Vontier Corp Q4 FY2020 Earnings Call

Thank you for joining us. I'm Maria, your conference facilitator today. I would like to welcome everyone to Vontier Corporation's Fourth Quarter 2020 Earnings Results Conference Call. Now, I will hand the call over to Ms. Lisa Curran, Vice President of Investor Relations. Ms. Curran, please go ahead.

Thank you, Maria. Good morning, everyone, and thank you for joining us on the call. With me today are Mark Morelli, our President and Chief Executive Officer; and Dave Naemura, our Senior Vice President and Chief Financial Officer. We will present certain non-GAAP financial measures on today's call. Information required by SEC Regulation G relating to these non-GAAP financial measures is available on the Investors section of our website, www.vontier.com, under the heading Financials. Please note that unless otherwise noted, the presented financial measures reflect year-over-year increases or decreases relative to the supplemental normalized financial data also posted on our website under the heading Financials. These supplemental normalized financials are adjusted for estimated stand-alone public company costs. During the presentation, we will describe certain of the more significant factors that impacted year-over-year performance. The supplemental materials describe additional factors that impacted year-over-year performance. 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 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 and subsequent annual report on Form 10-K. 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 Mark.

Thanks, Lisa. Good morning, everyone, and welcome to our fourth quarter earnings call. Before we get to the results for the quarter, I want to recognize our team's extraordinary performance, marking the end of a truly unprecedented year. The COVID-19 pandemic caused considerable economic, operational, and personal challenges. And so I want to first thank our employees and business partners who made it possible through their dedication and tireless actions and continue to do so with the ongoing pandemic. Not only did the team work through significant headwinds, but we are also making the most of the opportunities in front of us as well as posting excellent results. Our team delivered another quarter of double-digit earnings growth and a strong finish to 2020. The Vontier Business System continued to drive outstanding adjusted free cash flow conversion of greater than 140%, core revenue growth of 8.5% and adjusted core operating margin expansion of 240 basis points. These top-tier results underscore the resiliency of our portfolio as key secular drivers and market share gains drove outperformance. A proof point of the quality of our business and strategic focus is that even when excluding the benefit of EMV in the quarter, we still delivered high single-digit core growth. Furthermore, we ended the year with backlog growth of 40%, reflecting accelerated EMV adoption at Gilbarco Veeder-Root as well as continued strong demand across the product lines at Matco. Importantly, we realized these results while continuing to position our portfolio for the future and investing ahead for profitable growth opportunities. Not only were we able to deliver high single-digit core revenue growth across the platforms, which exceeded our previous outlook, but we also drove structural cost control and working capital productivity, which will continue to provide benefits into 2021. We're also making steady progress improving our innovation efforts by deploying lean portfolio management, launching growth accelerator sprint processes to gain market insights and adding talent focused on growth and product development. Our portfolio is strategically positioned across attractive markets. As secular drivers evolve towards increasing regulation and the growing need for clean, efficient mobility solutions, our enduring business model will provide even greater stability and growth through economic cycles. We remain focused on building a better, stronger Vontier by utilizing our balance sheet and deploying our significant acquisition capacity. With that, we are initiating our full year 2021 guidance, which includes our core revenue growth expectation ranging from a decline of 1% to growth of 1% and adjusted core operating margin expansion of greater than 25 basis points. This core growth outlook includes a more favorable view of the 2021 EMV headwind of $100 million to $150 million. Excluding the EMV impact, core revenue growth is expected to be mid-single digits despite our more challenging comps in the second half. Additionally, we anticipate full year adjusted free cash flow conversion of approximately 95%, reflecting the timing of tax payments and working capital headwinds resulting from a very strong 2020 performance. All this results in our full year 2021 adjusted diluted net earnings per share guidance range of $2.35 to $2.45. The guide amounts to a tale of two halves, reflecting the continued first half growth in demand for EMV ahead of the April adoption deadline in Q2, coupled with a favorable comparison due to the impact of the pandemic in the second quarter of last year. Wherein the second half, we have basically the opposite dynamic as we benefited from the V-shaped recovery and accelerated demand for EMV and Mexico regulatory solutions. In sum, this equates to expectations of first half adjusted earnings per share growth of greater than 20% and a second half decline in the mid-teens range. As I outlined in October, we identified a number of profitable growth initiatives to help offset the anticipated impact of the EMV sunset. These include simplification and productivity actions as well as further penetration in high-growth markets, regulatory and innovation strategic imperatives and continued improvement in businesses such as Hennessy and Teletrac Navman. We've made important progress advancing these initiatives, and I'm confident we will deliver. As such, our guidance reflects our ability to more than offset the top line and earnings impact from EMV and expectations of inflation. Dave will walk you through the key drivers and assumptions of our full year 2021 guidance in his remarks. We're also initiating our first quarter adjusted diluted net earnings per share guidance of $0.52 to $0.55, which includes assumptions of high single-digit core revenue growth and adjusted core operating margin expansion of greater than 200 basis points. With that, I'll turn it over to Dave to provide the financial results. Dave, take it away.

Thanks, Mark. Our adjusted net earnings for the fourth quarter were $147 million, an increase of 22% from $121 million in the prior year period. This translated to adjusted net earnings per share of $0.87 compared to $0.72 in the prior year period. The double-digit increase in earnings was primarily driven by volume growth with strong fall-through, which led to 240 basis points of adjusted operating margin expansion in the quarter. Core growth in the fourth quarter was 8.5%, driven by the continued strength of the EMV rollout in North America, regulatory-driven demand in Mexico, and continued strong demand at Matco. The strong recovery that we experienced in the third quarter continued through the fourth quarter with both GVR and Matco experiencing double-digit core growth in Q4. We also saw high-growth markets return to growth, posting mid-teens core growth. For the full year, we had core growth of minus 1.2%. However, we still continued to expand gross and operating margins for the full year, underscoring the power of VBS. The sharp recovery that we experienced in the full second half of 2020 reflects the resilient nature of our businesses in the markets they serve. Our adjusted operating profit for the fourth quarter was $201 million compared to $165 million in the prior year period, primarily driven by strong core growth and continued cost management in both cost of sales and operating expenses. We delivered gross margin expansion of 70 basis points, which contributed to the strong operating margin expansion, similar to the performance that we demonstrated in Q3, and a function of the team's continued application of VBS in what remains a dynamic environment. Although we have demonstrated prudent cost actions in this environment through the year, we have continued to fund our highest priorities to enable us to exit 2020 well-positioned for more profitable growth. Our earnings growth continued to translate through to strong cash flow performance with adjusted free cash flow of $207 million, a conversion of 141% in the quarter. While our performance in Q4 was strong, it is in line with normal seasonality. For the full year 2020, we generated adjusted free cash flow of $616 million or conversion of 147% of adjusted net earnings. A key underlying factor driving this outstanding full year free cash flow performance was how well our teams executed in this pandemic environment. Ultimately, the biggest lever in driving the free cash flow performance throughout 2020 was exceptional working capital management. We exited 2020 with working capital levels at a historic low. While we anticipate maintaining top-tier working capital metrics, we expect to see some increase in inventory levels to pace with demand, which will likely increase working capital needs in 2021. I will remind you that 2020 free cash flow benefited from only three federal income tax withholding payments, whereby 2021 will have five payments. This is a function of the timing of our spin and will create a headwind to free cash flow on a year-over-year basis. Nonetheless, we are extremely pleased with the work performed by many folks at the operating companies to leverage VBS to drive this cash flow performance. Looking at the top line performance of our two platforms. Mobility technologies had core revenue growth of 8.3%, led by low double-digit growth in GVR where we continued to see strong momentum from EMV demand and high-growth markets. As anticipated, we saw strong demand out of Mexico, driven by the fiscal security regulations we have previously mentioned and continued sequential improvements more broadly in other parts of the business, including a return to strong growth in high-growth markets. Overall, our high-growth markets, which are historically somewhat erratic, grew mid-teens with India and Mexico being the main drivers. In our diagnostics and repair technologies platform, core growth was 9.2% and driven by the continued strong demand at Matco. Matco experienced low double-digit growth as we saw demand continue to accelerate from the strong performance that we saw in Q3. The technician employment environment remains healthy. With new products coming online and having record net additions to our franchise base in Q4, we feel we are well positioned for 2021. We also exited the year with strong backlog in both platforms. Order growth exceeded revenue growth for the second consecutive quarter, with Matco orders growing in the low teens and GVR orders growing in the mid-teens. We continue to work through both the momentum at Matco and ordering for EMV ahead of the upcoming deadline in April 2021. I mentioned the return to growth in high-growth markets, and we generally saw sequential improvement in most of our significant operating regions. North America grew high single digits as did our developed markets in total, and high-growth markets grew mid-teens after declining mid-single digits in Q3. Last quarter, we noted that we would begin a series of restructuring actions in Q4, aligned with driving targeted operational improvements. We recognized a charge of $4.8 million during Q4, which is excluded from our adjusted net operating profit. We anticipate additional actions over the course of 2021 with a total full year charge of around $20 million, which we will exclude from adjusted operating profit. Before turning it back to Mark, I will walk you through our 2021 EPS bridge. As Mark mentioned, our profitable growth initiatives are a key driver of earnings growth. At the midpoint of our guidance, we'd expect these initiatives, combined with an easier compare and price actions, will more than offset an EMV headwind of about $0.38. Additionally, the impact of the return of the temporary costs that we took out in Q2 of last year is expected to be offset by the benefits of the restructuring actions in Q4 of 2020 and those that will be completed during the course of 2021, along with other cost measures. We expect currency to be approximately $0.05 favorable. Lastly, below the line and other items are expected to be a headwind of about $0.12 to $0.13, primarily reflecting a higher tax rate. With that, I'll turn it back to Mark.

Thanks, Dave. There's no question that 2020 was a historic year that presented many challenges. I'm proud of our team for rising to the occasion and delivering safe working environments for our employees, substantial working capital productivity, operational execution, and growth as we continued to invest in our future. The durability of our business model through economic cycles was certainly proven out this past year. We realized sequential improvement since last quarter in nearly all metrics, creating not only momentum but also a high jumping-off point as we head into 2021. I'm excited about our path forward, including the progress we've made since separation towards building out and resourcing our ESG programmatic initiatives and strategy. We're putting a lot of energy into this, and we welcome the opportunity to engage with all of our stakeholders on these efforts and to partner with you as stewards of your capital. To wrap up, 2021 is an important springboard to a multiyear transformation with a long runway of opportunities. As Dave highlighted, we are well-positioned for the growth and comparison dynamics as we progress through the year. While there is much work to be done, our teams are battle-tested, ready, and believe that the best defense is a good offense. We will continue to invest in organic and inorganic opportunities and remain prudent and disciplined in our approach. We're also well aware of the evolving secular drivers in our markets and recognize the value of optionality, rapid decision-making, and creative capital structures in this environment. We remain hyper-focused on unlocking shareholder value for the long term. With that, I'd like to turn the call back over to Lisa.

Thanks, Mark. That concludes our formal comments. Maria, we are now ready for questions.

Our first question comes from Nigel Coe of Wolfe Research.

This is Brian on for Nigel. If we could just maybe talk about GVR in the quarter, specifically in India. What drove that growth? Was it the new product introductions or just an improving macro backdrop and access to sites and things like that? And then also, how are you thinking about the outlook by geography into '21? That would be great.

Yes. Happy to do so, Brian. Yes, India returned to growth. As you know, it's been a lumpy business. It's been impinged by a number of things, COVID being one of them for sure. Certainly, the access to the customer site, as you mentioned, is a big deal so we can do installations. But I think that will even out. More importantly, we've got a great product there called Latitude that's well positioned in the marketplace. It's doing really well. We've responded very well to the tenders in the market, and we picked up tenders, so we've got a good backlog there to serve off as well. I think our position in India is unique, and I think we're beginning to capitalize on that, which is great to see. To get to the second part of your question about geography, when you look around the world, the developed markets are showing high single digits. The Matco and GVR in North America grew high single digits as well as Western Europe had mid-single digit growth, and that was a sequential improvement. When you look at the developing markets, as David said, those also had sequential improvement, with mid-teens growth. Mexico also grew because there is a great secular driver there that's played through and is continuing to play through in Q1. India was up sequentially, and China was a little bit down. So with that, Dave, do you want to talk about 2021?

Yes, that's great. We talked about some of the dynamics with EMV and frankly, some of the comparison issues that we'll have next year, or this year 2021, compared to 2020. Those really are North America-driven with both EMV and some of the strength we saw to Matco. When we look forward, we think most of the growth for next year will be driven outside the U.S., and we'll see some of those headwinds offset, but more of the growth coming from outside the U.S. from those North America-centric headwinds.

Our next question comes from the line of Andy Kaplowitz of Citigroup.

Mark or Dave, could you update us on your work on business simplification using VBS and what's included in your '21 guidance? You reported strong incrementals in Q4. It looked like they were closer to 50%, which seems like you're guiding to again in Q1. I think you've told us before to think more about 30%. Are you finding more opportunity than you thought to increase productivity as you reduce complexity? Have you increased profitability faster in some of your smaller businesses? Does this mean we can start thinking about higher inherent incrementals going forward?

Yes. Andy, I love that question. What we found through digging into our portfolio is that we have more opportunities. This simplification initiative really is about how we can ferret out the areas where we can do better. The separation has shown that focusing works, and the deeper application of VBS and the tools we're using is really uncovering that. I’m very encouraged by what we see for next year as we get our backs fully behind some of these opportunities. In terms of the total guidance, I think I'll leave it to the guidance numbers we put out there. But net-net, I'm very encouraged about what we're seeing, and I think there's an excellent runway of opportunities ahead.

Our next question comes from the line of Julian Mitchell of Barclays.

Maybe just a question around the narrowing of that EMV headwind versus what you had said before. What drove that? Do we just assume a sort of bigger headwind in 2022? I think you said you had a high $0.30 headwind from EMV this year in '21. That implies a very high decremental margin, maybe 50% plus. Just wanted to double-check if I'd misheard that.

Let me start with the question, and I'll turn it over to Dave too. First of all, I think we're getting a little better visibility. Narrowing that range on an improved outlook to the $100 million to $150 million is certainly good news. The difficulty we're facing is the adoption rate is hard to tell. The other two issues are we had a better jumping-off point. It was a lower number in terms of our starting point. I think we have built a better backlog. We were gaining share. There's a mix between what's called EMV kits and dispensers, which is also hard to determine. And then you've got the smaller network retailers; there are thousands of these folks that sell through two-step distribution. It’s a bit hard to call the overall adoption rate. We're doing our best to be transparent about what we see and what has changed. It’s tough to call even what happens after April, but we're confident in what we see. As we get smarter and as these dimensions become clear, we'll certainly update you.

Yes, I think on the decremental margin piece, Julian, you're right about it being around 50%. These products in the U.S., with their reasonably higher technology component, tend to come off at a little bit higher rate. But as we noted in the guidance, our profitability actions, our growth initiatives, and collectively, these are offsetting that impact. We feel pretty good about the outlook.

Maybe just a follow-up around broader portfolio thoughts. In two respects: One is some of the markets you're looking to buy in, like EVs or telematics, are very frothy valuations. Are you changing how you think about acquisitions? And also, does that impact your aspirations for stakes in companies like Tritium and Driivz and how to crystallize that value?

We're excited about the growth markets that are fragmented. As you know, it's about a $27 billion total addressable market that we operate in. We're enthusiastic about portfolio opportunities around smart cities, telematics, adjacencies, logistics, and supply chain, as well as e-mobility. We're not changing our views on acquisitions. We continue to look at bolt-ons, near-in adjacencies, and strategic acquisitions. We have a great balance sheet that allows us to pursue these opportunities. Regarding the EV valuations, we've observed the trends and stay attentive to the market. We have two minority investments: one in Tritium, a DC fast-charging company, and another in Driivz, focusing on energy management. These investments give us valuable insights and learning opportunities.

Our next question comes from the line of Jeff Sprague of Vertical Research.

Just two from me, please. First, back to EMV; I understand the riddles around adoption. Where do you stand regarding adoption, considering where you ended the year and your backlog? Assuming nothing else happens, where does that leave you?

When we look at our installed base, we have converted about a little over 70%, about 71% of our install base. We would then count the backlog and next year's activity. So we'd be over 80%, probably in the mid-80s, exiting 2021 based on the midpoint of the range we put out today.

Great. And just a follow-up on the minority stakes. What's the dynamic if the majority owner wants to go elsewhere? The risk of these investments maybe trading away from you seems significant. Do you aim to ultimately buy these companies outright, or are they just channel and partner plays?

It's difficult to hypothesize on those dynamics, Jeff. The actual terms of these agreements are confidential. However, we also have commercial arrangements with these companies that are outside the existing terms of our ownership. It's hard to predict in a market that is this early stage and exciting. We like our optionality and our position within these assets.

Our revenue from e-mobility, primarily electric charging of Tritium products, grew significantly this past year. It's mostly focused on Central Europe, approximately $25 million. It represents excellent learning, and we are gaining insights as the market evolves.

Our next question comes from the line of John Walsh of Credit Suisse.

Could you share how you're balancing finding opportunities that hit that 10% ROIC threshold versus share repurchase? It seems you are guiding for some dilution in the share count in 2021 compared to Q4.

Yes, we are. Part of that is a little more impacted by the spin, where we're now seeing the impact of stock-based compensation come in just beginning from the spin date. M&A remains our highest priority for capital allocation. Ultimately, we are focused on shareholder return, and we think M&A is our preferred vehicle to achieve that. That said, there could be times when share repurchase makes sense, but M&A will remain our priority in adding shareholder value.

And how did the point-of-sale business perform within GVR in Q4? How are you thinking about its growth into '21?

We didn't discuss point of sale specifically. We have a strong position in the U.S., and I think we did well there. I don't have the exact percentage growth for that product. However, regarding EMV, we are discussing the dispenser and the payment system embedded in them, not the point-of-sale system itself. Overall, we like our position in the U.S. and are excited about growth with new products coming online in international markets.

Our next question comes from the line of David Raso of Evercore ISI.

I'm looking for clarity on the guide. The backlog is up 40% at the end of the year. Do you have a backlog growth rate for ex-EMV? I'm trying to understand the growth for non-EMV. It was up high single digits in the fourth quarter, but you're expecting to slow to mid-single. Can you help clarify that dynamic? Also, the EPS guide implies the back half of the year is $1.40, so the first half is $1.00. Given you've provided first quarter EPS guidance, you're implying the second quarter EPS is below that of the first quarter. Lastly, is any balance sheet usage of cash flow included in the guide?

Regarding the guidance, we discussed a tale of two halves. The first half will be a lot stronger due to the easier comparisons as well as increased EMV volumes. We won't be providing guidance by quarter beyond the first. There are dynamics impacting the second quarter specifically that are not present in the first. Regarding backlog, EMV greatly contributed to the significant growth, but Matco and other parts of GVR that are not U.S.-related also had good growth. I can't provide an exact number, but the non-EMV backlog will grow, albeit not at the same rate. Regarding cash flow, we expect about 95% conversion, with some normalization after 2020's strong performance.

So there is no active usage of cash flow for M&A or repurchase?

That's right, no active cash flow usage for M&A or repurchase.

Our next question comes from the line of John Inch of Gordon Haskett.

I'm wondering if we could talk about the M&A process. I know you've talked about it in the past as Vontier was going public. How is this working in terms of concentrating on the smart cities initiative? How are you narrowing possibilities in this large set of opportunities with ample growth potential?

It's an exciting field. Our penetration in areas like GTT is notable, with access to 90,000 intersections in the U.S. We monitor half a million vehicles. For convenience stores, we have a significant presence globally among 260,000 refueling sites. Our challenge is how to narrow focus in a field with so much potential. We have a team looking into this and identifying priorities. Our aim is to ensure a disciplined, rigorous approach whenever we evaluate these opportunities. While there are exciting prospects, we're careful to say no to ensure we pursue only the best opportunities.

What would you identify as Vontier's core competencies to help inform future acquisitions?

We excel at solving high-value problems for our customers in this space. Our brands are well recognized. We have significant depth in serving customer needs, and we can leverage our scale across businesses. Furthermore, we have an entrenched M&A allocation capability and experience applying VBS to new acquisitions. We have a lot to work with, and I'm excited to leverage it.

Our next question comes from the line of Julian Mitchell of Barclays.

I didn’t hear much about telematics. How did it perform in Q4, and what is included in your guidance this year?

In Q4, telematics experienced some progress, and we remain on track. As you know, it's a SaaS business, and performance waned due to some churn revenue last year. We've seen the churn rate moderate. We expect to see the results of our operational changes starting to flow through the P&L by the second half of next year. It doesn't have a substantial effect on the guidance because changes occur slowly.

Ladies and gentlemen, that was our final question. I'd like to turn the floor back over to Mark Morelli for any additional or closing remarks.

Thank you, Maria. I'm incredibly proud of this team's ability to come together and execute despite these headwinds, and more importantly, to take advantage of the opportunities in front of us. I'm very excited about the road ahead. Our ability to springboard into this multiyear transformation is compelling. As a management team, we are engaged and eager to see what lies ahead. Thanks, folks, for joining us in today's call, and have a good day. Bye now.

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.