Vontier Corporation (VNT) Earnings Call Transcript & Summary

All right. Good afternoon, everyone, and thank you for joining us again. It is the ninth Annual Credit Suisse Industrials Conference. My name is John Walsh, and I am the multi-industrial analyst. It's the second day of our conference, and we're very excited to be joined here by the Vontier team. We have with us Vontier's CFO, Dave Naemura. . And I think we're going to head straight into the fireside chat. As always, if you'd like to e-mail a question, it's [email protected].

And once again, Dave, thanks for being with us. I'll start off with the obligatory supply chain question. Obviously, you guys just had your Retail Solutions Day. So we're not dealing with that long of a period of time, but let me ask anyway what you're kind of seeing on the supply chain front and if you've seen any easing or not since you reported the quarter?

Yes. Thanks, John. Really happy to be here. I would say what we talked about last quarter was we did see things tighten up over the course of the third and we've seen that environment, kind of continue what we'd experienced coming out of the third and the fourth. I think from when we talked about the third, I think things have been about as anticipated. In our case, here at Vontier, we continue to leverage VBS to work our way through which we are. It's not a great environment out there, but I think we've dealt with it well to date, continue to wrestling.

Great. Maybe let's kind of start with that Retail Solutions Day. Definitely a great teach-in. I appreciate that you guys did that. One of the things you talked about during that presentation was this kind of $2 billion of M&A capacity you have post DRB. It's interesting. If I look at your total addressable market, that you laid out at the Analyst Day, there were still some big pieces where we haven't seen, I guess, a lot of inorganic movement, whether that be your smart cities, your telematics, you've added to what you were doing with GVR with DRB. Just help us understand how you plan to grow in those other large total addressable markets that you play in?

Yes. That's a great question. Look, first stepping back, we would anticipate through the next, call it, 5-year timeframe, we would see organic growth despite the fact that we'll see some headwind in the middle of that from the impact of EMV rolling off. And M&A will also help accelerate that organic growth, we would anticipate. You mentioned a couple of the markets that are very interesting to us, telematics and smart city, which are broad markets where we have a presence today, but we could look to expand those -- that presence. Also, retail solutions, you saw the move with DRB, but it's one of the non-internal combustion-type areas within GVR that we're principally focused. So more broadly, around high-growth markets, we see opportunity there as well. And in all cases, we see good drivers from regulatory drivers, be it environmental or fiscal -- kind of payment and fiscal compliance side. And so we think those are all good opportunities going forward.

Great. And then if you think about DRB, right, there was a high software component to that. Would love to hear as you and others start to shift more into software, what are some of the financial metrics you use to evaluate those transactions, right, to make sure you're getting a good return on your capital?

Yes, great question. So, look, in all cases, we're returns-focused and strategy-led, however we look at M&A [indiscernible]. When we see a little higher software content, we tend to maybe see returns push out a little bit, but always within -- kind of within our framework. We tend to think higher software content tends to drive maybe a higher growth rate and a better margin profile that will be accretive to our fleet average over time. We tend to look more at software deals that are software-enabled hardware as to say, pure software. But what we're really focused on, is applications that are deeply embedded in our customers' workflows. We're stickier, they're aligned with the value-add and solving high-value problems of the customers and, frankly, harder to replace over time. And we think there's a number of opportunities like that, many of the end markets that we serve today are adjacent to where we serve. So a lot of opportunity in software, particularly as it relates to kind of enabling hardware. And I think DRB, as you pointed out, is a great example of that, where it's very much the value is delivered through software, but rides in the form of some hardware applications.

Well. And maybe building on that, as you think about that mobility business, right, you -- traditionally, you've expanded your TAM in that market. So I'm curious, as you've added on with these acquisitions, how much extra dollar content opportunity do you think now you have at a retail fueling station? And maybe I'll even phrase it a little bit more direct. But if we're not growing new retail fueling stations in the U.S. at least, what is the ability of Vontier to increase penetration of payment solutions and car wash and all these other things that you have in the portfolio?

Yes. Look, it's hard to provide a dollar value by site, and I think you have a large kind of variety of footprints out there. But I think the concept you're alluding to is exactly what we see and what we're experiencing. It's a little less about the number of sites, and it's the kind of concentration in the larger sites in the city and then the diversification of those sites. So we see inside -- the offerings inside to say the c-store, being diversified into fast food, into higher-quality merchandise, into different payment methods. And that -- all those things being with it, new applications for the workflows still tied to the forecourt. Eventually, we believe you will see what we would think of as an additional opportunity through adding electrification in the forecourt, which is adding another device. It needs to be correlated to inside c-store, point-of-sale systems, other aspects of the forecourt. And then carwash is an increasingly popular diversification item as well. So a lot of these new real estate footprints, adding carwash, which is a very highly profitable category as well. So you see a lot of different variations of this and kind of speaking to the U.S., right? A lot of different variations of this. But we see that diversification is driving opportunities inside the c-store within the forecourt, the carwash above the forecourt as you look at remote site management services and then below the forecourt as well with our environmental products. High-growth markets are going to come along for that journey. So at a much earlier stage of modernization, really the fueling infrastructure is being built out, places like India, where we see that doubling over the next 5 years. And then we'll see that following the same pattern that we've seen in the U.S. and other developed markets where we'll see a modernization and progression of that to a format that we see, that we're familiar with seeing today. So we think there's plenty of runway in this market today, although it shifts from -- maybe from the forecourt to inside the c-store or towards new applications like the carwash.

Yes. And that brings up a couple of follow-ups. Maybe the first one is, and feel free to remind us kind of, the moat your payment solutions business has within retail fueling? And then how different is the technology if you wanted to bring that to, say, fast food or another type of end market beyond the retail solution convenience store?

Yes. We've definitely opened up the aperture here with that portion of our business. But we're really differentiated in c-store because we're so embedded into the workflows of that particular customer set. We have an end-to-end solution offering for the provider that encompasses what happens outdoors as well as indoors. So we like that. We enjoy a very good top 2 position. And we think that our kind of being embedded in the workflows of that customer and the variety, the end-to-end solution creates unique barriers to entry. So we like that moat. We think it's a strength of our offering.

Great. And then the other thing you brought up there was your high-growth opportunity. And it came out on -- I guess it was just a quick comment at the Retail Solutions Day, but there is a significant difference in the margin between what you're experiencing in North America versus high-growth regions. So maybe help us understand how the high-growth regions get closer to what you're seeing in developed markets?

Yes. Look, the profitability in developed markets is much higher than you see in high-growth markets today, although we do enjoy good profitability in high-growth markets. But as I believe you know, many know, we've invested early in a lot of these places, in South America, India and other places as well. And we believe that we will see high growth markets follow that evolution that we experience in developed markets like the U.S. and North America as we go through that store -- that journey from a fueling kiosks or kind of think of it as a gas station to really a multi-use site in a convenience store. So there's volume growth that's going to help that profitability over time as we -- as the fueling infrastructure continues to be built out in a number of these places. And then the modernization as they move up the technology stack and have more sophisticated offerings, which is what we experienced in developed markets over the last 20 years, will be coming along for that ride and moving -- helping our customers move up that technology stack and doing that at higher volumes, and we think that again to close that profitability gap over time. All driven by a number of great regulatory drivers. Again, environmental in India; payment regulations in South America; throughout the world, there's a number of small regulatory drivers that happen on a recurring basis that has always driven this business, and we think we'll continue to drive it in the future.

Great. And we have a question here that came in through e-mail. We're going to kind of get to this later, but make sure we ask it now. As you think about your capital allocation priorities, has anything shifted kind of given the dislocation in the public markets or the volatility of the stock? And I'll leave it summarized at that.

Well, look, it's some were constantly analyzed, right? We have some optionality. We put in place in spring repurchase authorization that provides us some optionality going forward. At the same time, as you know, we have a pension for M&A, and we think there's opportunity here for long-term value-creation through M&A. But we continue to analyze it. And these things aren't mutually exclusive either. So I think you can't -- I can choose one or the other. So I kind of agree with the dislocation comment. We'll continue to watch that going forward, and we're focused on driving shareholder returns, and we'll act accordingly there.

Yes. And then as you think about that relationship you have on the mobility front with your customers, I'm just curious, as they're looking for their own transition around multi-fuel sources, are they coming to you for a solution? Or are you bringing to them kind of a menu of options that you can provide to them? I'm just curious if it's push-pull, and maybe it's a little bit of both, but...

Yes. As you can imagine, it is a little bit of both, and it's extremely early days, right? So depending -- and there's also a very much a regional dynamic to it, say, the U.S. versus Europe. But one, we're a trusted partner with those customers. So not only do we have deep embedded relationships. If you look to do things on a fueling side, you're sitting over tanks of liquid petroleum, right? So being a trusted partner, understanding the nature of the site and the safety concerns to go with that make us someone folks rely on in this regard. We have a product we call EVerse, that is -- brings more of a turnkey solution. So we've really focused with EVerse on the network management components of the charging infrastructure and then combining that with sourcing hardware to bring a solution to those customers that want to own their own solution. Again, it's very early days. We do believe that the real estate associated with the current fueling infrastructure is going to play a role in the charging infrastructure going forward, an important role. And as it develops, we think we're well positioned, we're coming along the right case to help our customers solve that problem as a trusted partner.

Great. And then a big part of the focus has been on recurring revenue and shifting the portfolio that way. Can you kind of break out what you characterize as the big buckets of recurring, whether that be kind of aftermarket service, software, what you kind of put into that definition?

Sure. So we see recurring revenue, reoccurring revenue in kind of that low- to mid-20s percent of total revenue. That's about 35% of that kind of mid- to low-20s. About 35% of that recurring revenue comes from service contracts, about 35% of it comes from SaaS. About 20% of it comes from spares from our hardware installation on the ground and the spare parts aftermarket business. And then about 10% comes from interest from our financing portfolio associated with our Matco business.

Great. And then maybe sticking with retail solutions. Just maybe a little bit more about your channel-to-market. Is most of this a direct business? Or is there -- do you have a kind of a network of independent agents that are helping you get to those customers?

Yes. It's really a mix of both, it's probably pretty close to 50-50. So direct sales with some of our largest customers and then we leverage distribution in many places, and that mix kind of changes regionally, depending on where you go. And then in a lot of cases, installation partners are doing the work to stand up a lot of these components together on a site and then we would own a lot of the kind of post-implementation service and maintenance.

Great. And maybe thinking about labor -- availability of labor. Is that impacting your business maybe across broadly? And then maybe a specific comment on Matco as you look to expand your geographic franchisees?

Yes. We haven't probably been -- we've been more impacted by, what I would call, labor availability then say, labor inflation. And that labor availability has been in a few hotspots in particular, granted, we've had a COVID issue here or there. But a couple of plants and in particular, one related to Matco. So where we don't manufacture a lot in Matco, which I know -- I think you understand most of that is sourced to the network of hundreds of vendors. But we do manufacture luxury toolboxes. We've seen some labor availability challenges there. We're countermeasuring that with a number of actions to kind of attract and retain that high-value workforce. It's not related to standing up new franchisees, where we have a runway of open territories that we can add new franchisees to, and we've got a robust funnel associated with that. It's more specific plant locations.

Great. And then, I guess, sticking to this kind of focus on resiliency, are there things you're doing with your own supply chains around dual sourcing, et cetera, that you could kind of highlight to us? And then maybe as a follow-on to that, how you're thinking about working capital and managing inventory as we're still living through supply chain constraints? .

Okay. That are great. From a supply chain standpoint, I mean, I think, first of all, thinking about VBS here, which underpins kind of everything we do is deeply embedded in our culture and the constant improvement mentality that comes along with that. We're clearly focused on how do we continue to improve. And I think anyone who came through lessons over the last couple of years, there's a lot of lessons to be learned. We're looking to apply those both on the length of supply chain and some of the products and vendors and the data that we used to underpin some of our requirement sourcing. So I don't know that I'm prepared today to go into particular actions. But I can tell you, we're definitely focused on making sure we take the lessons over the last couple of years and use it as an opportunity to continue to get better which is kind of what we do and embedded and how we operate. Working capital for us, I think, for many others as well, is really running at historical lows. We're seeing working capital as a percent of LTM sales that at a level this year that we haven't seen really in any recent memory. We thought last year was good. We had further improvement this year. And we see a lot -- we think some of that will come back into the system in the form of inventory. And so we -- we're focused on making sure it's the right inventory going forward, but definitely derisking supply chain as we get some safety stock build back up, getting underneath the data on what those parts are and where do we need them. But we think that will be well spent capital next year and working capital to help manage through that. So we'll see some normalization on the inventory side. We'll see how that develops coming into 2022.

Great. And then I guess on the pricing front, can you talk about either pure price, price/cost? Maybe how you're expecting that to kind of flow through here as we end the year and look into next year?

Sure, sure. I think we were in good shape entering the year. We started pricing early. It was more of, what I'd call, strategic pricing, right? We did a lot of analysis. Then we had a focus on pricing in a number of areas across the 6 operating companies at the time of 5 before we added DRB. And then as inflation really began to pick up, we really looked into inflationary pricing. We've done it all in the form of kind of base price, for lack of a better word and not surcharges. And we've stayed ahead of cost, both on a dollar basis and a margin basis throughout the full year, and we anticipate still being in that position both dollar positive and offsetting the margin impact for the full year as well. It remains a dynamic situation as we head into next year. We'll keep acting accordingly here. Not trying to call what's going to happen to inflation next year, but we don't think a big break is coming anytime soon. So we anticipate continuing need to react dynamically and we'll have the same objective next year as we've had this year. So we feel fortunate to where we've been so far in the year, and we'll continue to manage it.

Great. And then as we think about the framework you laid out the Retail Solutions Day for next year on a reported revenue basis, we've been getting a lot of questions around what that might mean for the segments. So I realize we might not get 2022 guidance today, but if you look at what you've said around EMV headwind for 2022 and you look at kind of your orders ex -- the mobility technologies ex-EMV, it would seem like you should be coming out of that flat for 2022, if my math is right? I don't know if you have a comment on that or a thought. .

Yes. Look, not getting into the next year guidance, we'll close the year down and get into that in February. But we made the comment in the retail solutions teach in, and I can elaborate on it somewhat. But we talked about reported growth. And a lot of that is the fact that, yes, EMV is coming down, right? Ex-EMV, we anticipate having growth in, call it, core Vontier. But then we also have DRB, which will have not have gone core. So by -- it will go core for the fourth quarter of next year, but it'll have 3 quarters where it's not. So when we look at the reported level, it will be uplifted by DRB so that the reported growth number, we would anticipate in the mid-single digits next year. And with that, having margin expansion and growth of free cash flow dollars.

Great. So I guess if we think about this and what you're actually delivering, maybe just remind us where you think mobility can grow long term. And if what you're seeing ex the EMV business, which will -- the headwind will abate if you still remain confident in that kind of growth outlook for mobility?

Yes. Yes. Great question. And we do remain confident. I think this business is driven by regulatory drivers, right, throughout the world, and we focus on EMV, which is kind of this mother of all regulatory drivers. But beyond that, we'll continue to see fiscal and environmental drivers. So we've always talked about this business as being kind of that GDP plus mid-single digit, maybe mid-single digit plus high-growth business. That gets a little growthier by the addition of DRB, right, which we talk about being a high single-digit growth business. What are the drivers within that? Things we always talk about, high-growth markets where we have a good position. We think those provide some opportunity, albeit very lumpy, but for some upsized growth out of South America, Middle East, Africa, India to name a few of the spots. And then retail solutions runway, both domestically and in emerging markets, right? We think there's a lot of opportunity as our large customer base continues to diversify. Very steady growth business in Matco, that's not mobility technologies, as you mentioned. But it's always been a very steady growth business. They've been experiencing some outsized demand now, but we think that will continue to be a good, solid, consistently growing business. So all those things give us confidence that was rather noncyclical business, we'll continue to behave that way once we pass through kind of this EMV moment in long moment in time.

Yes. And then just as we think about -- or you don't -- we haven't touched on it outside of kind of an opening question. But kind of can you talk to us a little bit about what you're seeing in the telematics business? I think there's been some riding of the ship there, how you feel they are on a growth path now going forward? Just maybe a little bit of color around that business.

Yes. Look, well-documented place where we're doing a bit of a turnaround, but a place where we're also pretty optimistic. So I would say we were less focused on growth, but also realizing, hey, what do we have to do to enhance the margins? Good-sized business that was basically breakeven a year ago this time. And I think we see some margin improvement opportunities, and some of that might come at the cost of some top line as we look at all the places we play and how we play there. And then we're also looking at, okay, how do we get to sustainable growth over time through targeting the right areas and having the right product features. And all the things that we're measuring towards that, we feel pretty confident about and we like the progress we're making. It takes time to turn to SaaS business. And I think we'll see a little more bottom line progress before we see it move faster than top line progress because it kind of can in the SaaS business. But we got Alain in there, who is a tremendous leader and kind of the right person at the right time, and we're confident with the progress we're making, and we continue to be very interested in what's a very, very good market. And we have a nice business in that strong telematics market.

Great. And then can you remind us kind of the replacement cycle, I guess, for the non-convenience part of GVR? This is equipment that's in a harsh environment. We are going to take time to manage the transition from ICE to whether that be EV, electrification. During that time, there will be a replacement cycle, I would assume. Maybe help us unpackage that thought a little bit on the cash that will still be spin off by that business that can be deployed.

Yes. Different people have different estimates, but we're really tied to the car park and not new car sales. And as the car park evolves, I think it's pretty standard thinking that it's going to take quite a while before internal combustion doesn't make up the vast majority of the car park. And with that, there's different folks have different size of firms and different firms still have different replacement cycles. It can range anywhere from probably the high single digits in years to the low double digits in years on average. And we forget that EMV actually started in 2014 and really picked up in earnest in 2016. So we're into this. And yes, it's shortened this replacement cycle, but then following this, we see the replacement cycle normalize out. So that will work itself through. But beyond that, there's an underground replacement cycle as well. There's a regulation around that. As people work through some of those regulations, it results in changing tankages and leak detection inside as well. And with payment systems, both inside and outside, there are standards around payment systems that are regulatory body driven and, in some cases, governmentally driven, right? So those drive upgrade cycles as well, as well as advancements in technology drives replacement cycles for things like point of sale. And then we proliferating -- we'll continue to proliferate the offering as the offering continues to diversify at many of these sites. So we think a lot of that provides a long runway of opportunity. We focus on dispensers themselves and that will work itself through here over the next 3 years or so. But we -- there is a replacement cycle in everything else we do as well or an upgrade cycle, maybe that's a better way to call it for the indoor stuff that always on a little different cycle but it happens on a more recurring basis hasn't been compressed in a shorter period of time.

Right. And if I understand it correctly, is independent, right, of the fuel source?

Yes, that's a great point. It is independent. The tanks are going to be in the ground a long time, there's regulation around that. Everything inside the store, it doesn't matter what fuel you're putting in, either be it electricity or liquid petroleum. So the diversification of that offering and the ability to tie together in an end-to-end solution, many of those components is the value-add proposition of GVR. And we think anytime we're adding things to that fueling site, it's beneficial to GVR's overall offering, our ability to kind of simplify the complexity.

Great. And I think I'm just looking at time, we might have to leave it on that. But I would definitely like to thank the Vontier team for being here with us. And we look forward to hopefully seeing everybody in person as we get into 2022.

Thanks for having us, John. Appreciate it.

Yes. No, thank you, and be well. Take care.