Fortive Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2022

Key Takeaways

  • The company delivered another quarter of outperformance with 12% core revenue growth, 80 bps gross margin and 160 bps operating margin expansion, 20% adjusted EPS growth and 22% free cash flow growth, all above guidance.
  • Intelligent Operating Solutions grew 14% core revenue with double-digit growth across workflows and regions, while Precision Technologies achieved 19% core growth driven by record Tektronix orders and robust price realization.
  • Advanced Healthcare Solutions saw a 1% core revenue decline and 400 bps margin contraction due to supply chain constraints and FX headwinds, but shortages began easing and margin recovery is expected in Q4.
  • Fortive Business System (FBS) and annual Kaizen events delivered significant improvements—20%–40% productivity gains on key product lines, 80% faster lead times and double-digit cost savings.
  • The Q4 outlook targets ~11% core revenue growth, >100 bps operating margin expansion and adjusted EPS of $0.82–$0.85, while robust backlog, recurring revenue streams and a strong balance sheet underpin 2023 scenario planning.
AI Generated. May Contain Errors.
Earnings Conference Call
Fortive Q3 2022
00:00 / 00:00

There are 14 speakers on the call.

Operator

My name is Dennis, and I will be your conference facilitator today. At this time, I'd like to welcome everyone to the Fortive Corporation's Third Quarter 2022 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. I would now like to turn the call over to Ms.

Operator

Elena Rosman, Vice President of Investor Relations. Ms. Rosman, you may begin your conference.

Speaker 1

Thank you, Dennis, and thank you everyone for joining us on today's call. With us today are Jim Leko, our President Chief Executive Officer and Chuck McLaughlin, our Senior Vice President and Chief Financial Officer, who present certain non GAAP financial measures on today's call. Information required by Regulation G is available on the Investors section of our website at www.fordive.com. Our statements on period to period increases or decreases refer to year over year comparisons on a continuing operations basis. During the call, we will make forward looking statements, including statements regarding events or developments that we expect or anticipate will or may occur in the future.

Speaker 1

These forward looking statements are subject to a number of risks and actual results might differ materially from any forward looking statements that we make today. Information regarding these risk factors is available in our SEC filings, including our annual report on Form 10 ks for the year ended December 31, 2021. 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 Weico.

Speaker 2

Thanks, Elena. I'll begin on slide 3. We had another quarter of outperformance with 12% core revenue growth, 80 basis points and 160 basis points adjusted gross and operating margin expansion respectively, 20% adjusted earnings per share growth and 22% free cash flow growth, all above the guidance we set coming into the quarter. Our ability to outperform reflects the quality of our portfolio, Our team's rigorous execution and the power of the Fortive business system, delivering higher and more profitable growth and free cash flow generation. The 3rd quarter also demonstrated continued success launching a number of new products and solutions that solve our customers' toughest Safety, quality and productivity challenges.

Speaker 2

We have strong conviction in the secular drivers favoring enduring growth in these markets. As a result, we are confident the work we do to create long term sustainable competitive advantages for our operating companies and strategic segments will yield best in class returns for Fortive for a long time to come. Turning to Slide 4. We are delivering 2022 at the high end of our initial outlook we set back in February, reflecting continued strong momentum as we've moved through the year. Short cycle demand has held up well with hardware product backlog more than double what it was at the beginning of 2021, while our software businesses have continued their double digit pace of growth.

Speaker 2

This speaks to the strength of our portfolio and our ability to countermeasure challenges. Our supply chain measures across the portfolio continue to gain traction, especially at Fluke and Tektronix, although we expect some component constraints to persist into 2023. Our latest outlook now reflects a year over year foreign exchange headwind of approximately $175,000,000 on revenue and $0.11 on EPS for the year. Despite these headwinds, we are driving higher growth and operating margins by leveraging FPS tools to accelerate profitable growth and position the company for continued outperformance in 2023. Moving to the right hand side of the slide, we are preparing scenarios for a range of potential macroeconomic outcomes in 2023, including moderating hardware product orders growth.

Speaker 2

Lastly, our strong balance sheet supported by robust free cash flow growth presents several levers for earnings growth and continued value creation compounding. Turning to Slide 5. We just finished our annual strategic plans for each of our operating companies. And I'm even more excited about the depth of our strategy to take advantage The secular tailwinds accelerating progress across our 5 critical customer workflows. Our solutions for managing facilities and assets, Environmental Health and Safety and Measurement and Connected Reliability keep much of the world running safely, productively and sustainably.

Speaker 2

We are enabling product realization with precision measurement and sensing solutions underpinning many of the most exciting product innovations in the world, From your phone and car to the electric grid and to safer food and pharmaceutical production, our healthcare solutions for the perioperative loop keep clinicians and patients safe, serving over 5,000 customers, including all the top U. S. Hospitals as well as hospitals around the world. Each workflow is well positioned to benefit from durable business models that underpin our vision and strategy to build a stronger collection of businesses with industry leading profitability and free cash flow margins. They also aligned to our sustainability mission by helping our customers Accelerate safety, good health and well-being, advance industry and customer productivity, utilizing new and more efficient clean energy resources and drive reductions in our customers' greenhouse gas emissions.

Speaker 2

Today, over 60% of Fortive's products and services Enable more sustainable outcomes that are aligned to the United Nations' sustainable development goals. As we continue to accelerate innovation for our customers at scale, Demand is proving more resilient even in the face of slowing economic growth given the recognition of how our workflow solutions drive productivity benefits for our customers. I will now provide more details in each of our three segments beginning with Intelligent Operating Solutions. IOS continued its strong momentum with revenues up 14% as unfavorable FX was offset by the ServiceChannel acquisition, which became core in mid August. Our region growth was broad based with low double digit growth in North America, mid teens growth in Western Europe and low 20s growth in China.

Speaker 2

Double digit core growth in every workflow drove 345 basis points of core operating margin expansion more than offsetting inflation and incremental FX headwinds. Some other highlights of the quarter include: At Fluke, demand remains solid with double digit point of sale growth in each major region. Using FBS, voice of the customer and product development tools, Fluke launched a breakthrough platform serving the renewables market that reduces the time to test solar installations by as much as half. This kit combines multiple Fluke hardware tools for the software platform and has been awarded industry recognition for its safety and time saving features. EHS had low double digit revenue growth as it continued to see the benefits of share gains and efforts to diversify its customer base.

Speaker 2

Industrial Scientific saw greater than 20% increase in bookings, strong Inet and Instrument bookings in both Europe and the Middle East and Intellect had another quarter of mid teens SaaS revenue growth. Moving to facilities and asset lifecycle. Portion revenues were up double digits once again With the business continuing to drive accelerated penetration of projects flowing through Gordian's job order contracting platform with an expanded set of customers. Accruent saw strong software demand with its SaaS offering growing low double digit. Accruent also continued to utilize FBS tools to improve its annual recurring revenue profile for the recent Kaizen's focused on driving price and improved customer retention.

Speaker 2

Finally, Service Channel had another exceptional quarter with strong double digit revenue growth and high teens growth in SaaS. As some customers face mounting cost pressures, They are increasingly turning to ServiceChannel to help them outsource their facility maintenance work, reducing their 3rd party contractor costs. As a result, we are reinvesting a portion of their upside into transitioning customers to our more profitable SaaS managed service offering to continue to drive profitable growth. Turning now to Slide 7 of Precision Technologies, which delivered core growth ahead of expectations in every business. Core revenues were up 19% with double digit growth in all our major regions, driven by continued investment in the industrial, power and energy, Semiconductor and Medical end markets.

Speaker 2

PT also saw 280 basis points of adjusted operating margin expansion with higher shipments and strong price realization more than offsetting inflation and FX headwinds. Some highlights in the quarter include 7 consecutive quarters of double digit orders growth in Tektronix, fueled by a number of new entry and mainstream scope product launches. As a result, trailing 12 month orders are now greater than $1,000,000,000 Our teams are diligently applying FBS to countermeasure supply chain constraints to deliver on this Record level of demand. SensingTech benefited from another quarter of volume growth and strong price realization. While supply chain constraints continue to limit output, Sensing book to bill was greater than 1 with strong demand in Qualitrol's Utility and Power Business.

Speaker 2

Similarly, Pacific Scientific EMC So improved material availability and capacity expansion across key production lines driving double digit revenue growth in the quarter. Moving now to Slide 8, Advanced Healthcare Solutions. Total revenue increased 3% in the 3rd quarter with a core revenue decline of 1% as continued supply chain constraints limited growth at ASP and Fluke Health Solutions, resulting in lower than expected core growth in the quarter. Mid single digit growth in Western Europe was more than offset by low single digit decline in North America and a mid single digit decline in China. We saw sequential improvement in core growth at ASP as their supply chain shortages constraining capital equipment growth started to ease in late September.

Speaker 2

Elective procedures improved to the low 90% range, excluding China, while rolling lockdowns kept elective procedure rates around 70% of pre COVID levels there. AHS core segment margins were down almost 400 basis points stemming from lower volumes and FX headwinds in the quarter as well as the recognition of a bad debt reserve in ImpeTech. As you can see, the team is diligently deploying pricing and cost controls to offset these headwinds, which we expect will deliver margin recovery in the Q4. Some other highlights of the quarter include an acceleration in new hospital bookings at Sensus and double digit growth in their SensiTrax SaaS subscription revenues. Probation SaaS offering has also seen good demand from customers looking to further standardize on probation across their health system.

Speaker 2

Lastly, we completed the sale of Fluke Health's therapy physics product line, which will be adjusted from core growth going forward with annual sales just under $20,000,000 Turning to Slide 9. Fortive Business System continues to be a differentiator for us, enabling our business to drive innovation and profitable growth. I'm excited to share that we just completed our annual CEO Kaizen event, accelerating our culture of performance. We brought together our most senior Fortive leaders, including our segment leaders and many of our operating company presidents with a total of 28 teams And over 400 team members driving significant improvements in growth, margin, free cash flow and breakthrough innovations. Affordiv's how we do Kaizen is what sets us apart.

Speaker 2

It's the deep engagement of our leadership and teams as well as The achievement of our high expectations. Some highlights include the teams at Fluke identified gross margin opportunities, resulting in margin expansion through freight cost reductions, value engineering opportunities. And IFC Lean Conversion Kaizen Realized a 20% to 40% improvement in productivity across 4 product lines and they improved the lead time for INET quotes by 80% and time to market for newly developed software by 75%. Our teams reduced the average test time by more than 25% on a highly constrained production process in Tektronix. Incentives implemented Kaizen's yielding a 2x improvement in productivity and reduce time to onboard new software customers.

Speaker 2

These results are a continued example of how FBS is driving results at Fortive. With that, I'll pass it over to Chuck, who will provide more color on our Q3 financials and our updated 2022

Speaker 3

outlook. Thanks, Jim, and hello, everyone. I'll begin on Slide 10 with a quick recap of our 3rd quarter performance. We generated year over year core revenue growth of 12%. Acquisition benefits were as expected, Contributing approximately 4 points of growth offset by higher than expected FX headwinds in the quarter.

Speaker 3

As a reminder, The Service Channel acquisition became part of our core growth in mid August. Turning to the right side of the slide. We saw double digit Core revenue growth in each of the major regions. North America revenue was up low double digit with mid teens growth in software. Western Europe revenue grew mid teens with favorable contributions from each segment.

Speaker 3

Asia revenue increased In the low 20% range with mid-twenty percent growth in China driven by robust growth in Precision Technologies, partially offset by a decline in Healthcare. Lastly, we saw high teens revenue growth across our high growth markets. On Slide 11, we show operating performance highlights in the 3rd quarter. Adjusted gross margins increased 80 basis points to 58.1% As volume and strong price realization continued to demonstrate the value proposition of our products and solutions, Adjusted operating margins expanded 160 basis points to 24.4%, up 440 basis points on a 2 year stack basis. Adjusted earnings per share increased 20 percent to $0.79 reflecting strong fall through on higher volumes, partially offset by higher interest expense.

Speaker 3

Free cash flow was another standout at $307,000,000 reflecting approximately 108% of adjusted free cash flow conversion. Turning now to the guide on Slide 12 and the outlook for the remainder of the year. For the Q4, core revenue growth is expected to be approximately 11% at the midpoint and adjusted operating profit Margins are still anticipated to be up at least 100 basis points year over year. Adjusted earnings per share are expected to be in the range of $0.82 to $0.85 in Q4, representing year over year growth of 4% to 7% We're 10% to 13% normalized or a low tax rate in Q4 of last year. This reflects an incremental $0.03 headwind from currency movements not contemplated in our prior outlook.

Speaker 3

For the full year 2022, We are narrowing and raising our adjusted earnings per share outlook to $3.10 to $3.13 to better reflect operational performance in the 3rd quarter, partially offset by FX headwinds. The tax rate is expected to be approximately 14.5% for the year. Lastly, we anticipate that free cash flow will be seasonally strong in the Q4 and we continue to expect full year free cash flow of $1,170,000,000 And conversion to be approximately 105%. Turning to Slide 13, I wanted to update you on our strong credit and liquidity position. Early in the Q4, we amended our $2,000,000,000 revolving credit facility, extending the maturity out to 2027.

Speaker 3

The amended credit facility utilizes a sustainability feature whereby pricing varies depending on our achievement of our recently published commitment to reducing our absolute scope 1 and 2 greenhouse gas emissions by 50%. We also added a new $1,000,000,000 delayed draw term loan, giving us the financial flexibility to refinance the $1,000,000,000 term loan Coming due in December with a prepayable loan where we can delever with available free cash flow without penalty. We are now levered at roughly 2 times on a net debt to EBITDA basis with an average debt maturity of 5 years and a 3.2 percent weighted average interest rate. The proactive moves we've made to strengthen our balance sheet, Combined with our robust free cash flow generation also give us ample capacity to invest for growth and compound returns through disciplined and accretive capital With that, I'll pass it back to Jim for some preliminary color on 2023 and closing remarks.

Speaker 2

Thanks Chuck. Turning to Slide 14. We wanted to share some initial thoughts on 2023. Starting with the hardware products business, which include Fluke, Tektronix and Sensing Technologies. Backlog across these businesses are roughly double pre pandemic levels and the secular trends I mentioned earlier are driving market expansion and development of new innovations where we have a strong right to play.

Speaker 2

As a result, that gives us increased confidence and our ability to grow through a potential decline in new customer orders in 2023. Our software services and other recurring revenue businesses, including Facilities and Asset Lifecycle, Environmental Health and Safety, Probation and others are expected to benefit from enhanced market positions, driving double digit growth in our SaaS and license revenue streams. At the same time, our healthcare businesses, excluding software, are 70% recurring with consumables and services. On the capital side, we expect supply chains to normalize while the overall pace of recovery in hospitals will continue to be slow given the labor and productivity challenges likely to continue into 2023. While we haven't completed our planning process for next year, We are confident the work we have done to build a more resilient revenue and earnings profile will enable us to outperform the evolving macro environment.

Speaker 2

Lastly, on Slide 15, we are demonstrating the results of our successful portfolio transformation, yielding higher cash compounding power Having nearly doubled free cash flow over the last 3 years, our sustainable competitive advantages are evidenced in our ability to outgrow the attractive markets we serve and deliver workflow innovations that solve our customers' most critical safety, quality and productivity challenges. Our team's continued success launching a number of new products and solutions, generating compelling investment returns and adding to our ability to continue to compound results. Lastly, our ability to raise our earnings outlook for the year once again in the face of continued headwinds speaks to the power of the Fortive Business System and our culture of Kaizen, which is all about finding a better way. We have a strong culture of setting high expectations And through the rigor, discipline and the unrelenting efforts of our teams, we are delivering strong results. When taken together, this creates a powerful formula for value creation.

Speaker 2

With a high quality portfolio of desirable brands, favorably leveraged to sustainable secular trends, industry leading margins and free cash flow generation and best in class execution, enabling Fortive to outperform in almost any environment. With that, I'll turn it back to Elena.

Speaker 1

Thanks, Jim. That concludes our formal comments. Dennis, we're now ready to take

Speaker 4

And your first question

Operator

is from the line of Deane Dray with RBC Capital Markets. Please go ahead.

Speaker 2

Hey, thank you. Good day, everyone. Hi, Dean. How are you? Doing real well.

Speaker 2

Thank you. Can we start with the comment on 2023 regarding the positioning on the Hardware backlog of 2 times historical. Can you parse out how much of that is Reflecting incremental demand versus supply chain inefficiencies. We talked a few quarters back, you don't typically see a big backlog in Fluke, But are lead times normalizing? And so I just want to get a perspective on how that hardware backlog looks heading into 2023.

Speaker 2

Yes. Dean, I think as we said, we continue to we'll take backlog down a little bit in the Q4, which I think is the Q1 we've done that In quite a while, order demand remains very robust. So if I were to look at that backlog, I would say a good chunk of it will be Yes, Tektronix, which we think is mostly demand in a number of places and lead times are out. So We feel very good about the backlog. Fluke is lowering backlog from where they were.

Speaker 2

They are And their lead times have come down a little bit. So if I were to think about it and most of the sensing backlog I think is Really advanced orders for 'twenty three. So if you're going to think about it, probably parses out to Protection of longer lead times of protection kind of getting in line, if you will, which makes it, I think, pretty certain. Probably half of that is at least half of that is that number and the other half is good demand throughout every mostly at Teck, but in other places as well. So that's why I think our confidence in the backlog is much higher than maybe what others might think just because I think We really examined it pretty deeply and feel good about the opportunity to deliver that in 2023.

Speaker 2

Great. Appreciate that color. And a follow-up for Chuck. Can you break out the year over year margin Klein and Advanced Healthcare Solutions, just kind of how much is supply chain price cost or maybe is that bad debt included if you

Speaker 3

Are you talking about you're talking about the Q3 specifically? Yes. So when you look at year over year, the biggest the first thing is the bad debt at Imetec is pushing $5,000,000 reserve, we still hope that we haven't given up on collecting that and getting some back to that, but that's an accounting reserve, It's good management there. I think that there's year over year, there's we've got FX and And inflation, that's probably 100 basis points that's causing us And then really just lack of the growth as the supply chain, the rest of it says supply chain and Fluke Health and a little bit in our biological

Speaker 2

I'm sorry, what was that last one?

Speaker 3

Biological indicators at ASP, it's

Speaker 2

Literally a plastic vial. When you think about the BIs go through The sterilization process to calibrate the effectiveness of the sterilization cycle.

Speaker 5

Got it. Appreciate it. Thank you. Thanks, Dean.

Operator

Your next question is from the line of Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Speaker 5

Hi, good morning guys.

Speaker 6

Hi, Josh.

Speaker 2

Jim, maybe just to Kind of close

Speaker 7

out something that Dean was asking about in terms of the backlog. I mean, we're hearing supply chain getting better pretty quickly here across A whole different host of verticals and product lines. It doesn't really look like 4Q guidance in iOS has significant amount of Backlog reduction or there's some assumption about seasonality orders or something else going in there. But of that extra backlog, I mean, is that something that You should be able to work down over the next couple of months. And would you prefer to keep more backlog in this business versus just kind of get it all out

Speaker 2

Well, I think first it starts with customers and obviously we're doing everything to take care of Fluke specifically and more broadly, but Fluke specifically point of sale is very strong. As we said in the prepared remarks, It's double digit across all regions. So point of sale is good right now. So we obviously want to take advantage of those opportunities. I would say, Josh, I would characterize the supply chain as broadly getting better, but at the end of the day, it's down to a few 100 components around Fortive That still has very, very long lead times like in the 50, 60 week kind of time frame.

Speaker 2

So while broadly that number of components It's gone down dramatically. There's still a number of components that are keeping our lead times out there. Now we're more used to it. It's more in our cycle. So, but that's why we suggested in the prepared remarks that supply chain constraints probably continue into 'twenty three and I think that's pretty well documented around the electronics supply chain world.

Speaker 2

So we'll take down a little bit of backlog here, but we'll I think the robustness of what we do Relative to FBS as those continued improvements helping us and that's why you see strong growth in iOS in the 4th quarter. But obviously, as we said in Dean's question, we'll still go into the year with what I would call a nice sized backlog In which to mitigate any potential short cycle challenges that might be out there potentially.

Speaker 7

Okay. So there won't be a quarter where you like blow out

Speaker 2

Supply chain situation is just not that robust in that sense.

Speaker 7

Got it. And then just following up on tech, I mean, Performance in the quarter was pretty exceptional. I know you guys have talked about kind of this virtuous product redesign cycle that everyone's going through based on New chip availability. I'm kind of wondering how much is that determining kind of the go forward visibility in tech versus maybe Yes, some residual backlog that could be electronics facing and more susceptible as the economy slows.

Speaker 2

Yes. I think one thing we've said from since the inception of Fortive is that we were going to work diligently to improve the growth rate of Tektronix And to reduce its cyclicality. And so they've had exposure to cycles in the past. And I think we're pretty well We've talked a lot with you and others about the fact that we've made good progress in that regard. What we're really seeing and we said in the prepared remarks around The 7 consecutive quarters of growth is really the secular drivers playing out.

Speaker 2

The innovation cycle that It's been such a great success at Tektronix, really hits the market at the right time relative to the kinds of things, whether it's The power challenges in the EV market or in IoT, everything becoming digital, requiring a hardware backbone and Infrastructure, all of those dynamics are secular in nature and are going to continue to be part of the investment cycle, I think, in over the next several years. Now, Part of the business will still be exposed to some of the macro potentially, but I think the backlog and the work we've done around innovation Match to these secular drivers is ultimately going to make it growthier and more durable for sure. Great. Thanks.

Speaker 3

I'll leave it there. Thanks.

Operator

Your next question is from the line of Steve Tusa with JPMorgan. Please go ahead.

Speaker 5

Hi, Steve. Hey, how's it going?

Speaker 3

Good. Good.

Speaker 8

Just on the I guess the follow-up to Dean's question on the Q4 at AHS. I mean, it looks like you're still growing core, but margins Maybe that's 4x or something like that. Can we get a bridge kind of to the Q4 there for AHS margins?

Speaker 3

Yes. So, Steve, when you look at the biggest thing is a little bit of FX, but I'd say a little more in AHS in 4th quarter around inflation. There, we don't it takes longer to get pricing In the Health segment and so I think inflation is a little bit ahead of us there unlike maybe the rest of our portfolio where we've been able to be ahead and we're ahead in Total on that. That's probably the biggest thing, the reason that we're down in the Q4.

Speaker 8

I guess why wouldn't that have been hitting you already Over the I don't know, over the last like 18 months of inflationary pressures, why is that hitting you now in the 4th quarter?

Speaker 3

Well, I think the it has been hitting us, but FX has also accelerated and it's hitting us a little bit more as well.

Speaker 2

Steve, I think the other part of that is, which the volumes that we ship in Healthcare because the predominance of the revenue being in consumables and service, We have we were able to mitigate some of those supply chain and expenses for a longer period of time than we were in some of the other businesses. So, as Chuck said, we're seeing a little bit more inflation. Most of this is all predicted, most of the many of these things. And ultimately, we're continuing to improve margins here at Health. So we feel like with mid single digit growth in the Q4 and into next year, we're going We'll start to see some of these improvements playing out.

Speaker 8

What's the carryover level of price you guys have in the next year, If you just snap the line today

Speaker 2

for total company.

Speaker 3

So if we It didn't do anything different. Well, the first half has looked probably a lot like the second half of this year, so probably plus 4% to 5%. We might lap a few things there, but we would expect to continue to deploy price to offset It was inflation throughout the year. So, it might be a little less than this year, but that's just the theory. We have to wait and see what inflation is.

Speaker 3

We're committed to being ahead on our price cost.

Speaker 8

Got it. And one last one, any loosening up of the acquisition environment, Jim, anything looking a bit more attractive here?

Speaker 2

Yes, I think for sure. I think the I think we've been patient in a number of situations here over the last several months, but you're starting to see, I think, Probably more on the maybe not as much on the private equity side, but maybe but certainly elsewhere On the other parts of the private market, certainly some public things that we're starting to see. So yes, I think we feel We obviously are going to be disciplined. It's a noisy environment as we all know and will probably continue to be and that should continue to Given the fact that we do work on these things throughout the cycles, we feel confident we can we'll be able to deploy some things That can certainly accelerate what we're trying to do in 2023.

Speaker 5

Great. Thanks a lot. Thanks, Steve.

Operator

Your next question is from the line of Julian Mitchell with Barclays. Please go ahead.

Speaker 9

Hi, hello. Maybe just a first question around the hardware business. Just trying to understand Exactly what's going on in orders. So I think orders in hardware were up 9% in Q2 year on year. It sounds like they're up Maybe low mid single digit Q3.

Speaker 9

And then is the point that they're down in Q4 And that's helping to explain the backlog reduction that's taking place. And if there's any difference to call out between hardware orders trends at iOS versus PT at the moment?

Speaker 3

Julian, good afternoon. This is Chuck. I think you've got the bookings right in Q2 and Q3. And in Q4, the rate slows, but it doesn't go negative. But in a normal Q4, what happens is We would normally expect sales to exceed bookings and then take backlog down.

Speaker 3

And I think that's what we've got modeled in there. But that doesn't mean our orders Actually negative in Q4.

Speaker 2

I think the other thing, Julien, is as we started the year, we had always said and that really consistently That the second half orders would be slower than the first. We saw orders much better in the first half. So some of that as we talked about was a little bit of things that we saw We're coming in a little earlier because of lead times and things like that. So parsing quarter by quarter is a little bit dangerous just because of the Strong demand we had stronger demand in the first half. And I think that really speaks to the strength of what Chuck just described of how we're really Obviously, saw a very strong third and we're going to continue to see a strong fourth.

Speaker 2

So I think it just speaks to the orders that played out Almost better than we thought for the full year for sure. And I think it puts us in a as we talked about, puts us in a great position for 2023.

Speaker 9

Thanks very much. And then my follow-up just on the Healthcare segment. You talk on Slide 14 about a modest Pace of recovery there on the ex software piece in 2023. Just when we're trying to think about the overall Healthcare business from here, I think this year you're guiding for just under 2% core growth for the year with a very big or a decent step up again in Q4. When you're thinking about next year, Yes.

Speaker 9

What's the sort of framework for health care growth? I think it's tended to come in a bit below what people had hoped for various reasons in the last 2 or 3 years. Are we thinking core growth is similar to this year's just under 2% next year? Or is there a chance to do better than that?

Speaker 2

Yes. I think first of all, what we're trying to sort of frame for 2023 is, we think the hospital market is going to be better in 2023 and 2022. Think it's pretty well documented. If you look at some of the public hospitals, as example, in the U. S, certainly the challenges Obviously, with COVID in the 1st part of the year and some of the labor challenges that they've had, we think that could we've studied it pretty deeply.

Speaker 2

We certainly think that the market will be good next year and we think mid single digit is possible. We're going to see that in the 4th and we think that's Leading into the year. So yes, it won't be back to what I'll call normal. I think we're still determining what the new normal is. But I think as we look from Q3 to Q4, it gets better.

Speaker 2

It gets better at probably Q4 to Q1. So I think we're pretty I don't want to be bullish necessarily in the overall situation in total, polyanishly if you will. But I think for sure the market is going to be better in 2023 than it was in 20 22. And as we look out, we just finished our strategic plans With all of our healthcare businesses, 24 looks better than 23. So I think obviously COVID wasn't that far away when we really think about it.

Speaker 2

It feels that way a little bit, but it It was only 4 or 5 months ago. So, as I think we continue to see step through some things. And as we said, really what we saw, The quarter from a revenue perspective would have played out as we said if it hadn't been for a couple of supply very specific supply chain challenges. So I think in general, we have some confidence in the outlook here.

Speaker 5

Great. Thank you. Thank you.

Operator

Your next question is from the line of Scott Davis with Melius Research. Please go ahead.

Speaker 4

Hey, good afternoon guys. Hi, Elena.

Speaker 2

Hi, Scott. Hi, Scott. Hi, Scott. Hi, Scott.

Speaker 5

Hi, Scott.

Speaker 4

Hi, Scott. Hi,

Speaker 5

Scott. Hi, Scott. Hi, Scott. Hi, Scott. Hi, Scott.

Speaker 5

Hi, Scott. Hi, Scott. Hi, Scott. Hi, Scott. Hi, Scott.

Speaker 5

Hi, Scott. Hi, Scott. Hi, Scott.

Speaker 4

Hi, Scott. Just since we're talking about healthcare, does you think that business would be kind of ripping on labor shortages, but at the same time, you think it's maybe hard to do installs when you have labor shortages too. So how does that When you have labor shortages too. So how does that what drives that business? How does that kind of ebb and flow with the issues that are going on today?

Speaker 2

Yes. Well, you're spot on around productivity. I think the productivity and value proposition It comes in the GI suite is very positive. And we talked about the SaaS numbers in the prepared remarks being very strong. We've seen a little bit of delay on the sales funnel, Scott, from the standpoint of just taking a little longer to implement.

Speaker 2

So some of our services revenue is a little slower Than it has been, but we're probably we're very bullish on the business. The value proposition is very specific and very, Very much in right in the sweet spot of what challenges hospitals and ASCs are seeing. So We secured a very large order with a large government entity that's going to take a little while to implement. But I think just speaks to the breadth and strength of the recognition of the value proposition. So yes, we think that business is going to continue to accelerate, Got a few challenges that we've got to work through because some of those labor challenges in hospitals aren't just kind of the folks in Sterilization Labs or whatever, they're also in some of the IT organizations.

Speaker 2

But I think when you start to look over the next 6, 12, 18 months, We feel really strongly about the business. And it's obviously still on track from a profitability and returns perspective. So we feel really good about it right now.

Speaker 4

Okay, good. And then follow-up, earlier question on M and A. You had an interesting response, which perhaps was different than what you've said in the Past where you mentioned publics. Now just to be clear, are you talking about pieces of public companies you could potentially take? Or are you talking about potential public to private or public to public, I'm sorry, opportunities, which is not necessarily something you guys have done a lot of in the past?

Speaker 2

Yes, I would say, first of all, when you look across, I think just public valuations being more in the zone in certain places. So I think it really is more a general comment relative to that. But we're certainly eyes wide open in whatever opportunities are available. And We've got obviously a really a very specific set of places where we think there's great investment opportunities, We're also patient relative to those situations. So, I never want to as you know, well, I never want to predict what we do For lots of reasons, but we feel good about where the environment is going to be going here over the next several months.

Operator

Your next question is from the line of Jeff Sprague with Vertical Research Partners. Please go ahead.

Speaker 6

Hello. Good day, everyone.

Speaker 10

Hey, hello. How are you guys doing? Great. Hey, just a little kind of geographic walk here if we could. First on China, do you think the strength here is kind of reflective of just the Lockdown bounce or I don't think you're expecting 20% organic growth to continue necessarily, but it does seem extraordinarily strong.

Speaker 10

So just what's driving that and what are you expecting here in the next quarter or 2?

Speaker 2

Well, we've had So much strength in China over the last 3 or 4 years. I mean, I think it really does speak to the how we built the businesses over there. Pretty independent China manufacturing and design for the market. There's a little bit of a bounce there. So that's I think that's definitely true.

Speaker 2

But our outlook still is pretty good. And I think, obviously, healthcare, as we said in the prepared remarks, Both iOS and PT were good. IOS obviously a little or healthcare a little slower just because of the COVID Lockdown. So I think as we look out, we still continue to see a good growth opportunity there. We'll see that in the Q4.

Speaker 2

We should see it Next year, some of that backlog obviously that we described in the previous conversations includes China as well. So So we think this can be a good market here certainly for the next several quarters as we look out.

Speaker 10

And how about Western Europe, Any signs of cracking there?

Speaker 2

For obvious reasons, we're continuing to put A real microscope on everything we do over there. Point of sale remained pretty good. So I think when we look across Some of the things that we typically tell us, we have good healthcare. I think it was our best region for healthcare. So I think at the end of the day, we continue to think Western Europe probably has hit some snarls here, but if you look at the signs that we would typically look at, still holding up there pretty well.

Speaker 2

But I would anticipate, It's hard to believe that just given some of the challenges they've got that there isn't some issues certainly in And 'twenty three, and it's part of our scenario analysis.

Speaker 10

And maybe just the last one sort of on that on kind of thinking about scenarios. Obviously, there's a lot of mix even within the segments. But at a high level, how would you have us think about decremental Margins, if we were to get into kind of a, call it, a moderate recession environment where you're putting up negative, Maybe mid single digit type organic growth?

Speaker 3

Well, I think if we got to negative Actual negative growth, you could probably expect what we did during 2020. With our up and down, we try to manage it to the same level. But Keep in mind that we've got a really strong elevated backlog position. And while we expect slowing, we also That might not be our base case, but we've always said we managed to the up and down decrementals.

Speaker 2

I think it's part of our as we look at our playbook too, Scott Sorry, Jeff. To Scott's question around how we should think about all this, I really think that when we look at Broadly our solutions and Scott got to the probation question. But if you look broadly across the portfolio, Everything we do pretty much today is around productivity improvements. And whether it's the probation example we were talking about Or what we do at ServiceChannel and like we talked about in the prepared remarks, how we're bringing innovation and design cycle times down with our Tektronix solutions, What we talked about in the prepared remarks around solar with Fluke, we're really focused on saving money for customers With our solutions because of our workflow strategy. And so I think to Chuck's point, we certainly have scenarios across the board of what could happen Relative to the macro, but I'd be remiss if I didn't sort of think about what we've really built in these workflow strategies is really To be there for customers at their toughest with their toughest challenges.

Speaker 2

And I think we're certainly seeing that in a number of places Where our orders are very, very strong because the reality is that customers are going to need to save money in the future I think. It's going to be more important And our solutions really play well to those challenges.

Speaker 10

Great. Thanks for that perspective. Your

Operator

next question is from the line of Andrew Obin with Bank of America. Please go ahead.

Speaker 11

Yes. Good morning.

Speaker 2

Good morning. How are you doing, Andrew?

Speaker 11

I'm doing great. I guess it's not morning, it's afternoon now. It's morning for you though. So when you guys talked about 2023 outlook and I appreciate it's very, very Initial, how should we be thinking about the pricing as we frame 23, right? I think price was 6 points in the 3rd quarter.

Speaker 11

So how much momentum do you have going to next year?

Speaker 2

Well, from a momentum perspective, obviously, we'll have more price The second half than we did the first half of this year. So I think that's a starting point from a momentum perspective. As Chuck said before, We don't take some of that lightly. We're continuing to look at situations where we would continue to get more price. So I think we think the pricing envelope for next year certainly in the first it's hard to have a 12 month outlook by every quarter.

Speaker 2

I think the price rate itself will not be as high as it's been this year, but our ability to retain price While at the same time getting additional price, I think still is there. So I probably stay away from a specific number until we kind of get closer to the guide and how we see the Q4 play out. But I think we still as we've talked about, we think we can get more price in the software businesses. We think there's still some more price to get in the healthcare businesses. So there's still opportunity within the portfolio to accelerate some things while at the same time Continuing to do the things that we've done so well over the last several quarters.

Speaker 11

Got you. And just a slightly different question. There were all these restrictions imposed by the Biden administration on China Semiconductor Production. I think there was a headline today that SK Hynix is like thinking to pull out of China. How do you how should we think about businesses like Tech, Keith Lee in China and I know even business like Fluke will have exposure to just sort of regular day to day CapEx in China.

Speaker 11

Have you guys been able to quantify or do any sort of initial assessment of the potential impact of the restrictions? Thanks so much.

Speaker 2

Yes. So first of all, as you know, semiconductor exposure broadly through Fortive is still pretty small. So I think we're certainly aware of what's going on there. Given the current regulations, we feel comfortable that that's not a huge impact Relative to customers, we typically don't sell into production fabs. We tend to be more in the innovation cycle.

Speaker 2

Some of that work that maybe That gets shut down or moved out of China, gets moved to other places. We should benefit from that, whether it be the U. S, whether it be back into Korea for other parts of the world. So I think we benefit from some of those changes over time as we see those play out. We need to continue to evaluate What we see and what happens in China from those regulations, which are still pretty new, I think what you know to be true is that we've continued to countermeasure challenges in China And still be successful over the last 3 years.

Speaker 2

We've had good growth over there despite export controls that started several years ago. And some of the other things we've lost close to 28 customers at CAC over the last few years because of export control. So we've weathered a number of these things as they've been applied. And I think we'll continue to do that as we see fit. And depending on reactions that come back from China, we'll react to those as well.

Speaker 2

So I think we understand what's going on there Today, it's obviously a very fluid environment. We'll continue to watch it. But I think one thing that's been true over the last several years is our ability to be successful despite You know, Rick, be able to play within the rules and do the things necessary to continue to build business more broadly around the world.

Speaker 11

Thanks so much.

Speaker 2

Thanks, Andrew.

Operator

Your next question is from the line of Nigel Coe with Wolfe Research. Please go ahead.

Speaker 12

Thanks. Hello and thanks for the question.

Speaker 3

Hi Nigel.

Speaker 12

Hey, guys. So yes, look, so obviously lots of impressive growth rates across Affordiv. What stood out to me was Gordon Accruent up high teens in iOS. So it seems like that's really clicking now, but we don't really expect These businesses to grow high teens may be a bit slower and steadier. So just wondering to provide a bit more breakdown on what's driving that growth.

Speaker 12

You mentioned pricing in software, but Just wondering what's driving the strong growth rate there. Maybe talk about net retention there as well.

Speaker 2

Thanks, Andrew, for the question. One, we really as we've said, with the addition of Service Channel and the combination of Service Channel, Gordian and Accruent into the one business that we really call facility and asset lifecycle, really a very strong quarter. We'd always said that we were going to have some self help Happening to Accruent over time and we saw good steps forward in that regard. So I think that business is very good. We Service channel is really a great value proposition for facilities managers.

Speaker 2

We're transitioning that business as well as we mentioned in the prepared remarks We're trying to take some of the pass through revenue and turn it into longer term SaaS revenue. So really we've executed well. Net dollar As you pointed out is improving. So that is inevitably probably now our 4th biggest business and will pretty quickly be Probably moving up the scale in that regard just because of its impressive growth rates. So I think it's been a great addition to the portfolio.

Speaker 2

We still have great profitability opportunity in the business. Gordian is certainly firing at all cylinders. So I think we feel like we feel very good about it. Lots of work to still do, But I think we really feel good about what's that and you heard that in the prepared remarks. I think longer term is we certainly see those opportunities to still be there Consistent with some of the comments I made about value propositions and productivity, really our solutions really give customers Better view of their facilities, better view of their assets, how they can reduce costs, how they can reduce investment.

Speaker 2

And obviously, pretty much everybody in the world is thinking that way these days. That value proposition is going to continue to resonate well into 'twenty three for sure.

Speaker 12

Okay. So it sounds like you still want to see the revenue synergies from Put together 3 businesses. Okay. And then going back to Tektronix, I understand the chip and everything Second of themes, but you've had an extraordinary amount of product vitality this year. I think you launched the 2 Series Mid year and there's been other launches this year.

Speaker 12

So I'm wondering, have those new product families, has that had a

Speaker 2

Yes. I would say they've been incredibly successful. The 2 series just launched in Really launched in the Q3 around the world and it's exceptional. And I think it really that is a product along with The new B version of our 6 Series, 2 big launches, the 6 Series just won our innovation award at Fortive last week. So I think we're still seeing early days of those innovations to be honest with you.

Speaker 2

So our capability there is just Only increasing with the value proposition of those products. Most of our success in the quarter really was more broad based than that. We still think we're in the early days of some of those successes. And really more broadly, the innovations that we've really Been doing over the last 12 to 18 months or still continuing to help from a success perspective.

Speaker 12

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

Speaker 2

All right. Thanks, Nigel.

Operator

Your next question is from the line of Andy Kaplowitz with Citigroup. Please go ahead.

Speaker 13

Hey, good day guys. Hey, Andy. Jim, you said you examined demand pretty deeply at seems like you're suggesting that your short cycle industrial channel inventory is in reasonably good shape, but maybe you could just elaborate on that.

Speaker 2

Yes, sure. Point of sale at FlukeTech has been good as I was mentioning before. Tektronix inventories have been at All time lows for the better part of a year now. So we feel we don't feel like there's destocking risk in there. Just given lead times, we really while orders have been strong, as you well know, our revenue has been accelerating.

Speaker 2

So we feel We look at the combination of backlog and inventory in order to make sure that things are not out of whack there and we feel good about that. Little bit elevated inventory at Fluke From a few years ago, but not anything recent. The point of sale really and our lead time sort of Would just the math there would suggest that that's nothing more than a little bit of elevated lead times. We're going to watch POS more than anything There and that continues to be strong. So certainly we're keeping a watchful eye on it, but as we sort of snap the line right now what we're seeing So far things look still look pretty good.

Speaker 2

We're not so we're not in any way shape or form thinking That's what's happening around the macro more broadly and certainly into next year wouldn't influence that. And that's why think we're keeping a close watch on that pretty much every day and every week.

Speaker 13

That's helpful, Jim. And then Chuck, you've continued to generate basically Spot on cash flow versus your own expectations, good conversion when most a lot of your peers have faltered to an Stan, we know much of the good performance is likely coming from FBS, but why haven't you incurred either bigger inventory build or receivables build as your core growth has been higher? And Do you see conversion continuing at this rate in 2023?

Speaker 3

Well, first, I'll take the Easiest one, we think 105% for the year is the right conversion rate for this business. I think there's 2 things that are really helping us here. The most obvious one is FBS and In a really tough supply chain environment, that's not only helping us get products out the door, but mitigating the impact that inventory is having on this. We do have elevated inventories from where we would normally be, but I think that's certainly, we've done very well maybe Versus some of our peers, I would theorize, because of FBS. The other piece is, our The addition of our these software businesses that will take in a hole have negative working capital.

Speaker 3

And so the free cash flow generation from the software businesses It's incredibly stable and I think that's an element that we're very that's playing out as we expected, but very happy with.

Speaker 13

And then Chuck, just real briefly, just given the changes on your balance sheet, should we knowing that there is some floating rate debt, should we think about I

Speaker 3

think because we're delevering, and we'll give absolute guidance Going out, but I don't think it's a huge headwind at this point from even though rates are going up, but our debt is coming down. Overall, our debt level is really very low. We would expect to be well, we're at 2.0 net leverage Now and going down between now and the end of the year.

Speaker 13

Thank you.

Operator

Today's final question will come from the line of Joe Giordano with Cowen. Please go ahead.

Speaker 6

Hey, guys. Thanks for taking me in. Two quick ones for me. When we think about the elected volumes, and let's just focus on North America for this. We haven't really had like COVID lockdowns or anything for a long time now.

Speaker 6

Is there some risk that like maybe the bar to go in for an elective surgery has just changed and Like we're trying to get back to a level that like isn't the level anymore? Is that a possibility?

Speaker 2

No. I mean, I think at the end of the day, when When you look at where we've been on electives here lately, we've been pretty close to the pin here. So China is obviously its own story, but When you look at the U. S, we've been pretty much spot on in what we thought. So I think at some point in time, we're going to get out of the conversation what Electives are doing and just talk about the growth rate year on year.

Speaker 2

And I think we think electives will continue to improve. I think that's where we see it today. It is COVID wasn't that long ago and labor productivity labor challenges do restrict. We have a number of customers that are not running all of their ORs right now, but would like to. So, I think you're going to continue to see that as an improvement over time.

Speaker 2

And fundamentally, that's going to be, as I mentioned a few questions before about how do we see the 23 hospital market. We think it starts it improves off of this year. 'twenty two is probably the low point from a combination of all kinds of challenges, The financial challenges that occurred that have sort of cropped up in 2021 2022, the labor challenges and COVID. So 2022 is probably the low point in that regard And we continue to see things pull up here over the next into 'twenty three.

Speaker 6

Fair enough. And just to be clear, I wasn't talking about your ability to Forecast for electives, what did I just meant like as a country what do electives actually do?

Speaker 2

Yes. No, I think they'll just going to continue to improve a little bit, but not they're not going to go from 92 to 105 or 110 right away, but they're going to progressively move up through, I suspect over the next several quarters. Okay.

Speaker 6

And then just last, like we've been hearing from some companies that while the order environment is still pretty good, but like behaviorally Maybe customers are being a little bit more measured about saying yes to things. So are you seeing like any sort of like incremental behavioral shifts or like the bar to accept Projects or anything like that is moving somewhat higher or taking longer to get to the end of line?

Speaker 2

Yes. I think we talked a little bit about this. We are seeing in a few places where funnel sales funnels are extending a little bit, Where we might have closed business, I'm just going to pick a number 60 days, maybe that's moved to 70 days or 75 days. So we are seeing sales funnels To close business move out a little bit, that's in software and hardware a little bit. So yes, we are seeing a little bit of that, but we're not losing business.

Speaker 2

I think In a number of places where we saw things extend that was caught on our eye, in no situation that we lost any business. So it's really just it comes down to maybe customers stretching their dollar a little bit. And that's why the point I made around our value propositions is so important because I think we're going to stay at the high at the top of the list of things to do with our customer base simply because of the value And our ability to save money and the return profile that you get from an investment in the workflow solutions that we've sort of developed over the last 5 or 6 years. So Doesn't mean it's going to happen exactly like we think it is from a timeframe perspective, but we're not seeing things fall out yet, which I think is good news Into 'twenty three for sure.

Speaker 6

Thanks everyone.

Operator

This concludes the Q and A portion of today's call. I would now like to hand the call back to Jim Leko for any closing remarks.

Speaker 2

Thanks, Dennis, and thanks everyone for taking the time today. We know you have a busy schedule today and this week. Hopefully, you heard from Chuck and our remarks on the Q and A as well as our prepared remarks. We're really proud of the quarter we just had. I think it demonstrates the power and the resiliency of the portfolio.

Speaker 2

I think the gross margin and operating margin expansion of free cash flow On the accelerated organic revenue, it's just demonstrative of the power of what we're building here. And we're really Excited about what's going on. Obviously, a lot of noise out there, both from a macro perspective and geopolitical. We understand that. We're not oblivious to that in any way, shape or form.

Speaker 2

We're preparing scenarios for that. We'll continue to see how things play out here in the Q4 and we'll look forward to talking to you through the quarter And obviously into 'twenty three as we get ready for a guide in the New Year. So thanks everyone for the time. Good luck this week And we look forward to talking to

Speaker 5

you all soon. Thank you.

Operator

This concludes Fortive Corporation's 3rd quarter 2022 earnings results conference call. Thank you for joining. You may now

Powered by Quartr