Fortive Corporation (NYSE:FTV) Q4 2023 Earnings Call Transcript

Fortive Corporation (NYSE:FTV) Q4 2023 Earnings Call Transcript January 31, 2024

Fortive Corporation beats earnings expectations. Reported EPS is $0.98, expectations were $0.93. Fortive Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: My name is Kristina and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to Fortive Corporation’s Fourth Quarter and Full Year 2023 Earnings Results Conference Call. [Operator Instructions] I would now like to turn the call over to Ms. Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

Elena Rosman: Thank you, Kristina and thank you, everyone, for joining us on today’s call. With us today are Jim Lico, our President and Chief Executive Officer; and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer. We represent certain non-GAAP financial measures on today’s call. Information required by Regulation G are available on the Investors section of our website at fortive.com. Our statements on period-to-period increases or decreases refer to the year-over-year comparisons unless otherwise specified. During the call, we will make forward-looking statements, including statements regarding events or developments that we expect or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and the actual results may differ materially from any forward-looking statements that we make here today.

Information regarding these risk factors is available in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2023 [ph]. These forward-looking statements speak only as of the date that they are made and we do not assume any obligation to update any forward-looking statements. With that, I’ll turn the call over to Jim Lico.

James Lico: Thanks, Elena. Hello, everyone and thank you for joining us. I’ll begin on Slide 3. Fortive delivered outstanding operating performance again in 2023 through our proven formula for value creation. Our transformed portfolio of businesses delivering consistent through-cycle performance reflecting a more durable company with mid-single-digit core growth in 2023 despite a mixed macro environment. Strong execution by our teams drove another year of record margins with adjusted gross margins now approaching 60% and adjusted operating margins nearing 26%. Throughout 2023, we focused on unleashing the full power of FBS, reflected by record participation in KAIZEN events, including our largest ever CEO KAIZEN week. The results of these KAIZEN’s were tremendous, including an average of 50% productivity and 50% lead time conversion improvements.

Our industry-leading free cash flow generation funded accretive capital deployment, including our best year executing on bolt-on acquisitions, accelerating our growth strategy across all 3 of our segments. We also opportunistically bought back shares and increased our dividend, enhancing shareholder returns. In summary, we remain committed to our strategy and its success is evident given the consistency of our results which I’ll highlight on Slide 4. We built Fortive to drive growth, drive progress and drive value. Reflecting on our evolution, we made significant steps again in 2023 towards our vision of a premier company. This includes 5% core growth and 160 basis points adjusted operating margin expansion. The benefits of our portfolio transformation are reflected in our progress to date, averaging rule of 35 [ph] performance over the last 5 years.

FBS is driving commercial success as we expand into new growth markets, speed innovation cycles and maximize investment returns across our 3 operating segments. For example, in 2023, we saw a 33% increase in our revenue attainment on new product launches. Many of these new products are contributing to the approximately 60% of our revenues that positively impact climate, health and safety concerns and aligned to the U.S. sustainable development goals. Our operating companies are seeing a greater than 20% acceleration in software development time through the use of Gen AI, improving our ability to deliver more value to customers. Our culture of innovation, learning and continuous improvement is contributing to gains in our industry-leading employee engagement scores, a critical component of our sustained success.

Lastly, our acquisition performance contributed to our record free cash flow in the year, underpinned by industry-leading net working capital performance and accelerated returns on invested capital. On Slide 5, you see how our portfolio is strategically positioned to increasingly benefit from secular growth trends. Every day, we are helping our customers harness the power of emerging automation and digitization technologies streamline crucial workflows and embrace the energy transition. Some highlights in the fourth quarter include: in IOS, Fluke’s new family of Multi-product Calibrators are providing the broadest workload coverage across some of the fastest-growing markets. Recent bolt-on in RedEye is helping to transform customers’ digital experience with a modern centralized hub for engineering document management, solidifying our Accruent’s leading position in that market.

In PT, Tektronix is harnessing the power of open source software with the first release of its Python Native Drivers to help our customers automate their instruments and accelerate their testing types. Together with EA which closed in early January, Tektronix is expanding its addressable market, adding complementary performance solutions to their best-in-class electronic test and measurement suite serving the fastest-growing areas of the power market. In AHS, Landauer is helping customers reduce energy usage, waste and carbon emissions with their new Digital Dosimetry Solution. And ASP launched their new sterilization monitoring products in North America and Asia helping customers achieve greater efficiency and assurance as they work to keep up with rising clinical demand.

Turning to Slide 6 and a spotlight on M&A performance; our two most recent large deals provide an excellent example of the Fortive flywheel for value creation and action. In 2021, we accelerated our segment strategies with the acquisitions of ServiceChannel and proVation information. These two world-class software offerings are creating compelling value for our customers. And Fortive, having fully embraced the power of FBS to drive double-digit ARR growth and significant margin expansion. For example, ServiceChannel exited 2023 with adjusted operating margins in the mid-20s up from breakeven when it was acquired. And proVation delivered 112% net dollar retention in its GI solutions, up approximately 8 points Censis acquisition. The execution of our disciplined acquisition strategy strengthened by the value FBS creates and is a critical component of how we achieve sustained results over time.

You see that reflected in their industry-leading net dollar retention as our innovation and customer centricity tools are helping them retain and grow their existing base. Turning to Slide 7; our ability to deliver differentiated results enable our world-class business system. Across Fortive, we leveraged FBS to better understand our customers, accelerate innovation, expand market share profitably, improve operations and forge the leadership skills we need for the future. One of the best things about FBS is that we never stop improving it. As our portfolio evolves, we are expanding the tool set and capabilities that allow us to set and deliver on high expectations, as you just saw in the ServiceChannel and proVation examples. In 2023 [indiscernible], our center of excellence for software data and AI expanded its capabilities to further support digital transformation and drive innovation, next-gen products and productivity across Fortive.

Core to our success is how our leaders immerse, teach and lead from the front with FBS. Together, they make KAIZEN the way of life for our 18,000 team members reinforcing our strong culture of inclusion or everyone’s contribution matters. Looking at the chart on the right, what is unique and differentiated about Fortive, the breadth of results that are compounding over time. Since 2019, we have sustained our target of mid-single-digit through cycle core growth. We have delivered outstanding margin expansion above our annual commitments. We have converted more revenue to income growing adjusted EPS at 14% compounded rate and converted more income to cash, compounding free cash flow at an average of 19% over time. With that, I’ll turn it over to Chuck to provide more color on our fourth quarter financials and our 2024 outlook, starting on Slide 8.

Charles McLaughlin: Thanks, Jim and hello, everyone. We ended the year with a high level of performance, generating earnings growth of approximately 3x revenue. Core revenue growth of 3% in the quarter reflected an acceleration in IOS and Healthcare, partially offset by anticipated slowing in Precision Technologies. We achieved record margins in the quarter and full year, driven by the strength of our brands. Earnings per share of $0.98, reflecting operational beat at the midpoint with earnings up 11% year-over-year. And free cash flow was $413 million, down versus the prior year as expected and up 56% on a 2-year stack basis. For the year, core revenue growth was 5%, exceeding our initial outlook of 4%. Adjusted gross margins expanded by 180 basis points to 59.5%.

Adjusted operating profit grew 11% and margins expanded by 160 basis points. Adjusted EPS of $3.43 grew 9% and we delivered on our free cash flow forecast of $1.25 billion which represents 32% growth on a 2-year stack. Turning to Slide 9; I’ll now provide highlights on the fourth quarter performance of each of the 3 segments, beginning with Intelligent Operating Solutions. Q4 core growth was 6%, reflecting continued momentum across this segment. with stable POS trends in all regions and new logos and customer bookings contributing to strong ARR growth. Adjusted operating margins expanded 300 basis points to 34.2% driven by margin expansion in all businesses, accretive software mix and price realization and productivity initiatives. Overall, we have seen better durability in Fluke throughout the year.

given the benefits of innovation and customer adoptions in key growth verticals. Environmental Health and Safety continues to see strong high net growth at ISC and double-digit SaaS growth at [indiscernible]. Facilities and asset life cycle at double-digit core growth throughout most of 2023 driven by continued strength in SaaS, contributing to record margin expansion. Moving on to Precision Technologies. Core revenues in the quarter were slightly ahead of expectations, down 1% driven by lower Sensing revenues more than offsetting growth in Power, Food and Beverage and Aerospace and Defense market. Adjusted operating margins expanded 270 basis points to 29%, enabled by favorable price and productivity benefits funded throughout the year. Additional highlights include Tektronix which had a record year with 9% core growth, up 25% on a 2-year stack basis, reflecting the benefits of our focused innovation and vertical markets growth initiatives.

And while Sensing Technology revenues were down low single digits in 2023, they were up low double digit on a 2 year stack and ended the year with a return to growth in 2 of our 4 businesses. Now on to Advanced Healthcare Solutions. Q4 growth was 3%, driven by an acceleration to mid-single-digit growth at ASP, excluding Invetech, AHS core growth would have been approximately 6%. Adjusted operating margins expanded 160 basis points to 25.7%, driven by flow-through on consumables, price realization and product additional highlights include. At ASP, we are through the North American channel transition from indirect to direct, driving 7% consumables growth in the quarter. Our Software businesses continued their pace of double-digit SaaS growth with new logo success at Censis and proVation.

We expect to sustain this momentum in 2024. Turning to Slide 10; you can see total growth in the fourth quarter of 4% was driven by expansion in the core with minor contributions from FX and bolt-on acquisitions. By regions, we had mid-single-digit revenue growth in North America, driven by growth in all segments, including stronger growth in consumables, benefiting AHS. Western Europe revenue was up slightly as growth in software was offset by normalizing growth in hardware analytics [ph]. Asia saw continued strength in India and Japan, however, was more than offset by high single-digit decline in China. As a reminder, we anticipated growth in China would be down as we lap outside growth in prior years. Turning now to Slide 11; we’re introducing 2024 guidance, starting with the full year.

We expect growth of 6% to 8%, with core revenues up 2% to 4% and acquisition contributions of approximately $215 million. Adjusted operating profit is expected to increase 10% to 13% with margins of approximately 27%. Adjusted diluted EPS guidance of $3.73 and $3.85 up 9% to 12% include a $0.13 headwind from higher interest expense associated with funding of the EA acquisition. The effective tax rate is expected to be approximately 14.5% to 15%, in line with the average of the last 2 years and reflecting the benefits of the EA acquisition. Free cash flow is expected to be approximately $1.38 billion, representing conversion in the range of 100% to 105% of adjusted net income and 21% free cash flow margin. For the first quarter, we anticipate revenue growth of 3% to 5%, with core flat to up 2%, driven by the continued momentum in our IOS and AHS segments, partially offset by a low to mid-single-digit decline in PT.

Adjusted operating profit is expected to increase 6% to 10%, with margins of approximately 24.8%. Adjusted diluted EPS guidance of $0.77 to $0.80, up 3% to 7% includes a $0.04 headwind from higher year-over-year interest and free cash flow of approximately $180 million, reflecting normal semi variation. Moving to Slide 12 and the outlook for 2024 by segments. You can see we expect positive growth and operating margin expansion in each segment in 2024, supported by our alignment secular tailwinds, new product introductions resulting from our robust innovation efforts. The continued resilience of our software and other recurring revenue businesses, the expected delivery of the remaining approximate $100 million of excess backlog in our hardware products businesses, another year of FBS driven execution and the carryover benefits of the productivity initiatives that we executed in 2023.

By segment for the year, we are planning IOS to continue its momentum with mid-single-digit core growth and another 100 basis points of margin expansion. Key drivers include stable demand and NPR traction in the hardware products and continued ARR growth supported by strong 2023 SaaS bookings. We are planning for PT revenues to be up 10% at the midpoint in 2024 with core growth up slightly, reflecting the benefits of the EA acquisition and normalization of orders in hardware and products businesses in 2023. We expect EA to be accretive to adjusted operating margins in 2024. And together with the benefits of our productivity initiatives, we expect PT margin expansion of over 100 basis points. PT’s outlook also reflects the realignment of INV into Sensing Technologies Group as we explore strategic alternatives for INV design and engineering business.

The remainder Invetech’s includes product revenues that align more closely to our automation businesses in Sensing. For comparison purposes, we have provided pro forma segment results for 2023 in the appendix. In AHS, we are planning mid-single-digit core growth, with operating margin expansion of over 125 basis points driven by volume, price realization and productivity. We expect an acceleration in the growth at ASP driven by their improved channel position, NPIs and procedure volumes and new logos and SaaS migrations are expected to drive continued software growth in Healthcare. Before opening it up for questions, I’ll pass it back to Jim for closing remarks.

James Lico: Thanks, Chuck. I’ll start this wrap up on Slide 13. I am incredibly proud of the contributions of our 18,000 team members to make 2023 another record year for Fortive. Over the last couple of years, our success executing our strategy to build a more resilient company reflects our strong foundation and enduring principles that underpin our unique and compelling culture. We talked about the operating rigor and leverage of FBS tools to innovate and drive growth across our segments. In addition to higher core growth, the deals we have done are contributing to our multiyear track record, including strong performance again in 2024. Since 2019, we are sustaining 7% revenue growth, delivering 120 basis points of adjusted operating margin expansion per year, driven predominantly by higher gross margins compounding earnings and free cash flow double digits; we have cut net working capital as a percent of sales nearly in half, building 50% more free cash flow per dollar of revenue.

This is a testament to our portfolio transformation and the power of FBS fueling our current and future success and with a $60 billion served market, we have substantial runway to accelerate growth organically and inorganically. This brings me to Slide 14 and how we drive differentiated performance and value creation for our shareholders. With a consistent and compelling 2024 outlook, including 6% to 8% total growth and over 100 basis points adjusted operating margin expansion in every segment. We are on track to our 2025 target of $4.50 of earnings and $1.6 billion of free cash flow. We are confident in our ability to differentiate our performance and believe our outlook is appropriately balanced, remaining agile to deliver for customers and shareholders should the environment differ dramatically.

As we showed at our 2023 Investor Day by executing the Fortive Formula, we expect to roughly double our earnings per share and generate more than $8 billion of free cash flow over the next 5 years. Our M&A funnel remains strong and our acceleration of capital employment as demonstrated in 2023, further positions Fortive as a higher growth cash flow compounder and a premier company delivering exceptional value to shareholders. With that, I’ll turn it back to you, Elena.

Elena Rosman: Thanks, Jim. That concludes our comments. Kristina, we are now ready for questions.

Operator: [Operator Instructions] Our first question comes from the line of Steve Tusa from JPMorgan.

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Q&A Session

Steve Tusa: Just the kind of trend in the shorter-cycle businesses, Tek and Fluke, maybe just an update on where you stand, book-to-bill how the revenue did this quarter and then how you’re thinking about how the year plays out next year?

James Lico: Yes, Steve, it’s Jim. I think, number one; I would differentiate Fluke and Tek here. I think we certainly saw, we saw mid-single-digit growth at Fluke in the quarter. We saw growth in orders, point of sales in the mid-single digit around the world. So I think we’re seeing the real benefits of the number of transformation things that we’ve done from an innovation perspective, also with some of the M&A work we’ve done and in good shape. And I would say Tek, Tek was low single digits in the quarter but quite frankly, off a 20% growth comp in Q4 ’22. So still saw some good performance there. We felt really good about the quarter they produced as well. And certainly, the year that Tektronix had is unprecedented a record year, as we said in the prepared remarks.

So as we go into the next year, I think it’s — I think, more of the same at Fluke. We’ve really seen some resilience and durability activity that we’ve talked a lot about over the years, playing out there. We probably have a quarter. They’re about their fifth quarter of negative bookings. And obviously, we’ve been working off backlog there. And we would anticipate that book-to-bill there turns positive and probably Q2. So we feel good. North America was really good for tech, where a little bit of slowing that we saw within China as we talked a little bit about our China growth in total and Chuck’s prepared remarks. But obviously, part of that Tek’s one of our bigger businesses in China. Part of that story is the Tektronix there. So I’ll pause there and you’ve got a follow-up, I’ll certainly cover.

Steve Tusa: Yes. And then just how much price do you assume in the for the guide? For 2024?

Charles McLaughlin: We’re thinking about 2% to 3%.

Operator: Your next question comes from the line of Nigel Coe of Wolfe Research.

Nigel Coe: Good afternoon, just like on the reclass of Invetech to PT, it’s a small business, it seems like margins are relatively depressed maybe 6% to 7% margin. Just wondering, I think, Chuck, you went through some of the logic about just maybe talk about what this achieves this class? And maybe just in terms of the importance of this ASP rather AHS acceleration, kind of like how is that benefiting sort of the outlook for AHS because were you assuming that Invetech recovers? Just trying to think about AHS on a like-to-like basis here?

Charles McLaughlin: Thanks for the question, Nigel. I’ll take the margin question first. We’re talking about the business expanding 125 basis points but that’s on a like-for-like basis, if you really look at where we ended with Invetech and we’re up probably 200,250 basis points but the business is generating margin expansion of 125 and that’s what we’ve got in the guide. I think the rationale for switching it is the event design engineering piece just isn’t as big as we thought it was going to be and it’s not but not really moving forward. And so the part that is now the majority of this business really fits better in Sensing.

James Lico: Yes. Nigel, I would just add, we called out in the slide materials that Invetech was a headwind in the quarter for health care to the tune of about 280 basis points. That’s probably the largest year-over-year headwind that Invetech has seen. I wouldn’t expect the size of that to continue but probably still in the 1% to 2% [indiscernible] continued to be in health care throughout 2024. But that’s now reflected in PT.

Nigel Coe: Okay. That’s helpful. And then maybe just on the transition ASP consumables. Just confirmed that’s now fully behind us. There’s no lingering impact there? It sounds like it is. But maybe I think we can see the clear sort of margin benefits that we should see coming through from capturing that distributor margin. But maybe talk about the opportunities to drive better growth and having that direct customer connection, what do you see as a potential for revenue benefits?

James Lico: Well Nigel, I would say, number one, yes, we’re definitely fully through it. So you saw the benefit of that. I think as we said in the prepared remarks, consumables in North America were up about 7%. Consumables around the world, we’re up about 4%. So good performance there. We think mid-single-digit guide for ASP for the full year is a good number. Certainly opportunity to go and on the margin front which we’re going after. We were just with the team last week. We actually had them with, we had our Board meeting there and we have the team there for an operating review, highlighting the level of innovation. I talked about in the prepared remarks. We now have a new set of consumables around steam sterilization that are going to now be in the U.S. and Asia that are certified.

So a number of opportunities here to continue to improve the growth. Those are obviously all in Consumables which obviously have higher fall-through. So you like the guide here overall held up 125 basis points in margin expansion mid-single-digit growth. We think that’s a great launch point. It certainly certifies I think a lot of the things we’ve been saying about the direct North American strategy and certainly more broadly around the strategy at ASP and how health will just be a real durable grower for Fortive in ’24.

Operator: And your next question comes from the line of Julian Mitchell of Barclays.

Julian Mitchell: I just wanted to check on the sort of margins in the first quarter. So I realize it’s not a big sequential decline in sales but you’ve got a very heavy sort of sequential step down in margins there in Q1, 100% or so kind of drop-through. So is that reflecting maybe something on mix in any of the businesses in the first quarter versus the fourth? I’m just trying to understand maybe on Precision, in particular, how their margins are starting out the year in Q1?

Charles McLaughlin: Nigel, the biggest thing is there’s just a seasonal step down in revenue dollars from Q4 to Q1 and that’s what gives you a normally seasonal step-down in the margins, pointing out that our Q1 guide is up 75 basis points. So that’s a pretty good expansion there. So I think we’re seeing pretty good performance across the segments in margin expansion, too.

James Lico: Yes. And I would just say that guide represents record operating margins in the first quarter for Fortive. So I think when you just look at, we do have some expenses that start back up at the beginning of the year, obviously, salaries and some of those things. There’s a little bit of that. But at the end of the day, if you just step back, record, that will be a record first quarter for, in the history of Fortive.