Vontier Corporation (VNT) Earnings Call Transcript & Summary

Now welcome to the -- our session for Vontier Corporation. I'm Rob Mason, senior equity research analyst at Baird, covering the advanced industrial equipment segment. I want to Introduce Vontier, is a global industrial technology company focused on smart transportation and mobility. Their portfolio operating companies offers innovative solutions to advance safety, security, efficiency, and environmental compliance worldwide. They run on a proven business system with an experienced leadership team and a [indiscernible] of continuous improvements. So I want to introduce Mark Morelli, who is CEO and Anshooman Aga, who has just joined as CFO of Vontier. Mark is going to open with a few brief remarks, and then we'll move to Q&A from there.

Yes. Thank you, Rob. It's a real pleasure for us to be here. Let me just frame up where we are, I think, as a business right now and just spend a couple of minutes on that. So we initiated a strategy-led portfolio of transformation designed to enhance growth and profitability with a tighter focus on the mobility ecosystem, delivering smart, sustainable solutions to that market. As many of you know, we have this strong secular driver that's now in tail off mode. Many of you know that as a super cycle called the U.S. EMV. And so we were in the tail end of this. And I think what's really important about this is that we have been preparing the business for this stage now since spin over the past 2 years. And we launched a set of profitable growth initiatives and portfolio strategies specifically to get after growth and improving margins. And we're leveraging the Vontier Business System, which is a direct outgrowth of the Danaher Business System and Fortive Business System, and we have the benefit of greater focus here and deeper deployment. So I could say 2 years now post-separation, we're really proud of the results that we've been able to demonstrate. We've been able to demonstrate better top line growth, we improved margins. And specifically, a couple of years prior to the spin, the non-EMV part of the business was actually in low single-digit decline. And we've been able to boost that to double-digit organic growth. At the same time, we've been able to deploy $1.5 billion of capital that we're very confident will deliver double-digit returns on capital in 3 years. And this is through addition, obviously, through the acquisitions that we made with DRB, Invenco and Driivz. But at the same time, we've deployed about $300 million in stock buybacks. So far this year, we have approval to do much more, and you're going to see us leaning much more into the stock buyback with the dislocation and value that we see currently in the stock price. So that might be a little bit of a change in rhetoric you're hearing from us. And we think portfolio management is also addition through subtraction. So we've announced the divestiture of 2 of our assets there. I think at the same time, we're a resilient portfolio, strong free cash flow generation, about 100% is which you can expect. It's been historical and going forward. And we think the business model will continue to have a strong free cash flow generation. We serve about a $28 billion market that grows at mid-single digits. And at the same time, it is focused more tightly on the mobility ecosystem. Think about this selling to convenience store retailers, car wash operators, fleet operators, auto repair shops and electric charging infrastructure operators. When you think about this market, it has relatively low cyclicality and has performed well in downturns as well. This is because of the strong secular drivers. Labor and skill shortages are something that accrues to our benefit because we have productivity solutions. There's increasing regulation. In fact, regulation has driven our industry for many years in the past and many years to come in the future. There's increased attention on sustainability and ESG. Very proud to report that yesterday, we published our first annual report on sustainability where we're signing up to science-based initiatives that are commitments for us for Scope 1 and Scope 2 that we think are very aggressive for our industry, and we are very proud of those as a management team. And we're in the secular driver that we're in -- is in the economy of convenience. Consumers want more personalization. Millennials don't own hoses. So car washes are a great place, we think, for a economy of convenience. And also, when you think of frictionless payment, these kind of things are all productivity enhancers for us that accrued our benefits in terms of secular drivers. So in summary, Rob, we are galvanized by our mission for accelerating smart sustainable solutions with a tighter focus on the mobility ecosystem. At the same time, our purpose is very motivating to us which is mobilizing the future to create a better world. So with that, we'll have a discussion.

Perfect. Perfect. And we are fresh off the third quarter last week.

So I thought maybe we'd start there and move outward. And just in the third quarter, probably a little more noise than typical but it does sound like you're setting the stage to clear this discussion around EMV. And you still have to work through the numbers next year, but I thought the element of the update was effectively you're calling an end to that EMV cycle and maybe a quarter or 2 early -- at that. And then again, not lost on the quarter itself was that news was just good execution, given all the mine fields that still surround supply chain. But just to go back to the EMV point and put a finer point on clarification around that, just explain what drove the pull forward on that, that decision. And then how did you arrive at the baseline that will reside at you call it, $250 million of baseline revenue going forward, the composition of that revenue.

Sure. So what we did announce is the sunsetting of the EMV tail, essentially a quarter earlier than anticipated. So we pulled forward $50 million of the downturn into the Q4 of this year. And at the same time, our peak to trough is roughly about the same. We said it was $450 million to $500 million. It's now going to be about $500 million. So a bit on the top end of our guide, and the benefit is that we'll move through this sooner. Essentially, what's happening though is that a disproportionate amount of our revenue right now is being sold to small businesses. These are the what are called small network retailers or mom-and-pop convenience store owners. Through recent channel checks through the [ net show ] that occurred at the beginning of October through the -- a lot of the data points that we collected at the end of Q3, we really think it's prudent that the adoption rate for these small businesses is not going to be what we initially thought it would be essentially earlier in the year. They're a little bit impacted by the higher interest rate environment. their access to capital and also the higher cost of fuel where they're spending more money to actually inventory that fuel. This is something a little bit hard to predict given the macro environment. And this is not normal for us because there's such a disproportionate amount of our business going to those small businesses because these are the folks that have yet to adopt on the EMV curve. The national accounts have adopted a long time before. So we think that moving -- there's a benefit to moving through this and it gets to your question about what's that run rate. We think it's a $250 million business for U.S. dispensers next year. And the reason being is we're actually stronger with the national account players. And the national account players represent that business. Keep in mind, pre sort of EMV back to 2013, 2014, this was larger than a $250 million business. We think this super cycle has afforded those folks to maybe pull forward some of those upgrades. So we feel good about that $250 million number. It represents the build-out of the convenience stores that folks are making commitments. These national accounts, they're acquiring some of the small businesses. They're also continuing to build out their infrastructure. It's a very vibrant part of our economy even in a downturn. And so we feel good about that $250 million guidance.

What level of maintenance replacement resides within that $250 million?

That's essentially dispenser volume. That's not aftermarket parts. Aftermarket parts is a strong growing part of our business. And we have focused on that a lot through our profitable growth initiatives. We're demonstrating really strong margin and profit, but that's not part of the $250 million.

And is it fair to think that because we ended up at $500 million of EMV benefit versus $450 million, you also grew your installed base at a higher level to support, may be that's an after-market.

The benefit of the EMV upswing, if you will, was -- gave us an opportunity to really focus on that and gain share, and we did. That sets us up better for replacement cycles, that sets us up better for a more robust parts business. A little bit of the pain, though is you have a harder falloff, and we're experiencing a bit of that pain right now. But we're very confident that this business will continue to demonstrate aspects of growth that we can take advantage of and will generate strong free cash flow for many years to come.

And one element or one driver of that aspect is and has been and continues to be around regulatory drivers? Is there anything that you can point to there that gives you confidence that, that...

Yes, absolutely. I'll let Anshooman you through the regulatory environment, but there's a patchwork of regulatory drivers that have been secular drivers for this business for a long period of time. Go ahead Anshooman.

Yes. So we have regulatory drivers that are both above the ground and below the ground with environmental portfolio when you start thinking above the ground. We -- for the payments, we have to comply with the PCI payment card industry standards, so right now in Canada, PCI 1 is being sunset, so we're seeing some volume from that. In North America, you're going to have PCI 2 sunset in a few years from now, which is going to be additional upgrades where customers will be buying the new PCI payment standards. When you start looking at below the ground, there's also environmental drivers and sticking with the U.S. for a moment. In California, we have the ISD In-Station Diagnostic that has more stringent standard, which is going to lead to volume. But really when you start going outside the U.S. with [ vapor ] recovery, there's growth coming in Brazil, India, Mexico, for example, and additional things in India and Brazil, for example, around theft and fraud preventing that. So we have very strong regulatory drivers, some of these bite size. But when on aggregate, these lead to stable growth in this business for years to come. And when Mark talked about the $250 million, that's a baseline -- a re-baseline for next year. All of these regulatory drivers is going to help grow that business. And we've said GDP plus kind of growth in that business going forward. So we feel very comfortable with the position we are in.

Very good. When you step back up just to the Vontier level, can you just give a brief perspective on what the current environment looks like to you as you move through the fourth quarter into next year, what kind of momentum you're seeing in various parts of your business?

We see strong momentum in several aspects of the business, particularly around our profitable growth initiatives where we worked on and the platform strategy. So let's take DRB as one. So acquisition, we're more than 1 year in, demonstrating really strong top line growth and increasing margins, and we're booking well into the back half of next year. At the same time, we see our ANGI business, which has -- we dispensed or provide equipment to dispense compressed natural gas, and that is about a $75 million business that is also experiencing really strong growth into the back half of next year. We've also announced that we're getting our initial sale of our hydrogen dispensers, it's a direct outgrowth of that business. And it's not only our right to play, but our right to win in that space, so really strong growth there. [ AMO ] parts, excuse me, AMO is the acronym for spare parts business is representing strong growth as well. And so environmental, we have said, has had a bit of an impact to the availability of underground equipment but we anticipate that to be a pretty solid grower for us and a pretty steady grower, not as much impacted by the EMV trend, and there's a lot of strong secular drivers behind that business. Another aspect of our business that is doing pretty well and is above fleet margin is our retail solutions business. This is part of GVR and this provides the convenience store operators with a deeply embedded point of sale and workflow solutions on top of that, north of a $300 million business, including payment systems. And we anticipate we'll be seeing strong growth at above fleet margins as well. High-growth markets, we think of based on the regulatory drivers that are there, there is a lumpiness to them. We've disclosed some of that lumpiness actually continually, there is some lumpiness of that business, but we anticipate that will also be a good grower for us. So we see a lot of growth opportunities going into next year. We've discussed a lot about the impact on the EMV trend and the small network retailers, but we think that has kind of isolated to this one aspect of our business, and we see some strong growth and some real evidence of that growth going into next year. which is why we're saying that we'll be exiting the year at mid-single-digit growth.

So when you think about areas that are cyclically sensitive in your business, where would people look for that?

So I think the business has performed well. It's a low-cyclicality business even in kind of -- across our markets. And when you look historically, -- that has certainly been the case. I think we're a little bit cautious on the macroeconomic environment based on what we've articulated, but we some strong aspects to that growth. We've also announced, based on the pull-in of this EMV downturn. We pulled -- we have an enhanced restructuring program. Now we've been lining this up for many years. So we have a restructuring program there anticipating the fall-offs so we're accelerating some aspects of that. And we see more headroom for us to do better on the restructuring aspect as well. Keep in mind, there's a strong element here of a self-help program that's at work, and we're about third innings on that self-help program. So we're -- we think even in a softening macro, we'll be able to deliver those kind of results.

If we could just stop and go back to DRB a moment. That is a business that's just now become organic for you. You're annualizing that. It's outperformed your expectations or at least the expectations we had for it. when you bought it. What's underpin the outperformance? You seem to be confident that, that -- some of that will continue. I'm not sure if it's possible at the current level, 30% growth is...

We're not promising 30% growth next year...

But what's really actually driving that.

Look, I think there's 2 things that are happening there. So first of all, you always push to do as best you can in the business and acquisition. And sometimes, you might -- I think you're always surprised, not very often, you're surprised on the upside. But I think what we're particularly happy with the business is, one, it's in a growing space, private equity and some of the national players are continuing to invest in the infrastructure. They get outstanding returns. I think they still see that way even in a rising interest rate environment. And so we expect that, that will continue in growth mode. Two, it's the leader in the space. And I think we're gaining share. I think the benefits accrue to the market leader. We actually don't make car wash equipment per se. We make the point-of-sale system with workflow software on top of that. And I think that we're seeing the benefits of that as well. We've had a -- changed out members of the senior management team this past year as well, and I think they'll really fit for the challenges of the future. And I think we're kind of through the integration phase, if you will, with the management team and we're off to a really great multiyear path and growth on this business.

What about the profitability since you've owned it? Has it been able to be -- have you leveraged that upside? Or have you reinvested more heavily than you would have originally expected to perpetuate that.

Well, I think we're investing for the business at the rate that we think we need to. We're -- along those lines, we're launching a new cloud-based software product called Patheon, which is going to be based on recurring revenue, which we think will be a really important part of the leadership in the market. But I think going back to the fact that we see growing profitability, and we acquired the business, it's already strong profitability, but we enhance 400 basis points of margin in the first year of ownership. And I think what's also happening there is that we're facilitating payments, which is a very interesting part of the car wash, and I think it accrues to other parts of the mobility ecosystem where you can facilitate payments, you can offer your customers a reduced payment facilitation and you can actually collect a part of that income stream yourself. So that's almost 100% drop-through. And so we see there's legs to that as well to increase the profitable growth of that business.

It does have a leadership position and in a fast-growing market. Like you mentioned how some of that growth is occurring in the market with private equity. There's always some concerns about overcapacity coming into a market. How are you trying to manage that risk as well as we go forward?

So part of our business is we have a strong data analytics arm, and that helps us in one area where we figure out for our customers where it's the best location to put a new car wash. We also put in place these pricing mechanisms and recurring revenue mechanisms. So we use a lot of data analytics. We've also used our data analytics to try to understand the economics of where car wash is going when that market might reach saturation. And we think that's a long way off. So we see many years of really good growth available to us in the U.S., and we also have international expansion opportunities.

The ANGI business was another area that was certainly highlighted on the last call with better growth maybe than would have otherwise been expected there. It seems to have a lot of good tailwinds as well. Just update us on where your opportunities could be near-term around now that you're entering the hydrogen space. That still seems a bit early, but just -- I'm just curious what the expectations are around what that can contribute to growth. And then, I guess, on the CNG side, how that can sustain?

So the CNG business is clearly experiencing I think a lot of growth, it's certainly in the near-term. I think we're growing significantly this past year, but also we're demonstrating that we're booking well into next year, as I said. The hydrogen is a really interesting opportunity because if you think of climate change initiatives, it's going to be really hard to achieve those without a multi-fuel future. And we think there is real opportunity for hydrogen-based infrastructure for things such as long-haul trucking. And we have customers asking us a pretty strong drumbeat of requests, because we have a premium brand, we deal with these kind of regulatory and safety drivers a lot. We are a large company. We stand behind our product. And the kind of innovation provided is right in our wheelhouse. It's at a higher pressure, dispensing compressed natural gas is at a higher pressure. And hydrogen is also at a higher pressure. So a lot of those same capabilities are also in our wheelhouse to be able to provide. So we feel like it's a real natural spot for us to do an organic investment, and we think there is a long runway of growth opportunities at a business relatively small, but has some scale around it.

And some of that effort to grow that falls under the alternative energy investments that you've now been calling out for a few quarters, just to give transparency to your efforts there Driivz is another one. What's the -- what's the prospect that, that investment level sustains at the level it's currently at? Should we think that it would expand as we move into next year, what's just our expectation...

I think we're comfortable with the investments that we've disclosed. I think we are investing responsibly for that space, and I think we're getting really good growth. Let me just spend a minute talking about Driivz we made this -- this is not a knee-jerk reaction. We've studied the electric charging space for quite a while, and we actually had an option in the electric hardware charging side. We developed this option in the electric charging software side. This is the operating system software to manage a fleet of operators -- excuse me, a fleet of chargers, and if you think about what needs to be done there, it's not only the maintenance and operations, it's the roaming, it's the tolling, it's the consumer access through apps. It's how it backward integrates into the energy management of the grid. It's got a high barrier to entry. And this is a leader in the space. And one of the other things that we've learned since owning this since the beginning of the year is completely covered up from customer demand. And we have thousands of ports under management, tens of thousands of ports under management today. It's a relatively small business. But the way it grows revenue is we take on new customers. We just made an announcement of Shell going forward with us in 10 countries. We have other charge point operators of scale. And so we make revenue based on our ability to land new customers but also we get additional revenue as the chargers earn higher use because it's a recurring business model. So we think this is a great space for us with the -- a pretty measured investment, which we think we get outstanding returns.

And you mentioned a leader in the space. Is it unique as a merchant provider in the space versus I'm not sure what the some of the other charge networks, if they're vertically integrated along those lines? Just [indiscernible]

So this is unique. And the reason why it's unique is that it provides software to folks that opt not to build their own software. So if you're a charge point operator, if you're somebody with a fleet of chargers, you may decide to write your own software to do everything we just talked about, or you can white label it from Driivz. And they are the leader in the space right now for doing that. And at the same time, it's hardware agnostic. So we work with over 500 hardware providers out there. So I think that this position that this company has built now for about 10 years, we're kind of at a really strong inflection point. They're seeing tremendous demand.

As you're able to look out and see the scale up of new charging -- new charge points, what should we think about from a time frame standpoint into revenue that drives becoming material?

I think if you look out to 2026, this should be north of $50 million in revenue. At -- It already has software gross margins, but as this business scales, the operating profit contributions are going to scale significantly. As Mark mentioned, we get revenue per charge port per month, plus we get transaction revenue. So as number of charge ports expand and that are being deployed by our customers and utilization to expand this revenue is going to scale pretty dramatically.

Okay. Real quickly, I did not want to leave out Matco. That was another business where it seems like the growth profile that you're communicating is a little bit higher where you've historically thought of low-single digit. Is that still the case? Or have you started to elevate the growth profile there?

I think the growth profile is elevated a little bit. It's above low single digit. We're saying mid-single digits. And it's really off the backs of a couple of things. So let me just walk through it quickly. First of all, we have a net opportunity to add franchisees as part of that distribution, about -- still about 30% of our territories are not covered. So that's an inherent opportunity for us to continue to build out on. The other aspect is we offer a very high vitality of new products to market, about 25% or 30% every year, what we bring to market is new that year. And if you look at the backdrop for auto repair, it's actually a pretty growthy environment. The age of the car park is now 12.1 years. It's getting longer, the sweet spot of repair for a vehicle is between 7 and 12 years, and the complexity of repair is going up, whether you own an ICE vehicle with more sensors on it or electrification or hybrid, that means over the next 2 decades, there's increasing complexity of the car park, which means that service technicians need to solve that with more tools to be able to do that, and that's what we provide to the market space. So technicians are also fully employed. They have plenty of money. Their wages are way up. They spend money on their professional tools, and that's what we provide.

In the brief time that we have left, I did not want to missed the opportunity to talk about capital deployment and your position there to the extent it's evolved, given just the current situation, your priorities around buyback versus deleveraging versus future M&A.

Yes. Let me -- I'm going to turn that over to Anshooman, but clearly, the posture with the kind of dislocation of the stock price is getting outstanding returns were buying back stock. But I did want to mention one thing about Matco. I apologize backing up we just launched Milwaukee as an offering for power -- for cordless power tools, which is a tremendous growth opportunity. And it's a fantastic platform excellent availability of product where they stock a lot of inventory in the U.S. for us. So that will also boost growth. Do you want to talk about the capital deployment?

Yes, we're very returns focused. And at the current valuation dislocation, the best return we see is true buybacks. So while maintaining a healthy balance sheet we generate a lot of free cash flow. We're going to return to normal free cash flow of roughly 100% of net income converted to free cash. And our priority is going to be share buybacks from a capital deployment perspective for the foreseeable near future.

Is there a leverage ratio that you would like to reach before you become more actively engaged in M&A there?

We've said we're going to get to about 3x for year-end and next year 2.5 to 3x. It's not either/or it's a and for us. We see a potential to do both at the same time. Additionally, we have 2 of our businesses, Hennessy and GTT that we set are non-core to our business that we have started the process to sell. Those proceeds will come in, and those will be deployed to pay down debt and to buy back shares at the same time.

Well, we are at time. If you do have questions, please join us. There is a breakout session afterwards, and we'll take those questions there. Thank you.