Vontier Corporation (VNT) Earnings Call Transcript & Summary

Thank you, everybody, for continuing with us on day 2 of our Annual Industrial Conference. Very excited to have Vontier present now. Obviously, there's been a lot of conversation around the name. A lot of questions about the valuation versus the underlying assets and from a terminal value to some even near-term issues. So really happy to have Vontier's CFO, Dave Naemura, with us, who can take us through, obviously, a lot of the strategy.

Dave, it goes back to the Danaher days. You're at Gates and then back sort of in the Danaher family with the Vontier Fortive down the chain on the spin. So you can give us a lot of history, but I think people are particularly interested right now in a lot of the structural issues around the portfolio. I might start, though, Dave, which is a key topic that people are wondering about today, the Russia-Ukraine situation. How it may impact Vontier directly on sales, supply chain, any opportunities around the world, maybe from the elevated commodity prices around it or some of the drags on how you think about your price cost structure. So I'll turn it over. Thank you very much again.

Yes. Thanks, David. Listen, it's great to be here. Appreciate you having us. I think broadly speaking, our revenue exposure is pretty minimal, kind of sub-$15 million when we think about that general part of the world. Aside from, say, the impacts to the more macro economy, I think there is a chance this is -- can be depending on how sustained it is. Good for some of our customer base. I think we tend to see kind of vertically integrated multinationals have a little more capital to spend, and that can be beneficial in some parts of the world, Western Europe. But also in say, some of like the U.S. market, we can see more profit being captured at the convenience store retailer, which is healthy for our environment as well. And of course, I would anticipate that we see some of this flow through to freight and logistics, which has already seen quite a bit of inflation, and we'll manage that like we managed last year where we were able to offset inflationary pressures on price. And I would anticipate that we'll be able to manage that again in the coming year.

Another big topic of late with your stock, in particular, though, the decision to do the accelerated share repurchase program. Can you just take us through the conversations and I don't think it's hard to surmise that the Board and management probably been a little frustrated with their stock really ever since the spin from Fortive. But particularly since you've already done a couple of deals, you highlighted where the company may be going with the Retail Solutions Day. Maybe just kind of take us through the conversation internally up to the Board? You picked the time frame, but I assume probably as you get past the third quarter earnings and the Retail Solutions Day, it became more of a topic that was being discussed on what is The Street missing in our strategy or how they're viewing the terminal value on these assets to be getting this valuation versus some of your peers and ended up with an accelerated share repo program?

Yes. That's great. Yes, I would say, of course, yes, we have been frustrated. I think we think there's a dislocation on intrinsic value in Vontier given our cash flow generation profile. But to your point, that got more acute in recent months. You heard a change of change, but an emphasis on the earnings call from us around moving into the market with share repurchase. I think as we saw further dislocation of the share price, in our opinion, we put the $250 million ASR out there, not only associated with terminal value personally, I do think we've gotten good feedback from investors around the M&A we have conducted, DRBs turned out to be a great deal. I think there was a pretty good enthusiasm also, at least good strong feedback around drives. But we recognize there's more near-term uncertainty around EMV. EMV has been a tremendous opportunity for this business beginning really back in the mid-2000 teens, right? And then starting in 2014, really picking up steam in 2016 and continuing through the peak. But if you will, all good things must end. And we've been able to, now, I think, get a little bit of line of sight into how that will tail off. I think the size of the tail off here as we've talked about on the earnings call, isn't necessarily a surprise, but the shape of that tail. And I think was it going to play out over 3 years or 5 years, and I think the same amount is playing out over a shorter period of time. And really, '21 and '22, which are more robust from where we'd originally planned them, playing off a little harder in '23. And I think that has led to some of the dislocation as opposed to say a terminal value issue. But nonetheless, we saw the opportunity to take advantage of that and generate some strong returns.

How did you come to the decision of the 250, if you can kind of make a supply in the wall on the various numbers that were sort of discussed and thought through and you made a commitment to obviously, there's still more M&A coming on the portfolio shift. So if you don't mind sharing with us a little bit how you came to that decision?

Sure. Well, first of all, we thought 250 was a number that given our particular volume flow, we would be in the market for a while. So that addresses share repo for a period of time here that is comfortable to us. We have an additional 250 under our existing authorization, so we can always make the decision depending on how things look to go further a lot. But we also think we can allocate capital toward share repo and also continue our M&A aspirations, right? So we think these things can be hand in hand. We've always talked about these not being mutually exclusive that we could do both. So I think that's very consistent with how you see us acting, and we'll see how the markets continue to behave and what the opportunities are.

Okay. And if you're in the market consistently, roughly what kind of time frame to complete the ASR, you would say?

Ultimately, that's up to our financial partner here and how quickly they deploy it, but I would anticipate it getting us into Q2 but not beyond.

Into Q2, great. You mentioned the appetite for M&A. I think you highlighted $2 billion over the next 2 to 3 years. Can you take us through some of the cash generation activities that you're working on to help obviously fund that M&A as well and maybe then take us through how you're thinking about the current landscape and maybe some of the recent volatility has shaken a few more assets where maybe the conversation on price is getting a little more attractive?

Well, look, one of the hallmark features of Vontier is our free cash flow generation capability, converting adjusted free cash flow at or above 100% adjusted net earnings. This year, we had an extra federal tax payment in the second quarter, but still we're 96% free cash flow conversion. So that free cash flow provides us a nice opportunity to continue to transition the portfolio over time, which we think we have a reasonable amount of time to do. And I think investors understand that the car park is a slowly evolving thing. We've also said, David, that we would continue to look at a range of size and types of deals. And I think in our first 2 deals completed, you've seen some of that. DRB has turned out to be a great acquisition. We were -- we knew it would be, but it's -- we're very bullish on it. We would think of that as really middle of the fairway, very adjacent to what we do today, moves us up the technology stack a little bit, bring some additional capabilities to the portfolio, but the type of market we understand and operate in very well. Driivz is our first foray ownership-wise into the electric vehicle charging infrastructure. We previously had a minority interest in an option on a fast charging company called Tritium. But as we continue to work through the market dynamics of that space, our interest really lied on the software side, on the network management side, which is what drives Driivz. We see that as a very attractive profit pool and growth area over time. We felt very fortunate to have a similar option on this company that we entered into in the early days of Vontier, frankly, in Q1 of 2020, and where it provided us an option by the end of 2021 that we ultimately executed on. I think we're very fortunate to have that opportunity to purchase at a valuation that was negotiated 2 years prior on what's turned out to be a pretty bullish growth end market dynamic in the electric charging infrastructure.

And I know you discussed a bit on your last call about the EMV decline that you expect in '23 being relatively sharp, $300 million, $350 million. When you think about offsetting that inorganically first, is the line of sight for the M&A for the rest of the year? I know it takes two to tango and things could change as we've seen this last week or 2. But do you feel more comfortable with this backdrop we've seen of late that you can get some deals done by the end of the year? Or are they may be slipping a little bit just given maybe the seller is a little less comfortable in this environment to sell given some of the changes?

Yes, I would say I haven't seen a change in the environment, maybe it's too short of a time to see that. But we have a real robust funnel. And this stuff is built over time, as we separated Vontier, we've continued the cultivation work from the bottoms up and pursued strategic opportunities, more corporate strategy down. So the funnel is robust. You made the point upfront, right? These things are hard to put a pin on time and certainty out there in the future, that's surely our intent and we think there'll be opportunities there, and we're looking to get that done, and it is part of the thesis. The larger part of the offset will come from the -- sorry, the organic growth underlying our business. We've talked about our growth ex-EMV, which has consistently been in that kind of mid- to high single-digit range, that only averages up. It feels like DRB, where we're looking at a nice sized business we've added to the portfolio, talk about it growing mid-teens this year, continued robust growth in the other parts of Gilbarco. So with those components, we see that as the primary offset. But as we then -- the decline becomes much smaller, we see the opportunity to offset that inorganically, and we're pretty confident about that.

And before we dive into the organic offsets, again, on the acquisition, just want to be clear, the Driivz business sounds like let them do their thing. You obviously give them access to capital to drive the investment in that business. But it feels like a platform that you're going to let it happen a bit organically. It's not like we now have that platform, and let's add a lot to it. Is that a fair summary first on Driivz?

I think that is a fair summary. I mean that asset has a nice spot carved out in a very early stage market. We need to treat it very differently, as you alluded to. I would also say it's not down the middle of the fairway type deal, right? And I think as we look at inorganic activities for the rest of this year, I would steer you to thinking more towards the middle of the fairway even though we will do a range of types and sizes of deals, I think DRP is more indicative of the type of things we're looking to do in the near term.

And DRB, I assume, given their market share, it's a nicely consolidating industry. The trends are coming to the more automated car wash. So I assume that's sort of also a strong platform, but not one you need to add to it. It's about execution. So when I think about the platforms that might be a little subscale or interesting opportunities to build upon some current niche positions you have, GTT and also Teletrac or Teletrac Navman, should we be thinking in that arena? I mean, you always have some high-growth market opportunities maybe in traditional GVR. But is it fair to say we should be thinking around scaling up the GTT Teletrac position as sort of the initial focus for this year?

Well, look, those are nice businesses, obviously, but I would probably steer you closer towards the retail solutions space. And as we look towards some of our existing capabilities, building off of attractive adjacencies, continuing to move closer to things like helping our very large customer base with operational efficiency and customer experience as those offerings continue to diversify at that attractive, consistently growing end-market convenience store footprint and then frankly, high-growth markets where we have a great physical presence today, we're big believers. We entered early into the high-growth markets, and we think there will be future opportunity to take advantage of that fueling infrastructure build-out, which needs to happen over the coming decades.

When you think about retail solutions, building off the technology you have, how broad would you go? I mean, obviously, most of your retail solutions is sort of centered around the refueling station experience, the convenience stores at those locations. How broad would you go? Would you break away from the refueling station location, the convenience stores around those locations?

Well, I think we are very embedded with the workflows of those convenience stores, which provides us a very unique opportunity for additional value-add applications and opportunities. So I think that is at the forefront of our minds. We also think the opportunity within the convenience store remains very robust, but there's a long runway of growth here, if you can solve some of those high-value problems around operational efficiency and customer experience. So we think that uniquely positions us to add value there. I think beyond that, there's a number of attractive adjacencies that we have. And whereby I would be the first to say we can't prosecute all of those. It's really about kind of down selecting things that are real near adjacencies. We add a lot of value to the deal, but the deal also opens up the right kind of markets. And I don't want to point too closely to where those areas would be, but there's a number of areas we're significantly interested with those characteristics.

And back to the organic side with non-EMV North America and even how you define EMV post 23s decline? Your comfort level with essentially what people refer to as EMV revenues sort of declining from this year's, call it, $600 million or so, down to sub $300 million or so, but then it levels off. When you say levels off, what are you referring to as leveling? Is that just then just some natural replacement demand related? Is it more the recurring revenue aspect, the software part of that business? Just trying to understand when you say EMV stabilizes at $300 million, people thought of EMV as very much just related to the regulation. Can you help us understand how you're defining that and then maybe broaden the conversation to non-EMV North America?

Okay. So EMV first. So when we talk EMV, we're really talking about how the refresh cycle in the U.S. owned was compressed due to the application of this regulatory plan. People needed to adopt. And by compressing the refresh cycle will create a bubble of demand that we define as really just the people's first conversion. That's it. So people need to convert. What percentage -- what percent of them are going to convert, what's the time frame that they're going to convert, how are they going to convert, are they going to buy an entirely new dispenser or just retrofit the payment system, there's some share shift along the way likely. But those are the things that go into the estimate of the incremental demand and then returning to a run rate business for dispensers in North America, that's driven by the refresh cycle coming back around as we round trip this phenomenon that began in 2014 as well as new site builds and consolidation within the market that tends to drive activity as well. Of course, we'll be selling EMV-compatible dispensers going forward. But really, as we talk about it, it's this bubble phenomenon that has been driven by kind of the initial adoption phase and how that is compressed and otherwise growing but not nearly as volatile.

So $300 million sort of that run rate underlying business of, again, some regular replacement demand and so forth from the historical base of your dispenser business?

In the U.S., correct.

And then the non-EMV revenues, I'm thinking about the gauges on the tanks and things of that nature, can you -- I mean, we've got the impression there is a bit of a replacement cycle coming for those, the gauges on the tanks for emissions issue as much as people might think it's a legacy business that's going away. There's a whole replacement cycle on the environmental side. Can you help us through some of these drivers? And if you could, I mean, give us some indication about '23 because people are trying to figure out the offsets to the EMV decline?

Yes. We refer to that as our environmental business, and it is tank gauges. It's leak detection and the factors there are regulatory drivers. Refresh cycle, like you've talked about, if we think just domestically in North America, it's really that refresh cycle. It's new site builds, which can happen through consolidation and to some degree, new products. We continue to add features to things, but that is an old business. It's an extremely profitable business, and it is a business with a long future. And we're enthusiastic about it. We see that as a more like a high single-digit growth business in the coming years. And given the profitability of it, it is one of the key offsets, the large business force, well entrenched, nice market share and we see as a very -- kind of a very stabilized business in North America and a reasonable part of the organic offset as well as our Retail Solutions business, where we're the #2 point-of-sale provider to convenient stores in the U.S. We have an excellent position to build from. We have innovation and new product aspirations there as well. We see that as kind of a double-digit growth end market where we have a nice position and again, profitable, more profitable than the fleet average of both those items, frankly, probably more profitable than EMV. So a lot of the organic offsets that will be coming in future years come on at a higher rate than EMV will be coming off. And EMV is above the fleet average also, but we have a number of items even above that, that will be part of the offsets that help offset some of the mix challenge in the future.

Can you size for us in '22 roughly, the environmental business in North America and the retail solutions just so we can run a little math of who's running at a high single digit, who's running at double digit, just to give...

Off the top of my head, I can't. I don't want to speculate it.

I can follow up. The high-growth markets, I know they had some tough comps. I mean, I know Mexico provided a really strong regulatory growth story that's been hard to replicate. But when I think about the build-out, and we're all aware of India looking at double the size of their gas stations and hopefully, increasingly, they're not just upgrading the pumps but also maybe some convenient stores or kiosks around the stations. Should we expect that business to return to double-digit growth kind of exiting even though it sounds like that the comps get easier by the time we get to the back half of this year. Just trying to make sure I understand it's not anything more structural that I'm missing, that's not just difficult comps and some really strong Mexico strength. And I know there were some COVID issues that, let's hope, don't repeat as well that really restrain some of the high-growth markets.

I think that's an accurate frame, David. I mean these high-growth markets, right, earlier stage markets are going to remain very volatile. They're lumpy. That's probably the best word we can use. But overall, we believe that net-net, those are double-digit growth, high single digit to kind of lower double-digit growth opportunity through the cycle and the shape of the year is as you suggested. We're going to deal with some tough comps coming off the Mexico comps and kind of the India rebound comp. But as we work through that, second half should be much better than the first half. And even with the tough comps, we see it as kind of probably mid-single-digit growth for 2022. And then as we exit, we'll exit at a higher rate. And it will be lumpy in future years as well, but it will return to that more normalized higher-than-average growth rate. And our physical presence there, we think, through time here, gives us access to some outsized growth.

I was interested when you said the environmental business and the retail solutions, I know they were high margin, but EMV was nothing to sneeze at though on margins. And you're saying they're higher. Somebody has to be lower. So I'm just trying to understand the math of -- these high-growth markets, I know they can be lumpy. But they will be decent, I would think, decent sales drivers when we look into '23 and exiting '22. Are those -- not to say you want to give me the exact margins, but are those very challenged margins? Or they're still double digit, just they're not EMV and environmental and obviously, retail solutions.

Yes. I would characterize it as appropriate margins, but what's great in there, yes, double-digit margins all up when we look at the high-growth markets. But the real opportunity here is the opportunity to expand those margins over time. This journey that we're going on through high-growth markets is exactly what we did in developed markets with this business. It's been around for a long period of time. So as we both move through the volume phase but also as the retail infrastructure associated with retail fueling moves through up the technology stack along the process, we move from content of, say, today, on average, by $30,000 per fueling type up to something in developed markets that were closer to around $100,000. So we got to move up that technology stack because there's more technology content added to the site, which we think is a great opportunity for earnings growth as we continue to scale in these markets where you made the point there's going to be incredible investment in retail fueling infrastructure. India was a great example of doubling their fuel sites in the next 5 years.

When I think about your, say, auto, but call it officially diagnostic and repair, the revenue growth at Matco it feels very constrained right now due to supply chain issues and it feels like volumes were even recently, maybe even down a little bit while you're getting some pricing. Can you update us on the supply issue for that business and then maybe dovetail that into also the appetite that you're finding in adding new franchisees in your white space? So maybe if you can first start with the supply chain issues and remind people, right, the toolbox manufacturing facility, kind of is that more the issue? Is it the products coming from overseas, the tools themselves? Can you give us a little update on that and then talk about the franchisee build out would be great.

Yes. So we've had supply chain challenges in this business like everybody else has. We tend to operate, not be vertically integrated, besides the luxury tool storage, which we manufacture up in the Northeast. Some COVID challenges there. But generally speaking, it's a little more across the board, both on what we purchase and what we make. We've done a decent job satisfying customer demand here. There's a little bit of pent-up demand. But we had our biggest event of the year, our Expo in Q1, where we saw record sales on below record attendance. So we're very enthusiastic about the back market drop here the demand environment behind the market here. So we got a very healthy end customer in the professional auto mechanic. And so things have lined up pretty well. We will work through the supply chain issues in the first half and get back to hopefully, a more normalized supply. We did a pretty good job of estimating what would be purchased at our Expo. So we order well ahead. And I think we probably did a little better job there than at least as well as we thought we'd be able to do. So great demand backdrop. That does not make things easier, but we think we'll work through it. What's most important is it's a great end market, and we have runway for growth through continuing to add franchisees. Now we added 86 net last year. We look to do above 50 every year. We probably have remaining territories available in the high 20s percentage-wise range. So it gives us a nice runway for growth. We have probably a little over 1,900 franchisees today. So we have a nice runway there for growth. And it's a nice, steady business that we frankly couldn't be happier. We've talked about kind of mid-single-digit growth for Matco this year, and I think that's a testament to the backdrop. That's coming off teens -- high teens growth from what we saw last year on a little bit of an easier comp. So they continue to do well even in the supply constrained environment.

I'm intrigued by the comment with the Expo record sales but on less than record attendance. So it's a pretty good appetite to have off of a lower attendance. Can you help us understand though your ability to execute on those orders? Is there anything that you're seeing on the supply chain that is making you feel like -- you said you ordered early, but the delivery still have to show up. So just trying to get some comfort around, is that -- is it -- I mean, end of the day, do you feel like your supply chain is going to be improving at all this year? Or the way you ordered early and the way you discussed it is, we're not expecting any help. We're just going to slog through and get what we can on price and just modest, modest volume growth.

Yes, I'd say the former. I think we think we will like to keep here. I think it's early in the year, but the early returns are pretty good. We continue to work our way through this. We think things improve over the course of the year for us here, part of that's our order pattern as we had some catch-up to do. We've maintained some reasonable backlog, but I don't think we've seen it get worse in recent months, quarters for that matter. So especially as we worked in COVID, where that was not the primary issue, but it was a challenge with some labor availability. As we work through those items, I think we'll keep pace here and make progress against.

It's easier for me to say, but it feels like a backdrop but -- easier for me to say, but why can't pricing be up 5%, 6%, 7% in this market? Is there something I'm missing about the competitive dynamics? But it does feel like it's an industry right now. We know how aged the park is. How hard it is to get a new car and clearly, even used cars are shot selling sometimes more than what you paid from now. You would think there'd be a little more robust ability to get price. What am I missing in that thought process?

Well, look, I want to be a little bit careful, but it is a competitive environment. We do, I think, a pretty good job on pricing appropriately to maximize gross profit dollars in the market. So I think we've got good experience pricing in this market, and our job is to pass through inflation and not just layered on at maximum capacity here. But I think what you saw in 2022 was us pricing ahead of inflation to maintain actually to be margin accretive. So we don't just offset the dollar impact, but we are actually accretive to margin at some degree. And we think we'll hold our own again in 2022. So I think what you saw is, okay, inflation versus strategic pricing, we definitely want to price for the value that we have in our products and solutions. And I think we're pretty good at doing that. And where we are advantaged in 2022, as we came into the year with some strategic pricing that put us on a little bit of a pricing footing. So when the inflation came, we were already leaning into it. EPS, obviously, is a benefit in helping us execute in this regard. And so I think we're operating well, and I think we'll continue to do that in this environment, very, very dynamic. So I think we'll price appropriately for lack of a better word.

I appreciate taking the time. So it sounds like you're pretty comfortable with what's happening though, it's still difficult. You're still feeling pretty comfortable with your ability to offset a lot of the EMV decline next year. And then it sounds like, obviously, with the ASR, you've got the funding to take care of that over the next 1 month or 2 and then it comes down to closing any deals that maybe you have a line of sight for the rest of the year as well, which, obviously, the earlier you get it done, the more it can be of a help and get it under your wings to help be part of that offset for EMV in '23. Okay. We really appreciate you taking the time. Thank you so much. A lot of interest in your name. So I'm sure we'll be in touch. And thank you, everybody, for participating, who's listening in. So thank you, and have a great rest of the day with the meeting today. Appreciate it.

Thank you. I appreciate being here. Thank you, David. Take care.

Thank you.