My name is Renée, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to Fortive Corporation's Second Quarter 2016 Earnings Results Conference Call. [Operator Instructions] I would now like turn the call over to Ms. Lisa Curran, Vice President of Investor Relations. Ms. Curran, you may begin your conference.

Thank you, Renée. Good afternoon, everyone, and thanks for joining us on the call. With us today are Jim Lico, our President and Chief Executive Officer; and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer. Please note that our historical GAAP financial information is presented on a carveout basis. In addition, we present certain non-GAAP financial measures on today's call. Information required by SEC Regulation G relating to these non-GAAP financial measures are available on the Investors section of our website, www.fortive.com, under the heading Financial Information. A replay of the webcast will be archived on the Investors section of our website later today under the heading Events & Presentations, and will remain archived until our next quarterly call. A replay of the conference call only will be available shortly after the conclusion of this call until Tuesday, August 9, 2016. Once available, the link to this conference call replay will be posted under the Investors section of Fortive's website under Events & Presentations. During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. The supplemental materials describes additional factors that impacted year-over-year performance. Unless otherwise noted, all references in these remarks and supplemental materials to company-specific financial metrics relate to the second quarter of 2016, and all references to period-to-period increases or decreases and financial metrics are year-over-year. During the call, we will make forward-looking statements within the meaning of the federal securities laws, including statements regarding events or developments that we believe or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set forth in our SEC filings. And actual results might differ materially from any forward-looking statements that we make today. 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'd like to turn the call over to Jim.

Thanks, Lisa. Good afternoon, everyone, and welcome to our first earnings call as an independent public company. This is certainly an exciting time for Fortive. We're pleased with our results as we delivered outstanding free cash flow performance and margin expansion despite core revenues being down slightly reflecting challenging economic conditions. On July 2, we successfully completed our separation from Danaher well ahead of schedule and with remarkable efficiency. We were able to achieve this outcome by leveraging the Fortive Business System tools and our deeply-rooted institutional knowledge and results orientation. Given our decentralized operating model, the separation didn't change the day to day for the majority of our employees. What is clearly evident, however, is that a reinvigoration of our culture is installed across the organization. The separation provides Fortive with the capacity for disciplined acquisitions and growth investments to strengthen our businesses and market-leading positions. The Fortive Business System will continue to be the cornerstone of our competitive advantage by providing a playbook for accelerated innovation and superior customer satisfaction that will, in turn, drive improved core sales growth, operating margin expansion and strong free cash flow conversions. We are committed to embracing our strong culture of continuous improvement and driving shareholder value for the long term. And now, turning to the quarter for a more detailed discussion of our results. Please note that the following results are presented on a stand-alone basis from Danaher's historical results. Adjusted net earnings of $219.8 million were up 40 basis points over the prior year. Both reported and core revenue declined 50 basis points. Geographically, high-growth market revenues were up low single digits and developed markets were down low single digits. High-growth market results were driven by high single-digit growth in China and strong double-digit growth in India, offset by continued…

Thanks, Jim. That concludes our formal comments. Renée, we're now ready for questions.

[Operator Instructions] And our first question comes from Scott Davis with Barclays.

Congrats on your first quarter out of the gate. I just want to talk a little bit about the M&A backlog and how that's changed. I mean, a lot of your management team and development team, I guess, really came together in the last few months. So where are you, if you had to put in terms of kind of what inning? Or where are you, as far as you think, capability to be able to go out and execute a transaction right now? And maybe just give us a sense of where you are in the pipeline, whether it's a full pipe, and how you feel, the confidence you have and what you see in being able to deliver something maybe even in 2016.

Yes. Thanks, Scott. I think as you mentioned, our team has come together in the last 90 or 120 days, an experienced team. As you know and having spent 20 years in this game, you can never predict when a deal will happen. But we're very busy right now. The funnel is in very good shape. I think in terms of both the breadth and diversity of the funnel is what really excites Chuck and I. We have a good set of value deals that we think -- but also some good deals on the growth side that might be slightly higher valuation, but would still give us a solid return over time. I think the most important thing is we'll continue to be disciplined. And we think the funnel is -- this environment is pretty good. The funnel is growing. And I would expect us to continue to build the funnel and transact something. You can never predict timing, but I think we're in a very good place right now.

And just as a quick follow-up, I mean, where do you -- in your underlying businesses, where do you feel better or where do you feel worse from the Analyst Day and outlook?

I would say that when we look across -- I'm not sure there's any place we'd say we look worse. I think the North American market has been slightly more noisy. And so in that place, in the last maybe month or 2, we've seen that firm up a little bit. But it's still mixed depending on the vertical. Strength, I think we saw it. Certainly, Transportation Technologies continues to be in a strong position. We've seen some good improvement in Qualitrol, Matco, as we described in the prepared remarks. And then Kollmorgen having growth in the second quarter, I think, is a nice place to be. So I think on balance, that's what gives us confidence in the guide here to be low single-digit growth in the second half. And I think right now, if you look at high-growth markets, we'd say, other than Latin America, pretty good. So as you look across regions, you look across businesses, there's a number of places where we saw either firming up or an improvement. And I think we're in a -- we'll be in a good place for the second half here.

Our next question comes from Steve Tusa with JPMorgan.

Congrats on the first quarter out of the gate here. So just a quick question on the follow-up on the M&A stuff, just remind us what your targeted financial hurdle is? Is it the old Danaher kind of 10% thing? Or is it more nuanced than that? And also, I think the messaging was you think you have the capability to kind of do, I think you said $2 billion to $3 billion over a 3-year period, but that -- kind of that would be weighted towards kind of the next year or so.

So, yes. Steve, this is Chuck. I'll take those in reverse order. The M&A that we think that we can -- the capital we can deploy is representing $3 billion over the next 2 to 3 years. So I think you've got that exactly right. The hurdles, I think going back to what Danaher's traditionally -- both Jim and I come from strong Danaher roots. Discipline means, for us, 10% in 3 years, 5 years for more of a platform-type deal. There's going to be certain situations where we'll stretch beyond that, and there'll be either small deals that maybe we see a great opportunity for value creation down the line. But most of the time, that is really going to be around those 3- and 5-year metrics.

Okay. And then I think you said low single digit for the second half. What do you expect for the third quarter for organic?

So we're coming from a flattish in Q2, and -- it will be low single digits but probably accelerating. We run into an easier compare when we get to the fourth quarter, but not in the third quarter. But we're still moving into low single-digit core growth in Q3.

Our next question comes from Nigel Coe with Morgan Stanley.

Congratulations on your first quarter out of the gates. Yes, so there's obviously a lot of debate about the sustainability of the EMV upgrade cycle. Maybe Jim, could you offer some perspective on where we are in that penetration curve? Are we maybe 20% through, halfway through? I mean, how sustainable do you think this upgrade cycle is?

Well I think if I break EMV into 2 places, one, the indoor and the outdoor, we still are seeing growth on the indoor side, as we mentioned in the prepared remarks. So we think that will continue. As we've talked out there a little bit, industry experts would put that penetration in around 50 in the marketplace. I don't suspect we'll ever get to 100. On the outdoor side, we're very early stages. If I were to do a baseball analogy, I'd feel like we're in the first or second inning here. So not sure what that is on a percentage basis. We will see some acceleration though in the second half due to EMV, both on the indoor and a little bit on the outdoor side. So you'll see that. As we mentioned before, we still believe it's a $500 million incremental opportunity over the next several years. And we're still not calling the timeframe in that other than the next 2 to 3 years just given how early we are in the outdoor penetration cycle, Nigel.

Okay. No, that's very helpful. And then a follow-up on Tektronix. It's been somewhat disappointing for the last 4 years or so. What do you think it's going to take to get this business back to growth over the next couple of years? I mean, is there an upgrade cycle? Is there an NPI cycle? What's -- what will it take to get back to growth?

Well I think when we look at -- we'll see some stabilization there in the second half as we -- some of that will be comp-related. But also, some of that is really some of the things they've been doing that will start to see some traction. I think when you look at the strength that they've had in China as well, what you'll really see is when there is a good macro trend, they're taking advantage of that. And double-digit growth in China, I think, is representative of their strength of their position in some places. We've certainly been investing there. In the second quarter, they have strong healthy gross margin expansion, but we took the opportunity to continue our technology investments. I think that's the beauty of the strength of our portfolio, is the opportunity to do that. And we'll see some of that in the part of 2017, in the second half of 2017. So I think you'll see continued stabilization through this year. And we think that while the macro trends there are a little tough right now on a global basis, particularly in the U.S. and in Western Europe, we think we're in a slightly -- we're in a better position, if you will, starting in '17.

The next question comes from Steven Winoker with Bernstein.

I'll echo my congrats for this first quarter out of the gate. That's great. Can we just stick on the Professional Instrumentation segment for a little bit? You just talked about Tektronix. I guess it's also the third quarter for Fluke where we're down. Last quarter was down mid single, high singles down before that in the fourth quarter, and this one's mid single, right? So just give us a sense for what's really -- what's going on there? You've got a good business, but what, on the macro front, is really hurting there?

I think what we're seeing is some slowness in the U.S. Fluke is probably the one place where we get a little bit of second derivative situation relative to oil and gas. Where we don't have a lot of direct oil and gas exposure, we do have some second derivative. And we see that geographically in the U.S. where we're growing pretty well with distributor sales out on the coast, but in the middle of the U.S., we're slightly slower. So that'll continue for a little bit. We were happy with a high-growth market growth there, particularly in India and China. So I think -- and also, continuing to get margin expansion in the second quarter despite the decline of Fluke, I think, really means we're continuing to get good price, it really shows the strength of the business. With the Fluke Connect condition monitoring launch and a number of other innovations in the second half, I think we'll start to see some acceleration. Beyond the comps in the fourth quarter, we'll start to see some acceleration as we get into 2017.

So Jim, since you're mentioning the oil and gas impact there as well, so if oil sort of stays at these levels, does that affect your view of growth in that segment then?

I don't think it does anything more. I think what we saw is we're sort of sunsetting a lot of that. And we're seeing -- you see that -- some of that in some of the publicly-traded distributor customers that we have, is that we'll start to see that as we get through the end of the year. As I said, we don't have a lot of oil and gas exposure in the portfolio. Fluke North America might be a little bit, but most of it's really more second derivative, as I mentioned, a little bit in the sensors process. But we don't think where oil is at today means any precipitous drop even where we're at right now is really -- is much more of an impact at this point.

Okay. Can you just speak also -- the whole Verizon acquisition of Fleetmatics for $2.5 billion, does that -- how does that impact the industry for you guys as far as your perspective's concerned?

Well, it's interesting. It isn't necessary -- we've obviously known Fleetmatics in particular because we've competed against them. We don't think that necessarily changes the competitive dynamics. Telogis and Fleetmatics are slightly different properties. So we think we're are in a good position. I think what it does is it establishes the strength of the market, both long-term growth and if you have a high -- if you're a large subscriber account like we are, it just shows the value of those kinds of properties. So I think, really, what you've seen with those acquisitions is really established the strength of our portfolio. We had a very good quarter relative to not only revenue growth, but also subscriber growth, and that's really ultimately in a fast business like that. That's what it's all about. We think we're in a good place. Obviously, I won't -- never comment on what happens until acquisitions from competitors is finalized. But we think we're in a good position, and I think the second quarter just amplified that position.

We'll take our next question from Shannon O'Callaghan with UBS.

Jim, can you just remind us where we are in Fluke Connect at this point, and what your expectations are there? What's the reception been like so far, et cetera?

Well, I'd say, when you -- the condition monitoring offering that we're launching here right now is a very exciting offering. It's a combination of just -- not just software and some of the things that we've demonstrated, but it's also a set of sensors, a network gateway that really gives you ease of installation. This is really our real breakthrough in Fluke Connect is really with the condition monitoring launch that we'll have going -- coming out right now in the third quarter. It will still be a small impact in the second -- or the second half of this year. Part of it is the SaaS offering around the analytics offering. So I think we'll start to see, obviously, good additions to the portfolio. There are some hardware sales as well. So we think that'll start to accelerate into the fourth. But it's really a 2017 and 2018 story when it starts to have meaningful impact in the business.

Okay. And then given the tough end markets out there, I was a little surprised about the growth at Kollmorgen. I mean, is that a particular market or a particular initiative that's driving that business to grow at this point?

Well they had good high-growth market performance. That was certainly part of it. I think that really shows to the technology offerings. Some of the work they've been trying to take the business into nontraditional applications like robotics has really been a big helper in some of the robotic initiatives they got in the China market. But across high-growth markets and even in Western Europe, they had good performance. So I think it really speaks to the power of FBS, the strategy that we've had to take us into different markets, and you're starting to see some benefit there. Obviously, they do have some tougher markets as well. We've seen that in some other players in the industry. But I think it's really been the work that we've done to try to make that business less cyclical. And really, a little growth here by some other segments is really starting to pay off a little bit.

Our next question comes from Julian Mitchell with Credit Suisse.

Just on the low single-digit organic sales growth guide for the second half and the acceleration within that. So when we're looking at the 2 segments, are you expecting a similar rate of acceleration at both in the second half? Or is it more weighted to PI because its trends are weaker right now?

Julian, it's Chuck. I think that it's really similar. What we're seeing is we've got some of our good growth drivers in Industrial Technologies. That business is a little bit ahead in the recovery and the growth. But it's really about the acceleration of references running into an easier compare in Q4. But I don't see it differentiated. They're both improving going forward sequentially.

Understood. And then, I guess maybe talk a little bit about the sensing business. So I guess on the face of it, the end markets and what it does, it's playing to a number of very favorable trends. It's been actually pretty weak for sort of 18 months or so. So how much sort of reinvestment do you think is needed by Fortive to get that business sort of back on its feet? And is it essential, I guess, to have acquisitions on top? Maybe organic investment isn't enough.

I think we were -- I think as we look forward, we'll see some good end market exposure. Our Anderson business is an example. Has good exposure into the sanitary market in the food and beverage industry. So they have some good macro trends that will deliver growth in the second half and into 2017. I do think it's going to take, for the remainder of the business, some time for us to continue to build on some of the good work that's already been done. M&A activity would certainly help accelerate in some key strategic areas. As we mentioned, I think when we were out over the spring, that this is a place where Chuck and I, as we go through our strategic plan efforts here in the late summer, early fall, we'll certainly get a better sense of some of the needs that the business will have given the different framework. But these are good businesses. As we mentioned, they did an outstanding job in the second quarter of protecting margins. They're steeped in DBS -- in FBS. And we'll have -- I think we'll have some good opportunities as we get into '17 and '18 as we build on their strategic plan this year. And Julian, you get $5 for getting -- drawing out DBS out of me for the first time on the call. So remind me next time I see you.

Our next question comes from Patrick Newton with Stifel.

I guess, Jim, with Verizon acquiring Fleetmatics, I guess 2 questions come to mind. One is, how do you see the competitive landscape changing, I guess, given the scale Verizon will have from both the Fleetmatics and recent Telogis acquisitions? And then also given the Verizon multiple paid, would Fortive potentially look to monetize its competing Teletrac business? Or is this business very core to Fortive's portfolio?

Well I think on the scale question, for sure, they'll have a larger business. But this will still put up as one of the larger subscriber account Telematics businesses in the world. So we still think we have scale in this business. And certainly, from our perspective, we think we're in a good position. So I think we -- Fleetmatics has been a good competitor. I don't suspect that in the next 12 to 24 months, that'll change. I think they'll continue to be a good competitor, and we'll have to continue to run the play that's been successful for us around driving subscriber growth. I think as we think about monetizing it, we like this part of the portfolio. I think the prices that are being paid in the industry have -- are very representative of certain companies and the needs for them to do things. But we've looked at M&A activity in that space as well, and I think there's a mix of deals out there. So we think we can continue to build our own strategy here and we'll run our own play. We like the business as part of the portfolio we have today.

Great. And then I guess just as a follow-up, kind of digging into the M&A conversation, you did talk about a growing pipeline in the prepared remarks. And as we kind of think here about timing and think about geographically, from a timing perspective, is it reasonable to think that we should, given the growing portfolio, see something announced perhaps before year-end? And then given the dollar strength and higher contribution of revenue from North America, would it be reasonable to assume that you're more willing to prioritize overseas acquisition?

I think on the first one, I would -- the timing of deals is always hard to do. Having done this for a while, it's always hard to predict. But I would think, as busy we are, we would hope to get something done before the end of the year. Returns are really more important than any one individual area. So I think while we -- when we look at our funnel, it's certainly global. It has representative opportunities throughout all geographies. Certainly, Europe is very representative of our funnel, and you never know where things will happen. But we're focused on a disciplined approach to returns. And any onetime currency situation or whatever is not necessarily going to be something that would drive us to do one thing over another over the long term. We have said that deals would probably bring our tax rate down over time, but again, that's another example of we wouldn't do anything necessarily for the tax rate, we would do it because it accelerates our business strategically. And ultimately, that also gives us a financial return, part of which might be lowering the tax rate. But we're always strategy first, return first, and that really -- that's why we're excited about the funnel being strong.

Our next question comes from Andrew Kaplowitz with Citi.

Jim, can you talk a little bit about the margin decline that we saw in Professional Instrumentation in the quarter? I mean, it was slightly bigger than we expected. And if you look at your guidance for the year of 30 to 50 basis points, at least for the second half, of 30 to 50 basis points of core operating margin expansion, I think that compares to 9 basis points for the quarter. So is it just the investments coming down that you mentioned, the technology investments that's going to help you? Is there anything else going on in the business that should get you to your guidance?

I'll take the PI thing, and then Chuck can comment on the go forward. I think when you look in the quarter, we definitely have -- took the opportunity to take some investments. I think what we like about PI is the fact that we were up 50 basis points in gross margin improvement. I think that really speaks to the power of FBS. You saw that at Fluke. You saw that at -- you saw good improvement at Qualitrol. We had good improvement at sensors, where we offset their volume decline. We did have some challenges in Product Realization. As we mentioned, the volume decline in tech hurt as a little bit, and some high contribution margin opportunities at the Pacific Scientific EMC which moved out into the second half. So those, I think, on balance, when you look across the portfolio, the fact that 5 of our 6 platforms had gross margin flat to up, really speaks to the power of FBS. And I think that really speaks to what we'll do -- what we can do here. So while Professional Instrumentation was down a little bit, when you peak below the numbers, we had some good performance in several platforms.

And then, Andrew, on the go forward, looking at operating margin expansion, in the second half, we -- as we've been talking about low single-digit core growth. But we have around 50 basis points to expect in the second half of OMX. [ph] A little bit more in Q4 than in Q1, because I think we're accelerating through those things. But I think a little -- I thought I heard you say 9 in Q3. I'd expect a little bit more than that.

Yes, I think it was 9 in Q2 [indiscernible].

Definitely, 9 -- so I understand, 9 in Q2. That's just a function of being flat. It's just little under flat, but a good acceleration from Q1.

Okay, that's helpful. And then can you guys talk about the inventory situation that you see at Fluke right now? You mentioned weak demand from distributors. But are they still in destocking mode where inventories at this point relatively low in the channel?

We're in -- we have good -- very good visibility to inventories, on a global basis, throughout Fluke. And we're in a very good inventory position. We don't see any issues there. There's always maybe 1 or 2 people that might be a little higher. But on balance, we've got very good visibility. We had great relationships with our top 20 channel partners around the world, and we feel we're in a good position here.

Our next question comes from Joe Giordano with Cowen.

We touched on it a couple of times, but can -- if you look at your China business like in aggregate, I know it's hard given the amount of business that, that touches. Most of the commentary on, I feel like this earnings season, has been pretty negative on China. You guys sound incrementally more positive. So what are you seeing there specifically? Anything kind of Fortive-specific that's driving that? Or is that kind of -- how would you compare what you're doing in China to like the current environment, broadly speaking, in China, I guess, is maybe how I'll ask it?

Yes. Well I think as we said, this is probably a place where the breadth of our portfolio helps us pretty well, because we don't have exposure to any one vertical in China. You're seeing semiconductor expansion and electronics expansion that's occurring in China benefits Tektronix, and to some extent, Fluke. Gilbarco's had some good additions in the China market as well. So a number -- we mentioned Kollmorgen as well doing well in China as well. So I think some of our businesses are off a lower base, and so the power of what they've done from an innovation perspective and from an FBS perspective is helping them. And that, really, when you add that all up broadly, means that we've been mid- to high single digits here in China over several quarters, and think that can at least continue into what's in the guide.

All right. And then, when you look at GVR, good growth this quarter. What do the comps look like in the second half for that business versus the first half? And maybe if you had to flesh out how you get to that 500 million like in broad strokes, like what major assumptions are within that number in terms of terminal rate of adoption and things like that?

Yes, I think we'll run against a slightly tougher comp at Gilbarco, I believe, in the fourth quarter. So little bit tougher comp there. But we think we can continue to sustain what we've got with a good, active funnel and a number of things that we've got going. The FlexPay launch that we talked about in the prepared remarks is just a good example of bringing more innovation in helping us take share in the market. Relative to our assumptions, we don't think we'll ever get to 100% penetration in 2 to 3 years, so we sort of assume that kind of an 80% penetration might be achievable in the next 3 to 4 years. But to be honest with you, when you look at the outdoor penetration we just started, we revise those models every month based on what we've seen both in terms of actual sales and orders, but also on what we're hearing from customers. And I think those models will really get more refined as we turn the table on '16 and into '17 as we see a more active customer base. And so while we could make some predictions around what that looks like, I think we're really -- were probably 5 to 6 months away from really knowing what that might look like to hard code that into whether that's 2 or 3 years or 3 to 4 years at this point.

And then if I can just sneak one in for Chuck real quick. What was the effective adjusted tax rate for the quarter? And what should we be thinking for the full year?

The effective tax rate for Q2?

Yes.

Q2 was the 60 -- let's see, the -- because we had a good guide. I think it's around 60. Doing the math in my head. 32%.

Okay. And that's...

And going forward, I think 30% is a good number for the second half of the year. We'd like -- we think we have a chance -- we expect to get down in 2017 into the 20s. And we've got a few things to put in place. We might even get there yet this second half. But I think 30% for the second half is a good number.

It appears there are no further questions at this time. I'd like to turn the conference back to our presenters for any additional or closing remarks.

Well, we appreciate all the time that everybody had for us today. Obviously, we're unbelievably excited about the future at Fortive. We're looking forward to continued conversations with everybody around all the good things that are going on and, really, what the opportunity is for us. Lisa and Josh are available for calls today and tomorrow. So we look forward to talking to you and we'll see you real soon. Thanks, everybody.

This does conclude today's presentation. We thank you for your participation.