Vontier Corporation (VNT) Earnings Call Transcript & Summary

Well, thanks very much, everyone, for being here. Up next, it's my pleasure to introduce Mark Morelli, President and CEO of Vontier; and Anshooman Aga, our Chief Financial Officer. We're looking forward to the Investor Day in a month. And maybe first off, Mark, over to you for just some introductory commentary.

Yes. Thank you, Julian. We're happy to be here. Just a little reflection. We finished Q4 with strong results, and we got really good momentum going into 2023. Our top line demonstrated really good execution with organic growth for ex-EMV of 11%, and we had high-teens bookings on ex-EMV which bodes well as we enter into 2023. Encouragingly, cash flow in the quarter has improved, and we're looking at a 90% to 100% free cash flow conversion in 2023. Importantly, in Q4, we sunset the EMV upgrade cycle that we've been talking about now for years, and 2023 will be our trough year on that. And I also think it's also important to reiterate that we see our U.S. baseline dispenser business to be $250 million in 2023. And incrementally, we're more positive on that, because the large folks in the market and the regional folks in the market who we have the majority share with are building out through their construction cycles, and we have good visibility into that this year. So we're very encouraged by what we see so far. At the same time, our business has a resiliency to it. And even through the economic cycles historically, it's proven to be -- have low cyclicality. And regardless of the economic outlook, we're ready. We've got VBS that has certainly helped us on the innovation side, but also helps us on our operational excellence, and we can certainly talk more about that. It enables us to take our costs out and improve our business accordingly. And at the same time, I think when you combine that with a strong capital appropriation that we've done with getting really excellent returns on capital that you have an attractive framework for value creation. Just a couple of minutes about our strategy. We are leading a transformation of the smarter and more sustainable mobility ecosystem. And I think this is important because we've made incredible progress over the past 2 years since [ spin, ] really transforming the portfolio. And hopefully, we'll be able to highlight more of this in our upcoming Investor Day. We are executing a strategy-led portfolio transformation that enables the smart, sustainable mobility ecosystem, which enhances our organic growth profile. And when you look at that, you look at the total market and you see that there are some really great secular drivers that are, in fact, driving our business forward. So the energy transition, we believe, is a great driver for us. We believe in a multifuel future. At the same time, governments are getting more behind sustainability and ESG, and these are great secular drivers for our business. It not only [ secures the ] payment, we think helps out society also environmental regulation on leak detection and vapor recovery means that we can build out the infrastructure in a more sustainable way. And there's incentives around things like building electric charging networks and hydrogen that accrue to our benefit in some of our -- the investments and the progress that we're making there as well. So if you look at this in its totality, I think 1 of the other drivers that come to my mind that is, I think, important to spike out is that customers are adopting more digitalization that enables us to provide solutions that really solve their high-value problems. And so when you look at our strategy together, what we're essentially doing with our strategy is we are connecting smart hardware, we're managing solutions that help end users more efficiency -- efficiently interact with our infrastructure, and it helps our operating efficiency for our end users -- or excuse me, for our customers as well. And so we talk about connecting, managing and scaling on digital platforms. And this will enhance our growth profile, it'll enhance our margins, because it's accretive margins and enhances recurring revenues. Looking at the strategy together and this vision, we view Vontier at the hub of this mobility ecosystem, which is a $32 billion market that is growing at mid-single digits. In fact, we think we're the best positioned, because we are the company with the most amount of depth and breadth to connect, manage and scale to solve high-value customer problems. So with that, we'll turn it over to questions.

Thanks very much, Mark. And maybe one is going back to that issue of U.S. dispense, and it's [ very ] often in the last 2 years that until that really troughs, it's hard for people to look at the other what will be sort of 90% of the company exiting 2023. But you need sort of confidence and conviction that this is the trough. So maybe expand a little bit on that. What kind of visibility do you have into your customer spending plans? Anything around sort of replacement cycles or replacement rates that you can use to sort of flesh out the idea that, that $250 million number [ doesn't ] deviates too much after this year?

Yes. So what we're talking about is the U.S. 250 dispenser business, and what gives us confidence to that is that the customers that we're talking about here are large convenience retailers or regional retailers like Wawa, Sheetz, as an example, or Buckies. And these folks are doing 3 things. They are building new sites which are great expansion opportunities for us. They are sometimes rebuilding on an existing sites. As a matter of fact, Sheetz in Raleigh near the airport is going to [indiscernible] 1 of their most traffic and profitable sites, because they're going to completely teardown and rebuild to make a modern site on there. And then the third area, which is also a really big area to note is they're acquiring some of the small network retailers in the marketplace and consolidating the industry. And all 3 of those mean that they're going to upgrade their equipment, and it's a tremendous opportunity for us, because we have the majority share with this portion of the market. So the reason why we have confidence in that is that there's good visibility on -- people don't plan these things overnight. I mean it takes time from construction and permitting if they're going to do an underground tank. There's a long lead time underground tank. And so even with folks like Costco, which is a great customer of ours, they're building out sometimes on existing sites, that takes a lot of permitting. And so we have visibility based on their plans, and that gives us confidence in the $250 million number.

Perfect. And the rest of the sort of fueling business, I think, is $900 million to $1 billion or so. How do we think about that growth rate this year and medium term?

So we view that growth rate as mid-single digit. And there's a couple of buckets to it that we point to. One is which is the aftermarket. Part of the U.S. upgrade cycle with EMV meant that we had an opportunity to really push and gain share. And I think we really dedicated ourselves to do that. Now there's a little bit of a downside as that's fallen off. We have the trough, but the real benefit is that we have a better installed base for aftermarket. And we've been really gearing up for this as one of our profitable growth initiatives for some period of time. We focus on this with VBS. And now you can see we're getting really good growth out of that aftermarket. And I think legitimately, it's a business we should have been doing better all along, but we just hadn't focused on that. And so we see really good growth there. We see very good growth in environmental, and that's been an area of focus, too. So it's above [indiscernible] growth with above [indiscernible] margins. And essentially, what drives that business, too, is replacement cycles and regulation. An excellent example there is actually in the United States. The underground tanks are reaching a 30-year lifetime where a lot of them went in 30 years ago, and that means that they're in the early innings of a pretty major upgrade cycle. And the reason why that's relevant is after 30 years, folks that own that equipment can no longer get insurance on it. So they have to pay that themselves. And so that really drives an upgrade cycle there. Of course, we've got a lot of high-value content. We don't actually build or install tanks, but we have a lot of high-value content on that; transfer pumps, gauges and sensors. And so that's an excellent business for us. And then the third leg of that is high-growth markets where folks continue to build out a more sustainable petrol-based infrastructure and think about a high-growth market. You might have a fueling kiosk in a country like India that might be 25 or 30 [ ground ] just refueling. But when you start adding all this automation in here, security payment, more environmental issues like we're talking about in automation, that could approach $90,000. So a lot more content as they're building up that infrastructure in a more sustainable way. So really good regulatory drivers and environmental drivers. And in fact, with more focus on sustainability, we're actually seeing more regulation, which is actually better for our industry.

And then the retail sort of point-of-sale business, I think that's about $400 million or so of revenue run rate now. Maybe give a little bit of background on that. I feel it's the business that when I talk to investors, it's understood the least well, because I think most people are more used to thinking about sort of hardware businesses. And what's the sort of the market position of Vontier? Who's some of the main competitors? What's the sort of differentiation you can bring there?

Well, let me start, and I'll turn it over to Anshooman on this one. But this is a business where we have worked on for a period of time. And we actually did an acquisition of Invenco in that business last year. And so it actually has a market leadership position, and people don't think about this, but we have 450 engineers working in that -- software engineers working in that business. So it's really a tech-enabled both, connected hardware and workflow software business.

Yes. So it's a $450 million revenue business roughly, including the Invenco acquisition. It has a very robust portfolio of point-of-sale systems, payments for our customers, workforce solutions and cloud services that we provide. And these solutions really help our customers drive operational efficiency, automation, managed services -- cloud-based managed services. In fact, we manage over 50,000 devices through our Internet of Things or cloud platform. We're the #2 player in this market. And with the Invenco acquisition, we've really enhanced our position, both from a payment perspective, but also bringing micro services into the retail environment. And we just introduced our INFX platform, which we've got some very good feedback from our customers on, and we're very excited about. So good position, very tech enabled, a lot of software engineers, as Mark said. And we're excited about this business' future.

Got it. And how do we think about the sort of the efforts to sort of up sell? It's in a number of sites, how much of the growth is expanding the number of sites that's in versus higher sort of dollar content per point of sale?

Yes. I think it's both. I think our real opportunity here is taking advantage of this application-based software through INFX, which is a market-leading approach. And it's interesting because you look at convenience retailing, and they are adopting trends that you see in other industries. It's a fairly -- has been historically a fairly unsophisticated market. So you see micro services in retailing today. And so it's just adopting that very API-based way by which customers have a choice of, if you want, our payment system, but their loyalty system, it's very application-based, so it has that flexibility. And so that is a real opportunity to both, upgrade existing sites for enhanced flexibility as well as an expansion when folks expand into new sites. So we think having a contemporary offering there will bode really well for our future.

Perfect. And then I think the other business, which it's not a sort of classic hardware business model in your portfolio is Teletrac. It has sort of required some reinvestment, maybe some strategic sort of shifts versus under [indiscernible] days. So what's the kind of the state of play on Teletrac, what kind of growth rate should we expect this year? Do you think the sort of the turnaround is sustainable?

So look, we've been really happy with the progress we've made. It's been tough to turn around. If you know anything about SaaS businesses, we have roughly $180 million SaaS business, 95% SaaS. So it's very much a tech company. And it was churning at about 25% when we took the business on. So that means there's a huge amount of technology debt that needs to be played down, paid off. And I think we're really happy with -- we've done a management change. We've launched a new product called TN360. Our go-to market, in fact, is different. We compete in North America, the U.K., Australia, New Zealand and also Mexico. And we are running these as a very sort of decentralized into those 3 regions. So it was really hard to get scale on the technology. So we reorganized the structure accordingly. And so we feel really good about it. We've been seeing some strong ACV or annual contract volume growth of double digit now for a bit. And as you know, in a recurring revenue business like that, it takes a while for it to drop through to organic revenue growth, and it has in Q4 as we promised it would. And going into this year with sort of this management team, new structure with upgraded technology, we feel pretty good about a mid-single-digit growth this year. But the market, we think, is growing more than that, and we think we have a real opportunity to further develop that growth longer term, should it increase.

Got it. And on Matco, that is a sort of classic hardware clearly. How are we thinking about the sort of franchisee growth there? Give some context on to the Milwaukee partnership that's fairly new.

Yes. So there's 2 pieces of that. So let me take the franchisee piece first. So 2021 was a robust year for franchisee growth. In fact, we probably outgrew our capability there a bit. It was more than double, even a good year rate. And then we gave back a little better, those franchisees into 2022. So 2023 is off to a good start. If you look at the franchisee growth, it's been a pretty stable low single-digit grower. If you take these uneven sort of lumps out of it. And I think that that's what folks should probably think about as the longer term, we're going to focus a lot more on quality. And then there's a couple of the product lines that we've been really working on revamping and one of those Power Tool lines. And I think we've got a great Power Tool offering there with both, Milwaukee and our existing offering in Infinium. That's been part of that. I think they're quite complementary. I think it provides a great platform for our franchisees and for service technicians. So we're really excited about that. I think one of the issues came from last year as we start with availability through supply chain. We go to market predominantly with the supply chain in that business. We only build toolboxes. And so we have -- the benefit is we have really high vitality, which means that about 25% of what we bring to market every year is new to the industry, fun fact for folks. We're the #2 seller of Oakley sunglasses in the country. And so it's -- we'll provide what service technicians need. And this backdrop of complexity of repair actually is something that we're really happy about with that vitality and supply chains are improving this year. We've got our toolbox factory on the mend. And so we're hoping to demonstrate a better performance in 2023.

And have you seen any sort of -- a lot of your business is not super macro-sensitive. You've got the regulatory element, things like Teletrac and point of sale, there's a lot of software in there. Matco is one of the more sensitive pieces. How is demand trending there? Have you seen any changes in customer behavior in recent months?

The backdrop on demand is really good, and let me explain why. Service technicians who we sell to -- our franchisees sell to those are our end-user customers are at full employment. Their wages have never been higher. It's actually leveled off a little bit. So it's stopped kind of going up at a really high rate, but still really strong wage rates. And I think of the other driver here, which is the average age of the car park is actually has been getting older. It's now about 12.2 years. And the sweet spot of repair is actually a vehicle that's older than 5 years. And so the car park is sizable, and miles driven remain elevated. So all of that means that it's pretty resilient. In fact, if you've looked at historical downturns, it's been pretty resilient through those downturns, because people love driving their vehicles and they might delay their repair a bit, but not much because Americans love driving our cars.

Perfect. That makes sense. And then as you think about the transition on the sort of the fueling forecourt, if you like, EV charging coming in. You've mentioned once or twice the example of Norway as maybe how the future of that industry could look globally. Maybe expand a little bit on your thoughts on that and then specifically sort of the drives -- [ stake ]house drives performing.

So we've looked at places where we think we don't only have a right to play, but also a right to win. And one of those areas, as we've said, the strategy-led portfolio transformation kind of led us to electric charging, but much more so on the software side, where we're hardware agnostic. Now we love hardware. Like in hydrogen dispensing, we've elected to be in hydrogen dispensing hardware and also connected hardware and software. But in the case of electric charging, we've elected to be more on the software side. What makes us really excited about sort of our early footprint here is that we believe that there are a lot of customers that are going to have to more effectively manage their network of electric chargers. I mean one of the biggest issues that [ face ] consumers is range anxiety, and everybody reads a lot about uptime on electric [indiscernible], who's going to manage all that? Well, we've got a market-leading software called [ Driivz ] that is the operating system software. So you want to manage that network of chargers better, roaming, tolling, smart use of grid energy in connection to the grid end-user applications for ease of use and accessibility and AI to be able to self-heal and provide better uptime for chargers. All of those things are much needed. So customers like EVgo, Shell, Circle K, MIR and recharge, which are very well known in European markets and leaders in the Nordics have adopted that. So if you look at the Nordics, which are leading the adoption worldwide for electric vehicles, we have 75% of the charging networks under management. And so I think that bodes well for the many players that have adopted our solution. It works and there's more uptake on that all the time. We're seeing very strong growth year-over-year in that business. And do you want to add anything there Anshooman?

Yes. The other thing we're very interested about is in that business, we've got 60-plus premier customers in the space. And the revenue model is recurring, but there's 2 step-ups in there. So as the 60-plus customers build out the charging network, we get a fee for every socket we manage, a recurring fee. The second is we get a transaction fee, so as they're more EV vehicles on the road, and they're using these charges more, there's a second bump up in revenue for us from the transaction. So there's really a 2-step after you win a customer growth and revenue, which is a great place to be as the EV charging hardware ecosystem is going to get built out.

Then strategically, sort of how easy is it to manage, drive sort of what input you have to how they develop, and what sort of informs the pace at which you're trying to push their growth?

Well, I think there is really based software company, a lot of great technology there, expanding internationally. We actually are the leading provider of the operating system software for Japan, which is not a huge market right now, but it's a great position to have. So I think you think of Europe predominantly as the sweet spot. And so we're working very closely with Driivz and also technology that we've embedded in there for battery management system called Sparkion, where we're actively working to develop how we expand that. So I think it's an exciting opportunity for sure that we're going to throw off a lot of cash flow from our business for a long period of time. And I think we're very disciplined on where we deploy that. I think we've also demonstrated through the Teletrac Navman SaaS business that we know how to run these kind of businesses, and we know how to further develop them.

And maybe switching to sort of profitability. For a couple of years now, you've had this big headwind of the dispenser business coming down, and that's offsetting a lot of the productivity work in the business and operating leverage in the other parts of Vontier. As you think about dispensing, again, stabilizing from here in the U.S., what's the sort of normal operating leverage that people should expect from the company, assuming that mid-single-digit organic CAGR?

We're very well positioned to continue to expand our margins over the next years. And there's really 2 dynamics at play when you have a mid-single-digit growth, we've typically talked about an incremental drop through of 30% to 35%, which is above our 22%. So there's just growth is going to drive an increase in operating profit margin. But the second thing is we're in the early stages of operational efficiencies. Our DNA, our culture is built around the Vontier Business System of operational excellence. One of the examples we talk about when you think longer term is the number of dispensers with the product line simplification efforts. We started off with 32. At the end of last year, we were down to 20 platforms. we're going to take that down to 8. Just think of the complexity reduction in our organization and manufacturing and the overhead support functions. And then think of the number of SKUs we can take out and drive working capital improvements. In the short term, we did a restructuring effort. We've given a range of 40 to 45. We came out at the earnings call and said, we're pretty confident we'll hit the high end of that range. And that's [indiscernible] [ new savings. ] So both, short term and longer term, we feel very confident of driving operational improvement, supported by top line growth to drive margins in our business.

Got it. And then capital deployment, the leverage isn't low, but there is some room given how high the cash flow margins are at the company. Should we think about buybacks, just where the stock is being the most likely use of cash this year?

Yes, we have a very disciplined returns-focused capital deployment strategy. And for this year, if you look at our midpoint of guide, both from an EPS and a cash conversion, you get to north of $400 million of cash flow. We've committed $150 million to $200 million to pay down some of the debt to reduce leverage below 3x. We're at 3.2x at the end of last year. So we'll get the leverage down. We have about $16 million of dividends that we pay out every year. So really, we have $200 million of free cash flow to deploy. You could expect a majority of that cash to be deployed. And at our current share price, we believe it's hard for M&A to compete with returns on stock buybacks. So stock buybacks remain a key priority for us for this year.

Good. Well, with that, we'll now switch to the audience response surveys. So please grab these gray devices, and then we can start the questions. So the first one, [indiscernible] the stock. So some owners, but not many.

Lots of opportunity for you guys.

That's it. That's it. The next question, what's your general bias to it right now; positive, negative, neutral? So very even, Steven. Next question is around what's the sort of EPS CAGR through cycle for the company? And the pace set here is probably sort of broad industrials or multi-industry companies. So in line is where most people end up. The next question is around sort of cash distributions, what to do with it? So mostly buybacks and then some degree of internal reinvestment. I see you have a lot of -- there's some good growth opportunities internally DRB. We didn't touch on and then, obviously, the software businesses. The next question, sort of what PE multiple on this year on Vontier trade at? So mostly sort of mid-teens. I guess a lot of question marks still on long-term growth. And then the next question, I think sort of relating to that, this is essentially why should it have a mid-teens PE not 20, or why does someone not own the stock right now. The biggest reason is core growth, no surprise. We'll see in a year once we get past the EMV sunset completely, if that answer changes. Last question now, does ESG play an active role in general? Most of the answers have been about 30% for #1 and sort of 70% for #3. It's a new question this year. So we'll see if these responses change next year. But in general -- okay, more balance. So there is a reasonable amount of ESG in people's minds when they're thinking about Vontier. So with that, well, thanks very much, Mark and Anshooman.

Thanks so much.