Fortive Corporation (NYSE:FTV) Q1 2023 Earnings Call Transcript

Fortive Corporation (NYSE:FTV) Q1 2023 Earnings Call Transcript April 26, 2023

Fortive Corporation beats earnings expectations. Reported EPS is $0.75, expectations were $0.73.

Operator: Thank you for standing by. My name is Brent, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to Fortive Corporation's First Quarter 2023 Earnings Results Conference Call. . I would now like to turn the call over to Ms. Elena Rosman, Vice President of our Investor Relations. Ms. Rosman, you may begin your conference.

Elena Rosman: Thank you, Brent, 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 present certain non-GAAP measures on today's call. Information required by Regulation G are available on the Investors section of our website at www.fortive.com. Our statements on period-to-period increases or decreases refer to year-over-year comparisons on a continuing operations basis. 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 actual results might differ materially from any forward-looking statements that we make 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, 2022. These forward-looking statements speak only as of the date 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 Lico.

James Lico: Thanks, Elena. Hello, everyone, and thank you for joining us. I'll begin on Slide 3. We had a strong start to the year, delivering better-than-expected revenues, margins and earnings in the first quarter. At 9% core growth, we're demonstrating strong execution of our strategy, building leading positions across our customers' critical connected workflows. Our ability to deliver strong growth and continued margin expansion is directly tied to our culture of continuous improvement and dedication to the Fortive Business System. As a result, we expanded adjusted gross and operating margins by 80 and 100 basis points, respectively, taking margins to a first quarter record expectations for further merger and expansion this year and into the future.

Free cash flow in the quarter reflects our normal seasonality as well as the timing of China collections that pushed into April. Overall, our teams have done an excellent job managing working capital in a more challenging supply chain environment as seen by our outstanding performance in 2022. By harnessing our unique competitive advantages and strong execution capabilities, we are confident in our outlook and are raising and narrowing our full year 2023 guidance. Turning to Slide 4. I wanted to provide an update on what we're seeing and what we expect over the course of 2023. Starting on the left in the current environment, hardware product orders were better than expected, down mid-single digit and backlog was more resilient with a book-to-bill of 1.0 in the first quarter.

Our software businesses continue to see good growth benefiting from strong customer value propositions, driving double-digit growth in our SaaS revenue streams. While industry challenges remained in our Healthcare segment due to China, consumables growth in March reaffirmed recovery is underway. We expect momentum to continue and accelerate growth and profitability throughout 2023. Moving to the right-hand side of the slide, we are seeing traction on our new product launches, favorably aligned to secular drivers including Fluke's latest family of solar tools and Tektronix' leading power and electronic test systems, together with continued software strength and recovery in healthcare, we expect to sustain core growth in the second half. Combined with favorable pricing, cost savings and discrete productivity initiatives that span all segments, we expect over 75 basis points of margin expansion in the year.

Lastly, we expect robust free cash flow growth again in 2023 which together with our very strong balance sheet, gives us confidence that our attractive M&A funnel will provide opportunities to enhance earnings and cash flow compounding in the future. Turning to Slide 5. We want to take a minute to remind you of all the work we've done to transform our portfolio and create focused segment strategies favorably aligned to a number of strong secular trends, has resulted in a more resilient Fortive with enduring growth and further margin expansion opportunities. As a result, today, we have a stronger collection of businesses with a more diversified end market mix and durable recurring revenue profile that includes leading healthcare and software franchises.

Together with our enhanced innovation capabilities, we have focused our portfolio around multiyear megatrends, including automation, digitization, the electrification of everything and improving healthcare trends to name a few, all to reduce the overall cyclicality of our businesses and provide more tailwinds for growth by expanding into new markets. As a result of these megatrends, we see continued growth across our portfolio. including the more durable software and services businesses as well as the nonrecurring portion, given the sizable amount of backlog, some of our product businesses are working through, while continuing to see resilient demand. Finally, our portfolio quality is reinforced by the substantial improvements we've made in gross and operating profit, working capital and free cash flow as a percent of revenue, driven by the rigorous application of the Fortive Business System.

Turning to Slide 6. FPS is a powerful mindset that makes continuous improvement a way of life at Fortive to drive deep engagement across our teams and hold them accountable for delivering on high expectations. With Kaizen activity accelerating, we saw significant results across the portfolio, including material improvement in delivery and past due backlog reduction in our hardware products businesses by improving planning and reducing part shortages with the Fortive material system. Board of software system deployment in our SaaS companies, including service channel, a current information is accelerating delivery of software features to customers, driving customer value and resulting in higher renewal rates and pricing gains. Our record gross margins in the first quarter were driven by a significant expansion of Kaizen events in the quarter, approximately double the number the prior year, setting us off for improved performance throughout the year.

Turning to Slide 7. Fortive made sustainability a priority since its founding. It is inextricably linked to our company's shared purpose, values and business strategy, which you'll read more about in our upcoming 2023 sustainability report to be published in May. This year's report will further highlight how our commitment to sustainability is grounded in our culture of Kaizen, leveraging the power of FBS innovate products and services that enable more sustainable outcomes. We'll also hear how our team has strengthened our responsible sourcing initiatives, ensuring robust review of the labor and given rights practices across our supply chain and how our strong and inclusive culture is creating a community where everyone belongs, which is positively reflected in our latest employee engagement and inclusion, diversity and equity performance.

In summary, we are accelerating progress towards a more sustainable future for Fortive and our customers as well as the environment and the communities in which we operate. We invite you to review our report next month. I'll now provide more details on each of our 3 segments, beginning with Intelligent Operating Solutions on Slide 8. IOS grew core revenue by 10% as our connected workflow strategy drove better-than-expected performance in the quarter. The segment saw a good growth in all regions with mid-single-digit growth in North America and Western Europe, and mid-40% growth in China, lapping prior year shutdowns. Solid core growth in each workflow and strong FPS driven execution resulted in 300 basis points of operating margin expansion, taking operating margins consistently above 30%.

Looking at our performance drivers by workflow. In Connected Reliability, Fluke core revenues grew by low double digits with mid-single-digit orders growth in the quarter and point of sale remained positive in all regions. Fluke is benefiting from lean portfolio management, driving record revenue attainment and Fluke's new product launches, including the SMFT 1000 solar tester, which are benefiting from strong demand in the energy, renewables and electric vehicle markets. Elsewhere at Fluke, eMaint posted another record quarter with strong double-digit growth. We are seeing accelerated customer adoption of the X5 CMMS system with enhanced connected worker capability also closed the largest deal on record with a strategic enterprise customer.

EHS revenues grew by mid-single digit with both Industrial Scientific and Intellect providing solid contributions. Industrial Scientific saw strength across all product lines, including iNET and orders growth outpaced sales driven by new product launches and cross-sell activity. Intelex posted another quarter of strong SaaS growth with low double-digit ARR growth. Moving to facilities and asset life cycle. We had high single-digit growth in the first quarter, driven by high single-digit SaaS revenue growth. Customers continue to shift larger projects to Gordian's job order contracting platform, while the wind down of endo-light programs are occurring, and the business model change and service channel lowered core growth, revenues exceeded expectations in as customers continue to seek more productive and digitized solutions to optimize their facilities management.

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For example, a large worldwide retailer is migrating multiple manual processes to the real estate management platform at Acron and a large enterprise customer is leveraging service channels automation services to save hundreds of thousands of dollars of mismatched invoices. Turning now to Slide 9. Precision Technologies delivered another quarter of strong double-digit core revenue growth or revenues increased 14%, driven by a high single-digit growth in North America, low double-digit growth in Western Europe and high 30% growth in China. PT also delivered 190 basis points of adjusted operating margin expansion with higher volume and strong price realization more than offsetting continued inflation and FX. Some highlights of the quarter included greater than 20% core revenue growth at Tektronix.

Orders were better than expected, benefiting from bookings growth and electric vehicle testing programs. This and strong point of sale in all major regions drove double-digit growth across its product businesses in the first quarter, which continued to see good demand for recently introduced entry-level and mainstream stopes. Sensing Technologies reported low single-digit growth as expected, driven by another quarter of strong price realization across all businesses and continued broad strength of Ultra. Pacific Scientific EMC reported a second consecutive quarter of greater than 20% growth as the business continued to deploy FBS to improve operational performance. Moving now to Slide 10, in Advanced Healthcare Solutions. Core revenues are flat as the improvement in electric procedure volumes outside of China was offset by some supply chain challenges at Fluke Health Solutions and the expected headwinds in China elected procedures and the wind down in Russia.

By major region, North America was up slightly, and Western Europe grew mid-single digits, offsetting a high single-digit decline in China. China elected procedures were covered in March, exiting the month at approximately 90% of normalized levels. Our outlook continues to assume that China electric procedures return to normalized levels in the second half of 2023. In the first quarter, AHS adjusted operating margins declined 260 basis points as a result of FX headwinds, supply chain challenges at Fluke Health, lowering contribution margins and higher-than-expected inflation. Some highlights in the quarter include we exited March with stronger ASP consumables growth, reaffirming recovery post COVID is underway with sales outpacing the market in most regions.

Double-digit growth at Census was driven by a Censo . Censis is also seeing strong demand for its AIT productivity platform and continues to drive productivity improvements through the application of FBS tools, which have accelerated the time from bookings to revenue. FHS saw solid demand for equipment orders and dosimetry services despite continued supply chain strengths that stalled equipment shipment. Lastly, Provation continues to perform very well with another quarter of double-digit growth driven by its Apex SaaS offering. Apex has seen continued high customer demand with substantial Q1 orders and a greater than 3x average revenue uplift from license migrations. Following a strong start to the year, we continue to expect the probations growth will accelerate through 2023 supported by customers looking to further standardize our formation across their health systems.

In addition to our remarks on the first quarter performance, we thought it would be helpful to provide more detail on our expectations for the AHS segment for the remainder of this year. The headline is that we expect sequential improvement in both revenue and adjusted operating profit margin as we move through the year. Specifically on revenue, we expect favorable price in addition to the recovery of electric procedures in China resolution of supply chain challenges at Fluke Health Solutions and normal healthcare seasonality to drive higher volumes over the course of the year. As a result, we expect core growth will go from low single digit in Q2 to mid-single digit in the second half of the year. On margins, in addition to the uplift from higher volumes and favorable price, we see compounding tailwinds from the benefits of the productivity initiatives taking second half margins to approximately 25%.

Go-to-market changes in ASP consumables in North America will improve performance and enable closer connection to our customers to better serve their needs, transitioning from a primarily distribution model to direct to the customer. All these actions will have carryover benefits in the years to come, positioning us for accelerated growth and profitability as the general healthcare environment continues to improve. With that, I'll pass it over to Chuck, who will provide more color on our first quarter financials and our 2023 outlook.

Charles McLaughlin: Thanks, Jim, and hello, everyone. I will begin on Slide 11 with a quick recap of our first quarter revenue performance for Fortive. We generated year-over-year core revenue growth of 9%. FX was 230 basis points of headwind to growth. Turning to the geographies. We saw another quarter of strong revenue growth in each of our major regions. North America revenue was up mid-single digits, with growth in all 3 segments. Western Europe revenue grew high single digit with mid-single-digit growth at IOS and AHS and double-digit growth at PT. Asia revenue increased in the 20% range with low 30% growth in China driven by strength in both IOS and PT as we lapped easier prior year comps. Growth in China was partially offset by a high single-digit decline in AHS related to lower electric procedures due to COVID as we expected.

Lastly, our high-growth markets together posted strong core growth of almost 20%. Turning to Slide 12. We show operating performance highlights for the first quarter. Adjusted gross margins increased 80 basis points to 58.4%. As Jim mentioned, FBS driven productivity and price realization more than offset inflation, leading to record gross margins in the first quarter, which was complemented by higher volumes. Adjusted operating margins expanded to 100 basis points to 24%, while adjusted earnings per share increased 7% to $0.75, reflecting strong volume conversion, partially offset by higher interest and tax expense. Free cash flow was $150 million. While first quarter is typically our largest free cash flow quarter, receivables were negatively impacted by slower China collections in the quarter, which has since recovered in AHS.

Turning now to the guide on Slide 13. We are raising and narrowing our previous 2023 guidance to reflect outperformance in the first quarter. For the second quarter, we anticipate core revenue growth of 2.5% to 4.5% with an FX headwind of approximately 0.5%. Adjusted operating profit margin is expected to increase 3% to 7% with margins in the range of 24.5% to 25%. Adjusted diluted net earnings per share guidance of $0.78 to $0.82, flat, up 5%, includes higher year-over-year interest and tax expense and free cash flow of approximately $285 million reflects approximately 100% of cash conversion in the quarter. For the full year, we now expect core revenue in the range of 4% to 5.5%, which continues to reflect year-over-year foreign exchange headwind of just under 1 point of revenue.

Adjusted operating profit is expected to increase 6% to 10%, with margins in the range of 25% to 25.5%. We are increasing our adjusted diluted net EPS guidance to $3.29, $3.40, which represents an increase of 4% to 8% and includes higher year-over-year interest and tax expense, as previously expected. Free cash flow is expected to be approximately $1.25 billion, representing conversion in the range of 100% to 105% of adjusted net income and 21% free cash flow margin. Turning to Slide 14. We've consistently said that the Fortive today is delivering a higher and more profitable growth. There is nowhere that this shows up more than in our free cash flow. Between 2019 and today, we have more than doubled our annual free cash flow, and we expect to continue to further enhance our compounding model with over $5 billion of capacity for M&A, enabling us to continue to invest appropriately in our businesses to further position Fortive for long-term value creation.

With that, I'll pass it back to Jim to review our upcoming Investor Day and provide some closing comments.

James Lico: Thanks, Chuck. I'll now start to wrap up on Slide 15. Our team is thrilled to be back in New York for our first in-person Investor Day since 2019 to be held on May 25. We are looking forward to highlighting our progress, executing our strategy and the results that has yielded over the last 7 years, building on our strong foundation and enduring principles that underpin our execution capabilities. We will showcase how our businesses have leveraged FBS tools to innovate, take advantage of the secular tailwinds, accelerating progress across our 5 critical customer workflows. This has translated into relevant product innovations helping to solve our customers' toughest safety, quality and productivity challenges and contributing to sustained strong growth for Fortive.

In the spirit of setting high expectations, we will set long-term targets. Looking out 3 and 5 years, culminating with the evolution of our strong free cash flow, supporting us ample opportunities to further accelerate our strategy. We are actively fueling our future success by building on the transformation progress and learning that has taken place since our inception, unlocking future value for Fortive. Wrapping up on Slide 16. The combination of portfolio work we have done and the productivity initiatives we are implementing in the first half of 2023, prepare us for the continuing evolving macro environment and set us up for differentiated performance again in 2024. As you saw in today's press release, we're also continuing to build on our exceptional leadership culture for the Fortive of the future by expanding Tammy Newcombe's responsibilities to include the Advanced Healthcare Solutions segment in addition to our current role as segment leader of Precision Technologies succeeding Pat Murphy, who will retire at the end of the year.

As you heard today, FBS is more robust than ever with powerful new capabilities to bring breakthrough innovations to market for our customers faster and drive enhanced business results. The evidence of this is reflected in our strong financial performance, including our free cash flow, the currency we use to measure our success. These factors culminate in the powerful formula for value creation, enabling Fortive to make a real difference in the world and deliver exceptional value to shareholders. With that, I'll turn it back to Elena.

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

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