drive some very different things. So it's conceivable we could build out around GTT or it's conceivable we can even operate in that space with not a lot of connectivity, the GTT. And an example of that might be in the tolling area or parking areas could have interest as well. So I think as we pick through that market opportunity, I don't think we're constrained by our investment there. It's been a great learning as well, but it's attractive to build off that platform, but it's, I think, a generally attractive space with a lot of dynamics that we think could give some growthy margin leveraged opportunity. So yes, we're happy about continuing to explore the depth of what smart cities might offer.

Great. And I'm just -- I'm going to be mindful of the clock, sneaking in this question here. But obviously, you talked earlier about Matco, I think as we look into next year, given your backlog, I think there was a little bit of supply chain disruption. Are we -- should we feel very confident that you have line of sight probably pretty good already for 2021 or at least the first half of that -- for that business?

Yes. John, we talked in the third quarter about having some supply chain constraints there, which I think we've pretty much gotten through. It's -- it should be a very short-cycle business, we don't carry backlog there. We've been carrying backlog as far as the market we've seen, we talked about how that came back very well in the third, and we anticipated that environment kind of continuing on for foreseeable future. So we'll see how next year looks. I think we want to get through the quarter before we think we have line of sight. It's a very short-cycle business, but it's a great, steady growing business. And I don't -- we usually carry very little backlog. We wouldn't carry a lot of backlog in, if that is what we mean by line of sight. But we like the runway of opportunity. I talked about it as one of the EMV offsetting growth items for next year. And I think -- especially on the easy compare, I think we like the position we're taking in into the year plus the opportunity to add new franchisees in the unpenetrated territories. So we really like the hand we're playing there.

Great. Well, just looking at the time, and I think this is the point where I'd like to thank Mark and Dave and the team for joining us here virtually. We do hope that next year, we can be live and in person. But I hope that everyone stays well and safe. And once again, thank you for the time and for being candid with your answers.

Yes. Thanks for having us, John.

Great. Take care, everybody.