Fortive Q3 2021 Earnings Results & Report

Fortive EPS Results

• Actual EPS: $0.66
• Consensus EPS: $0.65
• Beat/Miss: Beat by +$0.01
• One Year Ago EPS: $0.94
• EPS Beat Rate: 6 of last 8 quarters

Fortive Revenue Results

• Actual Revenue: $1.30 billion
• Expected Revenue: $1.31 billion
• Beat/Miss: Missed by -$14.95 million
• YoY Revenue Growth: +12.00%

Fortive (NYSE:FTV) (NYSE: FTV) is a diversified industrial technology company that develops and provides products, software and services designed to improve the productivity, safety, reliability and efficiency of businesses and public-sector organizations. Its offerings support customers in industries including manufacturing, healthcare, utilities, transportation, commercial facilities and government.

The company’s portfolio includes electronic test and measurement equipment, calibration and asset-management solutions, workplace and facility-management software, engineering and infrastructure software, product identification and traceability systems, and healthcare technology. Its brands have included Fluke, Fluke Biomedical, Tektronix, Accruent, Gordian, ServiceChannel and Intelex, among others. Fortive also provides tools and systems used for condition monitoring, electrical testing, equipment maintenance, workflow management and regulatory compliance.

Fortive was formed in 2016 through a separation from Danaher Corporation and is headquartered in Everett, Washington. The company serves customers internationally through a combination of direct sales, distributors, software platforms and service operations. Fortive emphasizes continuous improvement and applies its proprietary management approach, the Fortive Business System, across its operating companies.

Fortive Q3 2021 Earnings Call Transcript

Key Takeaways

• Fortive delivered 12% total and 9.1% core revenue growth in Q3 alongside >20% order growth, a 40% backlog increase, 22.8% adjusted operating margin and a 32% rise in EPS, generating $252 M free cash flow (105% conversion).
• Widespread supply chain disruptions led to significant order backlogs and delivery delays despite strong demand, requiring daily FBS countermeasures and expected to persist into 2022.
• The software portfolio grew low double digits to nearly $750 M in annualized revenue, with net dollar retention around 102%, underscoring fortification of recurring revenue streams.
• The ServiceChannel acquisition bolsters the Intelligent Operating Solutions segment’s facility and asset lifecycle offerings, with early customer wins such as Walgreens accelerating strategic expansion.
• Leadership depth was enhanced by key promotions and hires, including Illuminae Sherroya as IOS CEO and Tammy Newcomb as CEO of Precision Technologies, strengthening senior management across all segments.

Presentation

[Operator]

My name is Alexander, and I will be your conference facilitator this afternoon. At this time, I would like to welcome everyone to the Fortive Corporation's third quarter 2021 earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during that time, simply press star, then one on your telephone keypad. If you would like to withdraw your question, press the Pound key. I would now like to turn the call over to Mr. Griffin Whitney, Vice President of Investor Relations. Mr. Whitney, you may begin your conference.

[Griffin Whitney, VP of Investor Relations at Fortive]

Thank you, Alexander. 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 section of our website, www.fortive.com, under the heading Investors Quarterly Results. We completed the separation of our prior industrial technology segment through the spin-off of Vontier Corporation on October 9th, 2020, and have accordingly included the results of the industrial technology segment as discontinued operations. 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.

[Griffin Whitney, VP of Investor Relations at Fortive]

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 2020. 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.

[Jim Lico, President and CEO at Fortive]

Thanks, Griffin, and good afternoon, everyone. Early in the third quarter, Fortive celebrated its 5th Anniversary as an independent public company. This quarter, we continue to demonstrate the success of the strategy we outlined in 2016 to enhance growth and margins across our businesses through the successful execution of the Fortive Business System, the acceleration of innovation, and the impact highlighted by 32% growth in adjusted earnings per share. We continued to generate significant revenue momentum throughout the quarter, realizing 9.1% core revenue growth and order growth of just over 20% against a backdrop of strong broad-based demand. Strong execution and application of FBS helped to generate 325 basis points of core operating margin expansion, along with very strong free cash flow despite widespread supply chain disruption.

[Jim Lico, President and CEO at Fortive]

In the third quarter, our software businesses grew by low double digits, supported by strong demand and improving net dollar retention. In total, we now have almost $750 million of annualized software revenue across the portfolio with double-digit organic growth profile as well as a high share of recurring revenue and high operating margins. In August, we closed the acquisition of ServiceChannel, adding another differentiated high-growth software asset to our Intelligent Operating Solutions segment. The ServiceChannel acquisition significantly enhances our strategic position in the facility and asset lifecycle market, extending our leading suite of offerings for facility owners and operators, and providing a variety of potential avenues to deliver unique value-added solutions in combination with Gordian and Accruent. As you can see on slide four, across Fortive, we continue to invest in product development to drive organic growth and enhance our competitive position.

[Jim Lico, President and CEO at Fortive]

Many of our investments in organic innovation are focused on enabling digital transformation across our customer base. This includes vertically tailored software offerings at Tektronix and Fluke Health, emerging IoT solutions and sensing, as well as early progress. In addition, our investments in the Forge continue to drive data analytics and machine learning opportunities across all of our businesses. Our success in accelerating the pace of innovation across our portfolio is demonstrated by examples such as the Fluke ii900, a groundbreaking product which was recently recognized as Test, Measurement, and Inspection Product of the Year at the 2021 Electronics Industry Awards. We continue to build the strength of our talent base to accelerate progress across Fortive.

[Jim Lico, President and CEO at Fortive]

This quarter, we announced a number of important additions and promotions to the senior leadership team, including the appointment of Olumide Soroye as President and CEO of Intelligent Operating Solutions, the promotion of Tami Newcombe to President and CEO of Precision Technologies, and the promotions of Justin McElhatton and Bill Pollak to Group President roles within IOS. These moves highlight how we are building leadership capacity through a combination of internal development and external hires aimed at adding differentiated skill sets and experiences to our senior team. With Olumide and Tami, as well as Pat Murphy now leading Advanced Healthcare Solutions, we have significantly increased the depth of our leadership within all three of our segments. Turning to a quick summary of the results in the quarter on slide five.

[Jim Lico, President and CEO at Fortive]

We generated year-over-year total revenue growth of 12%, core growth of 9.1%, and orders growth of just over 20%, with backlog increasing by 40% year-over-year. Adjusted operating margin was 22.8%, while adjusted earnings per share was $0.66, representing a year-over-year increase of 32%. The strong adjusted operating margin performance helped us to deliver $252 million of free cash flow, which represented a 105% conversion of adjusted net earnings. On slide six, we take a closer look at the Intelligent Operating Solutions segment. IOS posted total revenue growth of 16.6% in the third quarter, with core growth of 13.1%. This included low teens growth in North America, high teens growth in Western Europe, and mid-single-digit growth in China.

[Jim Lico, President and CEO at Fortive]

Fluke's core revenue increased by mid-teens with very strong demand trends continuing across its end markets and major geographies. Fluke's performance was highlighted by high teens revenue growth at Fluke Industrial, which also generated order growth of greater than 20%. Fluke's industrial imaging business continues to perform well, paced by momentum from innovation across its acoustic imaging product line, which doubled year-over-year in the third quarter. Fluke Networks had a very strong quarter driven by innovation such as its LinkIQ product line. Fluke's efforts to expand its recurring revenue base saw further progress in Q3, including strong performance across both its service offerings and at eMaint, which generated high teens growth in revenue and SaaS bookings for the quarter. The combination of robust order growth and supply chain constraints in Q3 led to strong backlog that we're carrying into the fourth quarter and 2022.

[Jim Lico, President and CEO at Fortive]

Industrial Scientific revenue increased by mid-teens% as its instruments and rental business continued their strong recoveries. The ISC team has done an excellent job using FBS tools to accelerate product redesign initiatives, which have helped alleviate component supply challenges and limit impact on delivery times to customers. Intelex grew by mid-teens% and posted another record revenue quarter. Intelex is seeing solid FBS-driven improvements in its upsell process to support higher net dollar retention, Datamaran, which enables Intelex customers to manage their full lifecycle risk identification. Accruent grew by low single digits% in the third quarter while seeing strong bookings of greater than 20%. This booking strength was paced by continued demand for Accruent's Meridian engineering document management and Maintenance Connection CMMS offerings.

[Jim Lico, President and CEO at Fortive]

Accruent also continues to see strong demand for its EMS event workspace and resource scheduling solution to support emerging hybrid office models as customers execute their return-to-work plans. Among the notable new customer wins for the EMS solution in Q3 were several leading global financial services providers. Accruent also continued to see improved performance in its professional services business, which generated low double-digit growth. Gordian increased by mid-teens, with strong growth in procurement and in estimating. In the third quarter, Gordian continued to see increasing project volume as well as higher average dollars per project. Gordian is also seeing success from its expansion into healthcare, with significant demand for its facility solutions from hospital customers.

[Jim Lico, President and CEO at Fortive]

After completing the acquisition of ServiceChannel at the end of August, we are obviously early in our ownership, but we're very pleased with what we've seen thus far and are excited to have them join Fortive. Specifically, ServiceChannel continues to demonstrate strong momentum in its large enterprise retail business, with several large customer wins in Q3, including Walgreens, which will roll out automation software across their more than 10,000 locations, and the third-largest mobile carrier in North America as they transform their facility management program. Moving to slide seven. The Precision Technology segment posted a total revenue increase of 8.9% in the third quarter, with core growth of 7.7%. This included high single-digit growth in North America and high teens growth in Western Europe. China grew low single digits, but saw strong continued momentum and demand with double-digit order growth in the quarter.

[Jim Lico, President and CEO at Fortive]

Tektronix grew high single digits with strong demand trends across its product portfolio and double-digit order growth. Growth was led by the performance of its mainstream oscilloscopes with a greater than 30% increase supported by new extensions to the 6 Series MSO product line. Tektronix continued to see traction from its efforts to expand in data centers and other related wired communications applications, delivering a number of key customer wins, including Lenovo and Ericsson. Throughout the third quarter, Tektronix did an excellent job deploying FBS countermeasures to navigate sustained supply chain challenges while also delivering significant price realization. Even with this strong execution, given the continued robust pace of demand from its customers, Tektronix increased its backlog by more than 70% versus a year ago. Sensing Technologies increased by low double digits in the third quarter.

[Jim Lico, President and CEO at Fortive]

Sensing reported strong growth across each of its major regions, with robust order momentum across its key end markets. Setra registered additional market share gains with its HVAC offerings in Q3 and continues to generate strong growth across a range of critical environment applications, including hospital isolation rooms and pharmaceutical manufacturing. Hengstler-Dynapar had a very strong quarter by utilizing the FBS tool set to improve lead times and on-time delivery to drive share gains with key OEM customers. Pacific Scientific EMC grew by mid-single digits in its customer base. PacSci continues to see significant growth opportunities in its aircraft and space end markets with strong momentum across its critical safety technology offerings. Moving to Advanced Healthcare Solutions on slide eight. Total revenue increased 9.3%, while core revenue increased 4.7%. This included mid-single-digit growth in North America and low single-digit growth in China.

[Jim Lico, President and CEO at Fortive]

Western Europe saw a high-teens decline based on a difficult prior-year comp at Invetech, partially offset by strong growth at ASP and Fluke Health. ASP grew by low-single-digits in the third quarter, highlighted by a strong capital equipment performance, including low-double-digit growth in terminal sterilization capital. ASP continues to benefit from the solid sales execution, driving consistent execution in the U.S. In the U.S., the spike in COVID-related hospitalizations led to a notable decline in elective procedure volumes toward the end of the quarter, resulting in global elective procedures at approximately 88% of pre-COVID levels for the period. While we expect only nominal improvement in elective procedure volume in Q4, longer-term, we expect ASP's consumable revenue will benefit from procedure volume normalization and growth in its global install base.

[Jim Lico, President and CEO at Fortive]

Censis increased in the low 40% range, highlighted by very strong growth in professional services and related hardware. Its CensiTrac SaaS offering grew mid-teens as it continued to benefit from new customer additions, as well as good momentum with upselling and cross-selling to existing customers. Censis continues to have open access to customer sites and saw strong sustained order growth throughout the quarter. Fluke Health Solutions increased by high single digits, with continued strength in North America and Western Europe, tied to market share gains with OEM customers through the continued deployment of FBS growth tools. FHS executed very well throughout the quarter, driving significant price realization and managing through supply chain constraints to open new market opportunities. FHS continues to benefit from partnership efforts, good early traction from software innovation efforts, with 30% growth year-over-year in Q3.

[Jim Lico, President and CEO at Fortive]

Invetech declined by mid-single digits, which was better than expected against a tough prior year comp that included significant COVID-related tailwinds. The company continues to see strong demand across the diagnostics and life science verticals, and expects to end the year with significant order momentum and a healthy backlog to carry into 2022. With that, I'll pass it over to Chuck, who will take you through some additional details on our margins, free cash flow, and balance sheet.

[Chuck McLaughlin, SVP and CFO at Fortive]

Thanks, Jim, and good afternoon, everyone. We delivered another quarter of strong margin performance in Q3, using FBS tools to deliver strong pricing and successful value engineering to implement component FBS execution and the continued strength of our software businesses help deliver adjusted gross margins of 57.3% in Q3. This reflects 90 basis points of expansion on a year-over-year basis as we accelerated to 220 basis points of total price realization. Q3 adjusted operating profit was including countermeasures enacted in the face of ongoing supply chain challenges. We had strong margin performance across all of our segments, resulting in 325 basis points of core operating margin expansion. On slide nine, you can see that in the third quarter, we generated $252 million of free cash flow, representing a 105% conversion of adjusted net income.

[Chuck McLaughlin, SVP and CFO at Fortive]

Free cash flow over the trailing twelve months increased 22% to $991 million. Our current net leverage is approximately 1.6x, and we expect net leverage to be around 1.3x at year-end, excluding any additional M&A. Turning now to the guide on slide 10. We are raising the low end of our full year 2021 adjusted diluted net EPS guidance to $2.70, resulting in a range of $2.70-$2.75 for the year. This represents a year-over-year growth of 29%-32% on a continuing operation basis. This assumes that total revenue growth of 14%-14.5%, adjusted operating profit margins of 23%-23.5%, and an effective tax rate of approximately 14%.

[Chuck McLaughlin, SVP and CFO at Fortive]

We continue to expect free cash flow conversion to be approximately 105% of adjusted net income for the full year. We are also initiating fourth quarter adjusted diluted net earnings per share guidance of $0.74-$0.79, representing year-over-year growth of 6%-13%. This assumes total revenue growth of 6.5%-8.5%, adjusted operating profit margin of 23.5%-24.5%, and an effective tax rate of approximately 15%. The adjusted diluted net earnings per share guidance also excludes approximately $12 million of anticipated investments in strategic productivity initiatives that we expect to execute before the end of the year. For the fourth quarter, we expect free cash flow conversion to be approximately 125% of adjusted net income.

[Chuck McLaughlin, SVP and CFO at Fortive]

With that, I'll pass it back to Jim for some closing remarks.

[Jim Lico, President and CEO at Fortive]

Thanks, Chuck. We're very pleased with our performance in Q3. We worked diligently to countermeasure supply chain challenges that persisted throughout the quarter, and which we expect to continue into 2022. Our teams are doing an excellent job deploying FBS to navigate those headwinds, while also delivering strong margin performance and free cash flow generation. Looking across our end markets, the demand backdrop we're seeing is very strong, with significant momentum in our order flow driving continued growth in our backlog and double-digit growth across our software businesses. While continuing our focus on execution, we're investing in innovation, expanding our base of leadership talent, and pursuing additional capital deployment opportunities as we look to enhance our competitive advantage and pave the way for consistent double-digit earnings and free cash flow growth in the years to come. With that, I'll turn it back to Griffin. Thanks, Jim.

[Jim Lico, President and CEO at Fortive]

That concludes our formal comments. Alexander, we are now ready for questions.

[Operator]

Thank you. At this time, I would like to remind everyone in order to ask a question, please press star one on your telephone keypad. Again, that is star one to ask a question. Please limit your question to one and one follow-up question. We have your first question from Scott Davis with Melius Research. Your line's open.

[Scott Davis, Chairman and CEO at Melius Research]

Good afternoon, guys, and good evening, everybody.

[Jim Lico, President and CEO at Fortive]

Hey, Scott.

[Scott Davis, Chairman and CEO at Melius Research]

It's a pretty good quarter overall. I'm just trying to nitpick a little bit. If price up 220 basis points, did that fully offset your cost, Jim? Is price still going up as you go into Q4 here to offset kind of the deltas as costs continue to rise?

[Jim Lico, President and CEO at Fortive]

Yeah, Scott, thanks. I think number one is we've been ahead as you know, we've been in a really good position all year relative to price cost. Just about prices, when you think about it, we really think about it in the big hardware businesses as Fluke, Tektronix, and sensing. In those businesses, we were over 300 basis points. Yeah, and we'll see improvement from there in the fourth quarter. Yeah. We're in good shape. You'll see the price in the software businesses in the net dollar retention. Net dollar retention at 102 or so, with some of our businesses even higher, means we're also getting that price in a number of the software businesses. It just doesn't show up in the metric the way you'd like it.

[Jim Lico, President and CEO at Fortive]

We're, I think, in a very good shape relative to price cost in the hardware businesses relative to any inflationary pressure we might have.

[Scott Davis, Chairman and CEO at Melius Research]

Okay, good. ServiceChannel, you made some positive comments. What is it more specifically that you like, more perhaps today than when you closed the deal?

[Jim Lico, President and CEO at Fortive]

Well, I think, you know, number one, the team. I think, you know, we didn't have full access to the entire organization when we were in the deal. I mean, I think with the work we've done, we've been in person with the team, and I think we're excited about the quality of the organization. That's number one. We always said the product was great, so I don't think there's any surprise there other than the product is great and the solution is good. As we articulated in the prepared remarks, the breadth of opportunity is really positive. I would say the other thing is we're really starting to see how we can continue to expand the business and some of the levers that are out there.

[Jim Lico, President and CEO at Fortive]

We'll do, as you know, our 100-day plan here in, you know, about a month. We'll certainly, you know, codify for the remaining rest of the year, but more importantly for next year relative to our plans. Right now we're, I think, in a very good place relative to how we see the business.

[Scott Davis, Chairman and CEO at Melius Research]

Great. I'll pass it on. Thank you, and good luck in 4Q.

[Jim Lico, President and CEO at Fortive]

Yeah. Thanks, Scott. Good talking to you.

[Operator]

We have your next question from Deane Dray with RBC Capital Markets. Your line's open.

[Deane Dray, Managing Director and Senior Equity Analyst at RBC Capital Markets]

Thank you. Good afternoon, everyone.

[Jim Lico, President and CEO at Fortive]

Good evening, Deane.

[Deane Dray, Managing Director and Senior Equity Analyst at RBC Capital Markets]

Hey, just maybe start with Fluke. In most circumstances, something has not gone right if you're building backlog in Fluke with the supply chain issues. Maybe some color there would be helpful.

[Jim Lico, President and CEO at Fortive]

Yeah, sure. I think we had a very strong quarter at Fluke. As we mentioned, we did build backlog. As you know, any product that has a range of electronic components here is gonna be a little bit of a challenge. You know, orders were in the high teens, so we're in really good shape on the order side. We built backlog, as you mentioned. I've been with the team a couple times on the shop floor, and they're doing some really good work to get on with many of the component challenges they've had. But we're in a very good place next with backlog and with the position of the business. I like where we're at.

[Jim Lico, President and CEO at Fortive]

As we mentioned from an innovation perspective in the prepared remarks, the number of examples of where I think we're really handling things well and we're taking market share. Of course, all that's also really driving strong margins there as well.

[Deane Dray, Managing Director and Senior Equity Analyst at RBC Capital Markets]

Okay. Then, as a follow-up, I guess you should not be surprised. This is really a page from your playbook to jump on the opportunity to do some discretionary restructuring in the fourth quarter to get a jump start on the coming year. This $12 million, just to be clear, that was not in your prior guidance. Is that correct?

[Jim Lico, President and CEO at Fortive]

That's correct, Deane. We've got some things going on with the ASP Day 2 countries that we'd planned to get after but hadn't been put into our guide. We've also got some things around facilities reductions that we're looking into reducing our footprint.

[Deane Dray, Managing Director and Senior Equity Analyst at RBC Capital Markets]

Got it. Which segments would benefit from that spending?

[Jim Lico, President and CEO at Fortive]

Yeah. About half of it, half of it's in IOS and the other half's in the other two, almost split evenly between PT and health.

[Deane Dray, Managing Director and Senior Equity Analyst at RBC Capital Markets]

All right. That's good to see. Thank you.

[Jim Lico, President and CEO at Fortive]

All right. Thanks, Deane.

[Operator]

We have your next question from Jeff Sprague with Vertical Research. Your line's open.

[Jeff Sprague, Founder and Managing Partner at Vertical Research Partners]

Thank you. Good afternoon, everyone.

[Jim Lico, President and CEO at Fortive]

Hey, Jeff.

[Jeff Sprague, Founder and Managing Partner at Vertical Research Partners]

Interesting answer to the prior question, absorbing that. Also, is there some dilution from ServiceChannel in Q4 as you bed that down? And any change of view of kind of that year one accretion, I think in the $0.04-$0.05 range?

[Jim Lico, President and CEO at Fortive]

Jeff, it's Chuck. No change to the year one accretion in that around that $0.04 range. Actually it's coming in just as we expected. In the fourth quarter, we're gonna get revenue with really not a lot of operating profit as it moves into profitability really in next year. That's not different. Inherently, there is a little bit of dilution there in Q4.

[Jeff Sprague, Founder and Managing Partner at Vertical Research Partners]

Right. Margins look good in spite of that. Just on this Walgreens deal, was that something in the pipeline already or you know, is there you know, some synergy that's already occurring with the Gordian or Accruent or some other part of Fortive?

[Jim Lico, President and CEO at Fortive]

You know, Jeff, I'd love to take credit for it, but it was in their funnel. The team did a great job executing on it. I won't. We'll take credit for when the synergies happen maybe next year. Right now the team is, you know, we obviously saw it in the funnel when we did our due diligence, so we knew. You know, I think their say/do ratio of things they said they were gonna do during due diligence versus what they've completed during our short time period with them has been really high. That happens to be one of the things that they've executed on extremely well.

[Jeff Sprague, Founder and Managing Partner at Vertical Research Partners]

Is the answer to the tech backlog the same as the answer to the Fluke backlog? Essentially, just some supply backing up a little bit.

[Jim Lico, President and CEO at Fortive]

Yeah. I mean, it's you know, we're not the first company to talk about it, what I understand. I think at the end of the day, electronic components. You know, what we said at the beginning of the quarter was it would be more an availability issue than an inflationary issue. We've seen some inflation for sure, but a lot of that's temporary because we're just given the demand, it's continued to accelerate. It's a good news story here. This isn't just a supply constraint issue, it's really a demand acceleration standpoint. With the combination of demand accelerating really has our teams working diligently on these things.

[Jim Lico, President and CEO at Fortive]

You know, just puts us in a really good position at the end of the year, I think, to start 2022 off well, in addition to, I think, just having a good backlog in the fourth quarter.

[Jeff Sprague, Founder and Managing Partner at Vertical Research Partners]

Great. Thanks. I'll leave it there. Have a good one.

[Jim Lico, President and CEO at Fortive]

Thanks, Jeff.

[Operator]

We have your next question from Andrew Obin with Bank of America. You may ask your question.

[Andrew Obin, Managing Director and Equity Research Analyst at Bank of America Securities]

Yes. Good evening. Good afternoon.

[Jim Lico, President and CEO at Fortive]

Good evening, Andrew.

[Andrew Obin, Managing Director and Equity Research Analyst at Bank of America Securities]

Just a question on pricing. You know, just going back to the tariffs. You know, I just remember that putting in pricing price cost was an issue. We have a lot more cost, and all of a sudden price is not an issue. What has changed, you know, inside Fortive to enable this kind of pricing power? Because, you know, I just recall, like, three years ago, it was a lot more of a drag.

[Chuck McLaughlin, SVP and CFO at Fortive]

Well, I think a couple of things. One, we've been working at pricing all year long, and I think what you're remembering is we offset the tariffs, but on a one-for-one basis, and so that created an operating margin drag, you know, because equal amounts of price and cost will do that. In this case, what we've been doing is staying ahead of that and getting, you know, as Jim mentioned in our hardware business, this is up to 300 basis points of price. We still are getting PPV and taking it out of the business. But we are seeing that getting chipped away at, but we've been able to stay ahead, and that's why we're delivering margin expansion.

[Andrew Obin, Managing Director and Equity Research Analyst at Bank of America Securities]

Thanks. Just a follow-up question. You know, looking back, you turn out to be prudently conservative on your view on elective procedures relative to everybody else and frankly us. Where do you see elective procedures sort of going over the next three to six months? What's the pace of improvement as you see it globally? Thank you.

[Jim Lico, President and CEO at Fortive]

Yeah. Thanks, Andrew. You know what we saw, I think we ended Q3 at about 88%. Obviously, the Delta variant had impact in the quarter as the quarter progressed. We're assuming for the fourth quarter about the same, no real uptick. I suspect when we get a number, you know, the federal vaccine mandate in the United States continue to get hopefully we start to get kids vaccinated here. Hopefully, we'll start to see in the first quarter start to see some of those procedures coming back, and we'll get to the first quarter once we finish the fourth. Specifically for the fourth quarter, our assumption is things stay about the same as they are today.

[Jim Lico, President and CEO at Fortive]

You know, we're in a really good place at ASP. As we mentioned, we had, you know, not just to follow on to your question, a very good quarter at ASP. Equipment came in better than we anticipated to offset some of the headwinds from what we had on consumables. You know, on a continuous basis in 2022, we'll be in a really good position to take advantage of that.

[Andrew Obin, Managing Director and Equity Research Analyst at Bank of America Securities]

I'll leave it there. Thanks so much.

[Jim Lico, President and CEO at Fortive]

Thanks, Andrew.

[Andrew Obin, Managing Director and Equity Research Analyst at Bank of America Securities]

Thank you.

[Operator]

We have your next question from Julian Mitchell with Barclays. Your line's open.

[Julian Mitchell, Equity Research Analyst at Barclays]

Hi, good afternoon.

[Jim Lico, President and CEO at Fortive]

Hi, Julian.

[Julian Mitchell, Equity Research Analyst at Barclays]

Hey. Maybe just the first question around the core growth guidance for Q4. So I think it's sort of +5% at the midpoint. You've probably got around three points of price in there. So it's sort of two points of volume growth. Is that reflecting just a big slowdown in the sort of short cycle hardware bit negative in Q4? Maybe just any context around the sort of volume growth assumption for Q4, please.

[Jim Lico, President and CEO at Fortive]

Sure. There's a couple of things. I think, when the way you're looking at it, 200 basis points is the price increase. 300 is specific to the hardware businesses, but 200 overall. You've got that about right. When you look at it on a two-year stack, we actually think we're still, you know, expanding, growing, increasing our growth rates in Q4 versus even Q3. I think that's important. Also, I think as we noted, able to get out the door right now isn't really reflective of the underlying demand of the businesses. Julian, I'll just say a couple things. One, as Chuck said. The underlying demand on the orders for the second half is double digits, so, very good order.

[Jim Lico, President and CEO at Fortive]

You know, from a demand perspective, we're seeing good demand. Relative to your China question in the quarter, we had good growth at Fluke and in the fourth quarter, simply because while tech had a little bit lower growth in the quarter, they had over 20% order growth. We will see China get back to mid-single digit-like growth in the fourth quarter. We've seen good point of sale in China. We're watching it carefully, certainly because of a lot of the headlines. We had a good quarter. Chuck and I were on with the team last week, doing an operating review. They're optimistic about what's happening on the ground there. The fourth quarter should improve sequentially from the third to the fourth.

[Julian Mitchell, Equity Research Analyst at Barclays]

That's very helpful. Margins. You had very strong incrementals in Q3 year-on-year company. You're assuming, you know, something in the maybe mid-30s% for operating leverage, so very good but a little bit lower. Is that just the sort of run rate going forwards for where we are with current sort of volume growth outlook and price cost and ServiceChannel coming in? Is there anything sort of specific moving around in Q4?

[Jim Lico, President and CEO at Fortive]

Wait. Our underlying assumption is 40% incrementals, and I think when we print Q4, that's what we're seeing. Maybe when we get to the. Not seeing any slowing there.

[Julian Mitchell, Equity Research Analyst at Barclays]

Perfect. Thank you.

[Jim Lico, President and CEO at Fortive]

Thanks, Julian.

[Operator]

We have your next question from Nigel Coe with Wolfe Research. Your line's open.

[Nigel Coe, Managing Director at Wolfe Research]

Good afternoon, guys. Just going back to the restructuring, I think you said $12 million, Chuck, about half of that in IOS, I think. The decision to do that, was that just because you know you coming in you know had a plan, and so you just decided that you know good idea to maybe do some reinvestment here? How should we think about this? Is this something that we can consider to be sort of a you know quote-unquote “one-timer” or would the intention be to do you know quite restructuring of this sort of magnitude you know in 2022 2023 as well?

[Jim Lico, President and CEO at Fortive]

First of all, I think we always had an intention knowing that we'd bring on these Day 2 countries, and we'll need to continue to make some adjustments as we go forward to them on at the ASP realm. I'd also say that as we come out of COVID, we're gonna continue to evaluate our footprints here and see what we need going forward. That's probably going to be an evolving thing. You could theorize that we could see that going forward, but it's not like we have a plan, we're gonna do a certain amount each quarter. It's as we see what the situation is and we need to make a change, then we'll tell you about it.

[Jim Lico, President and CEO at Fortive]

Julian, or sorry, Nigel, the other part of it is we did some in the third within the business in Sensing to do some factory relocation as well. You know, really in the second half, these are really ideas around the second half. You know, quite frankly, I think puts us in a good position as we come together with our return to work plans. It really says that in certain, some of the Sensing businesses we have, we can take our footprint down. We're obviously gonna take advantage of those opportunities as they come at us.

[Nigel Coe, Managing Director at Wolfe Research]

Great. On Accruent, low single-digit growth, you know, versus mid-20s bookings. Obviously a big disconnect there. Maybe just update us on how you see the revenue momentum at Accruent. I think, you know, there's a SaaS transition going on there. Maybe just touch on as well the net retention of 102, that's the year-to-date metric. Is that changing at all, you know, through the quarters? What’s your target around net retention?

[Jim Lico, President and CEO at Fortive]

Yeah. Relative to Accruent, you're right, we had a little bit slower revenue growth there, but we did have good bookings, really strong bookings in several of what we would call the growth businesses. We called those out in the prepared remarks. Really, you know, strong bookings relative to the performance in those businesses. I think we're set up well for mid-single digit in 2022. You're right. We had a one-time hit on revenue that occurred in the quarter. A couple of little churn events or mini churn events that we didn't anticipate. Certainly slowed it down a little bit in the quarter.

[Jim Lico, President and CEO at Fortive]

We think we're in a good position for next year because of the order strength, particularly around new logos. Relative to the 102, you know, we're always gonna have some businesses up and down relative to where that number's at. You know, ServiceChannel and eMaint would be our best performers on that metric as an example. Intelex would be pretty high. You know, I would suspect we'll get to sort of with respect to 100 basis points of improvement, 100-200 basis points of improvement, somewhere in that range each year, at least for the next few years as we continue to, you know, while these businesses are still-

[Operator]

We have your next question from Josh Pokrzywinski with Morgan Stanley. Your line's open.

[Josh Pokrzywinski, Director and Research Analyst at Morgan Stanley]

Good evening, guys.

[Jim Lico, President and CEO at Fortive]

Hi, Josh.

[Josh Pokrzywinski, Director and Research Analyst at Morgan Stanley]

Just a follow-up question, not to nitpick on some of the like the margin differences here with the restructuring and then ServiceChannel coming in, but I just wanna make sure I'm understanding this right. In Intelligent Operating, if we sort of add back in that half of the slug restructuring that goes there, it doesn't look like ex ServiceChannel, there's you know really much of a difference in margins in Q4. Is there something seasonal there or supply chain that's sort of interrupting that? Or am I just sort of putting this under a microscope unnecessarily?

[Jim Lico, President and CEO at Fortive]

I think that there's just we're talking about some of the highest margins we've gotten in the company. I'm happy to get through your, you know, planning sheet with you in detail and to help you understand that. We're seeing sequentially margin expansion, I think, in all of our businesses.

[Josh Pokrzywinski, Director and Research Analyst at Morgan Stanley]

Got it. Just in terms of, you know, kind of your specific Fortive flavor of supply chain, you know, maybe talk about like the one or two things that would be particularly helpful. I know, you know, some folks are really focused on chips, others have like freight and air freight or labor as issues. Like, you know, what would sort of, you know, be kind of your top one or two things, Jim, that, you know, that would be best to see?

[Jim Lico, President and CEO at Fortive]

Yeah. Well, I could take you through a lot of detail because I think I've been more involved in these kinds of things over the last 60 days than I typically would. Takes me back to some roots, I guess. Josh, I would say a couple of things. One, certainly in our businesses, but think of it as the circuit board at Tektronix, which is incredibly complicated, has multiple semiconductors on it, has multiple, you know, all kinds of chip technology on a board like that. You're gonna just have higher variability because of that. Fluke will be as true as well, and then sensing a little bit less. From a, you know, just how that goes, it would. That's how it would be.

[Jim Lico, President and CEO at Fortive]

We are seeing mostly electronic shortages, and as I said in the previous comment, mostly around availability. We're paying a little bit more to get things, so there's some premium freight involved in the inflation. You know, not a lot of labor. We have pretty low labor content in the company simply because of, you know, of our, you know, decades of productivity initiatives. We're seeing some labor inflation, but at the end of the day, it doesn't move the needle as much. It's really about the material availability first and foremost. Given our gross margins on those products, it makes sense to, you know, even if we spend, you know, a few pennies more to get something in faster.

[Jim Lico, President and CEO at Fortive]

Given the high demand we have right now, and, you know, just given the momentum in orders right now, it makes sense to sometimes pay those things because ultimately the margins, it just makes sense to do that. Obviously, our first and foremost, we're taking care of customers. Hopefully, that gives you a window every day. We're well set up to deal with this because we have daily management, what we call visual management. You've seen it in our factories during tours. You know, our businesses put that on steroids a little bit in order to amplify the challenges and just get. It's how well we countermeasure that really makes the difference.

[Josh Pokrzywinski, Director and Research Analyst at Morgan Stanley]

Appreciate it. Best of luck, guys.

[Jim Lico, President and CEO at Fortive]

Thanks.

[Operator]

We have your next question from Markus Mittermaier with UBS. Your line's open.

[Jim Lico, President and CEO at Fortive]

Hi, Markus.

[Markus Mittermaier, Equity Research Analyst at UBS]

Hi. Good afternoon. Hey. Hi. I wonder how agile pricing is in your backlog. I mean, 40% backlog increase year-over-year sounds great on the one hand, but it's a double-edged sword, obviously. Once things hit your backlog, sort of how flexible are you to adjust price further if you have to?

[Jim Lico, President and CEO at Fortive]

Well, number one, I think what we do is in the big businesses where we sell into distribution, limit the amount of buying that can occur at pricing. If we have a price increase stated, we obviously have contractual terms, Markus, and we will contractually make sure, you know, we work with our obligations to not necessarily something like that. Part of how we work with channel partners. We've been able in many OEM cases to reprice orders as well. I think it really speaks to having problems in their backlog with pricing. We have really good granularity around what that looks like, and that's what gives us confidence to know that we'll continue to get the price here going forward and to know that our price cost will continue to improve.

[Markus Mittermaier, Equity Research Analyst at UBS]

That's good to hear. Maybe one other follow-up on ASP. You talked both a bit on elective procedures where that's trending, but in your opening remarks, you also commented on installed base growth. If I look into 2022, you know, what's potentially the bigger driver here? Because it seems like the equipment placing trends are actually quite positive as well. If I get that and elective procedure recovery, what sort of growth should we be dialing in here?

[Jim Lico, President and CEO at Fortive]

Let's say, Markus, you know, I think that you're right. Our underlying business and placing units is continuing to accelerate. We're very proud about that. I think elective surgery is coming back. You know, it could be half of quite a bit of the growth if it all springs back in one year. I think we need to get closer to next year to really see what they actually do and what month. I do think that it's. Just to answer your question, if it all came back at once, that'd be the bigger driver of the year for ASP. And be a quite a tailwind coming forward. We're not calling that all coming back at once in 2022. It'll probably ramp, it's over some period of time.

[Jim Lico, President and CEO at Fortive]

I think maybe, you know, Mark, it's one thing we know to be true over the last certainly over the last two years, but certainly in the last six months, is that something has occurred every three months relative to electives that's caused it to go a little bit sideways. I think it's premature to call next year, but it's safe to say that when we get to a more normalized sort of event in our hospitals, we'll be in that business is certainly laying the groundwork, laying the foundation for good growth. I was with a major hospital network about a month ago in their facility. They're placing equipment, and they're looking forward to adding more elective procedures as they go forward.

[Jim Lico, President and CEO at Fortive]

Maybe just one other comment on electives. It's not only COVID, it's also particularly in the United States, it is also the nursing shortage. It probably doesn't snap back, but it certainly comes back over time, which

[Markus Mittermaier, Equity Research Analyst at UBS]

Thank you very much.

[Operator]

We have your next question from Andy Kaplowitz with Citigroup. Your line's open.

[Andy Kaplowitz, Managing Director at Citigroup]

Hey, good afternoon, guys.

[Jim Lico, President and CEO at Fortive]

Hey. Hey, Andy.

[Andy Kaplowitz, Managing Director at Citigroup]

Obviously, Fortive continues to have a really strong balance sheet. I think you said 1.3x leverage at year-end. Could you talk about the M&A environment out there? We've obviously seen a flurry of software-focused acquisitions after your ServiceChannel acquisition. I know valuations continue to be on the rich side, but do you see Fortive remaining active over the next few quarters on the acquisition front? Would you lean toward, you know, continued focus on recurring revenue and/or software-related assets such as ServiceChannel?

[Jim Lico, President and CEO at Fortive]

You know, Andy, you know, as we've said over the last few years, you know that, as we've talked to you, we remain very busy. I think we're working on some hardware things. We're working on some software things to advance our, you know, what we do within workflows with customers. I think we have a balanced approach to things. I think we see lots of opportunities to deploy capital in ways that really not only accelerates our strategy, but gets us good returns, is additive from a growth perspective. We're certainly gonna lean in on recurring revenue. We think that's a good way to, you know, we really think that's a strategy towards building a more durable, resilient Fortive over time.

[Jim Lico, President and CEO at Fortive]

I would say we're certainly leaning towards those kinds of opportunities. As we know, even our hardware deals, whether they were Industrial Scientific or recurring revenue in those deals, even when they were hardware. We're gonna continue to look for those opportunities, not exclusively, but probably the majority of the things we're doing is really gonna have a passion for growth, but also with that idea that we can continue to build a more durable, resilient growth rate.

[Andy Kaplowitz, Managing Director at Citigroup]

Thanks for that. Maybe if I could follow up with asking you about Tek in sort of a different way. You know, you've always had good momentum there, and you talked about new product introductions this quarter. I know you've mentioned, you know, Tek's continuing strategy of focusing on, you know, data centers, EVs. Is that where the momentum continues to come from? Is Tek's growth just maybe on a higher plane versus past cycles, given this sort of change in focus?

[Jim Lico, President and CEO at Fortive]

Well, I think number one is it's more resilient because, you know, we had low single-digit growth in our service business. You know, just our resilient, durable base and foundation of revenue that we've built over time. Number one, I think we've got a more resilient, durable growth rate just because of that service business that we've built into the revenue stream. We've got some software offerings there that we've started with. We mentioned that in the prepared remarks. We're building a more durable revenue stream, while at the same time, as you mentioned, we've taken advantage of a number of real opportunities relative to, you know, what I would call higher growth situations.

[Jim Lico, President and CEO at Fortive]

Quite frankly, when we think about going forward, obviously the semiconductor cycle is gonna extend as people continue to invest in the kinds of things that we've talked about. But also these supply chain issues and constraints fundamentally require a lot of folks who have electronics in their products to redesign those products for different chips or different components. Quite frankly, one of the things they need to do that is an oscilloscope. We think there's also, you know, not only the sort of long-term secular trends that the business has been going after, but also some shorter term opportunities as people start to continue to have to deal with some of these supply chain challenges. Fundamentally, that can often end up in a redesign.

[Jim Lico, President and CEO at Fortive]

Certainly, we have the products and solutions to help people do that. It has a component of volatility to it, but I think the team has done a nice job of continuing to drive technology and innovation toward higher growth, more durable revenue streams.

[Andy Kaplowitz, Managing Director at Citigroup]

Appreciate it, Jim.

[Jim Lico, President and CEO at Fortive]

Thanks, Andy.

[Operator]

We have your next question from John Walsh with Credit Suisse. Your line's open.

[Jim Lico, President and CEO at Fortive]

Hi, John.

[John Walsh, Equity Research Analyst at Credit Suisse]

Hi, hi everybody. How are you?

[Jim Lico, President and CEO at Fortive]

Good.

[John Walsh, Equity Research Analyst at Credit Suisse]

Maybe just a first question going back to the gross profit margin improvement in the quarter. Obviously very nice in the face of inflation. You called out the price cost benefits in kind of the hardware businesses, but wondering if you're also getting a lift from kind of this portfolio mix that's showing up. Just curious how you'd parse out that growth.

[Jim Lico, President and CEO at Fortive]

No, I think that's a good question. Especially when you take a look at our software businesses. You heard Jim mention a little bit ago there where we also see price and great margin expansion. I mean, you got those businesses with their great gross margins growing faster than fleet average, you know, that's gonna give you a lift as well. It's certainly our software businesses, but also the staying ahead on the price-cost is very important in offsetting what's a challenging environment.

[John Walsh, Equity Research Analyst at Credit Suisse]

Great. Then, you know, you obviously highlighted both the internal and external promotions here. Was wondering if you could just give us a look, kind of the next layer down and kind of your ability to keep the talent from the acquisitions that you've made. Any color there, please?

[Jim Lico, President and CEO at Fortive]

Yeah, sure. Well, we're incredibly excited to have Olumide join us. We obviously announced that earlier in the quarter, and he's off and running iOS and really, we're excited to have him join the team. He brings a real view on software. It's really all his experiences in software. He created an enormous digital data analytics capability at CoreLogic. So he really brings data, you know, a data-centric approach to these businesses, which I think is a wonderful part of his leadership style. Obviously, Tami's promotion is a great view on our internal development capability and a window on how we develop internal talent. So we're in a very good place with her promotion. Relative to the next layer down, we announced two internal promotions, both of whom came with acquisitions.

[Jim Lico, President and CEO at Fortive]

Justin and Bill both came to us with acquisitions, Justin with ISC, Bill with Gordian. The promotions that we announced in the prepared remarks is a good example of how we continue to retain folks from acquisitions and how they're additive to our leadership capability. You know, we have a very rigorous internal development process. We announced several internal president appointments here recently as well to backfill for people like Bill and Justin. We're in a very good place relative to adding talent. On the healthcare side, we brought in some new talent from a healthcare standpoint at ASP to really give us the, you know, even be additive to our healthcare experience.

[Jim Lico, President and CEO at Fortive]

I think we've not only been able to retain people through a very rigorous development process, but we've become a destination for talent, and we've certainly been able to recruit some top-notch talent. We mentioned Reid Simmons as our Head of Strategy in the second quarter. We've continued to take opportunities to bring in folks who bring new approaches, and we've been very successful in being able to do that.

[John Walsh, Equity Research Analyst at Credit Suisse]

Great. I'll leave it there. Thank you.

[Jim Lico, President and CEO at Fortive]

Thanks, John.

[Operator]

We have your next question from Joe Giordano with Cowen. Your line's open.

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

Hey, guys. Thanks for taking my questions.

[Jim Lico, President and CEO at Fortive]

Hey, Joe.

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

One of your competitors to Tektronix was talking about having success in integrating, like, protocol analyzer capability into their scopes, for, like, connected devices. Is that something that you're doing or is it something you think is worthwhile? Just curious if that's an offering yet.

[Jim Lico, President and CEO at Fortive]

Well, I think at the end of the day that we have some protocol capability, but I think it depends on the use of the scope and the range of the scope where that's appropriate. I would say our direction has been more, rather than adding additional measurement capability to some of the scopes, we've been really adding more solutions focused to really different probes, different software around the application to really help folks. That's where we've been really successful in automotive and in data centers of really bringing forward, call it the post-scope work that really helps, you know, really helps the engineer in the application, specific application that they're moving forward with.

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

Okay. Jim, well, when you guys gave guidance last time, you knew electives, you were, you know, appropriately cautious on elective surgery, supply chain was bad then. I'm just curious, like, what are the one or two single biggest, like, top line variances that will end up being realized versus what you thought last time?

[Jim Lico, President and CEO at Fortive]

In the third quarter?

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

Yeah. Like, versus when.

[Jim Lico, President and CEO at Fortive]

Yeah.

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

you, when you gave.

[Jim Lico, President and CEO at Fortive]

Yeah. I mean, I think electives certainly were part of it. We thought electives were gonna be. You know, we were conservative on electives, but you know, they were lower than we anticipated. You could probably think about, you know, maybe $10 million of revenue that was, you know, there, just there. Then certainly we could have easily hit in the upper end of our guide relative to revenue, which is roughly 300 basis points if we hadn't had some of the supply chain constraints that ended up. You know, we always said that September's a big month and, you know, we had several things that hit us in September that we didn't anticipate.

[Jim Lico, President and CEO at Fortive]

You know, we still managed as we noted to have tremendous margins and tremendous free cash flow despite those challenges, and I think that really speaks to the power of FBS in terms of facing challenges, being able to countermeasure through those things. You know, this isn't a story of the absence of challenges, but rather the ability to deal with them. That's what we'll continue to do in the fourth quarter. You didn't ask it, but I would anticipate that we'll be dealing with a number of the supply chain issues well into 2022.

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

Can I just clarify one thing? The stuff that you couldn't get out from supply chain, is that because you couldn't? Well, I guess, can you break it down between stuff that you were able to manufacture and the customer wasn't ready to take delivery, and it's now sitting in inventory, or it's stuff that you just couldn't get the components on your side to kind of manufacture?

[Jim Lico, President and CEO at Fortive]

No, this is all not us not getting components. We have, you know, demand picked up tremendously through the quarter. As we said, we had very strong orders.

[Jim Lico, President and CEO at Fortive]

We'll have strong orders through the rest of the year. Our demand profile is very good. Customers are taking things as soon as we can get them to them in most cases. This is not an inventory situation or anything like that. This is, you know, purely a component shortage challenge that we're dealing with as, you know, I think it's been well documented by a lot of other companies.

[Joe Giordano, Managing Director and Senior Equity Analyst at Cowen]

Sure. Thanks, guys.

[Jim Lico, President and CEO at Fortive]

Thank you.

[Operator]

We have your next question from Andrew Buscaglia with Berenberg. Your line's open.

[Andrew Buscaglia, Director and Equity Research at Berenberg]

Hi, guys. I just wanted to ask-

[Jim Lico, President and CEO at Fortive]

Hey, Greg.

[Andrew Buscaglia, Director of Equity Research at Berenberg]

on Advanced Healthcare as well. I mean, it doesn't seem like, you know, this will exactly be a snapback situation. You're facing some tough comps into the first half of the year. I guess the question is where, you know, I get the FHS, but where will we see some margin leverage? Like, I guess, what needs to happen to, you know, to really see those margins pick up in kind of more muted, you know, first half maybe?

[Jim Lico, President and CEO at Fortive]

Well, I think you know, first in Q3, we saw some outstanding margin expansion in the AHS, Advanced Healthcare Solutions segment, you know, going from, I think, around 20% in Q2 to 23% of our adjusted operating profits. We're seeing good margin expansion, and that's not just at ASP. You know, Censis had a really good quarter, so did Fluke Health Solutions. So we've got our hardware placements there. You're seeing that already. What we're saying is it could have been better with elective surgeries, and that's gonna be a future advantage. Let's be clear, we had good step-up between Q2 and Q3 in health.

[Jim Lico, President and CEO at Fortive]

From Q3 to Q4, there is, we expect to do another 100-200 basis, even with elective surgeries just staying where they're at right now.

[Andrew Buscaglia, Director and Equity Research at Berenberg]

Okay. Fair enough. You know, Chuck, maybe you can comment. I know M&A is definitely on the top of your minds with given where leverage is. You know, stock is kind of getting cheaper here, and kind of hasn't done a whole lot the last year. You know, what are your thoughts on a buyback or, you know, maybe choosing that as a different avenue for the cash?

[Chuck McLaughlin, SVP and CFO at Fortive]

We remain very optimistic about the opportunity to deploy capital. We've said that we laid out that we had probably $5 billion in the first three years, post-separation with Vontier. We've done $1.2. It's not like we're running way behind there. We think we've got an ample opportunity for that, and we're not changing our priority being M&A.

[Andrew Buscaglia, Director and Equity Research at Berenberg]

Yeah. Okay. Thanks, Chuck.

[Jim Lico, President and CEO at Fortive]

Yeah.

[Operator]

We have your next question from Steve Tusa with J.P. Morgan. Your line's open.

[Steve Tusa, Managing Director at JPMorgan]

Hey, guys. How's it going?

[Jim Lico, President and CEO at Fortive]

Hey, Steve. How are you?

[Steve Tusa, Managing Director at JPMorgan]

Doing all right. Just a question on the AHS margins. I think if we kind of backed into a number last quarter, they were a little bit higher exiting Q4. I don't know if you know you did a better job on margins this quarter. Is there anything going on there? Is there a like is that elective procedures? You know, can we still kind of think about a potentially kind of high 20s margin as we look out into kind of next year?

[Jim Lico, President and CEO at Fortive]

First of all, I think that margins, we expect margins to expand for a number of years in health, as we discussed. Yes, they're lower in Q4, and it's all about elective procedures being, you know, around 90% rather than the high 90s. That's, you know, somewhere around $12 million-$14 million of 75%-80% margin business. When you do that clipped off about 200 basis points of margin expansion. We're still expanding margins from Q3 to Q4, and we know that elective procedures are gonna come back. That, you know, today's headwind there is tomorrow's tailwind. The destination or going into those high 20s, that's still what we think is very possible. Nothing's changed about that.

[Steve Tusa, Managing Director at JPMorgan]

Got it. Just heading into next year, you know, you're exiting at kind of a mid to, I guess, mid to highs on organic. I mean, anything about the comps next year that would make that exit rate kind of unreasonable from an, from an organic perspective? You know, should next year be more in line with your longer-term guidance to mid-singles, or can you maybe do a little bit better than that given the headwinds you're kind of facing here, in three and in 4Q with the supply constraints?

[Jim Lico, President and CEO at Fortive]

Well, it's safe to say that, you know, we're gonna end the year in a backlog position we never had before, Steve. That would certainly suggest some great opportunity for us next year. I'll hold my enthusiasm till we get to the full year guide. You know, things are setting up pretty well. Orders are very strong. They're gonna continue to be good in the fourth. There's a lot of variables out there. Obviously, they're still to be considered as we play out the rest of the quarter to give consideration to. You know, as Chuck just said, relative to how AHS is setting up, we certainly talk about the software businesses, even where we have a little bit less growth at constant currency, we had good orders.

[Jim Lico, President and CEO at Fortive]

We think we can continue to build on our net retention. I think we're certainly setting up for some good things, but let's get through this quarter. I'm pretty focused on the things we got to do right now to deliver October. We'll get there pretty soon. Obviously, I think if it plays out the way we think, we'll be in our best backlog position that we've ever been in.

[Steve Tusa, Managing Director at JPMorgan]

Great. All right. Thanks for the color, guys. Appreciate it.

[Chuck McLaughlin, SVP and CFO at Fortive]

Thanks, Steve. Thank you.

[Operator]

I'm showing no further questions at this time. I will turn the call back over to Mr. Whitney for any closing remarks.

[Jim Lico, President and CEO at Fortive]

Well, I think I'll take it from Griffin, but thank you, Alexander, and thanks everyone for your time tonight. We appreciate it as always. We benefited from the hard work and determination of our 17,000 employees all around the world. We appreciate all your support, and we look forward to continuing to follow up with any questions you might have around the quarter as we get into the finish of the year. Thanks. Have a great day, and have a great earnings season. Bye-bye.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.

Participants

Executives

• Griffin Whitney, VP of Investor Relations
• Jim Lico, President and CEO
• Chuck McLaughlin, SVP and CFO

Analysts

• Scott Davis, Chairman and CEO at Melius Research
• Deane Dray, Managing Director and Senior Equity Analyst at RBC Capital Markets
• Jeff Sprague, Founder and Managing Partner at Vertical Research Partners
• Andrew Obin, Managing Director and Equity Research Analyst at Bank of America Securities
• Julian Mitchell, Equity Research Analyst at Barclays
• Nigel Coe, Managing Director at Wolfe Research
• Josh Pokrzywinski, Director and Research Analyst at Morgan Stanley
• Markus Mittermaier, Equity Research Analyst at UBS
• Andy Kaplowitz, Managing Director at Citigroup
• John Walsh, Equity Research Analyst at Credit Suisse
• Joe Giordano, Managing Director and Senior Equity Analyst at Cowen
• Andrew Buscaglia, Director and Equity Research at Berenberg
• Andrew Buscaglia, Director of Equity Research at Berenberg
• Steve Tusa, Managing Director at JPMorgan