Fortive Corp (FTV) — Q2 2020 Earnings Call Transcript

Thank you, Nicole. Good afternoon, everyone and thank you 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. 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. We completed the divestiture of the Automation and Specialty Business on October 1st, 2018, and accordingly have included the results of the A&S Business as discontinued operations for historical periods. The results presented on this call are based on continuing operations. During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. All references to period-to-period increases or decreases and financial metrics are year-over-year on a continuing operations basis. 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 expect or anticipate will or may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, and actual results might differ materially from any forward-looking statements that we make today. Information regarding these factors that may cause actual results to differ materially from these forward-looking statements is available in our SEC filings, including our Annual Report on Form 10-K for the year ended December 31st, 2019 and subsequent Quarterly Reports on Form 10-Q. 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, Griffin and good afternoon, everyone. Today we reported adjusted diluted net earnings per share of $0.68 for the second quarter of 2020. We achieved better than forecasted revenue performance despite the difficult conditions created by the ongoing COVID-19 pandemic. It was a quarter that clearly reflected the power of the Fortive business system as we executed our playbook on expense savings and working capital management, enabling us to achieve decremental margins of 33% and generate very strong free cash flow. Throughout the quarter, we continued to operate all of our essential production facilities around the world and proactively manage our supply chains, while adopting new protocols to protect the health and safety of our employees. With a focus on maintaining continuity despite the shift to a virtual operating environment, the Fortive team leveraged new virtual sales and marketing tools to continue engaging with customers. We also adjusted product development processes to continue meeting project timelines while continuing to invest across the portfolio to emerge from this period with an enhanced competitive position. Our Q2 performance demonstrated the resilience we built over the past four years, with an increased share of recurring revenue from our expanding set of subscription-based software solutions, services, and consumables offerings. Recurring revenue accounted for more than 35% of total revenue in Q2, a new high for Fortive. Importantly, this resilience came through despite the fact that a key source of recurring revenue, Advanced Sterilization Products, experienced a decline in elective surgical procedures as healthcare systems worldwide dealt with the early months of the pandemic. Regarding Vontier, we made additional progress in Q2 preparing for its separation from Fortive as we continue to evaluate our options for structuring this separation either via spin or split. The Fortive and Vontier teams remain ready to move forward on an effective separation as soon as market conditions permit. We issued our most recent Corporate Social Responsibility Report at the end of Q2, highlighting the progress made across our portfolio over the past year. Our CSR framework organizes our priorities into seven strategic pillars, which capture the breadth of our initiatives around Corporate Social Responsibility. Consistent with our belief in the strength that comes from building diverse teams, we have aimed to cultivate an inclusive environment at Fortive. Over the past few months, we acted on these values to help our teams engage in internal dialogue about addressing critical social justice themes. Looking ahead, we expect total revenue to improve sequentially in Q3 but decrease by 5% to 8% on a year-on-year basis. We will continue to calibrate remaining cost actions based on top line progression from here as we anticipate decremental margins of approximately 35% in Q3.

Hey, Nigel, this is Chuck. I think what we’re trying to say is that we will deliberately manage the business to 35% as we move forward. The top line is on a better trajectory, at least, that it seems at this point in time, and that’s consistent with what we’re guiding there. So, we’ll strike that balance of managing our expenses and investing into the future as we go forward. So, 35% is the right number.

Thanks, Nigel. Yeah, I think a couple of things relative to the trends, I think we certainly as we sort of said in the prepared remarks, progressively things got better as we got through the quarter. Each month improved in trend perspective. July has started well, giving us confidence in our guidance. The trends are definitely on the upswing. As we look at our Professional Instrumentation side and elective surgeries, things have stabilized. Fluke is starting to show some positive signs with point-of-sale trends improving.

Thanks, Jim. Obviously the Q3 sales range is quite a bit better than what you pointed towards in April and then what you realized in the quarter. So I’m just curious, how is the organic sales progression looking as we transitioned into July?

I think the trends are improving. Every month definitely got a bit better, so from a trend perspective, July is looking good, but it remains uncertain how long it will continue. We have a solid sense of what EMV will look like in the latter half of the year. Overall, the macro conditions are improving.

I think what you’ll find is we’re managing the business to 35% decremental margins moving forward. The top line is improving. We’re balancing managing expenses with the need to invest for future growth.

Everything looks pretty encouraging here overall. Jim, you commented on the 70 basis points of price increase—did that come primarily from your subscription services?

It was primarily in Professional Instrumentation, driven by our software businesses, but we also saw good pricing power in some key hardware businesses like Fluke and Tek.

In summary, the decremental margins will be a consistent target as we manage expenses proactively while anticipating a steady revenue recovery by year-end.

To circle back to the revenue outlook, you're projecting a down year-on-year drop in Q3 of around 10 percentage points less than in Q2. Can you elaborate on that?

As we look at both segments, we expect IT to improve at a slightly better rate than PI. Our analysis suggests the sequential improvement in Q3 will largely be driven by demand recovery in both our businesses.

Regarding Asia, our core revenue there declined, but we saw some improvement due to the gradual recovery in China. We expect similar trends in North America, where conditions have been stabilizing.

Could you provide insights into how the Industrial Technologies segment is performing, especially regarding any potential recovery in GVR orders?

Orders in GVR remain strong in North America. We anticipate continued demand driven by key trends in the market, while conditions overseas are still complex due to COVID-19.

How will the recent partnership with Pioneer Square Labs affect your innovation strategy moving forward?

We’re leveraging our partnership with Pioneer Square Labs to accelerate our product development cycles and invest in promising startups that can augment our main offerings. This partnership is yielding several promising leads that we believe can quicken our time to market.

Can you provide clarification on the recent performance of your SaaS businesses, particularly around customer retention?

We’ve seen improvements in our net retention rates across SaaS businesses, which is a key focus for us. Our teams have done well to keep customers engaged during this period.

You mentioned strong demand for Industrial Imaging products; can you provide more context on what you’re seeing?

Yes, we are experiencing growing demand, particularly for thermal imaging and temperature measurement solutions. This growth is partly driven by the ongoing pandemic as companies reassess their safety protocols. I’m proud of our team’s efforts over the past three months, and while we undoubtedly face additional challenges in the coming quarters, I’m confident in our ability to navigate through them as we strive to generate value for our stakeholders.

That concludes our formal comments. Nicole, we’re now ready for questions.