Fortive Corporation (NYSE:FTV) Q3 2023 Earnings Call Transcript

Fortive Corporation (NYSE:FTV) Q3 2023 Earnings Call Transcript October 25, 2023

Fortive Corporation misses on earnings expectations. Reported EPS is $0.85 EPS, expectations were $0.86.

Operator: My name is Krista, and I’ll be your conference facilitator this afternoon. At this time, I would like to welcome everyone to the Fortive Corporation Third Quarter 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, Krista, 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 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 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 actual results might differ materially from any forward-looking statements that we make today.

An aerial view of an industrial complex, representing the company's property ownership.

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 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.

James Lico: Thanks, Elena. Hello, everyone, and thank you for joining us. I’ll begin on Slide 3. In the third quarter, we continued to see the benefits of our portfolio strategy with core growth and margin expansion in all segments. Third quarter core revenue growth was 2.5%, tempered by specific headwinds in health care and slowing in parts of Sensing in China. Strong execution by our teams drove substantial improvement in gross and operating margins, earnings and free cash flow. Adjusted gross margins expanded by 160 basis points to 59.7%. Adjusted operating margins increased by 150 basis points to 25.9%, and adjusted earnings per share grew 8% and free cash flow increased 25% to $384 million. As you can see, our strategy is delivering results with enhanced portfolio positions, innovative new products and dedication to the Fortive Business System, allowing us to consistently perform despite a mixed macro environment.

As we look ahead, our attractive funnel of bolt-on and adjacent M&A opportunities across our three segments and five connected workflows are expected to drive upside in 2024 as exemplified by the acquisition of the EA Elektro-Automatik as well as three other bolt-ons in the quarter. Turning to Slide 4. We wanted to highlight how the year is playing out relative to our initial expectations and begin to frame our thinking for 2024. Beginning on the left, hardware product orders were stronger in the first half of the year as traction on new product launches and leveraged to secular drivers provided more backlog to buffer the normalization of supply chains. Hardware product orders were down mid-single digit, which we believe reflects continued solid demand with orders up over 20% on a 3-year stack basis in the third quarter.

Point-of-sale trends in North America and Western Europe have remained healthy even as channels normalized, while we did see slowing specifically in China and parts of Sensing in the quarter. Software and services continue to demonstrate their resilience with high single-digit growth across our facilities and asset life cycle, environmental health and safety and perioperative customer workflows. The health care environment continues to improve. Core growth in the third quarter was constrained by the clearing channel inventory in ASP and continued weakness in the bioprocessing market in Invetech. Turning to the right-hand side of the slide, we are delivering 2023 performance ahead of our initial expectations coming into the year with mid-single-digit core growth with adjusted operating profit margin incrementals over 60%, delivering nearly 2x the margin expansion planned in the year.

And we are accelerating our capital deployment in the quarter with robust free cash flow and ample firepower to fund attractive M&A opportunities. Further evidence that our strategy to create a more durable growth company is working is highlighted on Slide 5. Our innovation and portfolio strategy continues to build on leadership positions in our connected workflows benefiting from customer investments in key megatrends, including automation and digitization, the energy transition and the need for productivity solutions contributing to our improved through-cycle performance. We have several good examples across Fortive, including: providing customer software solutions to digitize and automate processes and deliver customer success in AI-driven ecosystems.

Provation is partnering to enable real-time AI in the GI workflow, contributing to their strong win rates and accelerated mid-teens growth in 2023. And in the third quarter, Fluke added Azima DLI, a bolt-on acquisition, accelerating their AI-enabled predictive maintenance capabilities with vibration analytics and remote condition monitoring. Fortive is also helping to solve our customers’ toughest energy transition challenges with breakthrough innovations. Fluke and are both benefiting from strong demand in solar, EV storage equipment and the build-out and modernization of electric grid infrastructure. In addition, Fluke acquired Solmetric to further solidify their leadership position in the fast-growing distributed energy market with high-precision solar test and measurement products.

In this environment, our customers are putting a premium on productivity. ASP is launching new sterilization monitoring products, broadening their leading position in biological indicators, allowing customers to reprocess surgical instruments with greater speed and efficiency. Further, Gordian acquired NSR, a natural extension of the reconstruction workflow, which provides cost data that will allow them to expand job order contracting in the U.K. Turning to Slide 6. We are pleased to announce our agreement to acquire EA Elektro-Automatik, enhancing our leading position in advanced electronic test and measurement solutions. EA specializes in the high-power segment of the market that serves a number of growing end markets, including data centers, energy storage, e-mobility, grid modernization and hydrogen power alternatives.

EA expands Tektronix addressable market. It complements and diversifies their offerings in the fastest-growing areas of the power market, solving for power density and efficiency challenges and creating a more sustainable and electrified world. With an estimated $175 million of revenue and low 40s operating margins in 2023, EA is expected to be accretive to our growth in margins. Tektronix’ global scale, including a 10x increase in go-to-market resources, accelerates EA’s global market expansion. Further, the Fortive Business System will be a valuable tool in achieving commercial, manufacturing and operational synergies, creating unparalleled value for customers and shareholders. As a result, we are targeting an attractive double-digit return profile in year 5 and earnings accretion that ramps as we delever, given our robust free cash flow.

In summary, the acquisition of EA reflects our commitment to more durable and higher growth and ability to drive higher returns for Fortive for years to come. Turning to Slide 7. Fortive Business System continues to be a differentiator for us, enabling our business to drive innovation and profitable growth. We recently completed our annual CEO Kaizen Week. This event is a hallmark. We’re demonstrating our culture of continuous improvement and our ability to deliver outstanding results in our operating companies in one powerful week. As always, we bring together our most senior Fortive leaders, including our segment leaders and many of our operating company presidents with a total of 41 teams and over 500 team members driving significant improvements in growth, margins, free cash flow and breakthrough innovations.

Some Kaizen highlights include: at ISC and Qualitrol, their events realized 100% to 125% improvements in productivity. ServiceChannel reduced their time to onboard new customers, and Provation had a 2x improvement in the conversion of marketing leads, both enabling more and faster ARR growth. Tektronix deployed a Copilot, leveraging AI to bring technical expertise to customers and internal automation to significantly improve their efficiency and customer experience. And Fluke Health Solutions had breakthrough results in dosimetry reporting, reducing customer response time by more than 50%. In summary, this year’s event continued to emphasize the power of the Fortive Business System and the breadth of applications across our portfolio driving sustained results.

I will now provide more details on each of our three segments, beginning with Intelligent Operating Solutions on Slide 8. IOS grew core revenue by 4% with good growth in most regions. Margins continue to benefit from our portfolio evolution with high-margin software growth as well as price realization and productivity benefits driving 230 basis points of adjusted operating margin expansion. Highlights in the quarter included, core revenues were up low single digit as solid core demand and NPI traction buffered expected channel normalization. EMA continued its strong performance with another quarter of double-digit revenue growth. Fluke secured a number of wins in secular growth markets, including a sizable calibration order from an aerospace and defense customer.

Fluke also continues to see success with new product introductions with the recent launch of MecQ, a first-to-industry acoustic imager for diagnosing mechanical failures. EHS revenues grew mid-single digit with double-digit iNet growth at ISC and another strong quarter for SaaS and Intelex with over 50% growth in ACV customer bookings in the quarter. In addition, Marathon Petroleum, our largest iNet and SAFER Systems customer recognized Industrial Scientific with their Corporate Exceptional Partnership Award. Facility and asset life cycle revenues grew high single digit, driven by continued strength in SaaS. Gordian continues to drive market penetration as more customers utilize their job order contracting platform to procure and manage their large infrastructure projects.

Accruent secured an agreement with Zavery University to provide its facility management software which included cross-selling with Gordian, and ServiceChannel launched several innovations for both subscriber and provider software releases contributing to strong overall growth. Turning now to Slide 9. Precision Technologies reported 1% core revenue growth and adjusted operating margins of 26.5%, expanding 60 basis points, reflecting strong price realization and productivity benefits. Some highlights of the quarter include, Tektronix is executing on robust backlog in power and digital test and measurement solutions and delivering low single-digit core growth and outstanding operating margin expansion. This included over 20% revenue growth in North America, reflecting continued customer investments to solve the proliferation of new power design challenges for batteries, EVs and industrial applications.

Tek orders continued to normalize off a 40% 2-year stack at the end of 2022. Double-digit order declines at Tek were greatest in China. However, we did see weekly patterns improve sequentially as we moved through the quarter. Further, we expect continued lead time improvement and channel normalization, with orders returning to growth in the coming months as customers continue to prioritize investments in semiconductor advancements, AI-enabled compute and electrification of everything. Sensing Technologies saw another quarter of strong orders and revenue growth at Qualitrol. This included a meaningful deal in the quarter from a large U.S. utility customer for full transformer asset monitoring solutions. Elsewhere in Sensing, slowing in China was reflected in lower-than-expected orders and revenue -- Lastly, Pacific Scientific EMC reported another quarter of double-digit sales growth as it benefits from Kaizen activity to improve manufacturing capacity and operational execution to deliver on record backlog.

Moving now to Slide 10 and Advanced Healthcare Solutions. Core revenues were up 2%, reflecting improved underlying sterilization demand, partially offset by higher than expected U.S. channel inventory in ASP. For the third quarter, the total impact resulted in $11 million in less revenue, impacting AHS core growth by over 300 basis points and adjusted operating margins by almost 200 basis points. Elsewhere, high-growth markets saw revenues up high single digits, driven by robust growth in Latin America as well as good growth in Asia. Adjusted operating profit margins increased by 200 basis points year-over-year. We are seeing traction on pricing actions as well as the benefits of the productivity initiatives reflected in higher margins. Additional highlights in the quarter include Census continued to grow its subscription revenue with its Censitrac SaaS business increasing mid-teens, benefiting from continued traction in both new logo expansion and cross-selling opportunities as customers standardize on their leading instrument tracking software solution.

Blue Power Solutions revenue increased slightly as high single-digit growth in its core dosimetry business was partially offset by project timing. We also saw continued market weakness in Invetech, accounting for approximately half of the slower than expected growth in the segment in the third quarter. Lastly, Provation had another quarter of excellent growth, over 20% driven by continued APAC SaaS adoption and new logo success. Previewing the fourth quarter, the ASP channel transition is now complete, and we expect growth to accelerate EHS. This includes the initial ramp of ASP’s recently launched portfolio of steam sterilization monitoring products, which will further build over several quarters as they expand their global reach. We continue to expect margins to ramp in Q4 and 2024, driven by consumables growth, price realization and productivity actions.

With that, I’ll pass it over to Chuck, who’ll provide more color on our third quarter financials and our 2023 outlook starting on Slide 11.

Charles McLaughlin: Thanks, Jim, and hello, everyone. We generated year-over-year core revenue growth of 2.5%, which included a single-digit growth in North America. As Jim mentioned, we saw -- over 20% growth in Tektronix and acceleration in our software and recurring revenue streams, which more than offset moderation some of the Sensing businesses. Western Europe revenue was up slightly as growth in software was offset by normalizing growth in hardware products. Asia saw a continued strength in India, up mid-teens and Japan up high single digits, which was more than offset by low double-digit decline in China. We had anticipated growth in China would slow in the second half as we lapped outside growth in prior years. For example, Tektronix was down over 20% in China in the quarter.

However, it was still up 20% on a 2-year stack basis. We also saw continued slowing in Sensing, given the current macro environment, while AHS grew high single digit as electric procedure volumes improved in the quarter. Turning to Slide 12. We show operating performance highlights for the third quarter. Adjusted gross margins increased 160 basis points to a record 59.7%. On a 2-year stack basis, they are up an impressive 240 basis points driven by the benefits of our portfolio evolution, the continued application of FBS initiatives and strong price realization. Adjusted operating margins expanded 150 basis points to 25.9% or 300 basis points over the last two years, reflecting higher gross margins and the benefits of the productivity initiatives we executed earlier this year.

Adjusted earnings per share increased 8% to $0.85 despite higher year-over-year interest and tax expense. Earnings are up 30% on a 2-year stack basis, and free cash flow was $384 million, reflecting a 25% increase over the prior year and over 50% growth in the last two years as we continue to grow earnings and effectively manage working capital. Turning now to the guide on Slide 13 and the outlook for the remainder of the year. For the fourth quarter, we are adjusting our range to reflect caution around the macro in China and delayed recovery in Invetech. Core revenue growth is expected to be in the range of 1.5% to 3%. Adjusted operating profit margins are anticipated to increase by approximately 150 basis points, and adjusted diluted earnings per share are expected to be in the range of $0.92 to $0.95, representing 5% to 8% growth and includes $5 million of onetime additional corporate expense related to the remediation plans following a cybersecurity incident in early October.

We also plan to proactively fund an incremental $35 million of productivity initiatives in the fourth quarter, which are excluded from our adjusted EPS outlook with accretive benefits expected in 2024. Finally, we expect free cash flow of $415 million, representing conversion of approximately 125% of adjusted net income. Turning to the full year recap. We are reiterating the midpoint of our earnings guidance for 2023, which is coming in at the high end of the outlook we set at the beginning of the year. Things have largely played out as we expected with some upside driven by secular tailwinds driving market expansion in new customer innovations, resiliency of roughly 40% of recurring revenue, elevated backlogs and carryover pricing in our hardware products businesses, buffering, moderating demand as order rates normalize throughout the year.

As a result, we have core growth and margin expansion in each of our segments. Core growth for the year as reported is now expected to be approximately 5% with adjusted profit margins anticipated to increase approximately 150 basis points. Adjusted diluted earnings per share is now expected in the range of $3.37 to $3.40, having raised our guidance twice in the year, and we continue to expect free cash flow of $1.25 billion, representing a conversion of 105% of adjusted net income and 21% free cash flow margin. With that, I’ll pass it back to Jim to provide some closing remarks.

James Lico: Thanks, Chuck. I’ll start to wrap up on Slide 14. Consistent with 2023, we believe we will see sustained core growth and robust margin expansion and free cash flow growth in 2024 despite the evolving macro environment. What continues to differentiate Fortive is our ability to deliver mid-single-digit through-cycle growth, reinforcing our portfolio durability and the power of FBS to deliver strong margin expansion. The consistency of our execution reflects the strength of our product vitality and alignment to high-growth secular trends, continued solid customer demand in the buffer of excess backlog, adding to a resilient growth profile. In health care, we expect a continued modest pace of industry recovery to drive stronger growth and incremental margins as we lap discrete 2023 headwinds.

Lastly, in software and other recurring, our efforts to increase demand generation and strengthen our go-to-market capabilities is expected to drive strong SaaS and license revenue growth in 2024. This brings me to Slide 15 and how we drive differentiated performance and value creation for our shareholders. As we finalize 2023, we are demonstrating another year of strong execution, delivering record gross margins, operating margins and free cash flow. The sustained results underscore the power of the Fortive Business System to relentlessly drive continuous improvement throughout our portfolio. As we showed at our Investor Day in May, 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 acceleration of capital deployment, as demonstrated this quarter, 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 Elena.

Elena Rosman: Thanks, Jim. That concludes our formal comments. Krista, we are now ready to take questions.

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