My name is Emma, and I will be your call facilitator this morning. At this time, I would like to welcome everyone to the Vontier Corporation's Third Quarter 2021 Earnings Results Conference Call. [Operator Instructions]. I would now like to turn the call over to Ms. Lisa Curran, Vice President of Investor Relations. Ms. Curran, you may begin.

Thank you, Emma. 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. 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 quarterly report on Form 10-Q. 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, and good morning, everyone. I'm very proud of our third quarter performance. The team is making significant progress towards our profitable growth initiatives and portfolio diversification through the course of 2021. The team's exceptional execution features continuous improvement and deeper deployment of the Vontier Business System. We delivered another quarter exceeding our guidance on all metrics despite a very challenging backdrop. We achieved nearly 1 point of core revenue growth and nearly 10% core revenue growth, excluding EMV. Given the supply chain headwinds that every other company is also encountering, I believe the real standout measure for Vontier this quarter is our margin performance. We drove 90 basis points of adjusted gross margin expansion and 70 basis points of adjusted core operating margin. This strong performance driving our earnings growth reflects the efforts by our world-class supply chain team and swift price and specific actions taken across the businesses to counter persistent inflation and worsening material availability as well as labor shortages. Demand for our solutions is solid, with order growth, excluding EMV, up mid-single digits. And our ability to price continues to outpace inflation. We've managed positive price costs even in the face of dramatic cost increases associated with expedited freight, but it's becoming more and more challenging given the pace and rate of the inflationary and logistics headwinds. And while we were able to reduce backlog during the quarter, levels remained elevated. And so at the end of the day, our ability to deliver growth really comes down to the availability of materials. As many of you know, the Vontier businesses are short-cycled and we are continuing to derisk our supply chain through our simplification initiatives and by leveraging local partners with a diverse network. We are hyper-focused on securing this supply base. Daily management, one…

Thanks, Mark. Adjusted net earnings for the third quarter were $137 million, an increase of 2% from $134 million in the prior year period. This translated to adjusted net earnings per share of $0.80. The increase in earnings was primarily driven by continued growth in our non-EMV businesses and strong price, which offset the impact of material inflation, resulting in strong fall-through and approximately 70 basis points of core adjusted operating margin expansion in the quarter. Core revenue growth in the third quarter was approximately 1% amidst strong demand and against the prior year Q3, which benefited from a sharp recovery from the pandemic lows as well as regulatory-driven demand in North America and in the high-growth markets. The tale of two halves as we referred to it. Sequentially, revenue grew mid-single digits, directionally consistent with our historical seasonality. In the third quarter, core revenue growth was driven by our non-EMV businesses, which grew approximately 10% and was mostly offset by the anticipated roll-off of EMV and the regulatory driver in Mexico, which benefited the second half of last year. Adjusted operating profit for the third quarter was $188 million, a growth of 4% compared to the prior year period, primarily driven by revenue growth and solid operational execution as we managed through persistent inflationary pressures and supply chain disruptions across our operating companies. As Mark stated, through broad pricing actions and the team's continued focus on executing on our profitable growth initiatives, we drove approximately 90 basis points of adjusted gross margin expansion and 70 basis points of adjusted core operating margin expansion, more than offsetting a headwind of approximately $10 million from raw material inflation and logistics. In the third quarter, we generated adjusted free cash flow of $119 million, a conversion of 87%, reflecting some build of…

Thanks, Dave. Before I wrap up, I want to remind you of the Retail Solutions Teach-in on November 19, where Aaron and Dan will give you a deep dive into our GVR and DRB retail-focused businesses. It will feature a high-quality portfolio of scale with a long runway of attractive expansion opportunities and secular growth drivers. In closing, I hope you see what I see, exceptional execution, our culture of VBS at work and important progress on our profitable growth initiatives and portfolio diversification. We're growing into a more focused, higher-quality, industrial technology company. We're excited about the opportunities that come with that to build better teams, better innovation and a better planet. We're well positioned to deliver sustainable mobility solutions to the market. Our track record of transformation, strategic optionality and strong cash generation drives our long-term value creation by will. And we're committed to staying laser-focused on delivering more profitable growth and compounding returns. With that, I'll turn the call over to Lisa so we can get to your questions.

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

[Operator Instructions]. We'll take our first question from Andy Kaplowitz with Citigroup.

Mark or Dave, could you give us more color into the puts and takes of your margin performance? Obviously, good performance in Q3 with the incrementals greater than 40%. And the swing to 30% decrementals in Q4 isn't overly surprising. But as we think about that Q4 decremental, you mentioned a big part of the issue is the tough comparison for EMV strength and Matco. But can you update us on how you're thinking about price versus material and logistics costs in Q4 and really into '22, if possible? I know you mentioned price risk cost is positive in Q3, but does that swing to negative in Q4?

Thanks, Andy. This is Dave. As we look into fourth, we anticipate that we will still be price/cost positive as we have been year-to-date. Obviously, it's a pretty dynamic environment. We want to see where we exit the year before giving you guys an update or steer towards 2022. What I can tell you, as we look towards the end of the year, we'll see where we exit. But as we sit here today, we don't anticipate any improvement next year in a meaningful manner, so we're going to position ourselves for that accordingly. The -- staying price/cost positive was by far the biggest kind of margin action out there. And as we work through the tale of two halves and we see EMV coming off, that's obviously pretty good revenue. So there can be a mix headwind associated with that. But I think you've picked up on the [indiscernible]. And I would finally add that, from a supply chain standpoint, the third was pretty dynamic, and we don't see things improving as we get into the fourth. In fact, probably a little bit worse. And so we've kind of built some of that caution in as well. You talked about the incrementals and decrementals. We incremented well in the third. That obviously probably has a little bit to do with the loss small numbers as we saw some uncertainty in the revenue conversion timing. We took some actions that have a magnified impact on incrementals given the lower growth on top. And as we look to the fourth against the tough compare, the way I think about it is we're decrementing at 30%, which is a much lower rate than we've incremented through the course of this year.

Very helpful, Dave. And then you mentioned GVR orders, excluding EMV, grew high single digits, which seems relatively good, but maybe you can give us a little more color into how you're thinking about mobility as EMV continues to wind down. I know you told us last quarter that there'll still be a similar headwind in '22 from wind down in '21. So do you see enough demand, for instance, from healthier developed world customers or faster-growing customers in developing countries such as India to promote growth as we go into '22?

Yes. Thank you for that question. Look, I feel really good about the initiatives we're taking that are really driving that ex EMV growth there. I think you're seeing it show up continually. And what gives me some confidence there is that we have a set of profitable growth initiatives that are really taking hold and they're reading through. We saw strong growth in environmental, retail solutions, of course, auto repair through Matco, as well as our spare parts business. So I think you mentioned the high-growth markets. There's a number of initiatives there, particularly out of India, Middle East and Africa, that have been really strong. So we've lined up a pretty good slate of initiatives that we continue to deliver on, and we've got a lot of momentum around that. At the same time, when you go into next year, we got DRB for a full year. They performed really well in the last -- the 2 weeks we had them. We've been really impressed with what we see so far. So we're excited to add that to our portfolio, and I think you're going to see that read through really nicely next year, too.

We'll go next to Nigel Coe with Wolfe Research.

This is Brian Lau on for Nigel. Maybe I just wanted to talk about Matco quick. So 5 strong quarters in a row of franchisee adds. Backlog remains elevated. Just could you provide an update on the amount of geographies still available for franchisee adds? And then how are you thinking about all these franchisee adds ramping into 2022 perhaps driving some growth?

Yes. Thanks, Brian, for the question. Look, I understand why you're asking that. The business is performing really well. To be really concise on your answer, we've got about 30% of our territories that are open and available to us, which is kind of unique to compared to the higher-quality peers in that space. And we've been building that out, and we feel really good about the progress they've been making. The backdrop here is a really strong environment for technicians that continue to buy. They're flush with cash, and they're out there investing in their businesses. And that's reading through in our product lines. When you look at diagnostics, which is a higher-price item, they're continuing to -- actually, I would say, not continuing. They're actually stepping up purchases as well as high-dollar toolbox. And so when you think about sales, that's a real advantage. The other thing that bodes well for it is that -- for this business is that we've got a really strong vitality, which means that every year we bring about 30% products that are new to market. And so the key here is to continue that vitality, particularly as we go into next year, which I'm very confident we can because we're providing solutions that technicians want and will continue them buying. So we're going to take advantage of the strong backdrop, and we're going to keep pushing it forward.

Great. And then just a quick follow-up. With some of the revenue, it sounds like pushing to the right, do you have any more visibility into 1Q '22 versus what's normally a seasonally weaker quarter sequentially?

Look, I think the way we're thinking about '22 is a strong setup, but we'll give you more color on that in February as we normally do. But the backdrop there is strong, great demand environment as well as these tremendous momentum from these profitable growth initiatives. So I think the setup is good.

I would add, Brian, that we'll probably enter '22 with more backlog than we entered '21. But again, like the fourth quarter, it's going to come down to the supply environment. So we really want to see how that develops, and that will go a lot towards our visibility.

We'll go next to Steve Tusa with JPMorgan.

Can you maybe just talk about what you see today, if you kind of snap the line, what kind of price/cost would look like for next year?

Well, look, year-to-date price/cost, and we anticipate through the end of the year has been pretty favorable. And as you know, this is always a big focus area for us. I think it's -- we're going to have to get a read on the inflationary environment for next year. As I said earlier, Steve, I think we're assuming the worst as we make our plans for next year, but we have to see how that develops. And that will clearly drive our actions. Part of the setup for that is the fourth, and we're leaning into it. But I would also say that there's items beyond price/cost as we think of the profitability impact from inflation. We need to work all parts of the P&L in response to that. Mark, do you want to add to that?

Yes. Thanks, Dave. Look, Steve, I think the key is that this environment is not going to change quickly. In other words, there's a lot of headwinds that are in this. And we feel really good the way that we've worked through it so far. We have a really strong set of initiatives that are paying off. I'm happy to get into any detail that you all would like. But it's pretty clear we've been ahead of this curve from early on based on those initiatives. And as we go into next year, we're counting on this environment to be underway, and we're rolling out even more initiatives that dig deeper. I think that's the nature of this continuous improvement mindset that we have as we continue to peel the onion on this. A great example of that is our simplification efforts that actually reduce the number of SKUs that we need to chase, and it enables us to get better alternative sourcing and dig deeper on the components that really matter. And so I think that's sort of a new envelope that we're going to be pushing into next year that can even pay off more.

We'll take the next question from Andrew Obin, Bank of America.

This is David Ridley-Lane on for Andrew. I'm just wondering in mobility tech, have you seen any slowdown, maybe anecdotally, around your customers' ability to complete projects and willingness to start new projects around labor availability, cost inflation, some of the supply chain issues? Just wondering if your sort of orders -- we're hearing from your salespeople that these are sort of negative factors affecting your order pace.

Yes. It's a fairly short answer, no. I think that there -- I understand the labor-constrained markets out there. And certainly, we're working through those ourselves. But I feel like there's ways of finding solutions to that, and we've been pretty effective at doing that. And I think most of our customers are really in that. I'm not saying that, that doesn't exist, maybe in some pockets out there, but it doesn't read through when you add it all up.

Got it. And then just -- I think we have most of the components on bridging the core operating margin expansion from third quarter down to the fourth quarter guidance. Could you kind of give us a rank order of those in terms of some of the benefits, onetime benefits you were getting in the year-ago quarter versus what's getting incrementally worse?

Well, look, it's tough for me to do the full bridge here in this venue, but I will say that I would steer you back to our 30% decrementals. And within that, obviously, the top line decline is associated with our EMV product line, which is a reasonably high-margin item. So there's some mix impact associated with that. The price/cost assumption, we should assume that we continue to offset the margin impact, but that I would say that dynamic has continued to tighten as the years progressed, so we probably see the margin upside from price/cost tightening up as we go. I think those are the big items.

Your next question comes from Julian Mitchell with Barclays.

This is Trish Gorman on for Julian. And so just back on the supply environment, can you guys talk a little bit more about its impact on GVR relative to Diagnostics and Repairs and then maybe if that's changed your expectations for EMV headwinds in 2022 at all?

Yes, happy to take that question. Look, when you look at the environment for GVR, the biggest issue that we got to work through and the risk that we've been predominantly managing has been through some of the specific GVR factory-related material availability. And as I've said in our remarks, I think we've really worked through that admirably well. I think we're really proud of the efforts that we're doing there to pay off. You talked about Diagnostics and Repair. Of course, we've got a factory there for toolboxes. And we've got a lot of supply chain issues because we source a lot of products there. But on both accounts, there's been risk, no question about that. And we could have shipped more, as Dave said in his prepared remarks, if we can solve that better. And so that's clearly a work in progress. But I think when you think about how we think about risk there, it's mostly on material availability, somewhat on labor shortages and supply, as I said, but it doesn't rise to the specter of the material availability issues. And we continue to work through it admirably well. So we're a little bit cautious on the environment, but we're optimistic we can continue to work it.

And on the EMV point, I think we're going to see how the fourth comes together where we exit the year. But as of today, no update to our EMV outlook for 2022 that we previously provided which is that the impact could be similar to what we see happening in 2021, which is $75 million to $100 million year-over-year decline.

Great. That's very helpful. And then just maybe a follow-up. Can you just remind us how typical pricing works in both of these segments, maybe just like ballpark, what is it typically in a normal year kind of low mid-single digit maybe? And then just the cadence of from when you announced the price increase, typically, how long does that take for it to become effective?

Yes. So we had a number of price increases this year that were not sort of in schedule -- within schedule is a pricing increase for the end of the year that sets you up for the beginning of the year. And we've been pretty good at that, I would say, on a normal basis. What we started actually last year about this time was some deep analytics on strategic pricing that we could take. We did not actually know that the environment for 2021 was going to be as inflationary as it's been. But we got an early start because we recognized there was a strategic pricing opportunity that came out of our simplification efforts. And so that read through on a number of price increases through the year based on getting -- and we got an early start accordingly. So I think maybe that gives you a little color on how we think about it and how we're going to continue to prosecute this -- what I view as a net opportunity for us in the market.

[Operator Instructions]. We'll take our next question from Andrew Buscaglia with Berenberg.

So a lot of the near-term price/cost stuff is kind of taken, so I just want to ask kind of a more philosophical question. So I think DRB was a great deal. It definitely serves the purpose that helps offset the EMV headwind. But I think the market, the multiple, kind of beyond at that acquisition, and I'm wondering with M&A still a priority. What -- where do you like investments in some of the kind of longer-term growth-year-type deals or acquisitions or investments? How are they prioritized, I think, going forward? I know that won't help you financially near term, but I wonder if the stock would just be more sensitive to kind of showing some strategic change towards some growth areas, albeit long term?

Look, I think that's a great question. I do want to touch on DRB, but just give me a minute because I want to answer your question really specifically. We see a range of deals in our pipeline. We are super excited about the cultivation that's been going on. I mentioned in my prepared remarks we're coming out of our strategic reviews. And I think there's an excellent balance of really growthy-type deals out there. But we're looking at bolt-ons. We're looking at adjacencies like DRB. And we're looking at this growthier space that would provide early-stage technologies that are more strategic over the longer term. And I think that balance is something you should expect both hardware and software. And we're excited about it. I think the space is to think about our retail solutions, telematics, smart cities, just to name a few. But let me just touch on DRB because I think it's really indicative of kind of also where we're going. This is a great asset. This is an end-to-end technology platform. It combines this deeply embedded point-of-sale technology and layers on top of it workflow and monitoring software. It's got a great recurring revenue base. And it does things like integrated payments and digital marketing solutions. And so what's happening is you see a business moving up the technology stack. And that's exactly the kind of things that we also like as well. So more to come.

Okay. Yes. Helpful. I agree. I agree with that. It might just take some time for the market to kind of realize that. And I think -- if the stock is still kind of hanging out here into next year, where does share buyback -- where does that fall in your priority list? And if the stock is still kind of floundering, do you -- would that move up in your priority list?

Look, I think our focus is always on providing the best opportunity for shareholder return. And we continue to think that's through deploying capital on M&A. Obviously, things can change in the future, but that maintains our primary capital allocation priority right now, I would say.

We'll go next to Rob Mason, Baird.

I wanted to see if you could -- you spoke to the growth in environmental this quarter. I was curious how you view the runway on environmental here in the fourth quarter into next year and maybe juxtaposition against how you see that versus the retail solutions side of the business.

I think environmental has got drop to it. The fundamentals are clearly there. It's less impacted by EMV. A great set of products and solutions that are connected as well as workflow solutions there. And so we're continuing to push that opportunity, outstanding growth that you've seen. And so we're -- we've also launched a number of really innovative products to market this past year. And I think they're helping us really get better traction in that marketplace. So we feel good about where we are, and we're going to press every opportunity on that. So I also feel good about that going into next year, a lot of momentum.

In Retail Solutions perspective as well?

Well, the great thing is we get to talk to you on Retail Solutions on November 19. So we're pretty bullish on that opportunity. We'd love -- we're excited to showcase that to you, a number of really sticky customer-serving problems that not only help us sort of line up how customers can do better business and convenience retailing as well as what we are looking at in terms of car wash. So really happy to talk about that more in depth on November 19.

Very good. We'll sit tight on that. And then just as a follow-up, there was the mention that you took backlog down some. Was that the case in Matco's business? Or was that more in GVR?

That was more in GVR. We wish we had taken it down further. We talked about being supply chain constrained, and we would have been able to get more revenue out the door and more backlog off the books, for sure. So we're running at very high levels. We talked about almost 40% year-over-year higher. But Matco and GVR, were where we saw the primary challenges in getting backlog down and probably a little more GVR than Matco.

Our next question comes from Julian Mitchell, Barclays.

This is Trish on again. Just a follow-up for me. You mentioned backlog year-over-year, and you mentioned orders growth kind of ex GVR being up mid-single digits. What were the total company orders growth in the quarter? And I don't know if you have that by Matco versus GVR or if you'll disclose that?

Yes. On an orders basis, on a year-over-year basis, we were down kind of that mid-single digits total up. It's really the EMV dynamic. And heading into that tale of two halves that we talked about here. So sequentially, we tend to see orders come down a little bit, but it's really the impact of EMV on a year-over-year basis that I'm seeing here in the third. So continued robust demand environment and really most all things non-EMV, what we see the EMV dynamic picking it.

And just maybe following up on that with the EMV dynamic. Can you just talk about kind of margins by subsegments? Because I would think we'd see a little bit of a difference there given those dynamics.

Yes. Look, we don't get too granular on the margin impacts here, but EMV is clearly above fleet average margin for, I would say, for Vontier all up and definitely for GVR as well. And so as we work through that, that's a lot of the profitable growth initiatives that we see. But also Matco hoped a lot because Matco's a really strong margin business for us that we get some benefit from.

There are no further questions at this time. I will turn the program back over to Mark.

Yes. Thank you, Emma. Look, I want to take this opportunity to thank the supply chain team for their outstanding work and for the entire Vontier team for embracing our core values for more than a year now and particularly the driven of core value because I believe that's been important establishing Vontier as a company that achieves results. Thanks for joining us on today's call, and have a good day.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.