Vontier Corporation (VNT) Earnings Call Transcript & Summary

Thanks very much, everyone, for being here. It's my pleasure to have up next from Vontier Corporation, obviously, the first time at this event in person. So welcome, and thanks very much for being here, Mark Morelli, Chief Executive; Dave Naemura, CFO. Very glad to have you here. And maybe we'll straight go into Q&A, I think, anyone sort of looking out the QR code there, please take a few seconds to complete the audience survey response questions, and we'll distribute the outcomes of those in due course.

But maybe start out Mark and Dave, perhaps just with some context around the update recently. I think investors are trying to grapple with, did something change in your own view of that EMV roll-off? Was it just The Street not understanding the slope of things? Anything you could sort of provide around that just because it's the most recent kind of big event?

Sure. Thanks, Julian. What we've always grappled with, with EMV is this kind of this shape and time of the roll-off. And it's imperfect data, but we've done, I think, a decent job of trying to keep people apprised as we're able to refine our estimates. You've seen us have more near-term impact estimates. So at the time of the spin, we talked about 2021. 2020 being the peak, 2021 impacts that we saw, '21 ended up being better than that. We talked about then extending that view to 2022, which, again, ended up being better than we previously thought. But really, the ultimate amount of the decline in returning this business to something that resembles where the U.S. dispenser business has historically run wasn't the question, it was the shape. And now we see that playing out over a shorter period of time, which ultimately that near-term demand environment really some satisfying, some of that pushing out and really kind of creating a much bigger number in '22 ultimately, the demand pulling in and satisfying that in a 3-year period of time as opposed to over 4 or 5 years, creates the shape of that tail in 2023. So as we worked past the deadline in April, the adoption deadline, looked at some of the demand behavior as the liability shift has now moved to the smaller operators, which are really the people that are still adopting at this space, exiting the year, seeing the demand environment, for the first time, we thought we had a pretty decent bounding on that and thought it was the appropriate time to share that as we had, I think we zeroed in on it.

Julian, I'll just jump in a second on that one, too.

Yes.

I think we've spent a lot of time walking folks through that. I think let me just highlight what's new and what it's been the same. The peak to trough has been the same that we've articulated. What's new is that it's really the first time that we're able to dimensionalize the size and the shape of the tail. Obviously, there's a lot that goes into our estimates here. There's a lot of homework. And I think it was the first time that we really had visibility of how that would tail off. So everything that Dave just said is that dimensionalizing of it as we've worked through this business problem. And so it's -- I think the responsible thing to do is to rip the Band-Aid off and now we move on with how we offset it.

And when you think about the sort of the revenue and earnings kind of hold that takes next year, what's the conviction level in being able to kind of offset that you talked about last week?

One point, I think Mark can take us through some of the big offset items. But I think we talked about on the call that we would offset not all of it organically, but a significant amount of it organically with a lot of the activities we've talked about to date kind of getting that impact of that decline down closer to low single digits from, say, the impact of a full $300 million to $350 million decline, but also that that's before an inorganic activity, which we've had a history of doing and we'll have a history of continuing to do given our strong free cash flow profile.

Let's talk about how we offset the 2 -- the big decline in 2023. So first of all, we're early innings on our profitable growth initiatives. I think if you've seen the way this business has performed over the past year, we've adopted and put in place a really solid set of initiatives where we are demonstrating we can profitably grow this business. I think that's read through in margins. One of the things that when we first spun the business, people were quite skeptical whether we could expand margins. I think -- what we've put in place is early innings, and it's got a lot of legs to it. It's going to carry us into 2022 and beyond. Second, on the organic growth side, let's take a couple of dimensions here, we can peal the onion back. First of all DRB. DRB is growing at faster than fleet revenue and fleet margins. And I think it shows the power of our M&A ability here, and I think it's an excellent asset for us to carry forward. We talked about retail solutions that we highlighted in our teach-in Q4, also growing above fleet revenue and margins. And then the innovation initiatives through new product development. We doubled our EBITDA target this past year in terms of dollars. And that's early inning work. That's where we've locked off the long tail of not so profitable businesses, investing product development more into the higher value end, and we can talk more about that later, too. And then high-growth markets. It's been a steady grower at low double digits, and we intend that, that will continue to grow out because high-growth market has got a long tail to them. At the same time, our underperforming parts of the portfolio are demonstrating really strong traction in terms of growth. Tennessee is showing better margins and growth. Teletrac Navman is turning the corner into growth. So when you take that into account, then you bring up the overall level. And then you have businesses that have been with us for a long period of time, like Environmental Solutions, which is about 9% of our total sales is Veeder-Root, if you will. And that's a global business, high single-digit growth at above-fleet margins. So when you look at the road map that we have, we're very confident in our ability because this is something that we can line up for and we've been lining up for. So it's something that we're prepared to offset.

And when you think about capital deployment in general but also with an eye to that 2023 sort of earnings gap, there was the announcement of the sort of the buyback very recently. Maybe sort of just update us, thoughts on the relative merits of M&A versus buyback and how balanced or not that might be over the rest of the year?

Well, we have talked about being focused on shareholder return and also talk about M&A and buybacks not needing to be mutually exclusive. Given what we saw as a pretty severe dislocation in the stock price, we made it a near-term priority to announce the ASR that you saw yesterday. Having said that, going forward, there needs to be a balance. We're also looking for the long-term impact of transforming the portfolio and that will be done. We've always talked about range of types and sizes of deals from classic bolt-ons to things that are a little more longer earlier stage, more strategic in nature, like you saw us announce recently with Driivz. But I think more so in the way people should think about capital deployment towards M&A is kind of more down the middle of the fairway, which is what you saw in the deal we did for DRB, which continues to perform very well, which is a great asset in a really great end market that advance the strategy, market led. That's probably more the type of M&A that we would see helping transform the portfolio being accretive to the overall growth profile of the business into the future.

Perfect. And you mentioned Driivz as an example of a type of transaction. So as people often ask about the one you didn't do in the way Tritium. So maybe help us understand the sort of the different parts you took with those 2 and what underpins the different approach?

Yes. Actually, I'm glad you're asking that question because it gives us an opportunity to highlight how we think about things and how we think about allocating capital. Tritium is a good business, but it's a hardware electric charging business, fast, DCFC is its ticker symbol. We had an option to buy that business, but we decided to forego putting additional capital into the hardware part of electric charging because we think it represents a good growth opportunity, but we think it's a commoditized opportunity. Now at the same time, we think that Tritium, we have 16% ownership of it, it's a public company, and we have a position there that whether we decide to monetize that in the summertime or whether we decide to hang on to, we think, adds value to Vontier. At the same time, we had made a minority investment in Driivz, which is a -- in the fastest-growing most profitable segment of the electric charging value chain, and this is on the network software side. And the decision we made here was to be able to invest in that business with our capital, and we'll continue to invest in because we think it represents the strongest growth opportunity for the medium and longer term.

And with Driivz being brought fully into the company, what should we expect in terms of sort of additional resources there or a change in strategy or management? Anything around that maybe to ensure that you get high returns in the end from that acquisition?

Julian, first thing I'd say is we're not going to run Driivz in the classic way we would run what we think of today as an operating company. So we're not going to fold it into our existing operating company structure. We'll hold it reasonably separate. It's a very early stage high-growth business. We'll be running it to take advantage of the developing market and get our fair share, whereas in our normal course of things, we're very focused on a different set of kind of core value drivers here, we're going to be focused on really a set of OKRs that are aligned with the stage of life that business is in. We -- so we're not going to integrate it into the broader scheme. At the same time, we think our existing businesses and platforms can offer a number of areas to kind of help accelerate in this early stage of their momentum. So we're going to run them like what they are in early stage, high-growth technology leader in the space they play.

So what are the main kind of milestones when you're weighing that up as you go? How will you think about that the bang for the buck, what kind of revenue growth should we expect from the investment making?

Look, we think -- again, this is a very early-stage market. But as it develops, we think this is a high double-digit-growth-type market in these early stages. Driivz, we feel very fortunate to have had the position that we had with Driivz to be able to acquire it at this stage, kind of 2 years after the investment we made as a minority investor. And as this develops, there's a number of criteria around competing, getting plugs under contract, plugs under management, growing at the early stage and getting affiliated with the right players as this market develops really over the coming year or 2, where I think we'll have an opportunity to kind of make a significant move in what is really behind the high double-digit-type growth at this early stage.

And do you think that Driivz in itself, it's going to be big enough to succeed? Or is it the beginning of a bigger platform that you're going to build out?

Yes. In fact, we announced a press release of $500 million investment on alternative energy. We think not only do we have right to play here, we think we have a right to win. Driivz is a part of that $500 million over a 5-year investment. And so we definitely see opportunities to further build out around that. We think it's an outstanding foothold in that business. Other areas that we're also interested in are in the energy management side because we think that goes hand in hand with what is required as part of the electric charging network, and we think that's underserved, particularly on the technology side of things. And then on the organic side of growth, too. I mean we as you may know, have a CNG pumping business called ANGI where we dispense CNG. That's a higher pressure than petrol. It gives us the right to play in hydrogen. Lots of folks have asked us for hydrogen type infrastructure as well, and we believe that we can also work on building out CNG as well as hydrogen. So there's a lot of great spaces for us to play and lead in the alternative energy space, and so we're very excited to be doing that.

And as Vontier is evolving its portfolio mix, clearly, there's an inorganic acquisition aspect of that, which is important -- but you said as you bring in deals and you have the base business, there's a huge organic reinvestment that's going on. So how do you weigh up kind of making sure that those organic investments has a high return from them? I think soon after Vontier spun out, Mark, you talked about R&D efficiency, I remember early on. So kind of where are we in that R&D efficiency program? How are you thinking about making sure that the money you're putting into Driivz or DRB or the base business, you're getting a good return on that?

Yes. I think it's a great question. It's an area I'm very passionate about, and that's how we really get a better drop-through on our internal spending on new product development. And I think the -- this business was really ripe for a couple of things. So let me try to dimensionalize it. First and foremost, we took a look at how we spend and try to target the dollar towards higher-return-type investment activities. And this, believe it or not, you can have actually a very short-term benefit that extends into the long term because you essentially take your gross margin dollars invested into the gross margin dollars returns. And when you look at how you're investing in product development, you can balance that and saying, "Hey, we have a whole bunch of de minimis work here." And so that enables you to focus better and also enables you to execute better. At the same time, when you think of this overall opportunity playing out, we're doing a lot of complexity reduction, and we're focusing on the critical few when we're doing that. And when we focus about it, we get certainly better traction on our new product development activities. And I alluded to it a little bit earlier and what you asked for. So a very significant uplift, both of those on early innings. In Q4 of last year, we also launched for the first time the Vontier launchpad. And this is an incubator-type initiative that has -- when you take a very growth-oriented opportunity, you form a growth board, and there's a whole process that's been tailored around this. So we're putting a lot of energy into this. And we're seeing some early returns -- but keep in mind, it's early innings, and we think there is a tremendous amount of benefit to come from this for the future.

Perfect. And you'd mentioned, Mark, that the improvement at Hennessy, the improvements of underway and coming at Teletrac Navman, maybe flesh out those 2 points a little bit more. Where are the margins and the growth trajectory today? Where are you trying to move them to?

Yes. So both of them are below-fleet margins and the growth and represents solid opportunities for us to improve them. And I think what we demonstrated in 2021, we absolutely have got them on that growth -- better growth trajectory. In the case of Tennessee, it's the business itself. We approach that with a simplification lens, so we can understand what dimensions of this business do we need to, one, price better for and/or not focus on as much. And then what aspects of the business we need to actually double down and focus on more. So we're getting some great early traction. And my experience out of this is we'll get better tracks in the second year of pushing off this than we do the first. In the case of Teletrac Navman, a 95% SaaS software business that has been well reported on. We had lost our way the last couple of years through some technology missteps. And this business was at high churn when we took the business on in early 2020. So we've been able to, one, mend the churn, which is mostly been centered on North America. Two, we've been able to also reframe it into focusing on the right opportunities for growth and part of that was launching TN360, which is a new platform. And so for the first time in Q4 of this year, it returned to ARR growth and full year ARR growth, as you know, as a SaaS business, this will take a little bit to bleed through, but it's -- into organic revenue, but it's the first time that it's actually returning to growth. We got excellent management team in place on this business. And so we're -- we believe that there are much better opportunities ahead for both these businesses.

And Teletrac Navman is probably the one that people think most about. It's not a niche like a lot of Vontier's businesses. It's a big market with some big players throwing R&D into it. How do you assess the longer-term kind of returns you might expect or margin rates that you could hope for in Teletrac Navman?

So I think what we like about this business is that it does have a very good gross margin. And you saw us improve the profitability last year just by refocusing on the areas of growth. So there's no question, strong growth margins and the market is great. It's a strong growing market. It's still very fragmented when you look at it globally. And there's lots of ways to play that market. There's a lot of value add that can be had not just been by what we call the horizontal telematics player, which is a generalist player, but also a lot of niche applications that are very growthy and also very profitable. So I think there's a lot of areas where we can strategically reposition this business as we gain strength to be able to untap value.

And if we look at the core, I guess, or one of the cores, the traditional kind of Gilbarco business in particular and around sort of dispensing the gas station forecourt and so forth. When -- how are you thinking about the global installed base? What's sort of the growth rate there we should expect, I guess, the installed base? And also, any sort of thoughts around price per site? How do you kind of drive up that revenue per unit of installed base?

So we look at this as a mid-single-digit growth opportunity for us because, one, retailer sophistication has grown and we highlighted that in our Retail Solutions teach-in that we had. At the same time, what plays to our advantage is a consolidation of industry players because we have the most sophisticated offering for folks that need to manage these networks retailers with point-of-sale systems as an example, and better vapor recovery and leak detection, these kind of things certainly appeal more to the more sophisticated players. So consolidation in the market also drives into our sweet spot. So we think that this is a mid-single-digit growth opportunity for us. At the same time, you asked the question about the content per site. And in developed markets, a convenience store location might spend per site $80,000 to $110,000 per site on average. In developed markets, that's about $30,000 per site. And so what's happening in developed markets is they're looking for better security payments. So when you think you go to a fueling kiosk, you might be pumping a liter of gas. Are you getting a liter of gas, this can be managed. Also, paper recovery is being legislated, leak detection, fuel quality, all these things that you might see in a more sophisticated convenience store setup in a developed country are happening in developing markets, which means that $30 per site is going to double over the next couple of -- maybe the next couple of years. So the real opportunity here is to take what we can bring to the market and provide that in the growth setting of a high-growth market. So a couple of dimensions here where we can expect growth.

And if you look at the Retail Solutions piece, which I think is a few hundred million dollars of revenue without DRB. I think DRB brings it up sort of 500-plus or so. But looking at that $300 million or so number. Maybe talk -- remind us, I suppose, in light of that Investor Day, the sort of the growth entitlement you have there and also how's the competitive landscape? So I think industrial investors can sort of understand that the competitive landscape in fuel dispensing or Hennessy. But once you get into retail solutions, it's a sort of a different marketplace. So what's the market share, the degree of fragmentation?

So this opportunity -- let's just talk about the U.S. market as an example because it's easier to break down. When you talk about the point-of-sale system in the retail, let's not talk car wash, we talk car wash usually. We're the #2 player of point-of-sale systems in the U.S. market. And this is above-fleet growth and above-fleet margins. So we think that this represents an excellent opportunity as retailer sophistication is on the rise. So the convenience store format, I think people -- we've seen through COVID has been a very resilient format in terms of its accessibility, it's part of your local neighborhood. And that real estate is very valuable, and there's lots of opportunities to continue to add value for that retailer on that side. In terms of DRB, another story altogether because this is about a carwash footprint. And this opportunity for us is, one, we're the market leader in a growth market. So we've dimensionalized this as a $900 million market, and we've got 20% share. So a very growthy opportunity for us. I think you've heard of the growth rates that we're experiencing in this business, which is certainly well above our fleet margins and growth rates.

Perfect. And when we think about the overall business now that it's been stand-alone for getting on for sort of 18 months or so. Leaving aside the incrementals and decrementals at EMV for a second, what sort of operating leverage or core OMX sort of algorithm should people expect now that you've had time to see the business get tested in sort of different environments, putting some productivity measures?

Julian, we've historically talked about this business kind of being in that mid- to high 30s, maybe up to 40% incrementals. So I think we've demonstrated that. It's been -- continue to be juiced a little bit by some of the profitable growth initiatives. So we've demonstrated performance around the high end of that range. And then, of course, in this last quarter where we had to decrement because of the EMV headwind we've been -- we did that at a much lower rate. As we add deals like DRB to the portfolio, which structurally are attractive in relation to the fleet averages, I think then we continue to kind of average things up a little bit. But we think about it as that kind of mid- to high 30s range we historically have in overall kind of mid-single-digit plus on the top line.

I think cash has been something that's been consistently good, some one-timers moving around '20 to '21 and so forth, but that's behind us now. How are you thinking about sort of cash flow margins, if you like, medium term? Should they move up alongside the operating margin?

Yes. We've demonstrated very good free cash flow margin and -- almost 17% range coming out of last year. And it's underpinned by this kind of 100% conversion rate that we've historically operated at, that we've guided '22 to as well. And that's with an environment where we anticipate working capital continues to run at historically low levels. And I think we're all getting a little too much help on the inventory side. So we'll see some normalization there over time. But I think I do not see working capital levels returning to prepandemic levels. And then businesses like DRB are structurally very attractive, asset light. And as we continue to do M&A, it's obviously part of the calculus to continue to kind of enhance that already attractive cash flow profile.

When we look at the sort of the way the figures or the business is presented, it's in a way a more multifaceted today, perhaps, than 2 years ago. You have DRB there, there's a clearer definition around retail solutions. There's Driivz, there's the environmental piece, 9% of the group, is there maybe a way you thought about sort of presenting the business not as a one aggregated segment, but different pieces that align with something like that? Or how do you think about the best way to get that change in mix sort of across the people? And particularly environmental, maybe just remind us what are the main products and how big could that business get? How much of a priority is it for you?

Yes, so let's take the back end of that. So the environmental business is about 9% of our total business. And those of you that know sort of back in the Danaher days, this is Veeder-Roots so it was an early acquisition, outstanding margins, high single-digit grower and not impacted by EMV. So it's something that we think can continue to have recognized strong growth globally at outstanding margins. When you think about how we frame the business, keep in mind, when we took the business, it spun in a certain shape. And as we continue to work through the business problems here that there'll be opportunities for addition to subtraction and greater focus. And I think what you hear us talking about in terms of retail solutions is a pretty major theme for us going forward. I think you can see the growth rates. I think you see some scale of that business that's certainly developing as well as directions around alternative energy. So I think we've always said it's going to be a multiyear step transformation, and we're in the early stages of that. But as we continue to move forward, keep in mind, we're going to have an Investor Day later this year, will give us further opportunities to dimension that, to create more dimensions on this. So I think as we continue to go forward, one, establish a strong track record of performance; two, execute on really good M&A and I think we've been able to demonstrate that so far. Of course, you've got to continue on both those fronts. And then allocate capital in the most effective way going forward and then continue to work on our portfolio transformation.

And maybe just as the clock nears the end, please just a reminder on the audience response survey, if you could take a few seconds on that. I think Mark, something you just mentioned addition through subtraction. And clearly, people look at Danaher's history of that. How comfortable are you with that portfolio shape? And I think there are some lower growth businesses in it, but had very good profitability. So there's a value in the cash flow knock that you can then acquire into Driivz or a DRB or something in environmental. So how do you think about that in terms of -- it doesn't seem like there's a burning need to make divestment?

Yes, I think that's a good way to characterize it, Julian. At the same time, we could identify parts of the portfolio that are -- they're better off outside of our consolidation, right? And so something we continue to analyze, but could be a source of capital. We're going through a transformation here that will work both sides of it, the numerator and the denominator as we work through that. So too early to point to something. I don't think we would until we had conviction around that. But I think it's something that now that we're kind of 1.5 years post spin have our kind of strategy more refined going forward, I think it allows us to put everything to a little better filter here, so probably more to come.

Perfect. Well, thank you very much. And I see we've run out of time. It's a pleasure to have you here, Mark and also Dave.

Yes, thank you. Good to see you.

Thank you.